Republic First, J.P. More-Gain
By Michael Every of Rabobank
The weekend saw Chinese PMI data suggest deflation is a risk there --“But what about reopening?!”-- and yesterday’s US ISM flagged stagflation as a risk, as the headline remained below 50 but price pressures were seen picking up again anyway – what about that Fed pivot the market keeps pricing for?
Then we had First Republic Bank being taken over by J.P. Morgan in an ‘interesting’ piece of financial engineering which I don’t have the space to go into here in detail. Suffice to say that again, the US financial system has been ‘saved’; again, stock and bondholders haven’t; again rich, uninsured (Californian, Democrat-donor) depositors have; and Too Big To Fail banks are now even bigger and obviously even less allowed to fail, reversing what was supposed to be the post-2008 regulatory norms. Many points of discussion flow on from that:
Fed Chair J. Powell starts another FOMC meeting against a bank failure, and yet will again hike rates 25bps (this time to 5.25%). Moreover, the Wall Street Journal’s Timiraos says he isn’t likely to flag a pause, instead keeping the door open to doing more if necessary.
We may see some form of US credit crunch. Indeed, a US banking conflab was talking about that yesterday. On the other hand, there are some who think the Fed has been asking banks to scale back on lending to try to give them more leeway to pause – in other words tightening via backdoor policy. That sounds ‘un-American’ for those who know nothing about the real America, but it’s arguably still better than policy tightening via repeated bank failures.
J.P. Morgan is at the heart of things again. Some will recall that in the 2008 Global Financial Crisis, the bank was persuaded to swallow Bear Sterns and Washington Mutual, which CEO Dimon has said he would rather not have undertaken. Those with a longer memory will recall the 1907 Panic, where Mr. Morgan personally bailed out the US financial system. I expect fewer mentions this week of the allegations that Morgan was also involved in a planned fascist coup against President F.D.R. in the 1930s, the so-called “Wall Street putsch”.
Geopolitics is echoing the 1930s. Axios is the latest to say: ‘US allies prepare for possibility of war over Taiwan’; the US says its Mutual Defence Treaty with the Philippines is “iron clad” following maritime tension; China revised its conscription law to boost its pool of draftees, ‘Locks Information on the Country Inside a Black Box’, and even the US Chamber of Commerce in China warns of major increase in risks for businesses; China and Russia signed a deal on maritime law enforcement; Iran --which saw an oil tanker destined for China seized by the US, seizing a foreign tanker back-- proposed a “maritime security belt” led by the Shanghai Co-operation Organisation to provide “safety, security, and stability of global maritime trade”; and the US displayed bunker-busting bombs for use against Iran. Yet the Wall Street Journal also says ‘US Struggles to Replenish Munitions Stockpiles as Ukraine War Drags On’ noting, “plans to increase production of key munitions have fallen short due to shortages of chips, machinery, and skilled workers.”
How does this latter point link back to JP and First Republic? Let’s look at the wording of the Federal Reserve’s Section 2A. Monetary policy objectives (my emphasis added):
“The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”
Not just “stable prices”, which we won’t have if the Fed cuts rates as markets are pricing for; not just “maximum employment”, which we may not end ahead given demographics, onshoring, re-arming, and labor hoarding; not just “moderate long-term interest rates,” or financial stability, so acronyms like BTFP, which FRB partook of to no avail before being swallowed by JPM; rather, TO INCREASE PRODUCTION to allow all of the above to happen.
For three decades of a geopolitically benign environment and the last Cold War decade before, the Fed could get away with ignoring US production to rely on imports and financialisation. Now, as war rages in Ukraine and wider war fear mount, and de/re-globalisation shifts supply chains, it cannot. US production must increase, and financialisation decrease. The question is how, starting from here.
Rates are going to be much higher for much longer even before we get into the biggest picture issue of ‘de-dollarisation’. That’s a production problem according to economic theory. However, economic reality shows in a globalised trading system, lower US rates don’t see any increase in productive investment anyway – just pointless (but profitable for some) financialisation.
Clearly, much more productive investment is going to be required by the US economy when the current ‘financialised’ system has no ability or interest in supporting it. That means more national-security focused industrial policy, as White House National Security Advisor Sullivan made explicit last week, to tumbleweeds from a market unwilling to listen. It likely also means more QE, not QT, in the form of de facto MMT, not yield-lowering, excess-reserve-building exercises: it’s just when this happens. And/or it means a more centralised US banking system that listens to ‘guidance’ from the more powerful Fed telling it what is in the national interest for it to lend to.
In short, this time the “Wall Street Putsch” might be the other way round, and the is coup J(ay) P(owell) More-gain saying ‘Republic First!’
Only time will tell – but don’t be surprised if this is the way it plays out.
