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According To Bank of America, This Is "The Biggest Risk To Global Equities"

Tyler Durden's picture




 

On Monday evening we brought you “Bank Of America Begins 66-Day Countdown Until The 'Ghost Of 1937'" Returns,” in which we discussed why, if history is any guide, a rate hike cycle will be a disaster for equities. As a refresher, here’s the narrative:

Put simply, central bank's provision of liquidity for financial markets has been unprecedented. The extent of Wall Street addiction to liquidity is about to be revealed and the potential for unintended consequences is clearly high.

 

Which is not to say that attempts to "renormalize" rates are unheard of: previously both Israel and the RBNZ tried it and failed, with markets promptly forcing them to reverse tightening.

 

More notably, it was the ECB itself which in April of 2011 tried to halt Chinese inflation exports in their tracks, and pulled off one rate hike... before the wheels came off and Europe promptly entered a double dip recession.

 

But no episode is more notable than what happened in the US in 1937, smack in the middle of the Great Depression. This is the only time in US history which is analogous to what the Fed will attempt to do later this year, and not only because short rates collapsed to zero between 1929-36 but because the Fed’s balance sheet jumped from 5% to 20% of GDP to offset the Great Depression. Just like now. And then, briefly, the economy started to improve superficially, just like now, and as a result the Fed tightened in a series of three steps between Aug’36 & May’37, doubling reserve requirements from $3bn to $6bn, causing 3-month rates to jump from 0.1% in Dec’36 to 0.7% in April’37. As Bank of America notes, this didn’t end well: "The Fed exit strategy completely failed as the money supply immediately contracted; Fed tightening in H1’37 was followed in H2’37 by a severe recession and a 49% collapse in the Dow Jones."

 


So, now that Janet Yellen has the green light for liftoff courtesy of the BEA, Steve Liesman, and her friends at the San Francisco Fed, who have conspired to pass off an epic perversion of statistical analysis as a legitimate attempt to do away with what they would like the public to believe is a statistical aberration called “residual seasonality”, we can now look nervously towards mid-2016 when, after rates have been hiked by a total of 50bps or so, the elusive correction will finally come, only instead of a “healthy” 10% move to the downside, it may well be a gut wrenching, QE4-inducing firesale. 

But if the Fed does use a post-hike recessionary tailspin as an excuse to implement yet another round of bond buying (which should please the Boston Fed who, you'll recall, thinks QE should be moved from the "unconventional" policy toolbox into the bin labeled "use as necessary to micromanage business cycle"), expect the diminishing returns which everyone has now become accustomed to associating with QE to be readily apparent. Here's BofAML on why "another round of QE [is] the biggest risk to global equities":

While most are focused on the risks around a withdrawal of liquidity, we believe the biggest hit to confidence could be the opposite: if another round of US QE is necessary to prop up the economy. While the market could have a knee-jerk rally on an indication of forthcoming stimulus, we think this would likely be short-lived and could end in the red. QE fatigue is already evident: each subsequent round of QE has seen diminishing risk rallies. Another round of QE would imply that $4.5tn was not enough. And it would also likely have a very negative read-through for QE programs currently underway in Europe and Japan.

In other words, the Fed is cornered.

Normalizing policy rates could well risk destabilizing financial markets and the economy, both of which are addicted to central bank liquidity and haven't seen a rate hike in nearly a decade. But because the Fed needs to at least be able to say it tried to pull off an exit, the FOMC will gingerly tighten until it sees evidence that the wheels are coming off.

At that point, the addict will fall off the wagon as the Fed delivers a fresh dose of monetary heroin. The addict, having developed a tolerance, will not respond as planned, necessitating still more QE as the Fed chases the dragon while the BoJ and ECB watch in horror as the future of PSPP and Abenomics suddenly becomes crystal clear.

As for what happens next, we'll reiterate our warning from Monday: "If the S&P is cut in half the Fed will launch not just QE4, but 5, 6 and so on, resulting in every other central bank doing the same as global currency war goes nuclear, and the race to the final currency collapse enters its final lap."

 

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Tue, 06/16/2015 - 13:33 | 6202487 Duc888
Duc888's picture

 

 

 

Reset and a haircut, get ready.

Tue, 06/16/2015 - 13:51 | 6202546 NoDebt
NoDebt's picture

"While most are focussed on the risks around a withdrawal of liquidity, we believe the biggest hit to confidence could be the opposite: if another round of US QE is necessary to prop up the economy."

We'll jump off that bridge when we come to it.

- Peter King

Tue, 06/16/2015 - 13:54 | 6202553 suteibu
suteibu's picture

Hilarious.  I would emend it to say "You will jump off that bridge when we come to it." 

Tue, 06/16/2015 - 15:12 | 6202921 MonetaryApostate
MonetaryApostate's picture

According to banksters........!

Tue, 06/16/2015 - 17:17 | 6203325 Boris Alatovkrap
Boris Alatovkrap's picture

Biggest risk to Global Equity is Global Bankster.

Tue, 06/16/2015 - 13:56 | 6202560 Dr. Engali
Dr. Engali's picture

Mmmmmmmm......reubens. 

Tue, 06/16/2015 - 13:56 | 6202571 upWising
upWising's picture

"We will collateralize the bonds on that bridge several times, and then we will blow it up."

––Upwising

Tue, 06/16/2015 - 17:26 | 6203342 ZH Snob
ZH Snob's picture

CBs have no choice but to print their way to hyperinflation.  Up till now they've able to contain it, buying up all the bad debt from their tentacle banks, but deflation is beginning to and will continue to make them print in ever greater amounts.  The irony of their predicament is economic science in action, a beautiful thing to observe. 

It's QE and ZIRP 4ever, whether they like it or not.  In this respect, although they admire their own brilliance, they are revealed as hack technicians who've painted themselves in to a corner, left to obey forces way beyond their understanding or control. 

Tue, 06/16/2015 - 13:35 | 6202493 matinee55
matinee55's picture

just get the bought msm to lie some more

Tue, 06/16/2015 - 13:38 | 6202497 Charles Nelson ...
Charles Nelson Reilly's picture

The Fed has been cornered since the day they embarked on their QE policies.  It's all about saving the banks and screwing the taxpayers.  But hey, Hillary or Jeb will fight for the middle class.

I'm continually astonished at the bullshit americans not only gulp down, but actually promote.

Tue, 06/16/2015 - 14:18 | 6202646 lasvegaspersona
lasvegaspersona's picture

But now we have.....The Donald...I think....could not understand much of his announcement speech.

Tue, 06/16/2015 - 15:23 | 6202985 daveO
daveO's picture

Perot 2.0. Another establishment president by plurality.

Tue, 06/16/2015 - 15:30 | 6203007 shastatodd
shastatodd's picture

nah... its about trying to have infinite growth on a fininte planet, which doesnt end well

Tue, 06/16/2015 - 17:17 | 6203324 MonetaryApostate
MonetaryApostate's picture

The problem is most people have finite thinking, especially scientist, and that's where everyone goes wrong...

There are solutions but few people are smart enough to either create them or find them...

Wed, 06/17/2015 - 01:54 | 6204633 poldark
poldark's picture

I am also amazed at the bullshit the Europeans swallow.

Wed, 06/17/2015 - 02:14 | 6204652 hedgiex
hedgiex's picture

Not only Americans

Tue, 06/16/2015 - 13:37 | 6202506 Commodore64
Commodore64's picture

must manipulate.....must manipulate....

Tue, 06/16/2015 - 13:38 | 6202507 kchrisc
kchrisc's picture

Zion and their banksters are engineering the situation so that it IS beneficial for the FedRes to raise rates.

Unless one thinks the dollar is up on strength, and all the jawboning "honesty about the FedRes in recent months was truth.

"The plunder must go on."

Liberty is a demand. Tyranny is submission.

Tue, 06/16/2015 - 14:13 | 6202627 Kirk2NCC1701
Kirk2NCC1701's picture

The plunder will go on.  Cause people are sheeple.

I'd plan accordingly.

Tue, 06/16/2015 - 14:18 | 6202638 kchrisc
kchrisc's picture

When the sheeple get hungry and cold from all of the fleecing, they will awaken.

People like me will be there to steer them in the right direction as to who, how, and why.

Liberty is a demand. Tyranny is submission.

 

All was fine with the sheeple for Loise the XVI, until it wasn't.

Tue, 06/16/2015 - 17:20 | 6203332 MonetaryApostate
MonetaryApostate's picture

I'm afraid the sheep of the east are not only awake, but arming as we speak...

http://www.bbc.com/news/world-europe-33153703

Tue, 06/16/2015 - 13:40 | 6202513 TruthBeforeAll
TruthBeforeAll's picture

I'm sorry, but you didn't answer in the form of a question.

Tue, 06/16/2015 - 13:41 | 6202516 TheRideNeverEnds
TheRideNeverEnds's picture

The biggest risk in equities right now is that you don't own enough Netflix before it passes per share the price of an ounce of gold by sometime next year.

Tue, 06/16/2015 - 13:48 | 6202534 NoDebt
NoDebt's picture

Well said.

Tue, 06/16/2015 - 13:57 | 6202564 cn13
cn13's picture

Talk about biting the hand that feeds you.

BOA would no longer exist if it wasn't for illegal FED intervention to keep them solvent in 2008-09.

Tue, 06/16/2015 - 13:56 | 6202567 cordial savage
cordial savage's picture

Ok, fine, but BofA gave zero estimate of how likely QE4 is in their eyes.  I read their release yesterday, and they point out that this isn't their base case, but there's no hint of probability.  Not that they'd be accurate anyways, but hell, if you're going to throw this nonsense around, at least have some odds.

Tue, 06/16/2015 - 14:23 | 6202678 ThroxxOfVron
ThroxxOfVron's picture

"I read their release yesterday, and they point out that this isn't their base case, but there's no hint of probability.  Not that they'd be accurate anyways, but hell, if you're going to throw this nonsense around, at least have some odds. "

Odds?  

1.  This is a crooked casino.  Odds are almost 100% that you are gonna get shucked like corn in here.

2. You want Red or Black?  ( hand reaches towards two buttons under the edge of the table )

Tue, 06/16/2015 - 14:00 | 6202578 Dr. Engali
Dr. Engali's picture

When the time comes there will be a false flag big enough to pin the vaporization of the casino on. The blame will never fall on the fed.

Tue, 06/16/2015 - 14:03 | 6202588 madbraz
madbraz's picture

according to Bank of America, we are crooks

Tue, 06/16/2015 - 14:03 | 6202593 madcows
madcows's picture

Ok ok ok.  Got it.  Free money is now BAD for the economy.  It WAS good.  Now it's Bad.  Boy, fucking make up your minds already.

Tue, 06/16/2015 - 14:13 | 6202628 NoDebt
NoDebt's picture

Don't let the rhetoric fool you.  It has nothing to do with the economy.  For certain interests, more money is always good.  I'll leave you to ponder who those interests might be.

Tue, 06/16/2015 - 14:10 | 6202616 CarpetShag
CarpetShag's picture

Fuck them all with the wrong end of a pineapple.

Tue, 06/16/2015 - 14:34 | 6202729 TrustbutVerify
TrustbutVerify's picture

Is there a 'right end' of a pineapple?

Tue, 06/16/2015 - 14:58 | 6202859 CarpetShag
CarpetShag's picture

The one you don't sit on.

Tue, 06/16/2015 - 14:11 | 6202617 kizell
kizell's picture

Peter schiff was right about one thing.   The anxiety that is persisting over an extremely low interest rate hike is very indicative about the state of market confidence.

Tue, 06/16/2015 - 14:45 | 6202784 agstacks
agstacks's picture

He also said there'd be more QE's than Rocky movies. Looking like that might come through as well. 

Tue, 06/16/2015 - 17:21 | 6203308 BrosephStiglitz
BrosephStiglitz's picture

It depends, doesn't it.  It's more complex than Schiff makes it out, though he does put forward one credible scenario.

Interest rates could rise for multiple reasons (probably related) such as*:
- Runaway inflation. 
- Capital flight. 
- Contagion of fear amongst creditors, who then demand a premium for their loans.

Suffice to say, high interest rates appear to be a function of both strength and weakness (see: Russia, where the currency collapse risk becomes serious and rates get hiked, gutting the local banking system and highly leveraged corporations.)

We are going to see some wicked volatility around the corner and a definite lack of liquidity.  The two, again, are related.  As Kyle Bass said (paraphrasing).. 5-lane highway into a market during a boom, goat trail coming out.  This time it might be a 7-lane highway going in and a tightrope coming out.

Edit: The real questions are .. "When the shit hits the fan, do the central banks lose control?"  My bet is yes.  Follow that up with, "When the central banks lose control, which fire will be the largest and most destructive?" and "How do bodies with a mandate to combat said fires respond?"

*All of these have both internal and external components, which vary on a nation by nation basis.  Including the US.  Schiff takes an internal view, and there is nothing wrong with that, he could well be right.  He also might be surprised by some unforeseen external factor which bitchslaps the Fed out of nowhere.

Tue, 06/16/2015 - 14:21 | 6202665 DerdyBulls
DerdyBulls's picture

This is such crap. There will be no change to easy money policy or a rate hike. That exposes the monster for what it is.

Tue, 06/16/2015 - 14:38 | 6202746 Midnight Rider
Midnight Rider's picture

I think the bigger point here is that it doesn't really matter what they do. The economy will ultimately tank taking the financial markets with it. It's only a matter of when.

Tue, 06/16/2015 - 15:35 | 6203017 daveO
daveO's picture

The markets no longer represent the econ. They haven't since 2009 at 666! The economy can continue it's slow decline while CEO's continue buybacks, comrade. As the outstanding shares decline, the manipulation gets easier. The market will grind to a halt when there's nothing left to buyback, just after the FED buys the last share. Markets aren't needed in a centrally planned economy comrade.  

Tue, 06/16/2015 - 14:33 | 6202710 bankonzhongguo
bankonzhongguo's picture

One thing I have not heard much about are the revised rules for accredited investors as part of Reg A of that JOBS Act thing.

I thought the master plan was to crash the larger markets and drive everyone into this new bubble machine where Kickstarter meets the Fed's printing press.

When any moron with a YouTube video and a penny stock idea can raise $50MM, it seems pretty likely this is the new failed bubble to suck up all that money.

Also, the Democrats need to win the 2016 election, so it seems to me their best policy is to make markets personally euphoric for the common man until 2017.

Like i said, I have heard very little about how that transition is moving, which tells me its moving.

 

Tue, 06/16/2015 - 14:34 | 6202713 YHC-FTSE
YHC-FTSE's picture

I don't think it will be just about equities since currency, bonds, derivatives and commodities will be affected across the board. A rate hike in concert with a sudden Grexit (Yeah I know, they are most likely to kick the can instead but you never know) will probably be an irreversible break to the bottom.

The thing about crying wolf is that eventually it really is the wolf chomping down on your face. Considering a ~35% chance of a Grexit + the very high chances of a batshit crazy contagion across every bank holding active derivatives in play as issuers and buyers + untenable debts which the rate hikes will batter + lack of real liquidity other than the printers + the end of the oil/dollar cycle + the blatant fact that the Fed is the market, I've personally sounded defcon2 as far as my meager personal finances are concerned. I'm not advocating anyone do the same, since we're probably all tired of crying wolf about a systemic collapse of the financial system, but merely declaring what I am doing about it. I have closed all managed funds in the system, lost all my PMs in a boating accident, have cash reserves to last a few months, got a nice little larder growing in my garden and quite woeful contingency plans for civil disorder (But it's better than nothing).

When the real shit hits the fan, the markets are less than half their value and QE infinity starts revving its engine, there will be countries which will judge the sweet spot moment and declare that they are not playing this game to the bottom any more. I'm referring to countries which have been shoring up with gold for just this eventuality. The Swiss already did that with the Euro remember? That's when, in all likelihood, it may seriously go into Zimbabwe quadrillion dollar territory for the reserve currency. Whether we like it or not, the system is set up so that the casino markets are the be all and end all of the economy, so once that goes, it's the end of the liars and fantasists who have been propping up the whole edifice to commit wholesale theft from the public. Shitstorm, Bloodbath, Armageddon, Blessed relief, High Justice - whatever you want to call it, it MAY BE coming to a high street near you. The wealthy have not been buying up bunkers for nothing doncha know?

Tue, 06/16/2015 - 14:33 | 6202718 TrustbutVerify
TrustbutVerify's picture

5 basis points. 

Tue, 06/16/2015 - 14:41 | 6202763 Paracelsus
Paracelsus's picture

Greek 2 yr now 28%. This is closer to realistic pricing of risk.

On Wall Street they need to put up a dozen rusty guillotines alongside the bronze bull.

People never think about high risk/high yield until it is too late.

The market would have worked in 2008 if it had been given a chance.

Almost every major war has been started by an economic crash.

Put the Bankers in the dock for war crimes next time.

Tue, 06/16/2015 - 14:47 | 6202794 lester1
lester1's picture

I can tell some people here have been listening to Peter Schiff's podcasts.

Tue, 06/16/2015 - 14:52 | 6202819 Atlas Crapped
Atlas Crapped's picture

Earth to Hedge, uh ... we didn't have 200 trillion in interest rate derivatives back in 1937 ...
http://roacheforque.blogspot.com/2015/06/the-feds-rate-hike-narrative.html

Tue, 06/16/2015 - 17:27 | 6203365 BrosephStiglitz
BrosephStiglitz's picture

Right because no bank, central bank or government ever went bankrupt.

Tue, 06/16/2015 - 14:52 | 6202822 MEFOBILLS
MEFOBILLS's picture

Words are used to convey information, so what the hell does this following statement really mean?:

 

“Put simply, central bank's provision of liquidity for financial markets has been unprecedented. The extent of Wall Street addiction to liquidity is about to be revealed and the potential for unintended consequences is clearly high.”

Liquidity means something that moves easily.  General purchasing power, meaning money is “pay to the bearer upon demand.”  A TBill is really a misnomer, it is a bond.  All bonds have a time series to them, a temporal dimension.   Later, the bond can be redeemed, so the money returns back to the bond holder.

If a TBill is NEWLY issued with deficit spending, then it will find QE keyboard money from the FED.  Despite what economists say, FED QE keyboard money does have a transmission mechanism via TBTF banks, especially if TBTF banks take out a loan to buy Bill from primary market.  The loan is then discharged when Bill enters reserve loops, and then finally expands FED balance sheet.

Deficit spending expands M1, where it can be used to stimulate the lower loop of savers, labor, middle class, and transaction economy.  QE is not deficit spending.  QE is not deficit spending.  QE is not deficit spending.  Get it.

QE directed at EXISTING TBILLS (not new ones), does not make new money.  It changes the composition of existing money supply to less debt instruments and more general purchasing power.  Existing TBIlls are often found in Shadow banks, and then their basis for making loans collapses, making even less bank credit available for small business.  Witness GE exiting the shadow bank financial market.

 This general purchasing power (QE keyboard money) generally enters into financial markets, and chases after gains.  Or, it gets stuck in bank reserve loops, especially now that the fed “pays” for cash.  Now, there is a mental gymnastic move that only money masters can appreciate:  paying interest to bankers for cash held as reserves, to then prevent an overnight market rate collapse to zero.  Oh the lies we weave when we intend to deceive.

A bond holder looking to make interest, and to then convert bond to non-interest bearing general purchasing power, means that former debt holder will just go looking for more financial gains elsewhere.  QE then goes straight to the casino, it channels in unproductive paths, and creates Oligarchy.  QE rewards finance capitalism.  The first rounds of QE created a huge carry trade.  I guess economists were asleep while that happened?   Carry trades are giant rent schemes.

 Oh, where to make gains, asks former debt holder?  Perhaps the stock market, maybe.  Nah – there is no evidence of that is there?  Perhaps inventing even more creative ways to fleece the sheeple, like Insurance rate swaps, and other derivatives?  Nah, finance wouldn’t do that, create more debt instruments or worthless paper to shovel at each other and then try to make even MORE claims on the real economy.

Meanwhile, the real transaction economy is starving for real investment.  The Casino looks down and says, we might rain down some of our stolen rentier gains, but only if you offer your goods and wares cheap, we know you are in depression, and we like our commanding heights won through control fraud and theft.

With this fraudulent credit system it impossible to have real price discover in markets, when the money itself is unstable. Bank money credit, which comes into existence with a debt instrument mirror is unstable and usurious. If any Chicago School Monetarist reads this comment, and says that money is a neutral veil, and that markets do natural discovery, please check your-self into the local psycho ward.  Oh wait, your are the main defenders of debt money systems, because..guess what, you are under direct money influence of the tribe. So maybe you are not psycho, just evil.  Confuse the sheeple and take rents is your motto, the action of a parasite.

Maybe it is a step to far to ask to chunk western fraudulent debt money system onto the ash bin of history, but hey - what about haircutting onerous debts.  There are fraudulent conveyance laws on the books.  How about exercising the law?  Oh wait, you politicians are bought and paid for.

Or, how about real direct spending into productivity channels, instead of rewarding the Casino.

 

Economists and politicians, pull your head out of your ass.  There will be revolution if you continue to ignore how the money system really works.

Tue, 06/16/2015 - 14:57 | 6202852 Atlas Crapped
Atlas Crapped's picture

"Or, how about real direct spending into productivity channels, instead of rewarding the Casino."

Look Eastward for that ... it cometh as we transition from a debt based to an equity based system.

Tue, 06/16/2015 - 15:52 | 6203062 daveO
daveO's picture

The Rep's signed off on the debt ceiling increase in 2011 and got even more elected in 2012! My CONgress critter voted for the debt ceiling increase, but against the budget, and was reelected with nearly 2/3rd's. The dollar will collapse first.

Wed, 06/17/2015 - 02:17 | 6204654 hedgiex
hedgiex's picture

LOL. Chicago School dancing with seven veils ? Now you see now you don't.

Tue, 06/16/2015 - 15:00 | 6202868 JenkinsLane
JenkinsLane's picture

Still, on the plus side, the future is not going to be dull.

Tue, 06/16/2015 - 17:15 | 6203316 Handful of Dust
Handful of Dust's picture
Target Stores Insolvency Biggest In Canadian Retail History

 

http://www.mondaq.com/article.asp?articleid=402160&email_access=on

Tue, 06/16/2015 - 17:24 | 6203355 venturen
venturen's picture

be worried when your bank send you a nail gun!

Tue, 06/16/2015 - 17:27 | 6203368 Bighorn_100b
Bighorn_100b's picture

OT maybe: What if the biggest bank in the world was not a public company?

What if the Vatician, Catholics were to blame and fund ISIS or ISIL for some unknown reason?

Have they not started wars before?

They do have a rather large private bank. Assets all over the world and dropping membership.

Just trying to think outside the box. Don't kill me.

Tue, 06/16/2015 - 17:41 | 6203407 mt paul
mt paul's picture

Starve the beast

 

stop spending fiat dollars

velocity, or lack of

will slay the beast

Wed, 06/17/2015 - 02:00 | 6204639 talisman
talisman's picture

I really dont spend much in the way of fiat dollars.....
mostly I just bounce electrons around in my computer for stuff 
and keep wondering how Big Banking manages to juggle
their $200++Trillion dollars in derivatives exposure ???

from ZH left hand menu "Demonocracy":
http://demonocracy.info/infographics/usa/derivatives/bank_exposure.html

 

Tue, 06/16/2015 - 18:14 | 6203522 HopefulCynical
HopefulCynical's picture

"If the S&P is cut in half the Fed will launch not just QE4, but 5, 6 and so on, resulting in every other central bank doing the same as global currency war goes nuclear, and the race to the final currency collapse enters its final lap."

Which destroys the governments of all nations, ushers in the one-world currency, the one-world order, and the supremacy of Banksters overe the whole of the Earth.

NONE OF THIS SHIT is by accident. This has been the plan all along. I'm guessing either ol' Mayer Amschel hisself, or his rotten psychopath kids, cooked this one up hundreds of years ago.

Delusions of Deity + Belief in tribal superiority - any form of conscience = the most potent threat humanity has ever faced.

Tue, 06/16/2015 - 20:57 | 6204033 polo007
polo007's picture

According to Bank of America Merrill Lynch:

http://personal.crocodoc.com/AwP30H2

The Fed and income inequality

Don’t stop ‘til you get it on

Critics of the Fed argue that by stimulating asset markets easy Fed policy is benefiting upper income families, but not helping people who do not own assets. In reality, the biggest impact of easy Fed policy is to speed the drop in the share of the population that are unemployed and hence have zero labor income—the most pernicious instance of inequality. The Fed cannot fix the long-run trend toward income inequality, but it can reverse the recession-induced increase by ensuring a full recovery in the job market, normal wage growth and then—and only then—a return to normal interest rates.

Reverse Robin Hood

Critics of Fed policy have offered an ever evolving list of complaints: the Fed is risking runaway inflation, a collapse in the dollar, massive asset bubbles, and damaging people on interest income. The latest: the Fed is causing income inequality. Fed has caused a big stimulus to asset markets, but no real stimulus to the economy. Hence, the only beneficiaries of Fed policy have been upper income families with large asset holdings, leaving the average Joe behind. The Fed should normalize policy ASAP.

Ben blogs back

The latest counter argument comes from Ben Bernanke’s blog and several papers from Brookings. Bernanke points out that widening inequality is a very long-run trend and the impact of monetary policy is small and ambiguous. Easy policy does stimulate asset markets, favoring the rich, but this is more than offset by the stimulus to the labor market. Easy policy also benefits the middle class by raising asset values for the 60% of families that own their own home. Finally, by pushing up inflation Fed policy benefits debtors—lowering real repayment costs—over creditors, and debtors tend to have lower income than creditors.

Cutting off your nose to spite your face

In our view, if anything, Bernanke is being too generous to his critics. There are two big stories at play. First, monetary policy doesn’t push the economy back to full employment by magic; it does it by stimulating asset markets, bank lending and confidence. Hence, monetary policy cannot stimulate growth without rewarding asset holders. (By contrast, fiscal policy can target low income people.) Moreover, in each business cycle, the profit share of income surges at the start of the recovery and then fades in the second half of the recovery as the unemployment rate drops and workers acquire wage negotiating power (Chart 1). Advocates of an early Fed exit are in effect telling the Fed: “stop trying to get the economy to the second stage of the business cycle recovery when profit growth slows and wages accelerate.”

The second even bigger story here is that there is no better way to reverse a cyclical deterioration in income distribution than to quickly restore full employment. Unemployed people by definition have no labor income and rely purely on government help or investment income. Hence, in most cases, unemployment pushes workers into the bottom of the income distribution. Thus, the main cause of the cyclical increase in income inequality was not that wages were weak relative to investment income, but rather that the unemployment rate surged from 4.4% in mid-2007 to a peak of 10.0% in October 2009. The reversal back to 5.4% means 4.6% of people actively looking for a job are no longer earning zero labor income.

Taking this a step further, the cyclical drop in the unemployment rate—as always—has disproportionately benefited disadvantaged groups (Table 1). The unemployment rate for teens has dropped more than for prime age workers, rates for Blacks and Hispanics have dropped more than for Whites and Asians, and rates for people with a high school degree or less have dropped more than those with a college diploma. The share of workers in part-time jobs has dropped and the share of long-term unemployed has also dropped. These disadvantaged groups are still worse off than the average person, but the gap has shrunk back toward more normal levels. Why would the Fed want to abort this process?

Wed, 06/17/2015 - 01:25 | 6204604 polo007
polo007's picture

According to the International Monetary Fund:

http://www.imf.org/external/pubs/ft/sdn/2015/sdn1513.pdf

Causes and Consequences of Income Inequality: A Global Perspective

EXECUTIVE SUMMARY

We should measure the health of our society not at its apex, but at its base.” Andrew Jackson

Widening income inequality is the defining challenge of our time. In advanced economies, the gap between the rich and poor is at its highest level in decades. Inequality trends have been more mixed in emerging markets and developing countries (EMDCsf), with some countries experiencing declining inequality, but pervasive inequities in access to education, health care, and finance remain. Not surprisingly then, the extent of inequality, its drivers, and what to do about it have become some of the most hotly debated issues by policymakers and researchers alike. Against this background, the objective of this paper is two-fold.

First, we show why policymakers need to focus on the poor and the middle class. Earlier IMF work has shown that income inequality matters for growth and its sustainability. Our analysis suggests that the income distribution itself matters for growth as well. Specifically, if the income share of the top 20 percent (the rich) increases, then GDP growth actually declines over the medium term, suggesting that the benefits do not trickle down. In contrast, an increase in the income share of the bottom 20 percent (the poor) is associated with higher GDP growth. The poor and the middle class matter the most for growth via a number of interrelated economic, social, and political channels.

Second, we investigate what explains the divergent trends in inequality developments across advanced economies and EMDCs, with a particular focus on the poor and the middle class. While most existing studies have focused on advanced countries and looked at the drivers of the Gini coefficient and the income of the rich, this study explores a more diverse group of countries and pays particular attention to the income shares of the poor and the middle class—the main engines of growth. Our analysis suggests that

- Technological progress and the resulting rise in the skill premium (positives for growth and productivity) and the decline of some labor market institutions have contributed to inequality in both advanced economies and EMDCs. Globalization has played a smaller but reinforcing role. Interestingly, we find that rising skill premium is associated with widening income disparities in advanced countries, while financial deepening is associated with rising inequality in EMDCs, suggesting scope for policies that promote financial inclusion.

- Policies that focus on the poor and the middle class can mitigate inequality. Irrespective of the level of economic development, better access to education and health care and well-targeted social policies, while ensuring that labor market institutions do not excessively penalize the poor, can help raise the income share for the poor and the middle class.

- There is no one-size-fits-all approach to tackling inequality. The nature of appropriate policies depends on the underlying drivers and country-specific policy and institutional settings. In advanced economies, policies should focus on reforms to increase human capital and skills, coupled with making tax systems more progressive. In EMDCs, ensuring financial deepening is accompanied with greater financial inclusion and creating incentives for lowering informality would be important. More generally, complementarities between growth and income equality objectives suggest that policies aimed at raising average living standards can also influence the distribution of income and ensure a more inclusive prosperity.

Wed, 06/17/2015 - 02:06 | 6204645 polo007
polo007's picture

According to Natixis:

http://cib.natixis.com/flushdoc.aspx?id=85583

Public debt ratios must be reduced, but how?

The high level of public debt is a permanent threat to growth: if interest rates rise, rapid tax increases or government spending cuts would be needed, with the risk of creating tax distortions and reducing potential growth. This threat may also drive private economic agents to build up precautionary savings.

It would therefore be very positive to reduce public debt ratios, but how?

- By keeping long-term interest rates lower than nominal growth, although this reduces the public debt ratio extremely slowly. In addition, it is dangerous from a financial stability point of view and may generate negative incentive effects;

- By monetising the public debt, i.e. by transferring it to the central bank’s balance sheet, and by cancelling it (actually or de facto); but one must then accept the risks linked to chronic excess monetary creation;

- By considerably extending the maturity of the public debt, by replacing it with bonds with a very long maturity (50 years, 100 years, perpetuity), by taking advantage of the very low level of long-term interest rates. This would considerably reduce the interest rate risk weighing on the public debt. The criticism often levelled against this method is that it shifts the burden of repayment to future generations;

- A more original approach: by cancelling the part of the public debt held by residents; there is then de facto neutrality: on the one hand, the residents receive interest on the government bonds they hold and, on the other hand, they pay taxes that finance the interest on these bonds. The cancellation of the debt eliminates both the interest on the debt held domestically and the taxes that finance it, resulting in macroeconomic profitability. The redistributive effects of this debt cancellation will still have to be corrected, which is possible. We obviously know that this possibility will never be used.

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