[Editor’s Note: The following piece was originally published December 14, 2012]
At least for today (perhaps because I’m a little under the weather), when it comes to the Fed I’m about all ranted out. So this isn’t supposed to be a rant, but more an effort to tie together some loose analytical ends. Key facets of my Macro Credit Theory analysis seem to be converging: The myth of deleveraging, “liquidationist” historical revisionism, Rules vs. Discretion monetary management, and “Keynesian”/inflationist dogma.
The Bernanke Fed this week increased their quantitative easing program to monthly purchases of $85bn starting in January. “Operation Twist” – the Fed’s clever strategy of purchasing $667bn of bonds while selling a like amount of T-bills - is due to expire at the end of the month. The Fed will now continue buying Treasury bonds ($45bn/month). It just won’t be selling any bills, while continuing with $40bn MBS purchases each month. The end result will be an unprecedented non-crisis expansion of our central bank’s balance sheet (monetization). It’s Professor Bernanke’s “government printing press” and “helicopter money” running at full tilt.
During his Wednesday press conference, chairman Bernanke downplayed the significance of the change from “twist” to outright balance sheet inflation. Wall Street analysts have generally downplayed this as well. Truth be told, no one has a clear view of the consequences of taking the Fed’s balance sheet from about $3.0 TN to perhaps $4.0 TN over the coming year or so. It’s worth noting that in previous periods of rapid balance sheet expansion, the Fed was essentially accommodating de-leveraging by players (hedge funds, banks, proprietary trading desks, REITs, etc.) caught on the wrong side of a market crisis. Does the Fed’s next Trillions worth of liquidity injections spur more speculation in bonds, stocks and global risk assets? Or, instead, will our central bank again provide liquidity for leveraged players looking to sell (many increased holdings with the intention of eventually offloading to the Fed)? It’s impossible to know today the ramifications of the Fed’s latest tack into uncharted policy territory. It will stoke some inflationary consequence no doubt, although the impact on myriad Credit Bubbles around the globe is anything but certain.
Clearer is that the Fed has again crossed an important line. There has been previous talk of Fed “exit strategies.” I’ll side with Richard Fisher, president of the Federal Reserve Bank of Dallas, who Friday warned of “Hotel California” risk ("...Going back to the Eagles song which is, you can check out any time you want but you can never leave…"). There has also been this notion that the U.S. economy is progressing through a (“beautiful”) deleveraging process. Yet there should be little doubt that the Fed has now resorted to blatantly orchestrating a further leveraging of the U.S. economy. It will now become only that much more difficult (think impossible) for the Federal Reserve to extricate itself from this Inflationary Process.
I’ve read quite sound contemporaneous analysis written during the “Roaring Twenties.” There was keen appreciation at the time for the risks associated with rampant Credit growth and speculative excesses throughout the markets and economy. The “old codgers” argued that a massive Credit inflation that commenced during the Great War (WWI) was being precariously accommodated by loose Federal Reserve policies. Chairman Bernanke has throughout his career disparaged these “Bubble poppers.” To this day the “liquidationists” are pilloried for their view that there was no viable alternative than to wring financial excess and economic maladjustment out of the system through wrenching adjustment periods. Through their empirical studies, quantitative models, and sophisticated theories, contemporary academics – led by Dr. Bernanke – have proven (without a doubt!) that the misguided “Bubble poppers” and “liquidationists” were flat out wrong. Our central bankers are now determined to prove them (along with their contemporary critics) wrong in the real world. Yet there remains one rather insurmountable dilemma: The contemporaneous Credit Bubble antagonists were right.
The Dallas Fed’s Fisher stated Friday that the “FOMC is probably the most academically driven in history.” Well, I’ll say that a world of unconstrained market-based finance “regulated” by inventive and activist academics has proved one explosive monetary concoction. The Wall Street Journal’s Jon Hilsenrath (with Brian Blackstone) had two insightful pieces this week, “MIT Forged Activist Views of Central Bank Role and Cinched Central Banker Ties,” and “World Central Bankers United by Secret Basel Talks and MIT Connections.”
Inflationary cycles always create powerful constituencies. After all, Credit booms and the government printing press provide incredible wealth-accumulating opportunities for certain segments of the economy. Moreover, it is the nature of things that late in the cycle the pace of wealth redistribution accelerates as the monetary inflation turns more unwieldy. Throw in the reality that asset inflation (financial and real) has been a prevailing inflationary manifestation throughout this extraordinary Credit boom, and you’ve guaranteed extraordinarily powerful constituencies.
By now, “activist” central banking doctrine – with pegged rates, aggressive market intervention/manipulation and blatant monetization - should already have been discredited. Instead, policy mistakes lead to only bigger policy mistakes, just as was anticipated generations ago in the central banking “Rules vs. Discretion” debate. Today, a small group of global central bank chiefs can meet in private and wield unprecedented power over global markets, economies and wealth distribution more generally. They are said to somehow be held accountable by politicians that have proven even less respectful of sound money and Credit. In the U.S., Europe, the UK, Japan and elsewhere, central bankers have become intricately linked to fiscal management. As such, disciplined and independent central banking, a cornerstone to any hope for sound money and Credit, has been relegated to the dustbin of history.
Considering the global monetary policy backdrop, it’s not difficult to side with the view of an unfolding inflation issue. At the same time, the “liquidationist” perspective - that to attempt sustaining highly inflated market price and economic structures risks financial and economic catastrophe - has always resonated. The markets’ response to Wednesday’s dramatic Fed announcement was notably underwhelming. This could be because it was already discounted. Perhaps “fiscal cliff” worries are restraining animal spirits. Then again, perhaps the more sophisticated market operators have been waiting for this opportunity to reduce their exposures. After all, the Fed moving to $85bn monthly QE five years into an aggressive fiscal and monetary reflationary cycle is pretty much an admission of defeat.
I’ve argued that, primarily due to unrelenting fiscal and monetary stimulus, the U.S. economy has been avoiding a necessary deleveraging process. Some highly intelligent and sophisticated market operators have argued the opposite. They point to growth in incomes and GDP, while total (non-financial and financial) system Credit has contracted marginally. I can point specifically to Total Non-Financial Debt that closed out 2008 at $34.441 TN and ended September 30, 2012 at a record $39.284 TN. But the deleveraging debate will not be resolved with data.
The old “liquidationists” (and “Austrians”) would have strong views about contemporary “deleveraging”. They would shout “inflated price levels,” “non-productive debt,” “unsupportable debt loads,” “excess consumption,” “distorted spending patterns and associated malinvestment,” “deep economic structural imbalances” and “intractable Current Account Deficits!” They would argue that to truly “deleverage” one’s economy would require a tough weaning from system Credit profligacy.
Only by consuming less and producing more can our economy reduce its debt dependency and get back on a course toward financial and economic stability. The “Bubble poppers” would profess that in order to commence a sustainable cycle of sound Credit and productive investment first requires a cleansing (“liquidation”) of unproductive ventures and unserviceable debts. It’s painful and, regrettably, shortcuts only short-circuit the process. I’m convinced that they would hold today’s so-called “deleveraging” – replete with massive deficits, central bank monetization and ongoing huge U.S. trade deficits - in complete and utter disdain.
In a CNBC interview Wednesday evening, the Wall Street Journal’s Jon Hilsenrath called Dr. Bernanke a “gunslinger.” Our Fed chairman is highly intelligent, thoughtful, polite, soft-spoken, seemingly earnest and a huge, huge gambler. And he’s not about to fold a bad hand. Almost four years ago, I wrote that Fed reflationary measures were essentially “betting the ranch.” This week they again doubled down.
With his perspective and theories, Dr. Bernanke has pushed the envelope his entire academic career. He is now surrounded by a group of likeminded “Keynesian” academics, and they together perpetuate groupthink in epic proportions. These issues will be debated for decades to come – and who knows how that will all play out. But as a contemporary analyst and keen observer, there’s no doubt these unchecked “academics” are operating with dangerously flawed theories and doctrine. It’s not the way central banking was supposed to work. Ditto Capitalism and democracies. Whatever happened to sound money and Credit?
