Age of Wisdom, Age of Foolishness (16)
“Putting the ‘F’ Back in Federal Reserve” observed how “Team America” prepared the way for global cooperation between the Developed and Emerging Nations; in a way that will allow the Fed to “Taper” without the same instability that plagued the global economy, for the second half of 2013, after the “Taper” became reality. G20 Sydney provided the venue to see this global coordination in action. The consensus, amongst the Developing Nation G20 cohort, was summed up by Angela Merkel as broad support for the “Taper”[i]. Developing Nations are however much more circumspect. Having once challenged the US Dollar’s position as the premier global reserve currency, because QE had allegedly undermined it, they now find themselves begging for more QE. When this new QE comes, there will of course be conditions attached; in relation to economic reforms and commitments to remove barriers to Developed Nations’ goods and services. This may not be 1998, but Emerging Nations will find that they must behave as if it is, in relation to accepting economic policies from the Developed Nations. The Developed Nations’ policy agenda will be cloaked in the message of Free Trade; and will take the form of trade deals such as America’s TPP.
Leading into G20, Japan announced a shocking GDP report of just 1% for Q4/2013[ii]; and the BOJ announced that it was doubling up on its stimulus package[iii]. The BOJ even refrained from forecasting the future size of the monetary base; suggesting that an even greater monetary stimulus is coming[iv]. Clearly Japan intends to try and get G20 to accept a weaker Yen and more monetary stimulus. Thus far this strategy has been a failure; since it has produced the kind of inflation which is an economic headwind. The BOJ’s latest meeting took a leaf out of the Fed’s little book of euphemisms; and referred to this bad inflation as “rising moderately”, which implies success but more work needed[v].
China went into G20 with economic data showing that credit was growing, with an even distribution between the riskier “Shadow Credit” instruments and regular bank lending[vi]. The inference is therefore that, as the “Shadow Credit” bubble is deflated, normal credit will allow the economy to land softly.
On aggregate, Emerging Markets went into G20 in a form of capitulation[vii]. The contrarian calls by “Team America’s” Blankfein[viii] and Dimon[ix] have clearly been ignored; creating the value and opportunity for “Team America”.
On aggregate, Developed Markets went into G20 with a position of relative strength versus Emerging Markets; but also with some endemic weakness of their own.
There are early signals that America is on the cusp of another slowdown; brought on by the “Taper” discounting mechanism of 2013.
In relation to the next stimulus, commentators are beginning to understand that the supply of underlying mortgages is so weak that further purchases of mortgage backed securities (MBS) by the Fed is not a practical option[x].
Even if the Fed wanted to own 100% of the MBS market, this would not be large enough to provide a meaningful monetary stimulus. If the Sequester continues, then it is unlikely that the Fed could move the economic needle by purchasing Treasuries either. The next stimulus must therefore involve something that is not more of the same. A hint of what is to come could be found in the latest credit data.
The US Consumer, in the absence of rising wages, is resorting to debt to fund consumption. Unsustainable consumer debt is exactly what led to the last crisis; and the QE that followed. QE has got asset prices back to levels at which consumers now have collateral value to fund their consumption again. The problem is that stagnant wages make this consumption and debt unsustainable. It is this situation which led “Team America’s” Hatzius to have his epiphany that the Fed should be more focused on wages than on unemployment[xi]. This is also why the Fed’s Lockhart hinted that the Evan’s Rule will be dropped[xii]; and why Janet Yellen’s first testimony placed so much emphasis on wages.
The New York Fed accelerated the process, running into G20, by declaring the end of Deleverage in Q3/2013[xiii]. Americans have officially stopped deleveraging. Rising interest rates, from the “Taper”, are allegedly going to prevent Americans from getting into the same debt trap that led to the Credit Crunch. What this rationalizing fails to make clear is that, if the American Consumer is unable to carry the debt that the US Government is busily cutting then, the American economy will have no growth engine. Industry has already sensed this coming, which is why the recent Industrial Production and Capacity Utilization data signalled a slowdown. America is now on a quest for “Sustainable Consumer Leverage”. The only way that leverage can be sustained, is if incomes are rising. The focus of economic stimulus now moves directly from the Fed back to the Treasury. The Treasury has the fiscal tools to sustain consumer leverage through income redistribution via the convoluted tax code. The Obama Administration has made its position clear; that the Middle Class consumer growth engine needs re-tuning. The great enablers at the Fed (and Mr Hatzius) have also opined that wages are the next focus. The Sequester means that the Federal Government will soon be in surplus; which then provides the where-with-all for income redistribution which is deficit neutral and does not involve borrowing.
It was therefore no great surprise that the CBO prepared the arrival of Treasury Secretary Lew at G20 with cryptic references to the need for the US Minimum Wage to rise[xiv]. According to the CBO, the rise in unemployment created by a rise in the minimum wage would be more than offset by the boost to the economy from the increased consumption of those on higher wages. One can now clearly see why the Fed (and Hatzius) is so keen to ignore unemployment and focus on wages. Unemployment in America is going to rise as a consequence of higher wages.
It was also therefore no surprise to see the reappearance of a “Quiet American” for “Team America”. Nathan Sheets was famous, during the Credit Crunch and early days of QE, as Bernanke’s economic nuncio; coordinating Fed policy with global partners. His credentials, as MIT Alumnus and former student of Stanley Fischer, qualify him for this new global role; in which he will interface with other MIT alumni such as Mario Draghi. His former boss Bernanke, who the reader should remember is now at Brookings, had this to say of Sheets.
“Nathan is an accomplished economic diplomat as well as an expert economist……We depended on both his broad knowledge of international economics and his extensive and cordial relationships with his counterparts around the world.”
Having been “Federally” remunerated at the “Federally Owned” Citibank (where Stanley Fischer made his mark before jumping ship before the bubble burst and the Federal Government was forced to step in) for the last two years, Sheets will now apply his “accomplished” economic diplomatic skill on the behalf of Treasury Secretary Lew[xv]. In a carefully scripted legend, former Fed Governor (and MIT Sloan School Alumnus) Kevin Warsh opined that Sheets was particularly interested in the state of the European Banking System. As we observed in “Putting the ‘F’ Back in Federal Reserve”, one of “Team America’s” jobs is to enable “Team Europe”. This enabling would appear to be intended through the agency of the “accomplished economic diplomat” Sheets. The Fed has clearly already anticipated this move by applying tighter capital adequacy rules for large European banks with branches in America[xvi].
Mr. Sheets will also be able to coordinate with his old MIT tutor Stanley Fischer, over at the Fed, if all goes to plan. When the “Taper” emerged last year, to play havoc with Emerging Markets, Fischer was on hand to opine that this was a benign influence that would shield emerging economies from volatile capital flows[xvii]. MIT’s credo is “Mens et Manus”, which means “Minds and Hands” in the vernacular. The “Minds and Hands” from MIT can now be found at Brookings, the ECB and US Treasury; soon to be coordinating with their intellectual mentor Fischer at the Fed if all goes to plan.