Terminal Velocity “What Goes Around, Comes Around” observed a scenario developing; in which the epiphany of Larry Summers emerging as the next Fed Chairman coincided with the epiphany of an Emerging Market Debt Crisis similar to the one in which he served on the “Committee That Saved the World” in 1997/98. In the weekend of this epiphany, political events in America and Russia conspired to end Summers’ campaign to become the next Fed Chairman.
Mindful of a repeat of the Ruble and Asian Crises, which led to his emergence as Russian President, Mr Putin came up with an eleventh-hour compromise on Syrian chemical weapons which defused the crisis. The political conditions precedent for a return of Summers in an executive role disappeared; and with it his chances of becoming the next Fed Chairman.
The economic conditions precedent for Summers were however clearly in evidence. The July TIC data clearly showed the flow of global liquidity back into the higher yields and safety of US Treasuries after the “Taper Talk”.
Treasury International Capital
Leading into June, investors panicked about higher US interest rates and took their money out of North America looking for global growth. By July it was evident that the rise in US interest rates was killing growth opportunities globally; and sucking capital back to North America even if there was no growth to be had there. Terminal Velocity “What Goes Around, Comes Around” suggested that this repatriation of liquidity represented the delayed impact of QE four years after its inception.
Rising US interest rates and the initial exodus of liquidity from the American economy therefore created the weak economic conditions anticipated by the Doves in the Fed going into the September FOMC meeting. This can be seen in the bank lending data, which show that corporate lending has been falling even though lending standards have been lowered during the recovery and “Taper Talk” periods.
The decision by the Fed to put the “Taper” on hold should therefore not have come as a big surprise.
The Fed had in effect been “Tapering” with words for most of Q2 and Q3 and the banks had done the rest.
Chairman Bernanke had been emasculated and turned into what appeared to be a Lame Duck by President Obama’s urgency to usher in Larry Summers back in June.i
“They Did It Their Way”
As the song goes however, Bernanke “stood tall and faced them all” and did it his way. Not only did he surprise with his “No Taper” decision, but he also hinted that the Fed was moving to take care of the “Little Guy” aka Obama’s famous “Middle Class”. This emphasis on poverty and the “Middle Class” resonated strongly with the release of the United States Census Bureau’s report on poverty and income distribution ii the day after the Fed’s “No Taper” decision.
(Source: United States Census Bureau)
The report showed that even whilst median incomes were improving in 2012, that incomes only improved in 2005/2006 over the last eleven years. Income levels and poverty rates were not statistically different for most states and metro areas from 2011 to 2012, according to the statistics. Incomes remained lower and poverty rates were higher in 2012 than in 2007, the year before the recession.
Into this framing of Fed policy in terms of Poverty, Treasury Secretary Lew added his own context, the day before the FOMC decision, when he opined that:
“Growth is not fast enough”…….”And the very definition of what it means to be middle class is being undercut by trends in our economy that must be addressed.”iii
US poverty and income disparity are issues that arose at the turn of the century; and are now something that the Obama Administration intends to focus upon going forward. The monetary responses to the Dot.com Bust, 9/11 and the Credit Crunch have exacerbated these inequalities; by being narrowly focused on financial assets rather than the real economy. This new focus on the “Middle Class” was observed in Terminal Velocity “Gatsbied”.iv
The problem for Obama is that the Congress is divided on economic policy, so that there can be no coherent fiscal policy to address the situation. This means that the Fed must fill the policy gap. In its latest FOMC statement, the Fed actually listed negative fiscal policy as a reason for holding off on the “Taper”; and Richard Fisher has been eternally vitriolic in his criticism of the dysfunctional Congress.
The problem with leaving it to the Fed, is that the Fed’s toolbox is narrowly focused on capital market instruments, which translate into asset bubbles, rather than growth policies. The Fed has responded to this policy shortcoming by expanding its balance sheet to cover disparate asset classes, such as MBAS, that have a closer impact on economic behaviour; but as Bernanke conceded, in his FOMC speech, there are clear limitations and risks involved in doing this. To address this problem, the Fed is being captured by Obama’s nominations to fill upcoming vacancies. The politicization of the Fed and the Treasury is a two way street; as has been seen with the nomination of Sarah Bloom Raskin to Deputy Treasury Secretary. The capture will then be completed by the use of “Helicopter Money”; to combine guidance with a firm commitment to permanently create fiat money in the accounts of consumers rather than banks’ Reserves at the Fed. The position of Summers on “Helicopter Money” is not known, nor is it relevant any more. Janet Yellen however became a convert at Jackson Hole in 2012.v
The transition to “Helicopter Money” took a major quantum step with the events of the demise of Summers and the “No Taper” decision. As always however, it takes a real economic crisis in order to create the cover to make giant transitions such as this. The seeds of this next crisis were sown with the Fed’s “No Taper” decision. The Fed must be aware of this.
After the short squeeze higher in markets, speculators will begin to discount the timing of the next “Taper” decision. As was explained in Terminal Velocity “Stimulating Taper”, the repatriation of QE liquidity from global markets to North America is the kind of stimulus which will trigger domestic American growth. The recent “No Taper” decision will raise American confidence which will compound the impact of the returning QE. This confluence of events will show up in stronger economic data, which will then embolden the speculators who are looking for the real “Taper”. The market discounting mechanism will then also price in the recessionary impact of the “Taper”. The Fed will then deliver on its “Taper” promise, using the stronger economic data as the excuse.
At this point markets will head into a tailspin, which will knock on to weaker economic growth. At this point of weaker economic growth, the Fed now ably Chaired by Janet Yellen, will pull back the “Final Curtain” to create a new permanent expansion in the US Money supply through “Helicopter Money” rather than through the ephemeral creation of Bank Reserves which then get reversed.
A new permanent expansion in the US Money supply is also eagerly awaited by America’s global trading partners, who now remember its revitalizing economic impacts with fondness.