Societe Generale’s Albert Edwards is more worried than ever... and more hopeful than ever. His weekly note has a smattering of Good (hope for a Kevin Warsh Fed), Bad (the ignorance of a Larry Summers debtfest), and Ugly (corporate leverage has never, ever, been higher)...
Much to my own regret I had never familiarised myself with the views of Governor Warsh, who was at the Fed from 2006-11, and played a key role in navigating the Fed through the crisis. He got a rousing reception from the BCA audience as he talked a lot of sense - in particular on how the Yellen Fed has lost its way and current policy is deeply flawed.
He explained that the Fed has been "captured" by a groupthink of academics led by the "Secular Stagnation" ideas of his friend, Larry Summers. Rather than admitting they are wrong, this group, who failed to predict the current economic malaise, have constructed this theory to explain why ever more stimulus is required.
In particular Warsh warned that the Fed had become the slave of the S&P (I think the cartoon below from the fine folks at Hedgeye sums up the situation nicely).
Warsh's views were indeed a breath of fresh air for someone so close to policy. I have recently seen his name mooted as a future Fed Chair, and should a vacancy (unexpectedly) arise, he would definitely be my choice.
Larry Summers is definitely in the camp that says the Fed should not be raising rates and policy should, if anything, be easier and moving to facilitate infrastructure spending (aka helicopter money).
Certainly the still-subdued rise in nominal wage inflation (left-hand chart below) does not warrant higher rates, but what surprised me is that Summers is relaxed about the surge in debt that we are so concerned about (see right-hand chart below).
Summers' relaxed view on the debt build-up, particularly visible in the corporate sector, is in sharp contrast with our own view that this looks set to wreck the US economy. Summers was particularly dismissive of comparing debt to income as the former is a stock and the latter a flow concept. He thought it entirely appropriate in a world of lower interest rates that debt had reached record levels relative to income - belying, for example, the concerns expressed by the IMF this week.
Should we worry about the chart below or not?
The charts above and below have just been updated by my colleague Andrew Lapthorne (and using the S&P 1500 ex financials universe). Summers' point was we shouldn't be too stressed about rising debt as 1) QE is driving up asset prices and higher debt does not look excessive relative to assets, and 2) rock-bottom interest rates mean the debt is easily serviceable.
Now on the first point, Andrew shows that quoted company corporate debt has rocketed relative to assets to now exceed the madness last seen at the height of the 2000 TMT bubble.
Indeed the problem with Summers' analysis in my view is that it is the higher debt that is being used to push up asset values (via share buybacks), just as it did during the housing bubble in 2005-7. And by pushing asset values well beyond fundamentals you build debt structures on false asset values, which only become apparent when the asset bubble bursts.
In the next recession a sharp decline in both profits and the equity market will reveal this Vortex of Debility. US corporate spreads will then explode as the economy is overwhelmed by corporate defaults and bankruptcies. And with the Fed having been the midwife of yet another financial crisis, what price do you give me for it to lose its independence?
As Edwards concludes:
And am I in any way reassured that the Fed sees no bubbles? No, I am not. These dudes will never identify an asset bubble - at least before the event!