Oct 15. Channeling Tillerson
Here’s a quote from the blog of a famous central banker:
“The unpopularity of inflation may be due to reasons that economists find unpersuasive, such as the tendency of people to focus on inflation’s effects on the prices of things they buy but not on the things they sell, including their own labor.” Ben Bernanke
Usually I add links to the bottom of the note, but this snippet is so unbelievable that you might think I’m making it up. I’m not. I guess BB thinks all prices, including labor, go up at exactly the same pace. Here’s the link:
The real life problem that Bernanke seeks to address in his theoretical musings is that, in case of another downturn, the Fed needs policy space to respond. And, to be fair, Ben gets in early on some of his ideas. For example, in November of 2002 he gave his famous, ‘Deflation: making Sure ‘It’Doesn’t Happen Here’ speech. [One interesting line in the speech is “Today, an ounce of gold sells for $300, more or less.” GCZ17 settlement Friday: $1304.60. So gold’s gone up about 10% per year]. This speech also had the infamous line “But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.”
In this week’s paper, Bernanke talks about the concept of raising the inflation target, and then draws a distinction between inflation targeting and price-level targeting. He mentions the idea of the Fed having to communicate its policy and educate the public. At one point he blithely says, “Instead, following the inflation-targeter’s approach, the Fed would simply guide inflation back to target over time.”
Um, the problem is that the Fed is having trouble ‘simply’ guiding inflation. If anyone ever sought to write an eloquent paper that drives the public to the inescapable conclusion that the Fed should just follow a rules based policy instead of theoretical mumbo jumbo, Bernanke made the case. In spades. Fed officials constantly defend their subjective policy making, saying that the economy has so many nuances that it takes the superior assessment of seasoned bankers to guide the economy through rocky shoals. But the Fed hasn’t been able to hit its inflation target. The dots are consistently wrong. Fed officials openly acknowledge they’re not quite sure what’s going on. Circling back to the sentence at the top of this note, the reason the public doesn’t like inflation is because the price of the labor they sell IS NOT GOING UP AS QUICKLY AS PRICES OF THE THINGS THEY NEED TO BUY. Is that persuasive enough for an economist? It’s the core issue. Wages aren’t keeping pace with, well, let’s just refer back to our earlier example of gold, which has gone up 10% a year. The end result is income inequality. If Tillerson read that paper he might call the author… ahem, well…he might mutter something under his breath.
Look, I think inflation is going up. I think the Fed (and markets) may be caught by surprise, notwithstanding comments from Fed Presidents like Bostic, who said last week, “On balance, the limited market reaction to the rollout of the Fed’s new balance-sheet policy leads me to conclude that financial market participants do not view it as a significant tightening of conditions or a hindrance to economic growth.” In contrast, Brevan Howard announced a new fund “…to bet on both a steepening of the US yield curve and an increase in curve volatility.” I’ll go with BH on this one.
In terms of launching a contrarian fund for increased vol and a steeper curve, the market is kindly sending an engraved invitation. This week yields fell and the curve closed at the low of the year, actually, at the lows since the great financial crisis. In treasuries, 2/10 ended the week at 78.5 (started the year at 124). 5/30 closed 90.6 (started 113). In eurodollars, red to gold pack spread (2nd to 5th year) settled just over 40 bps (82.5) and the red to green pack spread (2nd to 3rd yr) at just over 14 bps (39). From VIX to treasuries, vol remains pinned to the mat. Stocks are at all-time highs and consumer sentiment this week ticked at the highest level since 2004.
However, given the Fed’s balance sheet reduction schedule, and suggestions that the ECB might cut its purchases in half next year to 30B EUR month, it will likely be sometime in 2018 that the ECB’s buys intersect with the Fed’s sales in terms of quantity. Possibly around the US midterm elections. That’s not to say there will be an absence of growth in central bank assets. We still have the BoJ, and China’s societal funding is still increasing as a % of GDP. But the change in trajectory will be obvious.
In terms of the actual target of Tillerson’s collegial nickname, President Trump is throwing a lot of darts at once. Although I’m sure no one could accuse Donald of hubris, his repeatedly taking credit for creating $5 trillion in stock market cap is sure to come back and bite him in the ass. Because that’s what markets do. Oh sure, there are times when passive management reigns, both on an economic and a societal plane, but then the cracks begin to show. I can’t do justice to this theme; I’m just another broken record. However, I’ll refer to an Op-Ed in the South China Morning Post (linked below) by Andy Xie, which is chock full of interesting tidbits. Below are a couple:
The mistaken stimulus has the unintended consequences of dissipating real wealth and increasing inequality. American household net worth is at an all-time high of five times GDP, significantly higher than the bubble peaks of 4.1 times in 2000 and 4.7 in 2007, and far higher than the historical norm of three times GDP. On the other hand, US capital formation has stagnated for decades. The outlandish paper wealth is just the same asset at ever higher prices.
In tier-one cities [in China], property costs are likely to be between 50 and 100 years of household income. At the peak of Japan’s property bubble, it was about 20 in Tokyo. China’s residential property value may have surpassed the total in the rest of the world combined.
Paraphrasing Tillerson…
In today’s bubble, central bankers and governments are fools. They can mobilise more resources to become bigger fools.
Xie’s op-ed concludes: “The most likely cause for the bubble to burst would be the rising political tension in the West.” He mentions midterm and presidential elections. I would only add that there are a LOT of possible catalysts out there, and they seem to be multiplying.
NOTE: This week is the 30th anniversary of the October 19, 1987 stock crash (where the Dow fell 22.6% in one day). Of course, that was a time of program trading and portfolio insurance. Nothing like that today… Also, we’re lucky not to have any impulsive senior federal officials, like then Treasury Secretary James Baker, who publicly threatened to devalue the dollar in order to address the trade deficit. : – l
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| 10/6/2017 | 10/13/2017 | chg | |
| UST 2Y | 150.8 | 149.3 | -1.5 |
| UST 5Y | 196.6 | 190.5 | -6.1 |
| UST 10Y | 237.2 | 227.8 | -9.4 |
| UST 30Y | 290.7 | 281.1 | -9.6 |
| GERM 2Y | -70.0 | -72.5 | -2.5 |
| GERM 10Y | 45.9 | 40.3 | -5.6 |
| JPN 30Y | 88.2 | 86.3 | -1.9 |
| EURO$ H8/H9 | 32.0 | 29.5 | -2.5 |
| EURO$ H9/H0 | 17.5 | 14.5 | -3.0 |
| EUR | 117.32 | 118.21 | 0.89 |
| CRUDE (1st cont) | 49.29 | 51.45 | 2.16 |
| SPX | 2549.33 | 2552.17 | 2.84 |
| VIX | 9.65 | 9.61 | -0.04 |
https://www.frbatlanta.org/news/speeches/2017/1012-bostic-balance-sheet-normalization-in-us
