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The Fed's Credit Channel Is Broken And Its Bathtub Economics Has Failed
Submitted by David Stockman via Contra Corner blog,
Among the many evils of monetary central planning is the conceit that 12 members of the FOMC can tweak the performance of a $17 trillion economy on virtually a month to month basis - using the crude tools of interest rate pegging and word cloud emissions (i.e. “verbal guidance”). Read the FOMC meeting minutes or the actual transcripts (with a five-year release lag) and they sound like an economic weather report. Unlike the TV weathermen, however, our monetary politburo actually endeavors to control the economic climate for the period immediately ahead.
Accordingly, the Fed is pre-occupied with utterly transient and frequently revised-away monthly release data on retail sales, housing starts, auto production, business investment, employment, inflation and the like. But its always about the latest ticks in the data - never about the larger patterns and the deeper longer-term trends.
And of course that’s the essence of the Keynesian affliction. The denizens of the Eccles Building - -overwhelmingly academics and policy apparatchiks - -rarely venture into the blooming, buzzing messiness of the real economic world. They simplistically believe, therefore, that the US economy is just a giant bathtub that must the filled to the brim with “aggregate demand” and all will be well.
Filling the economic bathtub is accomplished through something called “monetary accommodation”, which essentially means credit expansion. That is, market capitalism left to its own devices is held to have an inherently suicidal tendency toward depression - or at least chronic recessions and underperformance. As the Keynesians have it, households and businesses almost always spend too little and therefore need to be induced to become more exuberant in the shopping aisles and on the factory floor.
In this framework, the blunt instrument of artificially depressed interest rates is the natural policy tool of choice. If cautious households are saving too much for a rainy day or even their children’s education or their own retirement - - why then club them with ZIPR (zero interest rates). Get them shopping until they drop. Likewise, if businessmen are too benighted to see the case for opening another store or buying a new lift truck for their warehouse (or expanding same), bribe them with cheap debt financing.
In short, the primary route of monetary policy transmission for Keynesian central bankers is the credit expansion channel. Using that economic plumbing system they endeavor to goose aggregate demand and thereby fill the economic bathtub to its brim - otherwise known as potential output and full employment. Furthermore, by a Keynesian axiom - -the Phillips Curve trade-off between inflation and employment - there is no possibility of serious goods and services inflation until the tub is full and all capital and labor resources are fully employed.
So the whole gig amounts to a simple plumbing procedure: Keep pumping aggregate demand through the credit channel until potential GDP is fully realized because, ipso facto, that means that the Fed’s Humphrey-Hawkins mandates of price stability and maximum employment have also been achieved. At the end of the day, therefore, the Fed heads watch the ticks and blips of the “in-coming data” with such ferocious but misguided intensity because they believe their job will be done when the US economy finally reaches its brim. Just there; no more, no less.
This entire Keynesian bathtub model is nonsense, of course, not the least because the US economy is not a closed system, but functions in a rambunctious, open global economy. In that setting, massive flows of trade, investment and finance impinge heavily on prices, costs, wages and productive asset returns, and therefore the daily behavior of millions of domestic workers, businessmen, investors and financial intermediaries. Accordingly, if domestic costs and wages are too high relative to the global competition, the Fed can create “aggregate demand” to its heart’s delight, but the added borrowing and spending will leak off into incremental imports, not added domestic production and jobs.
So the Fed’s Keynesian model is fundamentally flawed - a reality that perhaps explains its stubborn adherence to policies that do not achieve their stated macro-economic objectives, but simply fuel serial financial bubbles instead. And it also explains its inability to recognize or acknowledge either untoward effect.
However, even apart from the fundamental flaws of its basic economic model, the Fed’s Keynesian pre-occupation with the economy’s mythical full-employment brim (and the short-run business cyclical fluctuations related to it) causes our monetary central planners to ignore the obvious. Namely, that the credit transmission channel is broken and done, and that the massive resort to money printing - especially since the dotcom bust in 2000 - hasn’t worked at all. In fact, massive monetary stimulus has been accompanied by sharply deteriorating economic trends.
Stated differently, the growth rate and general health of the US economy has drastically down-shifted during the last decade and one-half and now stands at only a fraction of its historic trends. Specifically, real GDP grew at a 4.0% rate during the golden age of sound money and fiscal rectitude between 1950 and 1970.
Then it dropped to about 3% during the next 30 years after Nixon defaulted on our Bretton Woods obligation to redeem the dollar in a constant weight of gold. This was an epochal move that permitted the world’s leading central bank to launch its one-time ratchet of the US economy’s leverage ratio, raising it from 1.5X national income before 1970 to 3.5X shortly after the turn of the century. The consequence was to allow the US economy to generate about $30 trillion of public and private debt beyond what would have been the case under the 100-year trend ratio that prevailed prior to 1971. This amounted to an incremental dollop of spending beyond that available from current production and income that temporarily juiced economic growth as measured by the Keynesian GDP accounts,
But since the dotcom bust in 2000 - - when the Greenspan Fed finally went all out with printing press monetary expansion - -real GDP growth has amounted to only 1.7% annually. That is just 40% of its golden age rate, and in truth probably even less if inflation were to be honestly measured by the government’s statistical mills.
Faltering growth, in turn, has meant severe job market deterioration and declining investment in productive assets. Indeed, during the last 14 years of its intense economic weather watching and money printing, the Fed has never once noticed that breadwinner jobs have declined by 5%, real net investment in business plant and equipment is down by 20% and the median household income is not only sharply lower, but actually only at levels first achieved in 1989.
Breadwinner Economy Jobs- Click to enlarge
Real Business Investment – Click to enlarge
Needless to say, these failing trends in the fundamental measures of macroeconomic health occurred at a time when the Fed’s balance sheet virtually exploded, rising from $500 billion to nearly $4.5 trillion - or by 9X - during the same 14 year period. Yet it keeps attempting to shove credit into the economy notwithstanding this self-evident failure because at the end of the day there is nothing else in its playbook.
So we have reached peak debt in both the household and business sectors. That means the fed’s massive flood of liquidity never gets out of the canyons of Wall Street, yet it nevertheless keeps the spigot wide open, and promises to do so for 80 months running at least thru mid-year 2015.
* * *
In short, believing they are filling the macroeconomic bathtub with aggregate demand and full-employment jobs, Janet Yellen and her merry band of Keynesian money printers are simply blowing chronic, giant, dangerous bubbles on Wall Street. If they are beginning to become fearful of a Wall Street hissy fit, perhaps they should look at the two charts below.
Household Leverage Ratio – Click to enlarge
Easy money is always the wrong medicine, but most especially for an economy that is already and self-evidently saturated with too much debt. In particular, the inflated and unsustainable growth that the Greenspan Fed engineered by encouraging main street households to stage a massive raid on their home ATM machines has sharply reversed, and properly so.
And this is no small number. Compared to the peak MEW (mortgage equity withdrawal) rate of 8% of disposal income, today’s negative 2% rate means there has been an approximate $1 trillion swing in household “spending”. Our Keynesian central bankers lament this as a loss of “aggregate demand” that they intend to remedy by printing more money. In truth, this was always phony demand that could not be sustained and had not been earned through production; its disappearance, therefore, marks the fact that households have been forced back to the old fashion virtue of “living within their means”.
Stated differently, the supply side is back in charge after a 30 year spree of one-time debt and leverage expansion. Consumer spending now depends on income - which means production, investment and enterprise are once again the source of growth, jobs and true national wealth.
The implication of all of this, of course,is that our monetary politburo is out of business; that “monetary accommodation” is nothing more than a one time parlor trick of central bankers. Unfortunately, like the real politburo in the Kremlin, the incumbents in the Eccles Building will not desist until they are finally chased from office by a massive uprising of the people - –that is, the savers, workers and entrepreneurs of America who have been shafted by the bubble finance policies of our monetary central planners.
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Bathtub economics. Bathing in your own filth. Genius analogy.
I pray for our country, I pray for our soldier's, I even pray for those misguided souls who sold their souls to the devil. I pray that you all know your Maker intimately, cause it's about to get VERY REAL.
God Bless and Go with God... <><
Financial emancipation bitches!*
Easy money is always the wrong medicine
Medicine? The actions of the Fed and government are not to cure a damn thing, they are a means to an end. It is the systematic theft and destruction of a nation. Anyone who mistakes these actions as 'medicine' is a damn fool. It is poison.
Correct. The FED is best understood as a seige machine, designed to conquer and kill.
Bringing down the whole thing man, into some nightmarish Orwellian total central control construct they've dreamed up, I've been saying it for years here.
Junkies always need their "medicine"...
"Easy money is always the wrong medicine" can't, by definition, be correct.
If you believe that, then you believe that tight monetarary policy is always right, and certainly there are times when tight monetary policy is the wrong prescription (sticking with the medical theme.)
There is no such a thing as 'the Fed's credit channel'
The Fed has nothing to do with credit, never did, never will
ZIPR - lulz
What's a wage/salary increase?
Wage Increase: a method by which banksters hide bad loans by increasing the debtor's ability to make repayments. Only to be used as a last resort when absolutely no other alternative is practicable. Normally the bankster just repossesses the asset and then sells it to someone else at a higher price. The effectiveness of reselling can be extended through Legislative gymnastics and derivative shenanigans, but these levers can only go so far. When they fail, the banks must begrudgingly make the debt more "affordable" without reducing the sticker price. It is then that they have to decide who should get a pay rise and how they can hide the cause and make it look as if Joe SixPack successfully negotiated the pay rise all by himself. (Hence "minimum wage rises" whereby the weakest, most defenceless workers suddenly have all this power to negotiate pay rises even though the rest of the time if they so much as think about having a toilet break the boss hits the "Classified ads - Employment" button on his speed-dial and starts perusing seek.com.)
Took me a long time to figure that one out.
Given that with electronic banking, the banks hold almost 100% of the money 100% of the time, it is now possible for the banks to collude and then identify with pinpoint accuracy which individuals hold the largest amount of debt that is closest to defaulting.
In the future, instead of handing out blanket pay rises, banks will manouvre and negotiate for certain people to be promoted in their job or given pay rises - not because the person has any talent, but because the bank wants that person to be physically able to make the repayments on their hideously large debts. Companies, being hugely in debt to the same bank, will have no choice but to do as their masters tell them. People who are carrying unusually small amounts of debt, no matter how good they are, will not get pay rises and will not be promoted, but will instead be the first to be sacked, and will not be rehired until they have accumulated a substantial debt that the banks can later on extract from their pay packets.
Oh yeah, and when I said "In the future", I actually meant, "Starting around 15 years ago".
Go ahead! Prove me wrong! I dare you!
'Chronic bubbles'....gee if only it were that benign....these insane retards are blowing pure crystal meth mixed with PCP bubbles!
They got a license for one tune PRINT
GDP growth may also have decreased because oil became less cheap. (Ah, forget it.)
Great post. The "monetary politburo" are indeed ignorant about the economic consequences of their actions. In actual fact, they're also ignorant about the fact that central banks are fundamentally bankrupt institutions.
This is taken from our contribution on the Cobden centre (renowned think tank for sound money and social progress): http://www.cobdencentre.org/2014/09/bank-run-incentive-central-bank-bank...
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We know, a priori, that all central banks are bankrupt due to a) the impossibility of making a profit in the long run, b) the virtual certainty of making a loss in the long run.
A. The Impossibility of Making a Profit in the Long Run
The central bank lends money into existence, and destroys it upon its repayment. It is impossible for more money to be repaid than is lent into existence. Therefore, it is impossible for the central bank to make a profit in the long run.
B. The Virtual Certainty of Making a Loss in the Long Run
All money lent into existence carries the risk of not being repaid. Therefore, it is virtually impossible for the central bank to recover 100% of the money it lends into existence. Therefore, it is virtually guaranteed that the central bank makes a loss in the long run.
In terms of the balance sheet (a "snapshot" of the present affairs) of the central bank, it must be the case that it its liabilities always exceed its assets, provided that the provision for doubtful debts is correctly factored in.
The title should have been wheel barrow economics
Then you could show the old German photos pushing around wheel barrows full of fiat to buy bread
Both people and governments have lived beyond their means by taking on debt they cannot repay. Over the last several decades we have created entitlement societies built on the back of the industrial revolution, technological advantages, capital accumulated from the colonial era, and the domination of global finances. Promises were made on the assumption that the advantages we enjoyed would continue.
Ever greater prosperity and entitlements were to be sustained through debt financed consumption growth. In that eerie fantasy world, debt fueled consumption was to be the catalyst to bring about evermore growth. Now reality has begun to come into focus and it is becoming apparent that this is unsustainable. The entitlements and promises that have piled up have become overwhelming. More on why this system will fail in the article below.
http://brucewilds.blogspot.com/2014/08/modern-monetary-theory-is-wrong-d...
I think the bathtub has a turd in it...
https://www.youtube.com/watch?v=TPxiXGr9nFM
More like heroin economics. Seriously bro, just one more and I will get better tomorrow.
Easy money
That is the policy the 1920's FED used, to bring on the Great Depression. Wash, rinse, repeat. The only thing different this time, is the scale. Bigger is not better.
How much in aggregate currency swaps. Debt swaps? Wife swaps? Seriously, only the IMF will be left and its drawing rights are based upon romises from the same CBs it will have to save.
Yep, that's the NWO plan. IMF drawing rights to be the new world currency, but only the elite will be permitted to posess or buy SDR's. The masses will have to make do with worthless fiat tickets, to go with their ration books.
Extremely well written, concise piece.
The best poignancy, reasoning and prose I have yet seen from Mr. Stockman.
I agree. David Stockman should be head of the Fed.
The Fed should not exist.
Too easy of a job for him.
It really doesnt matter all those pretty colored lines and shapes on the screen would mean something ..IF it wasnt all controlled by computers.. yes..the charts might show a separation between money/debt/growth..but face it..it really means nothing.
1) do you trust their numbers anyway?
2) will / can anything be done to fix it?
3) again..as long as their computers work (AND people trust/use the dollar) nothing will go wrong.
Yea..that last part I suppose is where the cracks are forming..but other than that..they have complete control.
So yea..the charts dont really seem to matter.
End of story.
Central planning would be the disease - a parasitical plague upon our society.
Pitchforks will serve as the medicine.
Man this guy has done enough work to convict the FED of treason. Good job Stockman. Now how do we arrest these fuckers?
There's a constitutional convention for that, DON"T MISS IT!
The requisite number of states have already called for a constitutional convention. Congress has failed to schedule one as required by the Constitution.
Central bankers have not a shred of decency. The only course left for a right-thinking and in-touch individual would be to admit they've made a mistake in judgement and correct themselves; this act itself would demonstrate some degree of humility but we are talking about central bankers the most corrupt and venal sub-humans on God's green Earth so expect nothing of the sort. Damn the torpedos, full speed ahead.
I've referenced these guys 100 times - will do so again. Lucas (1974) recognized the incentive distortions arriving from trying to pusuade economic growth through monetary policy. There is no real sustainable growth effects - only price effects. And without being verbose about it - to put a lid on it - James Grant said it best handing Steve Liesman his ass on the set of CNBC in December of 2013 "The FED can change what things look like, but, the FED can never change what things really are."
Always wrong; never in doubt.
They are bringing in an expert to help them create tiny bubbles
http://en.m.wikipedia.org/wiki/Don_Ho
You can't always get what you want...
So when do finally get what we NEED?
Unless and until money flows into the real economy, we cannot heal. There is 1 and only 1 semi stable solution to our situation and it will piss people off, but the G3 currencies HAVE to lose a LOT of value versus the RMB.
This post makes me feel like I'm breathing fresh air and helps a lot with that uneasy feeling that something just isn't right. Even though a ton is wrong on main street, when points line up with a ring of truth it definitely helps guide the things I am going to do.
I couldn't agree more that living within one's means is the way. I also have a good feeling about the supply side being in charge though I can't identify the components of what that means (I'd love some ZH help on this)
And since obviously the savers, workers, and entrepreners won't be acting in mob fashion in chasing the politboro out of the fed in person, but voting "with their feet" by their action, what is most effective course so we can minimize wasted effort and concentrate on our production?
Sooner or later the toilet plunger has to come out.
David Stockman has writen a great book "The Great Deformation", similar to this (only longer) read it and weep for the USA ( and anyone who trades with her... or shares a planet with her)
Once again, thank you so much Mr Stockman for those explanations. To all, read his book : the great deformation.