Silver Linings: Keynesian Central Banking Is Heading For A Massive Repudiation

Submitted by David Stockman via Contra Corner blog,

For several years now the small coterie of Keynesian academics and apparatchiks who have seized nearly absolute financial power through the Fed’s printing presses have justified the lunacy of unending ZIRP and massive QE on the grounds that there is too little inflation. The bureaucrats at the IMF even invented a lame-brained catch-phrase, calling the purported scourge of money which retains most of its value “lowflation”.

This whole consumer inflation targeting gambit, of course, is an inherently preposterous notion because there is not a scrap of evidence that 2% consumer inflation is better for rising living standards and societal wealth gains than is 0.2%. And there is much history and economic logic that points in exactly the opposite direction.

Between 1870 and 1913 in the United States, for example, real national income grew at 3.5% per year——the highest gain for any 43 year period in history. Yet the average inflation rate during that long period of capitalist prosperity was less than 0.0%. That was real “lowflation”, and it was a blessing for the average worker, not a scourge.

But this week the BLS itself let out a screaming, never mind! The core CPI for the 12 months ended in January rose by 2.21% and that’s actually a tad higher than the 1.98% annual average since the year 2000.

Please forgive the spurious accuracy of reporting the BLS’ noise-ridden, dubiously constructed CPI to the second decimal point, but it’s meant to underscore a crucial truth.  Namely, there ain’t no inflation deficiency problem and never has been!

The whole 2% inflation mantra is just a smokescreen to justify the massive daily intrusion in financial markets by a power-obsessed claque of monetary central planners. They just made it up and then rode it to ever increasing dominance over the financial system—-even though as recently as 15 years ago the 2% inflation theory was unknown outside a small circle of neo-Keynesian academic scribblers led by Ben Bernanke.

In fact, the whole cockamamie theory was explained in an obscure book called “Inflation Targeting” issued in November 1998 by Bernanke and two other academic power grabbers: Frederic Mishkin, who later was appointed to the Fed and became a principle proponent of the Wall Street bailouts in 2008; and Adam Posen, an academic (well)stuffed shirt who peddled the same nonsense at the Bank of England and has been an incessant voice urging the BOJ to print more and still more money.

You can look it up. The book stands at #2,503,823 on Amazon’s sales ranking!

Yet inflation targeting is now accepted as gospel by the financial press, and it’s not hard to understand why. Wall Street loves it because it justifies massive liquidity injections, free carry trade money and wealth effects based stock market goosing by the central bank. So the lazy journalists who feed the street with so-called financial news just xerox the mantra and pass it along unexamined, as in this gem out of Dow Jones MarketWatch:

Although too much inflation is viewed as dangerous for the economy, Fed officials think that a 2% inflation rate is best for the economy to grow……..Inflation has been trending below that target for the past four years. Low inflation is a signal of weak demand in the economy and raises fears of actual decline in prices or deflation, which can damage an economy, especially one with high debt burdens like the United States.

Let’s see. During the past year US consumption spending for health care rose by 5%, outlays at restaurants and bars were up by 9%, while spending for gasoline and other energy products was down by 22%. This was Mr. Market at work—–millions of households reallocating their spending in response to relative price changes. It had nothing to do with a macroeconomic abstraction called “weak demand”.

Actually, the medical care component of the CPI rose 3.3% last year, housing and shelter were up by 3.2%, while gasoline prices were down by 7.3%. It all added up to a 2.21% annual change in the overall index by the sheer coincidence of BLS’s arbitrary weightings of the components; it had nothing to do with the pace of total consumption expenditures or any other proxy for “aggregate demand”. And especially it was not due to an excess of a really primitive, nay stupid, metric the Keynesians call the “output gap”.

So the MarketWatch “senior economics reporter” who filed this piece, one Greg Robb, was writing gibberish and apparently didn’t even know it. Yet without this herd-like transmission of the narrative, the Fed’s ridiculous monthly deliberations about 25 basis points or not on the federal funds rate would be seen for the farce it actually is.

This chronic pretense of fine-tuning the money market to the second decimal point (i.e. 0.38% versus 0.12%) is purportedly all about delivering what the Fed judges to be just the right amount of “accommodation” to the macroeconomy to achieve its inflation and unemployment targets. Yet even scant attention to the internals of the various consumer inflation indices makes it  obvious that the “lowflation” proposition cited by MarketWatch (“inflation has been trending below that (2%) target for the past four years”) is a modern version of counting angels on the head of a pin.

That is, it is a pointless exercise in spurious accuracy that has nothing to do with improving the real world; it was only a ritual to justify the existence and power of the catholic priesthood then, and the monetary politburo today.

The chart below provides the trend in four versions of consumer inflation since the year 2000. The two CPI-based versions embody what is called a fixed weight deflator because in theory the weighting of the various components remain unchanged for long periods of time. In that sense, it is an attempt to measure the changing price of a representative basket of goods and services over time as it would be experienced by an individual consumer or household.

By contrast, the two personal consumption expenditure (PCE) indices are chain-type deflators, meaning that their component weightings are constantly adjusted based on the changing mix of aggregate consumption spending. Thus, if the proverbial shift from beef to chicken occurs because beef gets too expensive, the PCE deflators reflect more weighting for chicken and less for beef; and if things got really so desperate that everyone was forced to eat only spam and no steak or chicken at all, the PCE would get fully spammed.

That is, the weight of chicken and steak would fall to zero and spam would take their weightings instead. Needless to say, a household forced to consume 100% spam because the relative price of chicken and steak had soared out of reach would doubtless not be impressed with the news that there hadn’t been much chain-weighted inflation during the reporting period!

In fact, the PCE indices are an academic device to deflate the actual nominal spending of the aggregate economy to a constant dollar measure over time. To that extent, continuous reweighting makes sense because the economy’s mix of spending does change over time.

In short, the PCE deflators are for economic measuring and modeling and the CPIs for approximating the change in the cost of living faced by average households. And that’s why the social security and other annual COLAs are based on the CPI.

So here’s the thing. In today’s massively integrated global economy, cost and price impulses are constantly transmitted through relatively open markets for goods and services and through the capital and money flows which finance real activity. In that open global economy, 25 basis points on the New York money market rate, or even 250 basis points, has precious little to do with the rate of change in two conceptually different and equally crude measures of the U.S. general price level, especially when measured to the second decimal place.

The price of furniture and basketball shoes has everything to do with how much untapped labor remains in the Chinese rice paddies and virtually nothing to do with the monthly adjustments on the money market dials being fiddled with in the Eccles Building. Likewise, the price of financial services has more to do with the marginal cost of outsourced labor in Bangalore or the transaction cost reduction owing to the shift from plastic cards to smartphones than anything done by the FOMC.

Once upon of time in your grandfather’s economy of the 1950s, when the US economy dominated the world, there may have been a loose steering gear linkage between the Fed’s policy rate and the US consumer inflation rate. That’s because the policy rate could still cause incremental household and business borrowing and spending in an era before Peak Debt. Under those conditions, spending could temporarily get ahead of production and capacity, thereby enabling the general price level to accelerate owing to “excess demand”.

Those days are long gone. The US economy’s leakage into the global economy is massive and the private sector is stranded at Peak Debt. The money market rates pegged and administered by the Fed, therefore, have virtually nothing to do with short and medium term rates of change in the consumer price indices.

Accordingly, there is no reason at all for the Fed to target the inflation rate, let alone to two-decimal point variations around 2.00%. If anything, it should request that Congress repeal its so-called price stability mandate on the grounds that it no longer has any tools capable of making a difference. Once at Peak Debt, the central bank in effect has already printed itself out of a job.

But short of that honest solution it surely has no justification whatsoever for preferring the PCE to the CPI, and especially for hopping and skipping between a focus on inflation excluding food and energy when it is convenient and the full price index when it is not. Such as now.

During the year ending in January 2016, the annual inflation rate was 1.15% on the PCE deflator, 1.34% on the CPI, 1.36% on the PCE deflator less food and energy and 2.21% on the CPI less food and energy. Until global commodity inflation started pouring in, the Fed always preferred the ex-food and energy versions, meaning that at the present time we are talking about 40 basis points of variation around a average of 1.80% inflation between the fixed weight and chain-type measures.

Call it a double sham because the Fed cannot possibly steer the US economy in isolation toward 1.80% inflation; nor does it have any reason to side with the chain-type index as opposed to the CPI. Indeed, I was a member of Congress when Humphrey-Hawkins was enacted, proudly voted no, and am absolutely certain that the practical politicians who supported its mandates were thinking about stable prices from a  household cost of living point of view, not from a GDP reporting and modeling perspective.

Not only that, but any one with an occasionally functioning brain can see that the full inflation indices at 1.15% and 1.34%, as between the year-over year PCE and CPI, are down in that range only temporarily. That’s due to the one-time plunge in oil and other commodity prices and the pass-through effect on goods and services down the production chain.

And that great global deflation wave, ironically, is due to the past money printing excess of the Fed and its global convoy of central banks, whose massive fiat credit emissions caused an unsustainable boom in energy and materials demand and capacity investment throughout the global economy. It has absolutely nothing to do with the 1,2 or 4 baby step increases in the federal funds rate this year or the lack thereof during the past 84 months.

At the end of the day, 2% inflation targeting is an astoundingly transparent ruse being used to justify what amounts to an economic coup d’ etat  by an unelected gang of monetary central planners. During the last 15 years, the annual rate of consumer price change has been 1.70% on the PCE deflator less food and energy; 1.83% on the PCE; 1.98% on the CPI less food and energy; and 2.15% on the CPI.

In the scheme of things, these minor difference over time are trivial. Likewise, the difference between the 15 year average annual change for any of these inflation indices and the magic 2.00% is also trivial. And most importantly, virtually none of the trend rate of change in any of these consumer price index variations was attributable to the Fed’s micro-management and radical repression of money market interest rates since Greenspan went all in with money printing in December 2000.

Inflation targeting has been a giant cover story for a monumental power grab. But as we shall see in the next section, the academics who grabbed the power had no idea what they were doing in the financial markets that they have now saturated with financial time bombs.

When these FEDs (financial explosive devices) erupt in the months and years ahead, the central bankers will face a day of reckoning. And they will surely be found wanting. The immense social damage from the imploding bubbles dead ahead will be squarely on them.

In an open $80 trillion global economy and era of Peak Debt, central bank interest rate pegging and repression and massive QE, too, function almost entirely in the financial markets, not the real economy. Their primary impact is to falsify financial asset prices, risk premiums, yield curves, credit spreads, time discounts and risk/reward ratios throughout the entire trading complex in financial instruments.

They also stimulate rampant gambling in place of capital allocation owing to the fact that  the kind of massive central bank intrusion in interest rate and bond markets now being practices under ZIRP, NIRP and QEs destroys honest price discovery and the key ingredients of financial market self-discipline and stability. To wit, central bank policy makes downside insurance too cheap and shorting the market too expensive. Two-way markets give way to one-way momentum trading that eventually metastasizes into financial bloat and bubbles, which sooner or later collapse into a heap of loss and waste.

Needless to say, there is no evidence that our monetary politburo spends its time studying the baleful impacts where its policies actually have efficacy. That is, the degree to which it causes risk spreads to flatten, cheapens the cost of put options, shifts volatility skews, enables the spread of risky structured finance products, represses the cost of repo financing or weakens bond market covenants (e.g. cov lite indentures) to name a tiny few.

Stated differently, the overwhelming share of Fed policy emissions never leave the canyons of Wall Street. The above impacts and countless more are what these intrusions do all day and night. Yet Simple Janet apparently spends the same studying her labor market dashboards.

They are irrelevant!  ZIRP and QE never get there. They just deform, distort, degrade and destroy free financial markets, turning them into casinos of crony capitalist corruption.

And that brings us to the nascent crime of NIRP. Mainly what is going on in the eurozone, Switzerland, Sweden and Japan is crypto-NIRP or the imposition on negative rates on the excess cash reserves of commercial banks who are eligible to deposit at their respective central banks. But that maneuver is only squeezing bank interest margins and causing a run on banking sector stocks.

Likewise, this crypto-NIRP has driven upwards of $7 trillion of worldwide sovereign debt into negative yields at market prices, and the emphasis is on the latter. Bond yields on German debt up to 10 years are now negative because speculators are front running the ECB and other central banks.

That is, they are playing for price appreciation. For crying out loud, it is not a case of the world’s bond managers, benighted as many of them are, saying I’ll have some more of that tasty negative yield!

In short, the central bankers of the world are driving the lemmings on one last run toward the sea. Yet this fantastically dangerous experiment is doing nothing for the real economies of a world staggering under unpayable debt and massive excesses of production capacity, infrastructure assets and working inventories. Instead, it is just feeding the mother of all bond bubbles.

At length, the central bankers will go for the real thing—-NIRP in the neighborhoods were people actually live and try to save a nest egg. To be sure, a  pipe smoking economist is liable to say that there is no appreciable difference between positive 30 basis points and negative 30 basis points on a CD.

Yes there is. The negative sign will be the great political inflection point. The negative sign will be the flashing neon lights announcing that the government is confiscating the people’s savings and wealth.

So when they actually try to go to NIRP in the neighborhoods, the central banks will be signing their political death warrants. That day can come none too soon.