Riding ZIRP Into The Doom Loop—–Monetary Central Planning’s Dead End
by David Stockman, Contra Corner
What the Fed really decided Thursday was to ride the zero-bound right smack into the next recession. When that calamity happens not too many months from now, the 28-year experiment in monetary central planning inaugurated by a desperate Alan Greenspan after Black Monday in October 1987 will come to an abrupt and merciful halt.
Why? Because Keynesian money printing is in a doom loop. The Fed’s ZIRP policies guarantee another financial crash, which will trigger still another outbreak of panic in the C-suites of corporate America and a consequent liquidation of excess inventories and labor on main street. That’s the new channel of monetary policy transmission, and it eventually leads to recession.
This upcoming recession, in turn, will prove beyond a shadow of doubt that in today’s financialized global economy you can’t manage the GDP of a single country as if it were isolated in an economic bathtub surrounded by high walls; nor can you attain domestic macro-targets for employment and inflation through the blunderbuss instruments of pegged money market rates and wealth effects levitation of the stock market.
Instead, the Fed’s falsification of financial asset prices simply subsidizes gambling in secondary markets; enables daisy chains of collateral to be endlessly hypothecated and re-hypothecated; causes vast misallocations and malinvestments of corporate resources, especially stock buybacks and other financial engineering; and sends money managers scrambling for yield without regard to risk, such as in junk bonds and EM debt.
What it doesn’t do is get households all jiggy, causing them to boost their leverage and spend up a storm. That’s because they reached “peak debt” at the time of the financial crisis, and have been struggling to reduce debt ever since. In the most recent quarter, in fact, household debt posted at $13.6 trillion or 3% lower than in early 2008.
Stated differently, the household credit channel of monetary policy transmission was a one-time Keynesian parlor trick that is now over and done. All of the Fed’s vast emissions of central bank credit have pooled up in the canyons of Wall Street, and have not triggered a borrow and spend binge on main street.
Yellen’s post-meeting statement more or less conceded the point that the US economic bathtub is vulnerable to ill winds from abroad and that six years of “extraordinary” money printing and ZIRP have not succeeded in filling it to the brim. After reviewing a domestic economy that is purportedly in the pink of health (“Since the Committee met in July, the pace of job gains has been solid, the unemployment rate has declined, and overall labor market conditions have continued to improve.”), she was quick to introduce the skunk in the woodpile:
The recovery from the Great Recession has advanced sufficiently far, and domestic spending appears sufficiently robust, that an argument can be made for a rise in interest rates at this time. We discussed this possibility at our meeting. However, in light of the heightened uncertainties abroad and a slightly softer expected path for inflation, the Committee judged it appropriate to wait for more evidence, including some further improvement in the labor market, to bolster its confidence that inflation will rise to 2 percent in the medium term.
That’s right. They are waiting for moar inflation in the face of a gale force deflation blowing in from China and its food chain of EM materials and components suppliers. Yet as we pointed out in conjunction with the tiny 0.2% year over year change in the August CPI, waiting for the overall index to hit 2.0% is a fool’s mission because the latter is currently a meaningless average of hot and cold.
But now you have a clean bifurcation in the price indices that proves the utter pointlessness of so-called inflation targeting. One the one hand, virtually everything which is directly priced and traded on world markets is carrying a negative sign on a year-over-year basis.
That includes gasoline, which is down 23.3% since last August; fuel oil, which is lower by 34.6%; and gas and electric utilities, which are down by 11.5% and 0.5%, respectively.
Likewise, all other commodities are lower by 0.5%, while goods prices were materially lower than a year ago nearly without exception. For example, women’s apparel prices were down by 2.1%, window and floor coverings by 4.9%, appliances by 3.5%, household equipment and furnishings by 3.1%, furniture and bedding by 0.9% and tools and supplies by 0.3%
At the same time, the balance of the BLS table tells the Fed’s covey of inflation doves to shut-up and sit down. By any practical reckoning, upwards of two-thirds of living costs for average households are accounted for by shelter, transportation, medical care, education, entertainment and the like. Yet the year-over-year price change for the first three of these items was 3.1%, 2.1% and 2.2% respectively, while the cost of going to restaurants was up 2.7% and education costs (not shown) were up by 3.5%.
Nor are these one-year gains for the principal domestic services categories some kind of recent aberration that will lapse back into sub-2% inflation land if the Fed does not keep interest rates pinned to the zero bound. In fact, the 2.6% gain since last August for all services less energy services, as shown above, is spot on a trend that has been extant for the entirety of this century to date.
……it does not take a PhD in economics to figure out that the resulting “average” rate of price change for the BLS’ dubious market basket of consumer items is purely a statistical accident, and absolutely outside of the Fed’s ability to shape.
I was obviously wrong about the Fed’s capacity to see the obvious. The posse of PhDs domiciled in the Eccles Building opted to keep shoveling free money into the Wall Street casino when not only is the above data self-evident, but it is exactly this bifurcation of the index components, not the weakness of the US economy, that has been holding down the overall consumer price index for the last three years.
Indeed, ever since the China/EM commodity boom peaked in mid-2012 and the central bank driven global credit boom began to decelerate, the world price of commodities and manufactured goods has been falling. Needless to say, that trend thoroughly and effortlessly penetrated the imaginary wall of the US economic bathtub with which the FOMC is so wrong-headedly preoccupied.
Since then, CPI energy prices have fallen at a 5.2% annual rate and durable goods at a 1.2% CAGR, while domestic services less energy services have risen at a 2.5% annual rate. When you net all the puts and takes you get an overall CPI change of 1.1% annually for the past 36 months.
Are these paint-by-the-numbers Keynesian fools incapable of even elementary pattern recognition? Worse still, why are they confident that the tide of global deflation has run its course, and that it will soon fade after three years of the above?
Inflation has continued to run below our 2 percent objective, partly reflecting declines in energy and import prices. My colleagues and I continue to expect that the effects of these factors on inflation will be transitory. However, the recent additional decline in oil prices and the further appreciation of the dollar mean that it will take a bit more time for these effects to fully dissipate……As these temporary effects fade….we expect inflation to move gradually back toward our 2 percent objective.
That is not only a faith-based statement of monetary policy; it’s totally implausible as an empirical matter. It took nearly two decades for the global credit inflation to each its apogee in 2012-2014. Now the payback phase of this unprecedented crack-up boom will take years to unfold.
This means that when the FOMC surveys the “incoming data” in October and December and for months thereafter, it will see rising evidence of domestic weakness, domestic consumer inflation printing at a bifurcated sub-2% level and the Fed’s favorite new indicator, the Goldman Sachs financial conditions index (GSFCI), pointing to ever “tighter” financial conditions.
Indeed, as the stock average continue to roll-over while the dollar gains and credit spreads blow-out, you can count on a repeat of Yellen’s thinly disguised reference to the spurious statistical contraption that B-Dud invented while serving as Goldman’s chief economist:
Developments since our July meeting, including the drop in equity prices, the further appreciation of the dollar, and a widening in risk spreads, have tightened overall financial conditions to some extent. These developments may restrain U.S. economic activity somewhat and are likely to put further downward pressure on inflation in the near term.
Needless to say, Vice-Chairman Bill Dudley’s preposterous argument that the Fed does not need to stench the flow of free money to the Wall Street casino because the market has “self-tightened” may well convince a majority of the FOMC to keep deferring the date of “lift-off”. But it will no longer cause the robo-traders to buy-the-dips.
What happened after the Thursday decision announcement is that the in-grained six-year algorithms failed. In response to Fed meeting statements in the future, therefore, the bots will be increasingly programmed to sell the resulting FOMC confusion and incoherence, not buy the dips.
So there will also be blood in the casino like never before. Once the Fed is exposed as flat-out paralyzed, rent with public disagreements and out of dry powder, the gamblers and 1 percenters will not only desperately dump their “risk assets” in the mother of all meltdowns; they will also come to detest and loath the FOMC—-thereby setting the stage for show trials on Capitol Hill where the Keynesian posse responsible for fueling Wall Street’s stupendous gambling spree will hopefully feel the wrath of the nation’s awakened sleepwalkers and their currently clueless representatives.
Indeed, if you don’t think the financial markets are headed for a big spot of trouble, please click-on to Janet Yellen’s press conference. Yes, it’s painful to listen to and even worse to watch, but the exercise will make one thing abundantly clear. Namely, that the most powerful economic agent in the world is naïve, superficial, paint-by-the-numbers Keynesian bathtub plumber who has no clue about the incendiary forces that the Fed and other central banks have unleashed in the global financial system.
Among the most insidious of these is that the corporate C-suite has been morphed into a stock trading room. The mountains of cheap corporate debt that have been sold to yield hungry asset managers has enabled companies to literally rig their own stock prices higher and higher via $2.5 trillion of buybacks since March 2009. At the same time, the Fed’s wealth effects policy and free money to the carry trades has fulsomely rewarded buy the dips robo-machines and hedge fund gamblers, thereby insuring that the cash register keeps ringing on executive stock options.
Accordingly, corporate management of labor and inventory is now tethered to the stock averages, and that has especially perverse effects as the Fed’s financial bubble cycle ages. To wit, the C-suite becomes inordinately bullish and complacent as the stock averages move ever higher and executives’ net worth soars.
But when the financial bubble eventually bursts owing to unexpected “black swans” or the fact that the last sucker in the casino has hit the bid, the C-suite is caught short and lapses into panicked cost cutting and retrenchment. The evidence from the Great Recession cycle could not be more dispositive.
As shown in the chart below, the official dating for the recession incepted in December 2007, but total business inventories (manufacturing, wholesale and retail) kept building through a peak in August 2008, when they reached $1.54 trillion. Then came the stock market carnage of September through March, which elicited a violent liquidation of inventories.
In fact, during the next 13 months inventory investment plunged by $230 billion or nearly 15%, causing a cascading curtailment of current orders and production throughout the US supply chain. Only after the stock market put in a convincing bottom in March-August 2009 did the liquidation come to a halt, and the process of reinvestment begin.
Stated differently, the Obama $800 billion fiscal stimulus had virtually nothing to do with the turnaround depicted in the chart because only small amounts of its had actually hit the spending stream by August 2009.
Likewise, the violent shedding of labor occurred after the stock market collapse, not when the recession commenced. Specifically, during the eight months between December 2007 and August 2008, the rate of job loss was about 150,000 per month. Then during the next eight months it accelerated to 675,000 per month.
Similar to the case of inventories, however, the convincing rebound of the stock market after April 2009 brought the jobs contraction to an abrupt end. While the total non-farm payroll count did not hit bottom for another 10 months, the rate of job loss shrunk to less than 200,000 per month.
Needless to say, the C-suite channel of monetary policy transmission has not attained even the slight notice of the monetary politburo. Indeed, these retro-Keynesians are so manically focussed on the “labor market” that they can see almost nothing else.
But what they ought to be noticing is that US business sales have already rolled over, and the inventory to sales ratio is rising rapidly, just as it did in 2008 before the Lehman collapse.
In short, the US economy does not resemble in the slightest the labor market focussed picture painted by Yellen on Thursday. It is at a point of extreme vulnerability late in the business cycle in the context of a 20-year global credit boom that is now dramatically reversing.
Except this time when the stock market bubble collapses, there will be no ZIRP and QE to ride to the rescue and rekindle bullish greed in the C-suites. Instead, this time there will be a real, prolonged recession as the excesses and deformations from two decades of the Keynesian con game conducted from the Eccles Building are wrung out of the financial markets.
At the end of the day, cowardice and intellectual incoherence do not will out. By opting for the 81st month of ZIRP, the foolish usurpers of free market capitalism and its vital processes of price discovery who currently rein from the Eccles Building have lashed themselves to a doom loop.
It will eventually mean the end of monetary central planning, but not until tens of millions of innocent main street savers, workers and entrepreneurs have been unfairly and unnecessarily battered by its demise. Yellen and Co should be so luck as to only face torches and pitch forks.