Terminal Velocity “Helicopter Flight Simulator …. Flight Shtimulator” suggested that Jackson Hole had signaled a hardening in US economic policy; to prioritize domestic conditions at the expense of the Global Economy especially in Emerging Markets. President Obama’s recent failure at G20, to create a global consensus on Syria, was further evidence of the breakdown in global cooperation that could lead to American unilateralism. But perhaps the recent Putin “rescue” will forestall that (unilateralism).
One senses that America’s Emerging Market trade partners have the most to lose from this new domestic American agenda.
The capital markets data very clearly shows that Emerging Market debt has mushroomed in the period associated with the Fed’s various QE initiatives. Low American benchmark interest rates and increased US Dollar liquidity created the hunt for yield; which then created a bubble in Emerging Market debt.
At the same time, the US Employment situation appeared to improve; but this was primarily driven by a drop in Labour Force participation rather than strong job growth.
Those who have “participated” have got low paying service jobs; where wage deflation is the dominant vector. The “Middle Class” faces attrition from this new employment trend. In Terminal Velocity “Gatsbied”[i] the focus of the Obama Administration on the embattled “Middle Class” was observed. It was also seen to be extending as far as politicization of the Fed by the capture of Sarah Bloom Raskin[ii]. Bloom Raskin represents a cohort within the Fed which is sympathetic to the plight of the “Middle Class”; and frames this concern in the economic debate over the Wealth Effect and Income Inequality[iii].
The bubble in Emerging Debt is not commensurate with domestic growth in Emerging Economies; or their export sectors which live off the indebtedness of Developed Market consumers. Developed Market consumers are retrenching alongside their public sectors, so there is no source of export growth to be had for the Emerging Markets. The spectre of higher US benchmark interest rates has diverted capital flows back to North America. Increasing liquidity can therefore stimulate growth and thus attract more capital away from Emerging Markets. This increased capital flow can also serve to keep a lid on rising American interest rates. By “Tapering” therefore, the Fed is actually stimulating the US economy by sucking Dollars that have leaked into the global economy back to North America. This is the real impact of QE; and it has been delayed by four years. The problem is that the banks are custodians of this monetary stimulus; because it has come in the form of Reserves which they are supposed to multiply. Thus far, they chose to create a bubble in Emerging Market debt, amongst other asset classes by multiplying Reserves through the collateral markets which trade global capital market instruments. The banks didn’t lend to business and consumers; in fact business and consumers didn’t want the money as they were retrenching. The Reserves therefore leaked into capital market asset classes. It is logical to assume that the banks will just use the returning Dollars to create a bubble in some other onshore asset class. After this next asset bubble collapses, because it is predicated on economic growth that is not there, the Fed may then be persuaded to experiment with Helicopter Money. Until this point however, the Fed has declared its intention and capability to use its expanded balance sheet, which underpins this volume of liquidity, to focus the bankers’ flows into asset classes and sectors that are deemed to be deserving of monetary stimulus. The current focus is away from Emerging Markets and back to North America. It’s a fair bet that the Fed will focus attention first onto Treasuries; so that yields can be lowered back to levels that kick-start economic expansion again. After that, the bankers will have their choice to take it back to Emerging Markets or unlock some new growth stories within the American economy. If the money leaves America again, the economy will continue to stagnate. It would be much easier if the Fed could lend directly to business and consumers, but the banks always get in the way; and the Federal Reserve system maintains this status quo. When the banks go too far and get into trouble, they then get bailed out so the system perpetuates itself. Thus far, despite the raising of capital adequacy standards, there is no indication that anything substantial has changed.
Larry Summers knows all about this game; because he was an architect of the global financial system which regulates these capital flows. It is therefore no surprise to see him as the top candidate for the Fed Chair; as the current economic scenario with which he is intimate unfolds.