Age of Wisdom, Age of Foolishness – 1913 to 2013
On the eve of the centennial anniversary of the “War to End all Wars”, it is depressing to observe the new seeds of global conflict developing in what Professor Peter Turchin[i] has referred to as “Rich, Overeducated Elites”[ii]; attempting to prolong the duration of the current Fin de Siècle, by what is termed in the vernacular as “kicking the can down the road”.
Turchin’s analysis resonates with and affirms the observations in Terminal Velocity (15) “Gatsbied”[iii]; which concluded that the Obama Administration was trying to make common cause with the “Middle Class” before the Hegelian dialectic becomes violent. Coming full circle, in “Age of Wisdom, Age of Foolishness”[iv], the Fed has been forced to try and save the “Rich, Overeducated Elites” as a consequence of trying to save itself from large financial and credibility losses. There is presumably a school of thought which holds that the Fed in theory is an agent of the “Rich, Overeducated Elites”; and its behaviour in practice thus far would seem to affirm this. According to Turchin’s historiography, we are now on a rising trend of “political instability”. It is interesting to compare the current trend with the peak that occurred between 1900 and 1920. Commentators always reach for the comparison with the Great Crash of 1929; however applying our frame of reference on Turchin’s timeline, we are actually in the bubble which created the events that finally led to the Great Crash a decade later. Applying the thesis being followed in our analysis, we are therefore at the beginning of a great liquidity bubble (in the form of QE and Helicopter Money) which will show up as the Great Crash a decade later. What we currently are tracking is therefore World War I.
Professor Turchin’s dialectic closes in a cyclical act of metanoia; in which the system is reborn and rebalanced after undergoing a violent cleansing of excess. In our analysis, we will therefore endure a period of conflict characterised by what is for some a boom similar to that portrayed in the Great Gatsby.
The theme of “Celebrating Mediocrity” in the last report[v] was articulated with alacrity by Ben Bernanke last week. His latest “farewell speech”[vi] was intended to make the transition, from his Chairmanship to that of Janet Yellen, as smooth as possible. He opined that interest rates would remain low for some time, even after the end of QE; therefore supporting the transition phase, observed in “Les Miserables”, in which interest rates rise (a little!!!) whilst the Fed continues to unload the full nine yards of QE. Readers should remember that this rise in interest rates is actually the charge which the banks are levying on the Fed, to compensate them for facilitating the expansion of the Fed’s balance sheet into even riskier territory. The irony in Bernanke’s speech came when he said that,
“Our objectives are squarely tied to Main Street”.
Nothing could be further from “Main Street” and closer to “Wall Street”. The rise in interest rates hurts “Main Street” and the concurrent rise in liquidity, multiplied by the higher interest rates, boosts Wall Street. The “Tale of Two Cities”[vii] that we have used, as the analogy of the unfolding events, involves the cities of “Main Street” and “Wall Street”. The Fed is a willing prisoner in the Bastille on “Wall Street”. In its most recent hostage message, in the form of FOMC Minutes, the Fed was deliberately obscure. Having made an issue of transparency and guidance, the Fed suddenly found the need to be arcane again. The new party line is that it is being “Data Dependent”. Behind this cloud of obscurity is the hidden detail that the Fed has just been coerced into raising the fee it pays to the Banks, in terms of the Interest Paid on Reserves (IOR). Hiding in plain sight in the minutes was the misleading statement that the Fed is considering actually decreasing the IOR. By reducing the IOR, the story goes that the Fed will stimulate lending by banks. In practice what happens is that banks reduce their Reserve positions and shrink their balance sheets. Reducing the IOR therefore, is the last thing the Fed wishes to do; in fact it intends to do the opposite. Also hiding in the minutes was the revelation that the New York Fed is now more powerful than the FOMC. The FOMC , Yellen included voted to make the “temporary” global central bank swap lines “permanent”[viii]. If one understands that these swap lines were originally “crisis” measures, one can see that the “temporary global crisis” is a now a “permanent global crisis”. The New York Fed has total autonomy to conduct this swap business, in whatever way it deems to be appropriate, without consultation of any other national body. The New York Fed is therefore the de facto Global Central Bank of Central Banks; which implies that the Washington Fed is simply a member of the network. The New York Fed is the Bastille on “Wall Street”. The FOMC Minutes also reported that the New York Fed is conducting Reverse Repo operations. This detail, in addition to the head-fake about cutting the IOR, had the day-traders convinced the “Taper” was imminent. A day (and one hundred lower Dow points) later, the invisible hand had massaged the news report to imply that there would be higher interest rates plus more liquidity. Higher rates and more liquidity are allegedly good for Stocks and bad for Treasuries, so the Dow was massaged through the 16,000 resistance level. Equity traders now believe that it is the Fed’s “mandate” to move the Dow higher. Mediocre economic data only reinforces this conviction. “Bull Dudley”, the head of the New York Fed, made a speech in which he suggested that he sees the economy picking up momentum in 2014. It is clearly Dudley’s job to create the rising interest rate environment that the commercial banks require in order to charge the Fed more for increasing its balance sheet. James Bullard did nothing to disabuse observers when he then suggested that the Fed’s rush to lower interest rates in 2008 was a “mistake”[ix]; which has locked them into a permanently low rate environment in the absence of strong economic data. According the Bullard, the Fed is now hoist by its own petard. Bullard implies that rates can’t go any lower, so they should go up, even as more liquidity is thrown at the situation. The mediocrity prize should however go to Narayana Kocherlakota[x]. In a show of arrogance, that even Alan Greenspan would have been afraid of, Kocherlakota fired his two senior economists for having a view and analysis which conflicted with his recent Dovish conversion. As Orwell opined, in times of deceit telling the truth becomes a revolutionary act.
Bernanke’s comments framed the context of what was to follow, in the way of further Fedspeak and market behaviour, in relation to this information and the economic data releases. Following swiftly on Bernanke’s targeting round, Charles Evans opened up the magazine of suppressing fire on the critics of QE[xi]. The magazine in Evan’s liquidity ordnance has a capacity of 1.5 $Trillion more rounds of QE. Charles Plosser’s counter-offensive, which has the objective of setting a limit to QE, has therefore been suppressed and shredded by Evans[xii]. Acts of “revolution” within the Fed are being suppressed with extreme prejudice it would seem, based on the reactions to Plosser and the fired senior economists. Plosser has therefore now gone for the nuclear option; in which the debate over the Fed having a single Inflation Mandate is rekindled. Plosser is once again onto a loser because Inflation, the way Developed Nation’s record it, is headed towards Deflation.
It would make more sense to define Inflation as an index of prices relative to wages, rather than the Headline or Core measures used. In this way, what the economists call the “Great Productivity Miracle”, of expanding output and stagnant wages, would be seen as the “Great Inflation” for those on the stagnant wages. Those on stagnant wages have gone into debt, to fund consumption, which has allowed the prices of the expanding output of what they consume to rise. This debt pyramid burst in 2008, so that prices are now falling. The US Dollar is a currency that is backed by the debt of Americans. Inability to pay this debt represents eroding value of the currency. This has implications for the holders of this currency; and also those who derive income in its form. Unfortunately, companies are now demanding lower salaries and concessions from their workers; which run ahead of the fall in prices of their manufactured goods and services. Companies thus remain profitable and workers still feel that there is Inflation. For those with no jobs, there is definitely Inflation. The “Rich, Overeducated Elites” therefore rely upon the Fed, to lower interest rates to zero, so that consumers can still borrow in order to sustain consumption and prices. By borrowing more, the backing for the Dollar is strengthened because there are now more individuals who have to work off the debt to the holders of the currency. The US Dollar is saved for the holders of US assets; and the income of companies in US Dollars is also sustained.
Boeing recently became Ricardo’s neo-classical example of how returns to labour are being forced down in order to preserve profit margins[xiii]. Boeing is an interesting example, because one of its business lines involves the weapons of war (Defence and Space Security[xiv]), which makes it analogous to the arms manufacturers who had a great innings during World War I.
Presumably the gain of the “Rich, Overeducated Elites” comes at the expense of the“tired, poor, huddled masses” who were “yearning to breathe free” in America, according to plaque on Lady Liberty written by Emma Lazarus. The plight of one group of the latter was recently analysed by the Pew Group[xv].
These “tired, poor huddled masses” are now returning (with their money) to Mexico; as they are being replaced with even cheaper “tireder, poorer, huddled masses” from elsewhere in South America. As usual, Congress is fighting the last war on Immigration; Mexico surrendered years ago.
“Rich, Overeducated Elites” have learned a lot about self-preservation over the years. They have an overactive national security apparatus; which polices the conversations of their populations and treats criticism as a form of crime rather than patriotism as was originally alleged by Thomas Jefferson. The acme of skill has also been employed, through mass media channels, to externalize the threat to the nation as a whole. Faced with the external existential threat, the “Rich, Overeducated Elites” and “tired, poor, huddled masses” unite in a common cause against a foreign enemy rather than fight each other. Young patriots therefore now die on foreign fields, rather than at Gettysburg. It is ironic to see the current version of the League of Nations as the ground upon which the seeds of the next potential global conflict are being sown. Originally it was supposed to be the medium through which global conflict of the future is avoided. Now, in its modern form of the UN, it is the platform for extreme propaganda and adversarial views which are used as the casus belli for the localised sectarian conflicts which are driven by global imperatives. The eroding global consensus on the burden sharing for environmental costs, which are a result of the exponential increase in the population, is the latest unfolding casus belli. A nation cannot grow and prosper unless it can utilize increasing amounts of energy. Technological progress has not evolved exponentially, so that energy generation is still in the incremental Industrial Age utilising hydrocarbons. Population has however moved beyond what the Industrial Age can sustain, in terms of employment, production and energy generation. Developed Nations wish to maintain their industrial bases and supplies of hydrocarbon energy generation. Developing Nations wish to expand the same way. The two worlds meet each other in terms of global production overcapacity and insufficient hydrocarbon reserves. This is experienced as global unemployment and high energy costs, which some economists have called Stagflation. Malthus would have understood Stagflation all too well. The cypher for this current conflict is the Carbon Debate. Future historiographers should be looking here for the second global conflict; which follows from the first when the seeds of global liquidity have grown beyond “the green shoots of economic recovery” into choking weeds.