Age of Wisdom, Age of Foolishness (53)
“Be vewy, vewy quiet.”
The Republican success, in the US Midterm elections, cast a long shadow over the global geopolitical landscape. The American Middle Class (asset poor) shot themselves in the foot, by refusing to vote; in a fit of anger that President Obama has not delivered for them economically. In doing so they left the door open, for those with employable skills and asset portfolios, to vote and make sure that President Obama (and Janet Yellen and Jacob Lew) cannot rob them in order to reward the Middle Class. The next emotional outburst of the American Middle Class, which will be more pecuniary in nature, must now wait until the Presidential election.
“GOP Meter More Than Half-Full.”
Running into the Midterms, America’s strong US Dollar policy had been launched; and was working rather well.
“They Need Each Other.”
Age of Wisdom, Age of Foolishness (52) “Deathly Hallows” explained how Janet Yellen had deftly accommodated the FOMC Hawks, in order to facilitate the stronger US Dollar policy. Having achieved this tactical objective, Yellen should now be moving on to finding replacements for these Hawks; who are retiring and who have outlived their usefulness[i] to her. The desired replacements will no doubt share her perspective on wealth inequality; so that she can achieve the consensus she needs for the next step towards Helicopter money. The problem for Yellen post Midterms, is that she will now be under the Congressional microscope. The GOP focused lens would like to give the Fed a single inflation mandate; and roll up the monetary experiment with QE asap; so Yellen has been stopped dead in her tracks.
“Back to the Drawing Board.”
Stanley Fischer had been carefully working towards the “Third Mandate”[ii]; which would give the Fed total control over asset prices under the guise of macro-prudential stability. Using this “Third Mandate”, the Fed would therefore be able to intervene in any economic sector which was represented as an asset class in the capital markets. The “Third Mandate” is however now another casualty of the Midterms. Fischer now needs to go back to the drawing board and/or pray that the Europeans deliver the necessary crisis to put the life back into his plan. Fortunately for him, the Europeans seem very anxious to oblige.
Janet Yellen, had been working towards a permanent increase in the money supply; to then redistribute to the Middle Class with the help of a reformed tax code. Republican control of both Houses, effectively ends all adult discussions about fiscal policy; so that the Helicopter has been sabotaged.
Yellen must now exit QE; and with it all hope of the Helicopter. The temporary increase in the money supply, which was QE, is now receding. Once again, only the Europeans can now help her get to launch the Helicopter; by engineering a crisis of their own which goes global.
Yellen showed her innate political skills, when she compromised with the Hawks; and formally ended QE at the last FOMC meeting. This prescient act may have bought her some much needed political capital with a potentially hostile Congress. It is however unlikely that she will get any of the Fed appointees whom she wants before 2017. She will no doubt however play this card to her advantage; if and when the Eurozone forces some remedial unilateral action onto the Fed. In this situation, she will still have her Doves and will be unopposed by a quorum of Hawks.
Yellen may not get things exactly as she would like them. The latest personal income and consumption data, confirmed the deflationary backdrop; which she was betting on to fly the Helicopter.
The latest employment cost index data was more troublesome however. It would seem that there is a structural skills shortage in America; which is creating wage inflation for those with the required skills. Any move by the Fed to address this wage inflation by tightening, would be a disaster for the large number of Americans who do not have the skills and therefore have not participated in the economic recovery to date.
The Fed and the Treasury are hoping that, by redistributing the wealth from Helicopter money via the tax code to the Middle Class, aggregate demand can be stimulated; which will ultimately lead to job creation for those lacking in skills. The skilled will therefore find that their purchasing power is being redistributed to other sectors of population, in a form of social engineering akin to Socialism.
At these early stages, of the next round of the great American inflation, the inflationary base is low enough for the Fed and the Treasury to be given the benefit of the doubt. By further increasing long term interest rates, through formally ending QE and focusing attention on the tightening cycle, the Fed thinks that it has in some way mitigated the future effects of this overt inflation strategy. At this point there are no inflation problems, but the seeds of the problems are starting to germinate. A GOP controlled Congress has effectively stalled the great experiment with Socialism in any case at present; so it may not become an issue until the next Presidential administration, assuming that Mrs Clinton is in office.
“Spot the Lame Ducks and Spot the Survivors.”
When the President met with the Yellen last week, to discuss how domestic and foreign policy agendas were being supported by the Fed, there was much to talk about[iii]. The strong US Dollar strategy, recently given a boost by the ending of QE, has been successful. This US Dollar bid has also been amplified, by the fact that Federal borrowing is now at its lowest level since 2007[iv]. There may therefore not be enough US Treasuries around to satisfy the bid; especially now that the GOP holds control in Congress.
The global bid for the US Dollar and US Treasuries remains strong. Global demand for US Dollars and US Treasuries will easily replace the lost bid from the Fed as QE ends. The risk of a reduced bid for the US Dollar and higher US interest rates, has therefore been mitigated, which will boost capital investment in the US; and weaken trading partners and competitors to the extent that they are forced to pursue their own domestic economic stimuli. America is particularly keen to see Europe weakened in this way; so that the Germans are forced to follow the Saltwater policies promoted by the MIT alumni at the Fed and the ECB. US inflation risk is the price to be paid for this strong US Dollar policy.
As capital floods into US capital markets, it will also leak into the real economy; especially if this leakage is promoted by wealth redistribution via the tax code. Ironically, rising inflation will beget rising interest rates; which will then strengthen the US Dollar and boost further capital flight into America.
America has therefore triggered a dangerous inflationary positive feedback loop. Yellen and Co assume that rising interest rates will temper the inflation; but as has been explained they will in fact exacerbate it. When capital eventually flows out of America, because inflation risk is seen as detrimental, the Fed will then have to overcompensate by raising interest rates even higher to protect the value of the Dollar. This painful ending is years and thousands of positive Dow Industrials/NASDAQ/S&P 500/Russell 2000 index points away before it begins; but ultimately this will be the fate of the American economy.
“Sheep May Safely Graze in America.”
For now, the sheep have become US Dollar and US risk-asset bulls; because the rest of the world is such a risky place; and America therefore is attractively predictable by comparison. Japan has also provided them with the means to leverage the risk and return even further; by virtue of a new phase of the Yen Carry Trade.
“A Repeat You Can Believe In.”
Speculators, with the attention spans of sheep and chickens, cast their minds back to the last time a lame duck Democrat was held hostage in the White House. The rally in equities was quite breath taking; and no doubt it will be repeated.
James Bullard recently destroyed what remained of his credibility, in Age of Wisdom, Age of Foolishness (50) – “Hiding in Plain Sight”, by reversing his call for higher interest rates. He continued to perjure himself last week, when he said that the decision to end QE was justified; because the markets endorsed the decision by rallying after the FOMC announcement[vi]. Presumably had the markets sold off, he would have then talked out of the other side of his mouth. For the record, as of his last interview with Fox, he is now upbeat on the economy[vii].
“They’re creepy and they’re cookey.
The Statements are quite spooky.
Their policy is flukey.
Yel – lens F-O-M-C.”
(Age of Wisdom, Age of Foolishness (52) “Deathly Hallows”)
Despite the obvious differences on the FOMC, Richard Fisher still believes that the institution is the only one in America that has America’s real interest at heart. He therefore aligned himself with all his colleagues at the Fed and warned Congress not to interfere; pointing out that its own dysfunctionality was no job recommendation for Fed governance[viii].
Fischer also gave his colleagues a useful tip. He opined they should not wait to tighten, until the data shows strong growth, because invariably this comes at the top of the business cycle; so that the Fed actually triggers the next recession when it starts tightening[ix].
The compromise over the last FOMC statement to formally end QE, is starting to look like one of the Fed’s finest moments; and finest political calls. Yellen and Stanley Fischer must be eternally grateful for the checks and balances the Hawks have provided to the institution’s credibility. The Helicopter and the “Third Mandate” have been postponed; but they still live to fight another day, thanks to Richard Fisher’s loyalty and prescience.
This loyalty and prescience may be motivated by Fisher’s ultimate loyalty to the Trilateral Commission, of which he is a member[x]. It will be interesting to see if, some day in his retirement, Fisher calls for the “Third Mandate” and the Helicopter; if and when Europe creates the catalyst for them to be revisited by policy makers.
“It’s not Rocket Science.”
Age of Wisdom, Age of Foolishness (52) “Deathly Hallows”
Age of Wisdom, Age of Foolishness (52) “Deathly Hallows” explained how NASA was studying the competition for economic resources amongst social and economic groups in societies; and how global warming was creating more violent struggles between them[xi]. The great stalled Socialist experiment, which was just starting to take place in America and which Yellen and the President swapped notes about last week, no doubt is also based on NASA’s findings. American domestic economic policy is therefore following the global theme of sustainability.
Complementary American foreign policy can now also be seen at the United Nations. George W Bush unilaterally did away with the strategy of working through the UN; the Obama administration has since embraced it multilaterally. It was therefore interesting to see the United Nations Panel on Climate Change (UNPCC) issue its sternest edict[xii] to date on Global Warming and emission controls last week; just as Yellen and Obama were taking stock of progress to date.
American foreign policy is finding it much harder to promote the sustainability theme however. Presumably this is because the size and scope, of the global sustainability problem, is so great that a single coherent strategy cannot be projected by America. Foreign policy therefore appears ad hoc and incoherent. The explosion of “Chickenshit Gate”[xiii], onto the geopolitical scene, suggests that America and Iran are closer to a nuclear deal than the alleged “Chickenshit” would like.
“Putting the Cart Before the Horse.”
Age of Wisdom, Age of Foolishness (42) “Level 3”[xiv]
Age of Wisdom, Age of Foolishness (42) “Level 3”[xv] observed Prime Minister Netanyahu escalating the conflict, by moving the “Single State Solution” to the top of the political agenda. The co-location of ISIS with Hamas, following his mantra of the same[xvi], was supposed to move this agenda along. It would seem however that Iran has been able to make better use of the conflicts in Syria and Iraq than Netanyahu. The rise of ISIS is now associated with Israeli aggression, rather than Israeli aggression being justified by the rise of ISIS. Netanyahu therefore now finds himself fighting for his own political life. The recent letter from 106 IDF personnel[xvii], asking him to come up with a peace plan, shows just how scared Israeli strategists have become that Iran has transcended them.
Could it be that America now needs Iran more than it needs Israel? If this is so, what can Israel dramatically do to change things around?
“Playing a Cheeky Little One-Two.”
“New (World) Order – World in Motion..”
Age of Wisdom, Age of Foolishness (45) “Worlds in Motion”
This suggests that Ayatollah Khamenei’s vision of a “New World Order”, first seen in Age of Wisdom, Age of Foolishness (46) “If At First You Don’t Succeed….”[xviii] is somewhat nearer to the mark, than was initially presumed when he first made this arcane reference. American attempts to fight ISIS by proxy, have actually been undermined by its own airstrike campaign[xix]; which is now helping Iran, IS and the Assad regime more than the rebel proxies America favours. America has therefore enabled Khamenei’s vision, knowingly or otherwise. Further enabling is now being undertaken by the UN, in the form of erasing from the official record Iran’s nuclear proliferating past[xx]; so that a new settlement can be smoothly achieved.
Prime Minister Netanyahu presumably cheered more than any Republican at the Midterm results; since he now has a lame duck to outmanoeuvre rather than a healthy opponent. As a consequence of the Midterm defeat, the President retreated from his prosecution of the war against ISIS by decree; and swiftly returned to Congress, in order to get authority[xxi]. Obtaining similar authority to deal with Iran will no doubt be far more problematic.
Now that Obama has been hobbled by Congress, he may find it more difficult to manage the compromise with Iran. Already, France is leveraging over his ineffectiveness; by demanding that there should be more resistance to Assad, rather than just resistance to ISIS[xxii]. Clearly Assad is an Iranian proxy, so his removal makes negotiations with Iran fraught with problems.
“Blackadder Goes North.”
Age of Wisdom, Age of Foolishness (51) “Culture Shocks”
George Osborne continues to go North in search of political salvation through the creation of the “Northern Powerhouse”. Last week it was signalled that greater powers will be devolved to Manchester, Leeds and Sheffield in the Chancellor’s Autumn Statement[xxiii]. These great cities will no doubt be thanking their friends in Scotland; for providing the political crisis which created this regional devolution of power. Ironically, the pace of devolution in Scotland has actually slowed down, whilst that in the Northern provinces has accelerated.
The Bank of England’s Andy Haldane gave a vision of how the 21st Century central banker will monitor the new violent capital flows[xxiv] that American policy is creating. In his epiphany, the “Plunge Protection Team” in each central bank, will sit on a bridge resembling that of the Starship Enterprise; monitoring the latest capital flows in real time through a bank of supercomputers. One hopes that there is also a bank of lights on the same terminal which has red inflation indicators, rather than the current green ones; in order to clearly signal the inflation risk of the future, when this bold adventure reaches its end.
“Aiming High of the Mark.”
In Age of Wisdom, Age of Foolishness (52) “Deathly Hallows” the failure to meet its inflation target, because of the alleged impact of weaker Crude Oil prices, was suggested as being an excuse for the BOJ to become “even more aggressive in pursuing a weak Yen policy going forwards”. The surprise with which the markets then reacted to Kuroda’s announcement of an even more aggressive monetary stimulus[xxv] was therefore an emotional knee-jerk reaction to what should have been expected. Consensus has now been formed that the BOJ’s actions have given Abe yet more breathing space to implement the economic reforms, which will allegedly make Japan’s economy competitive again[xxvi]. This consensus now accepts that the Sales Tax hike next year is back on the table[xxvii]. It is also assumed that Kuroda and Abe will quietly do away with the dissenters on the Board of the BOJ; so that there are no obstacles going forward[xxviii]. Weakening the Yen so far has not had the desired effect, so why weakening it any further will be successful is moot; however the market discounting mechanism must now go through the motions until the resulting failure becomes apparent. Kuroda swiftly capitalised on the strengthened bid for the US Dollar, coming out of the Midterms, by opining that the BOJ had no limits[xxix] on how far to go with the next round of monetary policy expansion. The Yen is therefore moving into the free-fall zone.
Age of Wisdom, Age of Foolishness (37) “The Third Mandate”
Age of Wisdom, Age of Foolishness (52) “Deathly Hallows” opined how America’s new strong Dollar policy was challenging the BRICS and the Eurozone to respond with domestic economic stimuli, by sucking capital into American capital markets. Russia was observed as a heavy casualty, because economic sanctions amplified the capital flight.
“A change you can believe in.”
The Ruble is now in free-fall, which is yielding the threat of hyperinflation in Russia.
“Mixed Martial Arts.”
China continues to pursue the alternative economic bloc solution. In the upcoming APEC meeting, China will propose an Asian free trade zone; which directly conflicts with America’s Trans-Pacific Partnership (TPP) proposal[xxx] for the region.
On the risky periphery of the Eurozone[xxxi], credit creation is still falling and bankruptcies are still rising[xxxii]; as capital flies first to Frankfurt as Euros, where it is exchanged for US Dollars which then fly to New York. Further to the east, central bankers are being forced to cut interest rates[xxxiii], because the economic drivers to their west have run out of steam. These interest rate cuts, threaten to accelerate capital flight away from these economies; thus effectively neutralising the stimulus from the preceding rate cuts.
At the centre of the Core, Germany has effectively pulled the plug on its neighbours; and set out its stall to weather the next crisis. Last week, Chancellor Merkel agreed that the Eurozone was in a “fragile” condition; but refused any form of fiscal stimulus which would involve German Federal borrowing[xxxiv]. Clearly Germany intends to head into the next fiscal crisis, in a budget neutral mode; in the hope that the collapse in economic growth in the rest of Europe does not translate into a fall in German tax receipts which creates another deficit.
The term structure of German interest rates and its credit rating will therefore survive, whilst that of its neighbours goes to junk. Germany also assumes that, having reached junk status, its neighbours will have no option, other than to accept German terms for surrender of their economic policies. Germany therefore makes a huge assumption, that the EU will hold together politically in order to deliver the expected outcome.
The absurdity of the European situation was highlighted by the European Commission’s latest economic projections. Britain was projected to have robust growth[xxxv]; however this prediction is designed to justify the EU’s demands that Britain make a higher budget contribution based on the fact that its economy is stronger. The rest of the Eurozone is predicted to stumble along through conditions akin to deflation[xxxvi]. The Commission’s inflation predictions are lower than those of the ECB[xxxvii]; which highlights another failure of the ECB’s recent bank stress tests. The ECB’s inflation input for the tests was 1%. EU inflation is currently 0.4%; so the banks are actually undergoing an in vivo stress test right now, which the ECB has overlooked.
The fault-line for the next crisis emerged early last week, before Draghi’s press conference. In order to prevent Jens Weidmann from undermining his initiatives, Draghi has adopted a secretive and autocratic style. He appears to rule by fiat. Germany has now tried to regain the initiative, by directly attacking his style; and trying to force him to be more transparent and consensual. A direct attack on the ECB President however, will prove to be a very inflammatory tactic and potentially a fatal act[xxxviii].
At his press conference, Draghi tried to play down the threat; but only succeeded in giving it greater credibility through his denial[xxxix]. He also offered to do more monetary stimulus “if needed”; but his enthusiasm for action has clearly been curbed by the threat to his operation[xl]. Obviously, he sees that Germany has prepared its fiscal position for a crisis; and that he may become the victim of such a crisis. He therefore needs to manipulate perceptions of the crisis, in order to allow him to continue to “do whatever it takes”.
Now that his fellow MIT alumni at the Fed have been constrained by American politics, the leadership vacuum in the global economy will allow him to blame the coming European crisis on the Fed’s enforced tightening bias. He will then be able to posit, that since the Fed is now in tightening mode that the ECB must move into serious easing mode. And this is where his real problems begin; and what the prescient Germans have been preparing for.
“Better to Travel Than to Arrive.”
At his press conference, Draghi signalled that the ECB is coordinating its monetary expansion with the Fed’s monetary contraction[xli]. This coordination will make the bid for the US Dollar go exponential, in the same way that the BOJ just made the bid for the US Dollar against the Yen go the same way. Capital will therefore fly from the Eurozone and also Japan into America.
“One Big Happy Dysfunctional Family.”
The ECB and BOJ have therefore effectively stimulated the American economy, rather than their own respective domestic economies. The liquidity they create will ultimately end up in America, rather than their own economies. America has therefore become the new Emerging Market trade, in a reversal of fortune tale. They have also increased the inflation risk in America, in both financial assets and the real economy, whilst increasing the deflation risk in their own domestic economies.
The Fed will anticipate the rise in inflation with higher interest rates; and the ECB and BOJ will anticipate the deflation with easier monetary policy. The combination of such policies, euphemistically termed coordination, has created a positive feedback loop; which exacerbates American inflation and also European and Japanese deflation, by accelerating the capital flows based on the interest rate differentials.
This process will stop, when the speculators decide that the only cure for American inflation is a recession; obviously this point is a long way off. At this early stage in the great American inflation, there is plenty of scope for this positive feedback loop to get totally out of control; because no central bankers (with the exceptions of Plosser, Fisher and Lacker) understand it.
Whilst Draghi and Kuroda become the new FOMC members that Congress is preventing Yellen from hiring, Germany prepares for the capital flight that they have created; by balancing its own books so that it does not need to rely on external financing. Japan and the Yen are totally unprepared. Britain looks like a safe-haven, but its fiscal position puts it in the same parlous position as Japan.