The attempt by Chairman Bernanke to present the semblance of leaving his work unfinished yet with a sense of achievement was observed in Terminal Velocity (18) “Fed Historiography”. In what appeared to be his last Humphrey Hawkins Testimony, Bernanke continued to wind down and pass the book[i]. His Testimony and the Q&A that followed ostensibly allowed him to orally pass the baton of a normalized yield curve, deflated risk asset bubble and a flexible data dependent policy stance to the next Chairperson. It seems that he would also like to leave with the Dow Jones at new highs as the final line in his chapter.
As if by magic, having sat out the rout in mortgage backed securities, the Fed was back in buying again in the week of his testimony. If his comment, that the Fed can exit QE without causing a crisis in the markets, was calculated to end the deflation in the risk asset bubble it certainly worked; however it does not stand up to close inspection.
The mere hint of a “Taper” has caused yields to rise and unwind approximately half of their fall due to QE to date. A real tightening will therefore be far more painful if and when it materializes. In the meantime, Bernanke’s desired exit rally is well under way in equities.
The snap back in High Yield and Corporate Bond Markets suggests that the incoming Chair may have another bubble on his/her hands on their first day in office. The recovery in High Yield suggests that the “reach for yield”, which caused Bernanke to deflate the risk asset bubble after his speech at the 49th Annual Conference on Bank Structure and Competition sponsored by the Federal Reserve Bank of Chicago entitled Monitoring the Financial System[ii] back in April, is back on. Bernanke did leave a warning for the speculators however, which has thus far been overlooked in the risk asset bounce. He made it very clear that Basel III is only the floor in terms of the US translation of Basel III into capital requirements. This implies that US capital adequacy requirements will be the highest in the world. The risk that regulatory zone arbitrage once again occurs and causes global asset bubbles has been created. US institutions and the US economy will enter the next crisis on a firmer footing.
In Terminal Velocity (14) “Goldilocks Economy and the Three Bear Markets” it was proposed that QE drags future economic activity into the present; leading to the creation of a crisis point in the future at which there is no growth to sustain the high valuations of asset prices. Analysis has identified specific demographics which are associated with this phenomenon. Generation X can be seen as the principal driver and casualty of the great asset bubbles and recessions of the late 1990’s to date. Generations Next and Y have also acquired the debt and consumption habit from their parents.
Analysis from the Survey of Consumer Finances shows very clearly that the “Gen-Xers” have been the ones driving the growth in debts which has driven the US economy and transferred wealth, via asset prices, to the older generations. Generation X is effectively tapped out and now in enforced deleverage. Generations Next and Y are the only hope of the asset rich, who wish to maintain the elevated levels of their portfolios. Quantitative Easing has allowed the debts of Generations X, Next and Y to be valued at levels above their abilities to repay. In the absence of economic growth, the next crisis is a formality. If Generations X to Y are tapped out this implies that the older generations are going to have to take on more debt and consumption. The older generations are therefore going to have to cannibalize themselves in the absence of fresh meat. Fresh meat may be found in the global economy. The problem with the global economy is that America’s trade and investment partners have relied upon Generation X borrowing and consuming from them. In the absence of a new form of Colonialism, there is very little that the global economy has to offer Americans who are asset rich.
The latest Industrial Production and Capacity Utilization Data confirmed that the US economy continues its struggle, since the late 1990’s, to maintain the trend in economic growth that is needed to sustain the private debt mountains and the inflated asset prices associated with them. President Clinton allowed debt liquidation after the Bush Senior recession to occur. The ensuing growth was thus for real. The Dot.com bubble was the first hint that the illusion of future growth could be borrowed from the future; and discounted at a high premium created through excess central bank liquidity. This was the beginning of the great divergence of valuations of asset prices from real economic growth. Monetary policy was then used to sustain the level and value of debt rather than to meet the requirements of real economic activity. To end the recession following 9/11, the Housing Bubble was created; which pulled resources from the future so that the ensuing crisis saw economic activity fall even lower than the previous recession. So far, no economic growth has been borrowed from the future; yet asset prices are assuming that it has, because the Fed has created the liquidity associated with such growth. Debts have not been liquidated through bankruptcy; they have been refinanced and in many cases paid down. The absence of employment growth suggests that there is no surplus growth available in the future to borrow today. The real US economy is operating on a pay-as-you-go basis, but is valued on a borrow too much now and never pay basis. When Bernanke hinted at a shift to pay-as-you-go valuations, the system crashed and interest rates spiked. The Fed has just found out that it can never leave, despite all the “Taper” talk.
Money has become backed by private debt rather than by private economic activity. The value of private debt is several times that of the underlying private economic transactions in the real economy. When the markets lost faith in the private debt, the US Government had to confiscate the Taxpayers’ wealth to guarantee this private debt. Rather than literally confiscate private wealth through taxes to pay private debts, the Federal Reserve created the public money to uphold the private debt. At the first indication that it was about to end the creation of public money to uphold private debt, the Fed triggered a rise in interest rates that continued until it surrendered and agreed to return to creating public money again. The next incoming Fed Chairperson therefore will not start with a clean slate. He or She will start in crisis mode, where things have been since 2008.
Testimony/Chairman Ben S. Bernanke/Semiannual Monetary Policy Report to the Congress (before the Committee on Financial Services, U.S. House of Representatives, Washington, D.C.)/July 17, 2013
Testimony/Chairman Ben S. Bernanke/at the 49th Annual Conference on Bank Structure and Competition sponsored by the Federal Reserve Bank of Chicago, Chicago, Illinois/May 10, 2013