The Yellen "Resilience" Doctrine Is Dangerous Keynesian Blather
Submitted by David Stockman of Contra Corner blog,
Just when you thought that nothing could be worse than bubble blindness of Greenspan and Bernanke - along comes the Yellen doctrine of “resilience”. Its dangerous Keynesian blather, and far worse than Greenspan’s feigned agnosticism which held that the Fed does not have the capacity to recognize financial bubbles in the making and should therefore mop them up after they burst. The Maestro never did say exactly what caused the massive and destructive dot-com and housing bubbles which occurred on his watch - except that Chinese factory girls stacked 12-to-a-dorm-room apparently saved way too much RMB.
By contrast, Yellen’s primitive Keynesian mind knows exactly what causes financial bubbles. She has now militantly asserted that bubbles are entirely an irrational impulse in the private market and that the price of money and debt has absolutely nothing to do with financial stability. That’s right, if the Fed could find a way to peg the money market rate at negative 10% to further its self-defined dual mandate of just enough inflation and always more jobs - even then any speculative excesses would presumably be attributable to still another outbreak of the market’s alleged propensity for error, irrationality and greed.
Let’s see. If the central bank arranged to cause carry-traders to get paid 8% to borrow short-term money (i.e. on a negative 10% deposit rate) in order to fund the carry on junk bonds, Turkish construction loans and the Russell 2000, do ya think they might get a tad rambunctious? For crying out loud, when it comes to speculation, leverage, maturity transformation and re-hypothecation of financial assets the money market interest rates is “not nothing” as Yellen contends. Its everything!
That’s the heart of the matter and why Keynesian central banking is the most destructive and dangerous doctrine ever invented. In effect, it mandates central bankers to seize control of the single most important price in all of capitalism–the price of “carry” or gambling stakes in the financial markets - and then asserts that this drastic pre-emption will have no impact on the behavior of speculators, traders and investors.
That predicate is so perverse that it puts one in mind of the boy who killed his parents and then threw himself on the mercy of the courts on the grounds that he was an orphan! Keynesian central bankers like Yellen are doing exactly the same thing. Pegging the money market rate at zero for seven years amounts to killing all of the financial market’s inherent stability mechanisms.
That is to say, carry trades are made essentially risk free because the money market rate is officially pegged at zero. Moreover, the Fed has further promised to be utterly transparent in notifying gamblers as to when the spread between their funding cost and their asset yield will change, and with ample advance notice.
Furthermore, the downside risk on the asset side of the trade is also substantially removed. Owing to the long-standing Greenspan/Bernanke/Yellen “put” the cost of “protection” against sharp declines in the broad market (such as the S&P 500 index) has become dirt cheap. In effect, the Fed is massively subsidizing the cost of put options that allow speculators to insulate their risk asset positions.
Accordingly, momentum deals and carry trades are far more profitable than they would be on an honest free market because in the latter case market-priced insurance premiums would eat up far more of the winnings. Needless to say, out-sized and artificial profitability attracts massive excess capital and resources into the hedge fund and trading desk gambling arenas—–the very motor forces of financial instability.
Likewise, an essential ingredient of honest two-way financial markets is speculation from the short-side. Self-evidently, ZIRP, bond market repression and the Fed’s stock market put have driven the short interest out of the casino entirely. So now we have one-way markets that are inherently prone to powerful speculative excess.
Worse still, as one-way markets gain steam they are self-evidently prone to pro-cyclical acceleration and mania buying of anything going up solely on the grounds that rising prices beget even higher prices. Clearly that is what is happening in the C-suites today where companies are consuming all of their earnings in share repurchases in order to goose their share prices by attracting even more momentum chasers into their stock.
In this context of pro-cyclical acceleration of the bubble, “price discovery” is lost entirely, fundamentals become irrelevant and the market becomes a pure gambling arena. What all of this adds up to, of course, is massive, intensifying and dangerous financial instability.
At the end of the day, blaming the private market for financial instability is the most perverse form of statist lie that is imaginable. According to Yellen, the financial system should be made more “resilient” through strengthened “macro-prudential” policies. That’s Washington pettifoggery for more intrusive, extensive and arbitrary regulation of the financial markets.
But here’s the thing. When you sponsor a casino you should not be shocked to find that gambling is happening inside. And it is utterly naïve to assume that you can hire enough police to monitor, comprehend and regulate the amount of risk-taking that goes on among the gamblers.
Yellen has hinted, for instance, that the LBO market is getting frothy, and regulators are now proposing to limit leveraged loans to 6X EBITDA. Good luck with that! By the time regulators figure out all the “adjustments” to GAAP EBITDA, the next round of bankruptcies will already be underway.
So the clear and present danger is this: We now have two decades of financial instability and three bubble cycles that prove Keynesian central banking is the culprit. Accordingly, the way to make financial markets more “resilient” is to eliminate the central bank’s price pegging and propping policies which fuel serial bubbles and the economy impairing boom and bust cycles which go with them.
A place to start would be to repeal Humphrey-Hawkins, abolish the FOMC and let the money market rate be set by the supply of savings and the demand for funding. Once today’s Fed enabled gamblers had been laid low and purged from the system, the financial markets would take care of their own “resilience”.
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