How Central Banks Have Broken Fiscal Policy In One Sentence
By now, and certainly in the aftermath of the embarrassing US government shutdown, it has become clear to everyone that fiscal policy is terminally broken as a process through which to reform and fine-tune the economy. But far from affecting only the US, fiscal policy has failed miserably to encourage structural reform in virtually all broken European states, the bulk of which reside in the periphery but increasingly more France and also Germany. Why? A very simple reason: the Fed's shotgun monetary policy, which is rising the stock market to such unprecedented heights, it allows politicians the loophole they need to justify their irrelevance, and impotence. After all, if stocks are up who cares if the US doesn't have a budget for over 4 years. or if the Italian debt/GDP ratio is rising at a record pace, or if Spanish bad debt is accumulating at breakneck speeds, or if Greek youth unemployment is 60%+. Hey, look over there stocks, are up.
In short: if you want to blame someone for the complete breakdown in fiscal policy and the political negotiation process, blame the Fed. That much we made clear back in 2011 when instead of forcing Europe to deal with its issues on a fiscal basis, the ECB stepped in with the LTRO bazooka (and subsequently with Draghi's "whatever it takes" uberbluff) and made any structural reform unnecessary. The same has since happened in the US with QE3 and in Japan with QE Bazooko Circus.
But for now, while this decision-making hijacking process by the central banks, was largely implied, it was never explicit. Never, that, until this Friday when Italy's Prime Minister Enrico Letta came under fire from all sides over his 2014 budget proposal, which critics say has failed to attack deep-seated problems such as Italy's suffocating tax rates and lack of growth. In other words, yet another example of fiscal reform failing to promote long-term economic policies. The WSJ has more on the latest Italian budgetary failure:
Fresh from winning a confidence vote that many believed would strengthen his government, Mr. Letta was attacked by both Italy's business lobby and its unions, while former Prime Minister Mario Monti resigned as head of a small, centrist party that supports his government.
Mr. Monti criticized the budget's "timidity" in cutting taxes, a complaint echoed by business leaders.
Labor unions complained that the budget failed to extend unemployment benefits for the hundreds of thousands of workers who have been laid off during the downturn or may be next year. "Trying not to displease everybody doesn't mean pursuing the national interest," Susanna Camusso, head of CGIL, Italy's largest labor union, said.
Italian businesses pay an effective tax rate of about 68%, according to accountancy PricewaterhouseCoopers, when payroll taxes are included. Such taxes, which are almost as high for wages, produce a lose-lose situation in which companies are loath to hire and the net pay that employees earn is quite low.
The budget would cut overall business taxes by €2.7 billion ($3.7 billion). About €1.5 billion of that would go to workers in the form of lower payroll costs. But the monthly impact on the average wage earner would be worth little more than the cost of a pizza.
But however bad the proposed Itlaian budget may be, and no matter how bad, it is still orders of magnitude better than the US, which is simply unable to pass a budget, let alone one which balances, that is not the punchline. This is:
Economy Minister Fabrizio Saccomanni, a former deputy governor of the Bank of Italy, acknowledged that "more could have been done." He said political squabbling had complicated the government's work, but pointed out that that the budget keeps Italy's deficit below 3% of gross domestic product, as European Union rules require.
"Everybody hates this budget, but the stock market is up and the spread is down," Mr. Saccomanni noted.
And there you have it: no matter how bad, or non-existent a budget, a political compromise, a political proposal, a government shutdown, or a debt default threat... the market is up.
Why is the market up? Because between the Fed and the BOJ alone, some $160 billion in liquidity is created de novo each month, pushing assets to record prices around the fungible globe. Which simply means that since there is no feedback loop anymore to inform politicians that their decision-making process is just a broken, there is no impetus for any change.
And the biggest paradox is that it is the Fed whose various presidents, complain almost daily how they would promptly taper if only Washington would get its act in order, in the process proving the Fed has zero understanding of how a reflexive market process works. Because it is not Washington that is to blame that it is broken, it is the Fed... and the ECB... and the BOJ, whose monetary flood has made fiscal policy irrelevant, meaningless and moot.
The problem, obviously, is that once the Fed has no choice but to start easing off the Koolaid, whether that means S&P at 2000, 5000, 10,000 or much more, only then will the market finally awake to years of pent up fiscal policy mistakes but courtesy of the inflationary inferno that the very same central bankers will have created, there will be nobody to run to.
But that's in the future. For now, all that matters as Mr. Sack-O-Money put it, is that "the stock market is up." Nothing else matters.
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