The Terminal Velocity series has followed the flight plan of “Bernanke’s Helicopter” to Jackson Hole. The way point markers along this flight path are recounted below. This is a belated review of Jackson Hole 2013 and the Terminal Velocity series articles that preceded the meeting.
Terminal Velocity (21)
“The Pyramid Scheme”[i]
It was suggested that the Federal Reserve was adopting a new policy; in which its balance sheet remains expanded indefinitely. Jeremy Stein was noted as the key signal to suggest that this expanded balance sheet would be used as both an economic policy and macro prudential stability tool simultaneously. We said that:
“We will watch Jackson Hole closely this year, to see if this template becomes official global central banking dogma.”
“Bernanke’s Helicopter Landing at Jackson Hole”[ii]
Michael Woodford was identified as a key figure. His thesis[iii] that the benefits of QE have been undone by the implications of speculation on the timing of its reversal was articulated by Janet Yellen[iv]. Yellen is now a potential Fed Chairman candidate, so her endorsement of Woodford is important.
“The Wind Blows Towards Jackson Hole”[v]
An eruption of the debt crisis in Europe was identified as a potential catalyst that could create the conditions for the launch of “Bernanke’s Helicopter”. The dissenting voice of Charles Plosser was also heard to be losing its force for a clear communication of the QE exit strategy; because the Fed’s balance sheet was too large to return to the 2011 exit scenario originally contemplated.
“Flying Blind, On Fumes, With No Pilot”[vi]
Global Central Bankers admitted that their economic dashboards were not working; and that there was a dangerous monetary policy vacuum developing. Into this vacuum jumped the figure of Sarah Bloom Raskin; who suggested that extreme income inequality is preventing a sustained economic recovery in America. The inference was that a policy response to this systemic demand shock, involving the Fed’s expanded balance sheet, was on the horizon. Bernanke’s absence form Jackson Hole was telegraphed, increasing the vacuum: and unleashing the speculation over his successor which obscures the real story unfolding in relation to monetary policy. We concluded that:
“Jackson Hole therefore becomes a diversion, distraction and dilution in varying degrees. No doubt the “Helicopter” will be spotted there, but the conditions will not be appropriate for it to land.”
“Will the New US Pilot be Skilled with Helicopters”[vii]
The speculation over the successor to Ben Bernanke as a distraction to the economic debate was elaborated. Mario Draghi was also put on record for introducing the policy tool of negative interest rates; should they be required.
“Europe Spreading the Pain”[viii]
The spectre of “European Bail Ins” was introduced as the potential trigger for the crisis which would launch the “Helicopter”. It was concluded that Developed Market central bankers had a deflation problem; and were creating inflation to address it.
The “Voodoo Accounting” in future US GDP reporting, involving the counting of intellectual property and intangibles, was introduced as a fudge factor; which would allow US policy makers to show acceptable economic growth since the recession. This growth would be attributed to the success of QE. This fudge factor was nothing more than the use of price inflation, in the service sector of the economy, to overstate GDP against an economic background in which manufacturing production remained in recession.
“Minds and Hands on the Joystick”[x]
The “Taper” officially began here; with Bernanke highlighting the risks caused by speculators, “reaching for yield”, in a low interest rate environment. His call for greater macro prudential regulatory power for the Fed was extended to large systemically important institutions. The dissonant voices within the Fed, calling for tightening and further easing simultaneously, also became audible at this time.
“Getting Real Interesting”[xi]
The road to Jackson Hole was identified.
“The road to Jackson Hole therefore has three lanes:
- The “Hawks” Tapered Fed Balance Sheet Lane
- The “Doves” Deflation Lane
- The “Doves” Fiscal Drag Lane
The conflicts between travellers on the “Hawks” and “Doves” lanes are creating cognitive dissonance within the Fed, which is amplified by the markets.”
We also suggested that:
“Deflation will be framed as the greatest threat to the global economy at Jackson Hole.”
Rising real interest rates, thanks to Bernanke lighting the “Taper” in Terminal Velocity – “Minds and Hands on the Joystick”[xii], were seen as the real global economic threat.
The Bank of Korea Governor, Kim Choong Soo was the first Emerging Market central banker to opine the impact that this would have on capital flows. We observed that:
“Suddenly the Emerging Markets love American QE and wish it to continue indefinitely. This observation underscores the thesis that the US Dollar remains the World’s reserve currency; and that the Fed has become the World’s Central Bank. When the Fed exits therefore, it must take into account the global impact of its actions. We are back to where we were leading up to 2008. When the Fed tightens, the whole global economy has a recession. It is with this in mind that we believe that the Fed will be inclined to maintain an expanded balance sheet indefinitely, until the global economy has rebalanced itself into an integrated sustainable entity.”
Michael Woodford and his “Helicopter Money” co-pilot Adair Turner then became more vociferous in outlining their two discrete methods of Helicopter Stimulus. Woodford’s was the most passive; and involved Nominal GDP (NGDP) targeting combined with a “commitment” to expand the money supply to sustain this target. Turner’s was more overt; and involved the literal crediting of consumers’ accounts with same volume of money envisaged by Woodford’s NGDP target.
Bill Dudley warned that markets would overreact to the “Taper”; and it was suggested by us that this overreaction would be the catalyst needed for the Fed to commit to further balance sheet extension and possibly “Helicopter Money”.
The Fed’s attempt to normalize the Yield Curve, whilst maintaining an expanded balance sheet, was observed to be under way. The intention of the Fed was to create an incentive to invest, rather than to hold liquidity, by raising long term interest rates. The real risk in this move comes from rising interest rates when there is no rise in inflation. High real interest rates become a real threat to any growth. The most visible impact of this threat is to be seen in the Housing Market (see the related Housing Smoke and Mirrors Discussions).
The anticipated overreaction in markets, flagged by Bill Dudley in Terminal Velocity – “Getting Real Interesting”[xv], occurred. The pro-cyclical nature of QE suddenly switched to the counter-cyclical headwind associated with its exit that Michael Woodford opined at Jackson Hole in 2012. We concluded that:
“A well-engineered deflation of the asset bubble, which hits the professionals and provides scope to reward individuals with “Helicopter Money”, is an experiment that is now worth trying. Rewarding the banks created a bubble and weak growth, so it is time to reward those who will spend rather than save it.”
“Goldilocks Economy and the Three Bear Markets”[xvi]
The concept that QE pulls future growth (and its valuation in asset prices) forward into the present was introduced. If one looks at the way the GDP data have been boosted by the “Voodoo Accounting” in Terminal Velocity – “Helicopter Take-Off”[xvii], it is clear to see this process being booked in the US national accounts.
The embrace of a new economic stimulus package, aimed at the Middle Class and the wealth inequality identified by Sarah Bloom Raskin in Terminal Velocity –“Flying Blind, On Fumes, With No Pilot”[xix] was observed. The official termination of Bernanke’s position was noted; along with the distancing of James Bullard from his Fed colleagues over the issue of his deflation concerns. We observed that:
“We believe that we are now at a branch in the road. Currently, the American economy is on its way back to sound money, because of slow growth and enforced deficit cuts. There are however some economists, like Michael Woodford and Adair Turner, who believe that the application of “Helicopter Money” can avoid the full deflationary effects of the return to sound money and balanced budgets.”
“Don’t Show Me, Tell Me”[xx]
The Fed put its MBS purchases on hold, therefore deliberately causing the spike in mortgage interest rates and the economic headwind that will be the catalyst for the new stimulus suggested in Terminal Velocity – “Gatsbied”[xxi].
Bernanke winds up his legacy and also presents the launch pad for the next Chairman; in his speech entitled “The Financial Crisis, the Great Recession, and Today”[xxiii].
“The Great Divergence”
This picks up on the “Today” left by Bernanke’s speech entitled “The Financial Crisis, the Great Recession, and Today”[xxiv] from Terminal Velocity – “Fed Historiography”[xxv]. This “Today” is the convergence point; at which the growth that has been pulled from the future by QE and hidden by the “Voodoo Accounting” in Terminal Velocity – “Helicopter Take-Off”[xxvi] suddenly stops. At this point the markets will call for more QE and even the “Helicopter”.
“Who’s Been Eating My US Growth?”
The markets begin to digest and discount the contraction in growth and the fall in inflation since the “Taper” officially began in Terminal Velocity – “Minds and Hands on the Joystick”[xxvii].
“Taper Talk is Cheap”
The Fed frames the fall in markets as the successful execution of the “Taper”; and suggests that the rise in interest rates implied is higher than is currently warranted in the conditions of weak growth and low inflation. The Fed therefore directly addresses the convergence point suggested in Terminal Velocity – “The Great Divergence” above.
Which brings us to the Jackson Hole August 2013[xxviii] waypoint. Now read on………..
Observers have been used to receiving new policy initiatives in the past at this event. The absence of Bernanke, Carney and Draghi suggested that this event would be a case for reflection on central bank policy to date; and the current economic context for future policy initiatives.
The event kicked off with a presentation by Stanford’s Robert Hall[xxix]; which explained why inflation had not fallen significantly during and since the crisis. Hall defaulted to “Microeconomics 101”; and explained that the crisis had cut supply as well as demand for goods and services. The fall in supply and demand were roughly equal, based on his ex post analysis. Efficient markets therefore cleared at similar price levels as pre-crisis; and there was no apparent fall in inflation. This assertion therefore opens the way for an economic stimulus framed as an expansion of investment; which will boost supply and lower prices for the goods and services created. Lower prices will thus stimulate consumption; and the global economy will recover neo-classically. Importantly there is no inflation threat, so current interest rates therefore are too high, and a further fiscal and/or monetary stimulus can be attempted with confidence that there will be no inflationary consequences. Professor Hall also concurs with Michael Woodford’s analysis that guidance is no good without commitment to action. The pathway is thus cleared of academic obstacles to the expanded balance sheet envisioned in the Terminal Velocity series.
Hall was followed by Arvind Krishnamurthy, who opined that the Fed should cut its Treasury holdings whilst expanding its MBS purchases[xxx]. This supports the assertion, in the Terminal Velocity series, that the Fed intends to maintain an expanded balance sheet by varying the size and composition of the assets. Specific sectors of the economy will be stimulated and suppressed by the variation in this composition.
Krishnamurthy was followed by Augustin Carstens[xxxi]; who made the case for the Fed to take into account the global consequences of its actions when it “Tapers”. This resonates strongly with what was discussed in Terminal Velocity “Getting Real Interesting”[xxxii]. Panelist, ECB Member, Frank Smets opined that the ECB’s exit from QE is built into the LTRO process. Allegedly, the LTRO is now being unwound as the commercial banks repay the ECB. It is clear that the ECB and the Fed are returning to the harder currency rules of the game opined in Terminal Velocity – “Gatsbied”[xxxiii]. The ECB’s implied “Taper” reintroduces the threat from Europe; which may become a trigger for “Helicopter” launch. Smets was followed by Christine Lagarde; who emphasized the need for clarity on the direction of monetary policy from the Developed Market central bankers. The Fed members present at Jackson Hole have taken the hard-line; by rejecting all notions of coordination with their Emerging peers. This suggests that policy will be custom “Tapered” to fit the domestic American agenda[xxxiv]. The ECB is also “Tapering”, under its own steam, to fit a specific European economic and political agenda. This means that the Euro and the Dollar will be stable; and all other currencies will weaken against them.
This will certainly trigger the return of the conditions in Emerging Markets, opined by Korean central banker Kim Choong Soo in Terminal Velocity – “Getting Real Interesting”[xxxv], which were last seen in 1998. There is an interesting historical and contemporary twist to this scenario also; since it was Larry Summers (amongst others) who “saved the World” back then. History is rhyming. Will he do the same again as Fed Chairman? There is also an added geopolitical twist to the Summer’s scenario. This scenario would also arrest China’s global expansion in its tracks. America would have the opportunity to “Pivot” to Asia from relative strength; and set the new rules of the global financial system in the process. Mr Summers as former “World Saviour” and current adviser to President Obama would seem to be well versed and qualified to execute such a strategy (if it existed).
Day Two was more global. If Day One represented cause, then Day two represented effect. It was started by former French central banker Jean-Pierre Landau. He opined that central bankers should be more concerned with macro prudential rules than with monetary policy coordination to regulate capital flows[xxxvi]. This suggests that the Europeans are going to get their own house in order, in their own way. The Eurozone trigger for the crisis, which launches the “Helicopter”, therefore becomes an Asian crisis. Monsieur Landau was followed by Mademoiselle Helene Rey, of the London Business School; who dealt with the spill-over from these dangerous uncoordinated capital flows[xxxvii]. She advocates capital controls to augment the global macro prudential rules. Landau and Rey, therefore address the global problems created by the Fed and ECB’s return to sound money policies.
Within the sound money of the Developed Market central banks, there were however two special cases; namely Britain and Japan. Deputy Governor Charles Bean[xxxviii] and Governor Kuroda[xxxix] made it clear that their respective balance sheets will remain extended during the Fed and ECB “Taper” periods. Japanese QE has just started to yield results allegedly; and UK interest rates are implying too much tightening.
Jackson Hole therefore told us where we are; and what to expect in terms of market behaviour and policy response. As we speculated in Terminal Velocity – “Flying Blind, On Fumes, With No Pilot”[xl], the “Helicopter” was seen at Jackson Hole but did not land. Robert Hall’s affirmation of Michael Woodford’s thesis on guidance with commitment to action, in the opening presentation, was the “Helicopter” hiding in plain sight. Despite the alleged breakdown between Developed and Emerging central bankers, there is also the evidence of the coordination that Christine Lagarde wants to see. The Developed Market currencies (ex Sterling and Yen) will strengthen; and Emerging Markets will have a crisis. The new rules of the game will be delivered to Developing Markets, possibly by Larry Summers; and the Fed will have the chance to expand its balance sheet and operations in any way it deems necessary. This expanded balance sheet will be the currency needed for the next American stimulus package, allegedly aimed at the Middle Class. A strong US Dollar and bid for US Treasuries guarantees that any monetary and fiscal expansion can be executed without the threat from the bond and currency bears. Jackson Hole has therefore been the launch pad for a new global policy initiative; by framing the context in which this initiative comes. As in 2008, a financial crisis will be used to engineer the policy initiative desired. Perspicacious (and slightly paranoid) observers will understand that the next crisis itself has been engineered along the lines suggested by the recent discussions at Jackson Hole. The waypoints observed to date therefore continue out to into the immediate future.