What in god’s name does Janet Yellen think she is doing? Just a few weeks ago she established the ridiculous Fedspeak convention that “patient” means money market rates will not rise from the zero bound for at least two meetings. Now she has modified that message into “not exactly”.
As her Wall Street Journal megaphone, Jon Hilsenrath, was quick to amplify:
Ms.. Yellen signaled the Fed is moving toward dropping the reference to being patient from its statement, but sought to dispel the notion it would mean rate increases were certain or imminent.
“It is important to emphasize that a modification of the [interest-rate] guidance should not be read as indicating that the [Fed] will necessarily increase the target rate in a couple of meetings,” Ms.. Yellen told the Senate panel.
So two meetings is no longer two meetings. That’s worse than Greenspan’s double talk at his worst, and here’s why. It’s all make believe!
After 74 months of ZIRP, a hairline increase in the money market rate to 25 bps or even 100 bps will have absolutely no impact on the main street economy—–nor on whether the “in-coming” data deviates up or down by a few decimal points from 5.7% on the U-3 unemployment rate or 1.7% on the CPI.
The Fed is absolutely incapable of impacting the short-run ticks on its so-called inflation and unemployment “mandates” because its “credit channel” of monetary transmission is broken and done. The household sector is still saturated by peak debt and the ZIRP fueled runaway stock market rewards corporate executives for share buybacks and M&A deals, not investment in productive assets—even with borrowed money.
So there is absolutely no reason to peg interest rates at freakishly low levels. It has manifestly not enabled household to supplement spending from their tepidly growing incomes by means of ratcheting up their leverage ratios. That Fed trick worked for about 45 years until households used up their balance sheet runway in 2007 and thereupon smacked straight into “peak debt”.
The graph below shows household debt relative to wage and salary incomes, and the latter is the true denominator for computing leverage ratios. The Wall Street stock peddlers—who are pleased to call themselves economists—-always use personal income as the denominator, but that’s completely misleading. Upwards of 25% of personal income represents transfer payments including more than $1 trillion of Medicare, Medicaid and housing vouchers. Try paying sending you credit card bill to your Medicare carrier for reimbursement!
More importantly, transfer payments represent merely the shuffling of already produced income from taxpayers to entitlement recipients. The latter overwhelmingly do not borrow via credit cards, car loans and mortgages because they are not creditworthy, even by today’s lenient standards. So its middle class households which borrow money and which generate wage and salary income; and its the ratio of these two variables which measure the true condition of leverage.
During the four decades after 1971, the apparatchiks who run the Fed, and the economists who gum about its machinations, declared themselves to be monetary wizards. By deftly dialing the Federal funds rate up and down and flattening or steeping the yield curve, they claimed an ability to steer the entire US GNP to feats of growth and prosperity that were far beyond the halting, inferior performance of free market capitalism left to its own devices.
Needless to say, in return for conferring such blessings on the unwashed consumers and voters of the land they demanded an unfettered right too steer the economy by the lights of their superior wisdom. In due course this became the hallowed doctrine of Fed “independence” from democratic oversight through Congress. It amounted to a de facto appendum to the constitution by which the central bank instructed its legislative inferiors with the injunction———-you don’t ask, we won’t tell.
But this was all a giant hoax. The monetary politburo which has seized power in an economic coup d’ etat during recent decades had no magic power to levitate the economy or improve upon capitalism at all. What it actually did was trick and misled households and businesses about the cost of debt via the false price signals emitted by its interest rate pegging actions.
Not surprisingly, this did not lead to economic gains in the context of steady-state leverage ratios. Instead, the years before the 2008 financial crisis saw a relentless ratcheting of leverage ratios to higher and higher levels relative to incomes. At the peak household debt to wage and salary income ratio of 220% reached in 2007, the leverage ratio was triple the steady state ratio that had prevailed before the Fed was unshackled from the Bretton Woods gold standard by Richard Nixon in August 1971.
And, no, that action did not represent a fit of enlightenment by America’s palladium of darkness; it was a calculated ploy to permit a compliant Fed chairman, Arthur Burns, to slash interest rates and thereby goose the US economy into a roaring boom just in time for Nixon’s reelection.
Once Nixon and Burns figured out the trick, there was no looking back. At length, the Eccles Building inhabitants came to realize that there was absolutely no constraint on their ability to falsify the price of debt and, by the same token, the return on liquid savings.
But even as the Fed caused massive expansions of credit and leverage, it could not eliminate the laws of economics entirely. Accordingly, in the period since the financial crisis, an event which actually marked the arrival of peak debt, household leverage has been steadily reduced—–even though it still towers vastly above pre-1971 levels.
So there is no mystery as to why “escape velocity” has not been achieved despite annual projections of its arrival by Wall Street and Fed economists. The US economy is stuck in its 2% growth channel because that’s all the incremental labor and productivity that is being produced by the private sector. There are no longer any GDP afterburners from incremental leverage adding to the spending pie, as was the case during the long post-Camp David credit expansion.
The story the same with respect to business debt—although the mechanics are slightly different. On the eve of the Lehman event, total non-financial business debt—including both corporations and unincorporated businesses and partnerships—was about $11 trillion—-a figure which has since ballooned to nearly $14 trillion. But unlike in earlier business cycle recoveries, this $3 trillion of incremental debt did not go into the purchase of additional plant, equipment and other productive assets. Overwhelmingly, it went into financial engineering in the form of stock buybacks, cash M&A deals and LBOs.
Indeed, these transactions have actually totaled more than $3 trillion since 2008, but it is their impact on the economy which is of even more significance. None of these funds went into the primary market for new assets; the entire tsunami of cash employed in pursuit of financial engineering circulated though the secondary market where it bid up the price of existing financial assets and showered their owners—-and especially the fast money hedge funds and other gamblers which dominate Wall Street—with completely unearned windfalls.
In fact, the process is even more insidious and destabilizing. Zero interest rates provide free funding cost to carry trade gamblers, while the Fed’s massive bond buying program and stock market “put” artificially reduce risk and inflate risk asset prices. But as the resulting financial bubble inflates, the pressure on corporate executives to channel cash flow and borrowings into even greater levels of financial engineering intensifies enormously.
At the end of the day, however, true economic growth flows from productive investments and improved productivity and increased labor inputs to the economy. Yet the rampant financial engineering in the business sector owing to Fed financial repression causes just the opposite. Namely, staff reductions and “restructurings” to artificially increase “ex-items” earnings; and the aggressive cycling of cash flow and borrowings into the secondary market via stock repurchases and buyouts.
So ZIRP and QE have been downright perverse. Since the credit channel of monetary transmission is a busted historical anachronism, the Fed massive balance sheet expansion has only functioned to reflate the financial bubble, not stimulate the main street economy.
And that’s the real reason that the presumptive adults who occupy the Eccles Building have been reduced to the kind of duplicitous babble which Yellen engaged in during the last two days on Capitol Hill. Yellen and her merry band of money printers are petrified that Wall Street will have a hissy fit, and that the whole edifice of financialization and drastically over-valued and over-leveraged financial assets will come tumbling down.
Indeed, it doesn’t take more than a moments reflection to realize that the U-3 unemployment rate is a completely artificial metric. It has virtually no meaning in the context of a global economy where the price of labor is set on the world market, not in a closed bathtub economy between the Atlantic and Pacific; and where there are 102 million adults who do not currently hold jobs—of which only 45 million are on OASI retirement.
Likewise, the CPI measure of inflation is so distorted by imputations, geometric means, hedonic adjustments and numerous other artifices—-that targeting to 2% versus 1% or even zero rate of short-term measured consumer price inflation is a completely arbitrary, unreliable and unachievable undertaking. Yet, Yellen’s latest exercise in monetary pettifoggery is apparently driven by just that purpose:
Ms. Yellen said the Fed would act only if the job market keeps improving and once it is “reasonably confident” that inflation will move back toward the target.
That formulation could become central in Fed deliberations about rates in the months ahead. It could also lead to a new challenge. Inflation is facing downward pressure from low oil prices and a rising U.S. dollar. It is not clear at this point what will make officials confident it is heading back up toward 2%.
Here’s the thing. The single most important price in all of capitalism is the money market interest rate. That is the price of poker in the Wall Street casino; it is the cost of production for the carry traders and gamblers who provide the marginal “bid” for risk assets.
By supplanting free market price discovery with an artificially pegged price of zero, the Fed is unleashing the furies of greed and reckless speculation in the financial system once again. So it has truly become a serial bubble machine headed by a babbler who apparently believes in make pretend.
For six years the Fed has been engaged in radical financial repression that has had no impact on the main street economy because the credit channel of monetary transmission has failed. Now that is has inflated the mother of all financial bubbles instead, it remains completely blind to the financial disaster waiting in the wings.
And there is indeed monster storm lurking on the horizon, not the least in the emerging market debt and junk bond markets where trillions have been driven in a central bank induced blind scramble for “yield”. As Wolf Richter noted earlier this week,
Bond specialist Martin Fridson, Chief Investment Officer at Lehmann Livian Fridson Advisors, summarized it this way, via S&P Capital IQ LCD:
A perfect storm is hitting the high-yield market. Secondary issues are extremely overvalued, and covenant quality is at a record low.
So another annual Humphrey-Hawkins testimony passes, and the Fed chairman indulges in yet another round of oblivious double talk. As one Kool-Aid drinker noted, perhaps not realizing the farcical implications of his words, Yellen caused the market to inflate to even more lunatic heights this week on the basis of a new low in central bank intervention—-namely, “talk therapy”.
“There is this kind of talk therapy going on,” said Ethan Harris, chief economist at Bank of America Merrill Lynch. “She tells the markets not to worry about this and don’t worry about that. Today she told the market, ‘Don’t worry if we remove patience.’
Right. Don’t worry—–its already too late!