Moral Hazard

On ECB Q&A: Yawn! Can’t always be a rainmaker and light fireworks every month. 

The policy of the Status Quo since 2008 boils down to this assumption: if we prop up an artificial economy long enough, it will magically become real. This is an extraordinary assumption: that the process of artifice will result in artifice becoming real. This is the equivalent of a dysfunctional family presenting an artificial facade of happiness to the external world and expecting that fraud to conjure up real happiness. We all know it doesn't work that way; rather, the dysfunctional family that expends its resources supporting a phony facade is living a lie that only increases its instability. The U.S. economy is riddled with artifice: millions of people who recently generated income from their labor have gamed the system and are now "disabled for life." Millions more are living in a bank-enabled fantasy of free housing. Millions more are living off borrowed money: student loans, money the government has borrowed and dispensed as transfer payments, etc. Assets are artificially propped up lest a banking sector with insufficient collateral be revealed as structurally insolvent. It's not difficult to predict an eventual spike of instability in such a system; the only difficulty is predicting the date of the instability. Hiding a broken, dysfunctional economy behind a facade of artifice and illusion can't fix what's broken, it only adds to the system's systemic instability as resources that could have gone to actually fix things are squandered on propping up phony facades of "growth" and "health."

We believe an unsustainable new global financial architecture that arose in response to the US and European financial crises has replaced an older, more sustainable, architecture. The old architecture was crystallized in Washington- and IMF-inspired policy responses to the numerous sovereign defaults, banking system failures, and currency collapses. Most importantly, the previous architecture recognized limits on fiscal and central bank balance sheets. The new architecture attempts to 'back', perhaps unconsciously, the entire liability side of the global financial system. This framing is consistent with a purely political—institutional stylized—fact that it is nearly impossible to penetrate the US political parties if the message is that there are limits to their power…or that their power requires great effort and sacrifice. This is why Keynesians (at least US ones) who argue there are no limits to a fiscal balance sheet are so popular with Democrats, and why monetarists (at least US ones) who argue there are no limits to a central bank balance sheet are popular with (a decreasing number of) Republicans. Party on! Again, nobody chooses hard-currency regimes – they are forced on non-credible policymakers. Let me put it more positively. If politicians want the power of fiat money, let alone the global reserve currency, they need to behave differently than they have - or the consequences for Gold are extraordinary.

The new policy of unlimited quantitative easing is an experiment. If those theorists of insufficient aggregate demand are right, then the problem will soon be solved, and we will return to strong long-term organic growth, low unemployment and prosperity. I would be overjoyed at such a prospect, and would gladly admit that I was wrong in my claim that depressed aggregate demand has merely been a symptom and not a cause. On the other hand, if economies remain depressed, or quickly return to elevated unemployment and weak growth, or if the new policy has severe adverse side effects, it is a signal that those who proposed this experiment were wrong.

What took Ben Bernanke sixty minutes of mumbling about tools, word-twisting, and data-manipulating to kinda-sorta admit - that in fact he is lost; Ron Paul eloquently expresses in 25 seconds in this Bloomberg TV clip. Noting that "we are creating money out of thin air," Paul sums up Bernanke's position perfectly "We've Lost Control!" From mal-investment to Bernanke's frustration and the unintended consequences, the full 5-minute interview is a must-watch.

Cui bono--to whose benefit?--is a skeptic's scalpel that cuts through the fat of propaganda and political expediency to the hard truth. Since the world has been trained (in Pavlovian fashion) to hang on every word issued by America's privately owned central bank, the Federal Reserve, it's appropriate to ask a simple but profound question: Who benefits from the Fed's existence and its policies of loaning "free money" to banks at 0% and ZIRP (zero interest rate policy)? The Status Quo's answer is "the American people," of course, a deliciously juicy layer of "Big Lie" propaganda and obfuscation. Any healthy political and financial system would have broken the fraud-based system and dismantled the failed banks en masse in an orderly fashion. One institution stopped this from happening: the Federal Reserve. The Fed exists to serve the banks. Everything else is propaganda. Ever-expanding debt leaves America a nation of wealthy banks and increasingly impoverished debt-serfs. Cui bono, baby.

I have often identified Keynesian economists and the Federal Reserve as cargo cults. After the U.S. won World War II in the Pacific Theater, its forces left huge stockpiles of goods behind on remote South Pacific islands because it wasn’t worth taking it all back to America. After the Americans left, some islanders, nostalgic for the seemingly endless fleet of ships loaded with technological goodies, started Cargo Cults that believed magical rituals and incantations would bring the ships of “free” wealth back. Some mimicked technology by painting radio dials on rocks and using the phantom radio to “call back” the “free wealth” ships. The Keynesians are like deluded members of a Cargo Cult. They ignore the reality of debt, rising interest payments and the resulting debt-serfdom in their belief that money spent indiscriminately on friction, fraud, speculation and malinvestment will magically call back the fleet of rapid growth. To the Keynesian, a Bridge to Nowhere is equally worthy of borrowed money as a high-tech factory. They are unable to distinguish between sterile sand and fertilizer, and unable to grasp the fact that ever-rising debt leaves America a nation of wealthy banks and increasingly impoverished debt-serfs.

We have desperately tried to explain the sheer idiocy of the circular argument of the Fed 'attemping' to stimulate fiscal policy by enacting an overly permissive monetary policy, having failed miserably time after time. Perhaps the 'simplistic' argumentation of Diapason's Sean Corrigan will succeed where we have failed (although we are not holding our breath) as ne hotes, in true Orwellian fashion that 'Weakness is Strength' and "Once bailed out, always bailed out seems to be the guiding inference. Meantime, close your eyes and pray."

While still of the belief that a wholesale disintegration of the European Monetary Union remains a distinct tail-risk event, Citigroup's chief economist Willem Buiter succinctly summarizes his core view as "the euro-area will stumble and bumble towards an eventual resolution." However, that 'final' solution does not look like your grandma's European Union as he expects nothing more than a "continued Monetary Union, probably without Greece, having undergone both major sovereign debt restructurings in the periphery and financial debt restructurings for banks in the periphery and core." Transcribed from a three-minute clip, Buiter eloquently answers three key questions: How is the Euro crisis (and its consequent solution) shaping up? Does Germany have the upper-hand? and What sort of moral hazard issues might we see in the near future? He concludes "we won't have a smooth solution to this crisis."

Putting our trust and faith in a few unelected bureaucrats and bankers, who use their obscene wealth to buy off politicians in writing the laws and regulations to favor them has proven to be a death knell for our country. The captured main stream media proclaims these men to be heroes and saviors of the world, when they are truly the villains in this episode. These are the men who unleashed the frenzy of Wall Street greed and pillaging by repealing Glass Steagall, blocking Brooksley Born’s efforts to regulate derivatives, encouraging mortgage fraud, not enforcing existing regulations, and creating speculative bubbles through excessively low interest rates and making it known they would bailout recklessness. They have created an overly complex tangled financial system so they could peddle propaganda to the math challenged American public without fear of being caught in their web of lies. Big government, big banks and big legislation like Dodd/Frank and Obamacare are designed to benefit the few at the expense of the many. The system has been captured by a plutocracy of self-serving men. They don’t care about you or your children. We are only given 80 years, or so, on this earth and our purpose should be to sustain our economic and political system in a balanced way, so our children and their children have a chance at a decent life. Do you trust that is the purpose of those in power today? Should we trust the jackals and grifters who got us into this mess, to get us out?   

Expansionary monetary policy constitutes a transfer of purchasing power away from those who hold old money to whoever gets new money. This is known as the Cantillon Effect, after 18th Century economist Richard Cantillon who first proposed it. In the immediate term, as more dollars are created, each one translates to a smaller slice of all goods and services produced. How we measure this phenomenon and its size depends how we define money....  What is clear is that the dramatic expansion of the monetary base that we saw after 2008 is merely catching up with the more gradual growth of debt that took place in the 90s and 00s. While it is my hunch that overblown credit bubbles are better liquidated than reflated (not least because the reflation of a corrupt and dysfunctional financial sector entails huge moral hazard), it is true the Fed’s efforts to inflate the money supply have so far prevented a default cascade. We should expect that such initiatives will continue, not least because Bernanke has a deep intellectual investment in reflationism.

A Fight Both Liberals and Conservatives Can Rally Around ...

For months everyone was confused, like lost lambs in a sea of noise and 500x leverage, not knowing how to navigate the stormy, choppy FX seas. Now we know. For that beacon of anti-precision, the man, the myth, the legend who bats 0.000 and thus is the most certain contrarian bet in history, Goldman's Tom Stolper has spoken: "We would now recommend going long EUR/$ at current levels with a one-day stop on a close below 1.18 for an initial target of 1.30." Start your selling.

Goldman's ex-employee Mario Draghi is in a box: he knows he has to do something, but he also knows his options are very limited politically and financially. Yet he has no choice but to escalate and must surprise markets with a forceful intervention as per his words last week or else. What does that leave him? Well, according to Goldman's Huw Pill, nothing short of pulling a BOJ and announcing on Thursday that he will proceed with monetization of private assets, an event which so far only the Bank of Japan has publicly engaged in, and one which will confirm the world's relentless Japanization. From Pill: "Given the (to us) surprisingly bold tone of Mr. Draghi’s comments last week, we nevertheless think a new initiative may well be in the offing. We have argued in the past that the next step in the escalation of the ECB response would be outright purchases of private assets. Acting in this direction on Thursday would represent a significant event. We forecast the announcement of measures to permit NCBs to purchase private-sector assets under their own risk to implement ‘credit easing’, within a general framework approved by the Governing Council. This would allow purchases of unsecured bank debt and corporate debt, enabling NCBs to ease private-sector financial conditions where such support is most needed." Why would the ECB do this: "A natural objection to outright purchases of assets issued by the private sector is that they involve the assumption of too much credit risk by the ECB. But substantial risk is already assumed via credit operations." In other words, the only thing better than a little global central banker put is a whole lot global central banker put, and when every central planner is now all in, there is no longer any downside to putting in even more taxpayer risk on the table. Or so the thinking goes.

The coincidence of comments from Germany - both the Bundestag's Hasselfeldt "If a country is not in a position to fulfill its obligations, or is unwilling to, then it must leave the Euro zone"; and vice-Chancellor Philip Roesler (of the FDP) to the effect that the dangers associated with a Greek exit had faded - and the IMF (which has been suspect for a while in its 'steadfastness' with regard Greece, seem to suggest as UBS notes, that there is notable suspicion of collusion among the politicians to apply pressure to the Hellenic Republic. Against becoming too concerned there is the Realpolitik of the Euro area. Decisions about the direction of the Euro project are taken by a very small coterie of political leaders within the Euro area, and we should be concerned not necessarily because of the specifics of the comment or the associated “hardball” bargaining stance, but because politicians still feel that comments like this can be made at all without fear of repercussions. As silly season is set to begin, we should prepare for the impact of politicians need to hear themselves speak.