Well, that was the week that the Pollyanna’s prayers weren’t answered and the Panglosses’ pleas went resolutely unheard.
Despite all the unsubtle prompting from the Bulge Bracket and all the wishful thinking from the rest of the sell side, the Bernanke Fed signally failed to live up to its billing as Deus ex Machina, with its much-vaunted ’Operation Twist’ proving a severe disappointment.
It should not really have come as much of a surprise to readers of this publication, for we have long warned that, such is the political revulsion against bailing out the plutocracy at the expense of the purchasing power of the masses, the Fed had too little political cover to enact anything more dramatic—that, as we have put it several times before, the ‘Bernanke Put’ is likely to lie further out of the money than Wall St. might hope. And so, indeed, it proved.
Yes, by his narrowly ingenious lights, Blackhawk Ben tried to achieve the maximum impact on long yields by spreading the buy programme further out the curve than most of the commentariat had expected.
Yes, again, he may have been more crafty than has yet been recognised in announcing that MBS and Agency redemptions would be re-invested in more mortgage product since this provides the Fed with a mechanism whereby it can cushion the blow if the Administration ever does put his mass refinance proposals into operation at some future remove.
But, what he could not do was offer a route to more, naked monetization of debt and so, the price exacted to play such games as he could was a high one.
The sense that the Uberdoves have temporarily run out of bullets (or that dissent on the FOMC will not allow these to be discharged) was compounded by the fact that, in order to justify even this latest chicanery, the accompanying declaration had to offer a post hoc endorsement to every stock bear and double-dipper out there, by painting the bleakest economic picture possible.
Even without that, this fixation with reducing long rates is a futile one. No less than 320 years ago, Sir Dudley North already knew better than Ben Bernanke that to assume that low interest rates are a cause, rather than an effect, of prosperity is to put the cart very much before the horse.
In his 1691 ‘Discourses Upon Trade’, he argued that:-
These things consider’d, it will be found, that as plenty makes cheapness in other things, as Corn, Wool, etc. when they come to Market in greater Quantities than there are Buyers to deal for, the Price will fall; so if there be more Lenders than Borrowers, Interest will also fall; wherefore it is not low Interest makes Trade, but Trade increasing, the Stock of the Nation makes Interest low.
It is said, that in Holland Interest is lower than in England. I answer, It is; because their Stock is greater than ours. I cannot hear that they ever made a law to restrain [it]…
What our good Fed Chairman also seems unable to grasp is that businessmen do not work simply off their direct arithmetical estimate of the negative cash flow consequences of a hypothetical borrowing, but they must also be assured of the positive cash flow prospects of whatever it is that they are borrowing to achieve, i.e., the hurdle rate they apply is usually the decisive factor and this hurdle always contains a sizeable, subjective—and eminently variable—risk factor.
Thus, it will be to little avail if Bernanke reduces the going bond yield by 50bps if, in doing it, he is so adding to the general uncertainty that hurdle rates go up by 500!!
It is interesting to note that, in the ten quarters since the crisis broke out, US non-financial corporates have switched from being net takers of $1.2 trillion in funds, to net lenders of a near equal-and-opposite $1.1 trillion and that, more to the point, they have devoted almost 40% of that hoard to piling up cash and near-cash holdings—a sum not far short of the net amount devoted to making direct investments abroad, their other primary outlet in this period.
This has left them with a modern era high proportion of 11.5% of net worth and 6.0% of total assets parked in quasi-cash instruments—a testimony to the paralyzing effect of the regime uncertainty imposed by the likes of the Fed, a degree of unease which has mounted even in the face of the record, nominal after-tax profits they have simultaneously secured for themselves.
Meanwhile, the empty round continues wherein the Fed tries to find ever more convoluted ways to help the government spend new money into existence and that same government borrows ever more from foreign export surplus nations so that it can hand out record amounts of subsidies and transfer payments. These are what purchases those same exports while the whole helps maintain (and inflate) domestic corporate revenues.
That extended and expanded dole next helps obviate the need for the Captains of Industry to employ anyone so that the hirees may earn the means with which to buy their wares, while also increasing the comparative disutility of labour and so perpetuating the scourge of unemployment (check out the jobless duration time series in comparison with its behaviour in previous recessions).
Thus, despite the elevated profits, everyone becomes so concerned about the sustainability of all this market suppression over the longer horizon and each is so frightened of sudden, arbitrary changes to currency parities, import duties, energy taxes, etc., by way of ‘fixes’ for the ongoing malaise, that they pile up cash with banks who are themselves still so mutually distrustful that THEY can think of nothing better to do with the money they receive than park it with the local central bank, whence first it emanated.
Having tried more and more of the same, to the only end of digging us all deeper and deeper into the same hole, you might think it was about time we pretended that Hoover had retired harmlessly while still Commerce Secretary and that Roosevelt had stuck to swanning about on his yacht, indolently squandering the sinecures he acquired from his numerous family connections. In this more rational alternative universe, we could then assume that we all go back to letting recessions blow themselves out by themselves, just like we used to until the end of the fateful third decade of the 20th century.
In the spirit of such counterfactual imagining, let us just suppose that, having exhausted all the other possibilities, we summon up some vestige of economic clarity and strike some exceedingly rare vein of political courage and proceed roughly as follows.
First, we allow for bankruptcy to proceed as swiftly as possible for all entities, individual, corporate, or sovereign who can show sufficient legal proof of their inability to meet their existing obligations. As much debt as possible is then commuted into equity—including, in the sovereign case, the privatization of any and all identifiable state assets and the transfer of the relevant title deeds to their creditors.
Any lender or stockholder brought low by this cleansing should be similarly wrapped up and its residual estate disposed of forthwith. Any bank which requires it should be then be privately recapitalised, but only after forcing all financial entities into a mutual bonfire of the vanity of their $60 trillion-odd of on– and $550 trillion-plus of off-balance sheet claims on one another in a grand ripping up and netting off of the inhibiting legacy of their long years of undercapitalized, state-sanctioned, casino capitalism. This act of mutually assured reconstruction will have the salutary effect of both cleaning the Augean stables of mark-to-myth and reducing total assets to a level where the required amount of new equity is minimised to the greatest degree possible
Any bank which cannot survive this should also be summarily put out of its misery. If it is absolutely necessary to do so, this triage may be effected via the temporary agency of a governmental ’bad bank’ and—accepting the unfortunate fait accompli of an unstable fractional reserve system—to the accompaniment of a time-limited guarantee of retail and SME deposits and the payments system.
Will there be redundancies? Yes. Will there be hardship? Yes. Will many find that they are not as rich as they once thought or that their skills and experience are not so readily marketable? Yes, again. Whether there will be more such losses than we are suffering at present, whether they will take longer to make good, or whether the hardship will be distributed any less equitably under this more direct approach is, however, a very moot point indeed.
In trying to decide this, what we must not lose sight of is the fact that none of this will diminish the material patrimony or the sum of individual efforts which form the actual machinery of our subsistence, occasional luxury, and secular self-betterment. All it will do is reprice its components in line with a fairer estimate of their ability to generate income. It will inevitably reallocate it to presumably more competent hands, or at least into the control of those who have proved their superior stewardship of the assets heretofore entrusted to them, men and women whom we can therefore expect will do just as good a job of maximising the value to be extracted from whatever its is they also now acquire as the reward of their foresight, thrift, and entrepreneurship.
If, amid the less forgiving financial scrutiny of this brave new reality, there is a service which can no longer be provided by the lazy deceit of unfunded state spending, there will also be no impediment to any private enterprise from attempting to make an honest living in providing it to those who retain a discretionary control over their pocket books. If, in fact, they do turn out not to want it, its provision can be regarded as nothing other than wasteful—no matter what the legal status of the provider—and the resources devoted to it should be redeployed elsewhere at once.
If some sprawling, Ozymandian works are revealed as the easy-money follies we already suspect them to be, well, they can always be parcelled out to fulfil other purposes; broken up and recycled as scrap; or turned into leisure facilities or museum pieces with a radically different price tag to reflect the real measure of their worth, but also with a bracing absence of a dead weight of unserviceable debt hanging about both them and all those who might otherwise have been expropriated to maintain the pretence that they were actually useful.
A steep, overt recession we would surely have, in place of the insidious, covert erosion of our wealth which we have been suffering these past four years and more.
Many, many things would fall in price, especially where those prices have been borne artificially upward by an infusion of irredeemable Ponzi credit. But, assuming that the core money supply is not allowed to contract—that is, assuming there is no deliberate deflation—and that the relentless writing off of unserviceable liabilities and the unsentimental renegotiation of contracts take their course unhindered, each fall in price would improve some potential buyer’s real income until a floor was found, a floor which could not but correspond more closely to each item’s genuine value in a world now dedicated to honest accounting, sound money, and minimal government.
To expect all of this to come to pass in today’s world is, frankly, unrealistic, but while the stalwarts of the Bundesbank continue to resist the evil allure of Bernankism and so provide a standard around which north European politicians can rally their consciences alongside their common sense, it just might be that the Old Continent achieves rather more of this healing than anyone currently credits.
Then, if the Fed would only spend a little less time listening to the wheedling of its pack of welfare brats on Wall St., devote less time wallowing up to its ivory-towered armpits in the deranged divinations of DSGE theory, and a great deal more time paying heed to what actual wealth creating businesses are saying and doing, who knows? — we might even spark a genuine recovery one of these fine days!