The Truly Stupid Case For More ZIRP

Submitted by David Stockman via Contra Corner blog,

I know its not fair to pick on an old guy who should have been put out to pasture long ago. But the chief economist for Dow Jones/MarketWatch, Irving Kellner, posted something this morning so truly stupid that he deserves a smackdown——especially after 40 years on Wall Street as top economist at Chase, Chemical and Manufacturers Hanover etc.

Making the case for yet another Fed rate delay, Kellner offered up this gem right out of the gate:

Every day brings another reason why the Federal Reserve should hold off before raising interest rates………First and foremost there was the recent plunge in stock prices.

Huh? Apparently dips are now “plunges” and no longer permitted.

I was actually thinking this was the obligatory hat tip to the casino, and that some better reasons for delay would soon follow. Alas, they got worse!

It wasn’t that Kellner has espied a hair-curling recession lurking around the corner, which might have been flagged by the stock market’s recent 10% “correction”.

No, it was just that the market stumbled for fear that the Fed might stop the juice, and that was reason enough to keep the free money flowing into the 81st month:

There were a number of reasons advanced for its plunge, but when you peel them away one reason stands out: the stock market did not like the idea that the days of easy money, which kept equities afloat, were about to come to an end.

There you have it. The case for ease is that Wall Street prefers ease.

Stated differently, the Fed and other central banks have generated such an humungous and incendiary bubble that they dare not risk puncturing it——even if it means indefinitely perpetuating the absolute lunacy of ZIRP.

In fact, in his apparent dotage, Kellner argued exactly that. The Fed has to keep rates pinned to the zero bound because all the other central banks are doing the same thing.

Another reason for the Fed to stand pat on rates is that most other central banks are easing. A tighter Fed at a time of global ease would only exacerbate its effects both domestically as well as internationally.

Well, indeed it would, but that’s exactly the trouble. We have been in a time of “global ease” for the past 20 years running. Owing to the madcap money printing spree of the world’s convoy of central banks, the very notion of financial discipline and honest price discovery in the money and capital markets has been expurgated from the system.

Ever since Greenspan bailed-out the big Wall Street  banks at the time of the 1994 peso crisis and Mr. Deng’s China went all out cranking up the red printing presses with a 60% devaluation of the RMB the same year, central bank balance sheets have been on a tear. From a combined footing of approximately $2 trillion at the time, they have now exploded to upwards of $22 trillion.

This was not chump change for the bingo parlors. It was high powered central bank credit, and it has grown at 13% per year for two decades—-nearly without respite.

Consequently, the global economy has become saturated with an unsustainable $200 trillion burden of public and private debt; an immense overhang of malinvestments, excess capacity and deflationary pressures; and vastly and systematically falsified asset prices owing to the massive intrusion of central banks in financial markets everywhere on the planet.

Needless to say, the epicenter of this unprecedented monetary deformation is the Red Ponzi of China. But by Kellner’s Keynesian lights this $28 trillion pyramid of runaway credit is some kind of economic “powerhouse” that has now stumbled slightly, providing still another reason for delaying the rate increase:

Behind this were rising concerns over the state of China’s economy. Until recently it was a powerhouse that helped propel many other economies higher. Lately, however, demand emanating from China softened, dragging commodities prices down with it.

Then there is this ritual throwback to the old-time Keynesian playbook. Apparently 25 basis points in the canyons of Wall Street—–rates that no one on main street can ever access—–will cause exports, housing and autos to crumble:

…..higher interest rates will act as a brake on the nascent recovery. It will hurt exports while encouraging imports. Tighter money will also hurt interest-rate sensitive sectors such as autos and housing.

Oh, c’mon. This doddering old fool is saying that if money costs anything at all, it will stop capitalist prosperity dead in its tracks. Not that several centuries of economic progress prior to 1995—-when interest rates were never zero—- would tend to suggest otherwise.

Here’s the thing. Kellner’s dopey case for more ZIRP may be downright primitive and stupid, but its the essential argument of the vast majority of Wall Street economists and strategists. Like Kellner, they have been so mesmerized by the Fed’s magical printing press that they can no longer see the forest for the trees.

Well, here’s the forest. The Fed is sitting on a powder keg. As my colleague, Lee Adler, noted the other day, the eruption of Federal Reserve credit since the early 1990s, but especially since the financial crisis, has inundated the banking system with excess reserves.

To wit, so called “required” reserves are in the range of $95 billion, but excess reserves parked at the New York Fed amount to upwards of $2.6 trillion. So, as shown below, the Fed’s massive credit emissions never left the canyons of Wall Street.

Needless to say, this enormous reservoir of money caused a rip roaring inflation, but it was in the goods that Wall Street makes—-stocks and bonds—not the products and services generated by the factories, shops and offices located on main street.

It seems that Kellner and his fellow travelers missed that one too. In fact, the main reason the Fed is supposed to keep inflating the already drastically inflated prices of financial assets is that its chosen measures of consumer inflation remain well below its 2% target:

Not surprisingly, the rate of inflation remains well below the Fed’s desired range.

Well, of course it is. The vast mountain of excess reserves created by the printing press in the Eccles Building may be in the custodial care of the New York Fed, but the roaring inflation of financial asset prices it enabled has spread like wildfire through the global financial system.

Accordingly, two decades of cheap, nearly limitless credit and other forms of capital have saddled the world economy with staggering levels of excess capacity in energy, mining, manufacturing, transportation and distribution. But like all crack-up booms in commodities and capital goods, this central bank driven deformation has now, inexorably, morphed into a relentless deflation.

Stated differently, the DM central banks insist that they must keep pinning money market rates to the zero bound because there is not enough consumer inflation. In fact, it is the unprecedented credit inflation of the past two decades that kindled the compensatory deflation now underway.

Global Debt and GDP

Global Debt and GDP

In truth, the orgy of money printing by the Fed over the last two decades would have caused a thundering collapse of the dollar had other central banks not reciprocated by cranking up their own printing presses. So doing, they issued a stupendous flood of yen, won, yuan and real in the process of pegging their exchange rates and buying in massive amounts of US treasuries and other DM bonds.

This cascading wall of money not only put an artificial floor under the dollars exchange rate and thereby suppressed US domestic inflation, but actually fueled the issuance of trillions of off-shore dollars by foreign governments and corporations. That is, yield starved money managers in the US scarfed up some $10 trillion of inherently risky foreign bonds and loans—-a high share of them issued by EM borrowers—–in a desperate effort to beat their benchmarks and retain their AUM.

Indeed, there is no better measure of the monetary deformation of the last two decades than the explosive growth of central bank balance sheets and so-called FX reserves among the four major sectors of the world economy outside of the US and Europe.

Exported Dollar Liabilities And The Convoy Of Money Printing Central Banks

Needless to say, all four categories of central banks shown above functioned as roach motels, buying in dollar and other DM liabilities and rarely selling them. The petro states, for example, kept their exchange rates flat as a board notwithstanding vast current account surpluses year after year during the two decade long credit boom. Consequently, the balance sheet of the petro-state central banks exploded from $150 billion to more than $1 trillion during the last 15 years.

Obviously, this same pattern was exhibited by the mercantilist exporters like Japan, South Korea and Tiawan, as well by the mother of all mercantilist exporters, the red capitalist machine of China.

The next installment will explore the danger posed by these monetary roach motels as the global economy transitions to a deep, deflationary correction.