The Third Man(date)
Age of Wisdom, Age of Foolishness (37)
“Coming Soon, to a Cinema Near You.”
The report entitled MIT Engineers More QE (December 12th 2012)[i] explained how Stanley Fischer’s MIT protégées were leading the “change that we can believe in” in global central banking.
On this occasion, “Fischer Doctrine” was seen embracing the concept of universal and perpetual QE. “Fischer Doctrine” was developed at the Saltwater School of MIT; and its apostles are now in the vanguard of the leadership of the thought-school that drives global central banking. All the key individuals have studied at MIT under the guidance of Professor Fischer; and since then he has remained their guide and mentor throughout their central banking careers.
“Minds, Hands and Bumpsie Daisy!!!”
This school of thought has now been given the modern eponym of Macroprudential Regulation. Fischer has also personally profited vastly from the evolution of this thought process, during his time in charge of Citigroup; when the creation of credit which has occasioned the need for this Macroprudential Regulation got out of hand.
He was then observed opining that the Taper was actually a blessing for global stability; even as it was sucking away capital flows and endangering emerging markets, in Terminal Velocity (14) – “Goldilocks Economy and the Three Bear Markets”[ii].
Readers will understand Macroprudential Regulation as the attempt to keep Exter’s Inverted Pyramid growing, above the narrow base of Gold Reserves, without falling over with disastrous economic consequences. Having recently successfully infiltrated the temple of central banking in Washington, Fischer has gone to work on the next move in his global strategy. Fischer’s next move is to create a new third Fed mandate, to replace the anachronisms of the Inflation and Growth Mandates[iii]. QE has undermined the existing two mandates to such an extent, by narrowly targeting asset prices only, that the Fed must now legally take control of the monster that it has created. Janet Yellen’s failure, to accept that liquidity held in the reservoir of inflated asset prices is the source of tomorrow’s hyperinflation, makes the need for this new mandate imperative. A permanent increase of the money supply is now envisaged to come out of Jackson Hole this summer. The Fed and the Bank of England, seem set to land their Helicopters first.
The money for QE thus far has been borrowed from the banks by the Fed. The Fed temporarily put this money into the banks in the form of Reserves; and then paid interest on these Reserves to the banks. If the Fed withdraws these Reserves, the money supply will contract, because the banks will have no Reserves to multiply as credit. The Fed therefore needs to permanently increase the money supply, by leaving these Reserves in the Federal Reserve System.
If as predicted the money supply is permanently expanded, as the Fed balance sheet remains permanently expanded, then the threat of hyperinflation is a clear and present danger. It would manifest itself, should faith in the capital markets be lost and the permanent excess liquidity in them exits in favour of real assets and price levels in the real economy.
The Fed therefore needs to create faith in the capital markets, by having a direct mandate which authorizes it to regulate them as the Uber Regulator. The mechanism to manage the capital markets is through management of the assets on the Fed’s balance sheet; as Jeremy Stein explained in great detail during his time at the Fed. There can be no Macroprudential Regulation without a massive Fed balance sheet of assets to regulate. QE itself therefore necessitates a permanently expanded balance sheet, which has become the vehicle of Macroprudential Regulation. Faith in the Fed’s Macroprudential credentials translates into faith in the permanent expansion of the money supply. Stanley Fischer’s mandate is to achieve this new Fed mandate.
“A Sceptical Audience for Political Theatre.”
Congressional Approval Rating Languishes at Low Level
He faces a partisan Congress and a public which distrusts the Fed (nearly as much as it despises the Congress). In order to win over the sceptics, he therefore needs another crisis; which threatens to become systemic unless the Fed is given the new mandate to regulate it. He must get there by convincing the sceptics that the next crisis has not been created by the Fed’s QE policy however. Given the partisan climate and the mistrust of policy makers in general, this crisis will need to be very emotive; and also must appear to be un-connected to the Fed.
“A Selfie You Can Believe In.”
This partisan climate was recently given an extra edge by the move to impeach the President movement’s release of the latest piece of “Kompromat”; which calls into question the President’s nationality again. Dick Cheney also coincidentally turned up the heat, opining that Obama is the worst President of his lifetime[iv]. Whilst he admires Sarah Palin’s misguided patriotism, for trying to impeach the President, Cheney is more inclined to go for Speaker Boehner’s lawsuit.
“That’s another fine mess you’ve gotten us into Stanley.”
Stanley Fischer therefore needs a foreign crisis, which then threatens to go global; and eventually comes back to America and threatens to undermine all the Fed’s good work. The seeds of the crisis are to be found emerging in the Middle East and Ukraine; and more importantly now in Europe as the Taper and geopolitical situation combine to expose the fact that the European banking system is still insolvent.
A recent Bloomberg opinion poll found that investors now believe that the ECB has been too timid; with its actions falling way short of Draghi’s promises[v]. There is now room to the downside for huge disappointment, verging on capitulation by the longs. This will be Draghi’s signal to act boldly and Fischer’s signal to push through the “Third Mandate”. Fischer will then go before Congress and point out that the emerging foreign headwinds call for the end of the Taper (hence the permanent increase of the money supply); and that in order to prevent this from creating inflation the Fed now needs a new Macroprudential Mandate.
Jeremy Stein provided most of the data and analysis as the input for this rationale; however a visible crisis is still needed to frighten the Congress into responding with alacrity in order to avoid a re-run of the Credit Crunch.
Mario Draghi needs a crisis in order to accelerate the process of debt mutualisation, under the broader heading of a “Federalist United States of Europe”. He can therefore lay the blame for the next crisis squarely at the door of the European politicians and their failure to integrate their economies faster. Two birds therefore get killed with one stone. Helicopter money gets landed and a “Federalist United States of Europe” gets created, as direct consequences of the next crisis. A crisis presents an opportunity to create the changes that cannot be engineered by any other means.
“No Time for Losers, ‘Cause We Are the Champions….”
The coming final act, of the European crisis, is being set up nicely by Jens Weidmann’s quest to discover what true fear is; originally observed in Age of Wisdom, Age of Foolishness (35) “Red Lines/Green Lights”. Weidmann signalled that Germany’s greatest fear is that loose monetary and fiscal policy, at the ECB and EU level respectively, will create economic overheating in Germany. Weidmann recently confirmed this fear, when he opined that Germany actually requires higher interest rates[vi].
A German inspired ECB Taper, is currently not even remotely factored into the pricing of Eurozone assets. Draghi however suggests that the market’s current belief in the panacea of easy money, for all sectors and asset classes, is fundamentally misplaced. In his latest testimony, he qualified the conditions for further targeted easing. Lending to financial companies will be penalised; however lending to non-financial companies will be stimulated[vii]. His objective is to try and avoid bubbles in financial assets which do not reflect underlying strength in the real economy.
In practice however, the real economic agents are not borrowing; on the contrary they are retrenching to meet austerity guidelines. ECB liquidity therefore has no demand, other than from the financial speculators. If the financial speculators are to be penalised, the liquidity will not get used at all. In fact, there is a now a real risk that the next wave of ECB liquidity does not get soaked up in the reservoirs of either financial asset or capital asset investment. Such money, with no home, ultimately creates inflation in the prices of goods and services in the real economy. It is becoming clear that Draghi (deliberately or not) will create inflation. It is also clear that Weidmann sees this; and intends to resist. The dialectic between the two is a catalyst for volatility.
This volatility will get magnified by the new offensive from Wolfgang Schaeuble[viii]. He has called into question French legitimacy and fidelity to be given the position of Commissioner for Monetary Affairs. This translates as a question about the liberty, equality and fraternity which France wishes to project onto the European Project. Schaeuble has clearly seen a trap, in which the French will be able to influence monetary affairs, in order to get the result they (along with PIIGS) desire. These desires may even extend to the verboten subject of deficit monetization.
We have now reached the point, identified in Terminal Velocity (14) – “Goldilocks Economy and the Three Bear Markets”[ix], at which the markets observe that asset prices and global growth are out of sync. QE has pulled economic growth forward, from the future to the present. The real economy has therefore been converging on a point in the future at which there is no growth; because it was all sucked forward in time to a point which has now become the past. The sudden surprises in Q1/2014 US GDP and the recent weak GDP prints from China and Europe (ex-Germany), suggest that we have now passed this convergence point.
“Framing the Debate.”
Markit Global Business Outlook Survey
Goldman’s big call last week, that the Commodity Super - Cycle is over, also resonates with the sudden disappearance of present economic growth[x]. Even Robert Schiller got in on the act, opining that the equity markets are not justified at these levels[xi]. The latest data from Markit Economics suggests that this convergence point actually occurred between May and June this year. The reporting of economic data is historic; and therefore has the redeeming feature of confirming that the convergence point has occurred even if it could not inform whilst it was occurring.
“Nothing to Smile About.”
Eurozone: Industrial production falls in May and business optimism wanes
Even Germany, despite Weidmann’s words to the contrary, has been hit.
“The boy so stupid he could not discover what fear was.”
Weidmann is in fact making things worse, by calling for higher interest rates just as the economy starts to weaken. His quest to find fear, like that of Seigfried, will be over soon; as he discovers that his fear of overheating should have been a fear of recession and inflation (Stagflation). The latest ZEW Survey, showed the seventh consecutive monthly drop in expectations from German investors and businessmen[xii]. Weidmann is discordant with his domestic audience, who see none of the overheating that he is worried about. It appears that he is engineering a crisis to fulfil their expectations.
Legend has it that Siegfried learned fear from Brunnhilde; so let’s wait to hear if Angela Merkel has been reading her libretto!
Pundits have been swift to blame inclement American weather for the weak US GDP print; and whilst this is seductive and rational it does not fully explain the whole global picture. Another explanation is that the impact of the Fed’s Taper on the real economy, through the back-up in interest rates, is now being seen in the data. This explanation is rational; and more importantly plays into the hands of those who wish to end the tightening of liquidity and start easing again. Going forward, one is more likely to hear this argument advanced for ending the Taper. Whatever the truth, it is now an undeniable fact that the real economy and risk asset prices are out of sync. We are therefore beyond the convergence point.
The central bankers are however one step ahead of the game this time around; having engineered it in the first place. It is clear that they understand that QE just borrowed economic growth from the future. Their response however is to try and borrow some more. This cannot be done with QE however; it can only be done with a permanent increase in the money supply that does not have to get paid back.
The next panic in financial assets already has the contingencies, of permanent QE from the Fed and “do whatever it takes” from Mario Draghi in addition to the printing of money by the BOJ, in place by default. The trigger signals of the crisis in Peripheral European Equities and cyclical stock indexes, such as the Dow Industrials, can therefore coexist with the permanent liquidity increase signals from the NASDAQ. The Bull and the Bear can therefore occupy the same space at the convergence point; because they are required to do so in order to frame public opinion to accept what the central bankers have planned to execute next.
The smart money has observed this next move coming and is already moving into the NASDAQ. The price action of the NASDAQ is the key signal, which evinces the new Fed mandate combined with the permanent increase in the money supply. The NASDAQ has become the most important benchmark index in the global capital markets. It has replaced the Risk Free Rate, at the Zero Bound, as the benchmark valuation tool for all models which are a derivative of the Capital Asset Pricing Model. It is also the index by which the Fed seeks to gauge the level of risk appetite in the capital markets. It has therefore replaced the Fed Funds Rate as the most important index for policy makers and capital markets practitioners. It also can go anywhere, because the vagaries of its reporting requirements allow CFO’s to book hypothecated future cost savings as present income. Companies can therefore cut costs by creating unemployment. The profits booked through this cost-cutting actually represent losses in consumption to the real economy.
“MSFT the Stagflation Hedge.”
The news from Microsoft last week, that it will cut 18,000 jobs is a classic example of this point[xiii]. NASDAQ can then add on another premium for discounting the Fed’s easy money response to the falling consumption power, created by the NASDAQ companies cost cutting behaviour. Economic contraction is therefore discounted as economic growth by the NASDAQ; in a classic signal that the convergence point has been reached. Jeremy Stein understood this. Stanley Fischer probably gets it, but doesn’t care. Janet Yellen just had her own Jeremy Stein moment. Her latest Humphrey Hawkins testimony was constrained by the equivocal data, which showed weak labour markets but a solid industrial rebound in Q1; and the Hawks on the FOMC with whom she must compromise over the exit from QE. Yellen therefore had to be equivocal about the economy and the prospects for ending QE[xiv].
She did however take a Jeremy Stein like pot-shot at overheating risk assets[xv]. She also left the door open to Stanley Fischer’s “Third Mandate”, by vigorously rejecting a GOP sponsored initiative to force a single inflation mandate onto the Fed[xvi]. Her comments, about risk assets, came with the big disclaimer that bonds and equities were fairly priced. After digesting her commentary, speculators were sufficiently emboldened to conclude that they should still be long NASDAQ. European speculators concluded that their equity markets are a proxy for NASAQ; and squeezed higher in sympathy. Yellen has therefore filled in the price action on the charts which prints the disconnect between economic reality and asset prices perfectly. The next significant print is therefore the realization, of the disconnect, which manifests itself as a downward correction.
What she failed to articulate with candour, was the way that the American economy is starting to resemble Japan’s experience with Abenomics. Recent BOJ credit data confirms that QE is still going into financial assets, rather than the real economy; which has accentuated the disconnect between asset valuations and real economic activity[xvii]. The mendacity of Japanese policy makers has reached new all-time lows in positively framing the contradictory economic data. The latest low watermark is represented by the recent attempt to say that the output gap has now disappeared as a consequence of Abenomics[xviii].
Common sense however suggests that economic demand has only just appeared to catch up with excess capacity in the economy; because this domestic capacity has relocated offshore as the aging structure of the Japanese supply of labour has forced employers to look offshore. Aggregate demand has shrunk for both cyclical economic reasons and structural demographic reasons. The jump in inflation, because of Abenomics, has actually accelerated the rate of decline in demand; by making consumers consume less units of output at a higher price. Multiplying the higher price of output by the reduced volume however creates a larger headline GDP figure. Downsizing in the Japanese economy has therefore been spun into the narrowing of the output gap. Supply has therefore shrunk to meet smaller demand; rather than demand rising to soak up excess supply. Inflation has therefore narrowed the output gap.
The Fed’s policy to save housing has now become an unintended policy, to provide profits for asset managers who own real estate and rent it out. Housing affordability is now great for buyers and poor for renters. The only buyers who can afford the price tags are however resident on Wall Street not Main Street. They subsist on raising rents, which has the effect of denying renters and hence the economy purchasing power.
The Fed’s policy to save housing has become an economic headwind. This situation was illustrated in a recent study by the Harvard Joint Center for Housing Studies[xix]. This policy mistake must be added to the borrowing of growth from the future via QE. Yellen’s way out is a permanent increase in the money supply, combined with wealth redistribution via the tax code to those most economically at risk .
Age of Wisdom, Age of Foolishness (36) “By the Rivers of Babylon” advised caution over the level of the US Dollar and all fiat currencies in general; because the conventional wisdom, that the global economic recovery led by America and the Taper, supporting Dollar FX flows was flawed. A recent FX survey by Bloomberg[xx] reported that developing nations now have reserves in excess of $ 3 Trillion.
These US$ reserves were first accumulated to maintain the competitive position of developing nation currencies during the QE process. This accumulation has also created the benefit of a cushion against what is supposed to be the negative headwind caused by the Taper; which is alleged to be sucking hard currency away from developing nations back to America where yields are rising.
Developing nations are therefore in better shape to deal with the upcoming volatility of the big risk-off event that Fischer and Draghi are cooking. The world is therefore well supplied with US Dollars; and is just about to receive a permanent supply of these Dollars, which were allegedly only a temporary QE measure, once the Helicopter lands and the Fed’s balance sheet remains permanently expanded. A permanent supply of Dollars means that the developing nations have to permanently monetize their own US$ reserves in order to maintain currency competitiveness. A new race to the bottom is on for global currencies, which will then see Gold reflecting its true value.
“No Fly Zone.”
Malaysian airlines once again seems to be the subject of airline controversy, which this time is being linked to President Putin, as pro-Russian separatists in Ukraine are blamed for the downing of another one of its airlines with the loss of 298 lives[xxi]. Hillary Clinton was the first out of the blocks to politically capitalize on this tragedy, by firmly demanding that the EU take responsibility for bringing Russia to book for this heinous act[xxii].
The BRICS signalled that they anticipate another economic crisis soon; and intend to try and get ahead of it. They used the Fortaleza summit to announce their intentions and capabilities, in the form of rival institutions to the World Bank and IMF; which will be based in China and have a rotating presidency[xxiii]. America and the EU immediately responded by tightening sanctions on Russia[xxiv]. Economic warfare is therefore underway, which runs parallel to the unfolding military conflicts; as the US Dollar hegemony is once again challenged by the multipolar world order.
“Spies like us.”
America is however not sure of one its European allies. American spying, on its alleged ally Germany, suggests that Washington is not certain that Berlin shares the same worldview. This would not be the first time; since there has always been a suspicion that the Gehlen Network, which formed the spine of America’s Cold War operations and became West Germany’s intelligence agency, never totally had the same worldview. Germany has specific geographical and economic interests in Europe, which historically have not always been aligned with America’s. German economic domination of Europe seems to be following its dominance on the football field. It recently red-carded the resident CIA Chief in retaliation for American spying operations against German targets[xxv].
If Britain heads for the “Brexit”, who can Washington rely on? The latest Malaysian Airlines tragedy and Hillary Clinton’s call for justice, will test exactly who is a friend of a friend or otherwise. The behaviour of European asset prices, in relation to the latest tragedy in Ukraine, suggests that the crisis in the markets which results in the “Third Mandate” has now begun.
- MIT Engineers More QE December 12th 2012
- Terminal Velocity (14) – “Goldilocks Economy and the Three Bear Markets”
- Stanley Fischer Urges Congress to Expand Fed’s Mandate
- CHENEY: Obama Is 'The Worst President Of My Lifetime'
- ECB Found Too Timid by Many in Poll as Europe Worsens
- ECB interest rates too low for Germany, says Bundesbank chief
- Draghi Says Banks Shouldn’t Count on Another Carry Trade
- Schäuble doubts French claim to EU Commission monetary portfolio
- Terminal Velocity (14) – “Goldilocks Economy and the Three Bear Markets”
- Goldman Forecasts Lower Commodity Prices as Cycle Ends
- Booming Until It Hurts?
- German ZEW index down for seventh straight month
- Microsoft Eliminating 18,000 Jobs as Nadella Streamlines
- Yellen Says Weak Job Market Shows U.S. Still Needs Stimulus
- Yellen Sees Risk of Bubbles in Leveraged Loan Market
- Yellen Rejects Republican-Backed Push to Impose Fed Policy Rule
- Kuroda Loan Spigot Drowns Japanese Yield Curve as Banks Buy
- Demand Exceeds Supply in Japan for First Time Since 2008
- Affordability is the big Challenge for Housing
- Reserves Break $3 Trillion Mark in Emerging Markets
- Jet Attack Puts Putin in Corner; 'This Isn't His Plan A'
- Clinton Says EU Must Lead Response to Attack on Malaysian Jetliner
- BRICS Ink $50 Billion Lender in World Bank, IMF Challenge
- Vladimir Putin condemns latest US sanctions against Russia
- After Germany expels CIA chief, will US spies back off?