“If one has been a financial genius, faith in one’s genius does not dissolve at once.”
John Kenneth Galbraith
Watching the jobs numbers this week, one is tempted to say “told you so” with respect to those analysts who are pounding the table for the US economy. Who can look at expanding investor bubbles in asset classes like housing assets or even auto paper, and conclude that the real economy is on the mend? As one analyst said last week, the housing market has recovered but the mortgage sector has not.
The explosive growth in subprime auto paper is especially notable since it reflects a deliberate downward move in credit targets to boost sales in an irrational industry. Most auto producers don’t even hit their cost of capital in terms of equity returns in a normal market. The expansion of auto sales volumes via growth in subprime debt issuance is one of the least followed big stories of 2013. “Irrational exuberance” somehow does not quite do this situation justice.
As with the mortgage market in 2007, nobody at the Fed has taken public notice of the mid-double digit growth in auto securitizations over the past several years. Indeed, the Fed views the expansion of consumer debt as a measure of success. There may not be any real growth in jobs or income, so the Fed economists seem to believe, but we can borrow our way to prosperity. No surprise then that the neo-Keynesian socialists who populate the majority on the Federal Open Market Committee assert that buying RMBS and Treasury paper is somehow going to spur the real economy to recover in terms of jobs and, magically, without stoking domestic inflation.
David Kotok of Cumberland Advisors noted in a comment this week:
“When the Weimar Republic attempted to meet international flow requirements under the Treaty of Versailles, it did not immediately cause hyperinflation. The process started with currency expansion and banking manipulation in an attempt to manage foreign-exchange flows. It ended with hyperinflation, the demise of the government, and the rise of Nazism in Europe. Thus, the European contagion did not begin with the fall of the government and rise of Hitler in the 1930s; it started years earlier.”
The overtly inflationary policy stance of the FOMC is especially significant when you consider that Fed Chairman Ben Bernanke is no longer in control of monetary policy. The Greenspan protégé is now outnumbered by appointees of President Obama, who would gladly hyperinflate the US economy in order to protect their short-term political interests. The fact that most investors have acquiesced to this policy direction is reflected in credit spreads, which are now at the tightest levels since the 2007 meltdown. As Rick Santelli at CNBC correctly notes, “the rotation” is back into bonds kiddies so long as confidence is maintained.
Irving Fisher, the man labeled by Milton Friedman and John Maynard Keynes (correctly in my view) as the greatest US economist of the early 20th Century, famously pronounced in the fall of 1929 that all economic restraints on unlimited future growth had been eliminated. Two years later he wrote the definitive essay on how to unwind a debt contraction deflation, but EVERYONE best remembers him for that 1929 bull market call.
The arrogance of the reflationist majority on the FOMC is proportionate to the exuberance which temporarily blinded Fisher and his contemporaries in the late 1920s, and also economists in the 1990s and 2000s. Robert Shiller wrote in his 2005 book “Irrational Exuberance” about the psychology of bubbles:
“Many perceptive people were remarking, as the great surge in the stock market of the 1990s continued, that there was something palpably irrational in the air, and yet the nature of the irrationality was subtle. There was not the kind of investor euphoria or madness described by some storytellers, who chronicled earlier speculative excesses like the stock market boom of the 1920s. Perhaps those storytellers were embellishing the story. Irrational exuberance is not that crazy. The once-popular terms speculative mania or speculative orgy seemed too strong to describe what we were going through in the 1990s. It was more like the kind of bad judgment we all remember having made at some point in our lives when our enthusiasm got the best of us. Irrational exuberance seems a very descriptive term for what happens in markets when they get out of line.”
Of course, the Fed’s initial response to the 2007 subprime crash and the threat of global deflation was appropriate, namely the proverbial wall of money. The trouble is that neither the FOMC nor their counterparts in the EU or Japan understand that buying time via massive infusions of liquidity does not create the circumstances for growth unless it is followed by debt reduction and restructuring. While the US has made some progress restructuring in terms of refinancing and/or modification of mortgages, there is still a vast pile of assets that are not being fixed. No surprise, therefore, that GDP growth and job creation lags popular expectations.
The reluctance to restructure is not merely because investors must feel pain. Any restructuring of zombie banks must involve a discussion of financial fraud, a topic nobody at the Fed or other bank regulatory agencies want to touch. It is interesting to note, in this regard, that the upcoming elections in Iceland will turn on proposals by the Progressive Party candidate to haircut both underwater mortgages and sovereign debt.
Just imagine how the fascist operators of the great Eurocracy will react if Iceland actually does impose permanent debt haircuts on domestic banks and sovereign creditors. Call it Cyprus cubed. The Icelanders, a more bold and audacious people than their cousins in Norway, have apparently figured out that their country cannot grow and pay excessive, fraudulent debts at the same time. A choice need be made. We face the same dilemma in the US, but as yet nobody wants to admit that fact.
In simple terms, the Fed has simply run out of bullets. When Rep. Augustus Freeman "Gus" Hawkins and Hubert Humphrey (D-MN) sponsored their eponymous jobs legislation in 1978, the former stated emphatically that the bill would bring full employment within two years. He also wanted the federal government to guarantee a job for every American, a commitment that the Congress was not willing to support – even in the heady days of the late 1970s. Rep. Hawkins did not seek reelection in 1990 and was succeeded by Rep. Maxine Waters (D-CA).
The Humphrey-Hawkins legislation now drives the FOMC’s policy to use zero interest rates to spur job growth. It needs to be mentioned that HH was merely an extension of the post-WWII Employment Act of 1946, which called upon the federal government to pursue "maximum employment, production, and purchasing power." Keep in mind that prevailing Keynesian economic thought in the 1970s held that aggressive government spending could be used to counter cyclical decreases in consumer demand and employment. You still hear such thinking from socialist thinkers such as NY Times columnist Paul Krugman.
Now that the possibility of massive fiscal stimulus has been taken off the table as a means to counter job losses and flat consumer demand, however, the Fed and other global central banks have explicitly embraced monetary expansion as a substitute. The plan announced by the Bank of Japan, for example, to move inflation up to 2% within the next two years via a massive expansion of the money supply shows the complete bankruptcy of economic thinking in the market economies.
Hyperinflation may allow the BOJ to monetize the nation’s massive public debt load, but it will not generate real growth for Japan’s people or the global economy. The same holds true for the US and the EU. But none of our beloved central bankers have the courage to admit the truth to the public. As one Sell-Side analyst wrote this AM: “One of the best pieces of advice I received from some of my Japanese friends is that Abe, not only has a limited understanding/experience of economics and markets, but that he is also-- crazy. I'm not betting against the BoJ for the first time in 20 years.” Somebody tell Kyle Bass to adjust accordingly.
Many Americans forget (or never knew) that inflation was a big concern in the US before WWII and during the 1970s-1980s. The fact of an aging demographic profile for the US population allows the FOMC to pretend that inflation is not a concern, at least for a while. But one must wonder how long it will take for the Fed and our political leaders to realize that no amount of inflation is going to create real jobs and, more important, get real wages to rise. Seeking to support confidence is fine, don’t get me wrong, but confidence without substance in terms of restructuring will only result in economic stagnation and rising prices down the road.
See you in Washington next Tuesday at AEI’s next housing bubble event: “Bubble bubble: Is the housing toil and trouble over?”
http://www.aei.org/events/2013/04/09/bubble-bubble-is-the-housing-toil-a... [36]