Asset Targeting Reaps the Whirlwind
The Fed's asset-targeting policy all adds-up to an outbreak of inflation ahead...
"I GUESS I SHOULD WARN YOU," Gary Dorsch, editor of Global Money Trends, quotes former Federal Reserve chairman Alan Greenspan.
"If I turn out to be particularly clear, you've probably mis-understood what I've said," Greenspan was fond of saying when he controlled the Fed's money spigots. So for many Fed watchers, it was a great relief when "Easy" Al finally retired from the Fed, since there is nothing more vexing than trying to interpret Green-speak.
"Everything depends upon proper listening. Of ten individuals who listen to the same speech or story, each person may well understand it differently – perhaps only one of them will understand it correctly," an eighteenth century theologian observed. So it was of great interest, while listening to a March 27th interview on Bloomberg TV, with the maestro, Mr.Greenspan, who is settling into his twilight years. This time, Greenspan spoke more clearly about such arcane subjects such as "Asset Targeting" and manipulation of markets.
Asked about his outlook for the US economy, Greenspan answered by saying everything depends upon the ability of the monetary authorities to influence the direction of the stock market...
"Ordinarily, we think of the economy affecting stock prices. I think we miss a very crucial connection here in that this whole economic recovery, as best as I can judge, is to a very large extent, the consequence of the market's bottoming last March, and coming all the way back-up. It is affecting the whole structure of the economy, as well as creating the usual wealth effect impact."
Thus, what Mr Greenspan is describing are the contours of the monetary policy that he pursued as Fed chief – "Asset Targeting", or the utilization of the Dow Jones Industrials index as a key instrument of national economic policy.
By "actively managing" the direction of stock index futures contracts, the Fed could impact the wealth of tens of millions of US households, and by extension, influence consumer confidence and spending. Greenspan generally pursued an "asymmetric" monetary policy – in other words, always quick to slash interest rates and flood the markets with liquidity whenever the stock market was tumbling, but was very slow in draining liquidity or raising interest rates, when stock markets were booming. There was always an inherent bias towards asset bubble inflation, under the Greenspan Fed's policies.
For big-time risk takers in the US stock markets, speculators could usually rely on the safety net of the "Greenspan put" – or a quick easing of monetary policy – to cushion the market from steep losses when risky bets turned sour.
Under the tenure of the Fed's next chief, Ben "Bubbles" Bernanke, speculators have enjoyed the easiest monetary policy in history, which also earned Mr.Bernanke the designation of Time magazine's "Man of the Year" for running the printing press at lightning speeds.
According to Greenspan, the aggregate value of stock markets worldwide has rebounded by $15 trillion from their lowest point a year ago, with the US stock markets recouping $5.4 trillion of lost wealth.
"We're going to get a significant rise in employment," he predicted. But as the long-term unemployed re-enter the job market seeking work, the 9.7% jobless rate would stay little changed, he said.
In the United States, the Fed's central mechanism for inflating the stock market and fueling a powerful stock market rally, has been the radical shift towards "quantitative easing" (QE), in which the Fed printed $1.75 trillion of high powered money – and channeled the cash into the coffers of the Oligarchic banks on Wall Street, which in turn, bid-up the prices of high-grade corporate and junk bonds, thus narrowing their yield spreads with US-Treasuries.
"Remember, it is the market value of equity in a financial institution that determines the ratings of its debt. It's not the book value. As the stock prices have gone up, debt became far more valuable and you can see this blossoming of finance – the huge issuance especially of junk bonds," Greenspan added.
Thanks to the booming stock market, there were $311 billion of new stock offerings on Wall Street, including IPO's, and secondary offerings, in the second half of 2009. Junk bond sales worldwide reached a record $38.3 billion in March 2010, as rising profits and ultra-low interest rates, attracted swarms of yield hungry buyers, who are fed-up with zero rates of return on CD's and money market funds.
There is great optimism on Wall Street that a virtuous cycle is now beginning, in which S&P 500 companies would start to re-hire workers again.
US companies have slashed 8.2 million jobs over the past 27 months, while utilizing the vast oversupply of unemployed workers, to slash wages and medical benefits. Thus, corporate profits jumped $109 billion in the fourth quarter to $1.47 trillion, up 31% from a year ago, as companies benefitted from reduced labor expense. S&P-500 companies bolstered their cash balances to $1.2 trillion, to weather any downturn in the economy.
However, much of the new hiring over the next several months would be for temporary workers by the US Census Bureau, which hired 181,000 workers in the Jan-to-March period. According to some estimates, about 150,000 jobs have to be created every month, in order to keep up with population growth. So although the US economy gained 162,000 jobs in March, the most in three years, a vast portion of American society is either unemployed or underemployed.
About 15 million people are without jobs and another 9.1 million are working part-time, because full-time work is not available. Thus, the main engine of growth for American company growth profits derives from the "exploitation of labor". with US workers, on average, producing 7% more than a year ago, for 6% less wages.
At this critical juncture, with the Dow Jones Industrials index bumping against the psychological 11,000-level, Greenspan was asked about his views for the longevity of the stock market's rally. Greenspan sees the market flattening out in the months ahead, but what spooks him, is the slumping Treasury bond market, which has been trending lower for the past 15-months. Yields on the benchmark 10-year note, are climbing dangerously higher, towards the key resistance level of 4-percent.
"It is a canary in the mine at this stage," Greenspan warned...
"The way I look at it, if the markets are working well, the short term outlook is one of increasing momentum. You can see it developing. But if the 10-year note and the 30-year bond yields begin to move-up, in other words, if the ten-year note begins to move aggressively above 4-percent that is a signal that we are in some difficulty.
"There is basically this huge overhang of federal debt which we have never seen before. It is going to have a marked impact eventually unless it is contained, on long-term rates. That will make a housing recovery very difficult to implement and put a dampening on capital investment as well..."
Greenspan is spooked by the "dangerous divergence" that is developing between a high and rising S&P 500 stock index and the simultaneous slide in the Treasury bond market. They are moving dangerously in opposite directions. And at some point in the future, if the Treasury bond market continues to tumble sharply lower – lifting yields sharply higher, either under the weight of massive new supplies, or Chinese dumping of T-bonds, ahead of a probable revaluation of the Yuan against the US Dollar – then the divergence between the asset classes would grow even wider, to the breaking point that triggers a stock market crash of unknown magnitude.
Amongst the delirious stock market bulls, there's an unshakeable faith in the magical powers of the "Plunge Protection Team" (PPT). These bulls are convinced that the Fed and Treasury can deftly prevent the yield on the key benchmark 10-year Treasury note from spiraling above 4%, no matter how much supply hits the debt market. For now, the Fed is trying to put a safety-net under the T-bond market, by promising to keep the fed funds rate pegged near zero-percent for an"extended period of time," hoping to attract yield starved investors to the long-end of the curve.
"The economy continues to require the support of accommodative monetary policies," Bernanke told lawmakers on March 25th. "If it were positive to take interest rates into negative territory I would be voting for that," said the radical inflationist, San Francisco Fed chief Janet Yellen on Feb 22nd. Yet the Fed is winding down its year-long $1.75 trillion monetization scheme this week, which could make it difficult for Washington to finance its massive budget deficit in the months ahead.
Instead, there could be a torrent of T-bond sales by Beijing if the US Congress can marshal a veto-proof majority for a fast track bill in May to slap tariffs on Chinese imports.
"My belief is that China will not do anything unless they're required to, and every day we wait is a day we lose wealth, we lose economic advantage, we lose jobs," said New York Senator Charles Schumer on March 23rd, claiming that Beijing continues to keep the Yuan "misaligned" with the US Dollar.
Senator Lindsey Graham, a South Carolina Republican, said he agreed quick congressional action was needed because China's currency reforms are frozen in suspended animation. "At the end of the day, China is too big to be allowed to have this under-valued currency advantage. The only thing they seem to respond to is pressure," Graham said.
In response, "The US internal and external deficits remain large, and its unemployment rate is extremely high. Since US politicians don't want to blame themselves, the best available scapegoat is China and its exchange rate," said Fan Gang, of the People's Bank of China on March 26th.
Yet Fan concedes that Beijing may resume a managed float of the Yuan, once the uncertainty of the post-crisis situation diminishes...
The US Congress should be careful about what it wishes for. A significantly stronger Chinese Yuan would greatly boost China's purchasing power for raw materials and agricultural imports, which in turn, could fuel a generalized rally in the commodity markets, and ignite a whole new round of inflation worldwide.
Although a vast supply of jobless workers would help to weaken US wages further, an outbreak of inflation in the US economy could still become unleashed, linked to soaring global commodity markets, which are stoked by booming Asian economies.
Although official government statistics on inflation are often skewed by apparatchiks, feeding the propaganda of the ruling political party, bond traders are looking beneath the surface, taking their cue on real-time inflation trends, from the direction of the commodities markets. With the Dow Jones Commodity Index hovering 23% higher from a year ago, and Chinese and Indian economies expanding at around 9%, combined with trillions of excess paper currencies floating around in the world's money markets, it all adds-up to an outbreak of inflation in the year ahead.
While Greenspan said he sees little threat of inflation now, in the long-run inflation will pick up unless the Fed withdraws the massive stimulus it has pumped into the economy.
"We are still by any measure in a disinflationary environment," he claimed to Bloomberg. However, "unless we sterilize or unwind the big monetary base we've built-up, inflation will begin to take hold." The size of the Fed's balance is "not sustainable" and will eventually have to be reduced to "something just north of $1 trillion," Greenspan said.
"My concern is that legislation or other actions on the part of Congress may prevent the Fed from withdrawing the stimulus," Greenspan added. Such actions have already taken place in Seoul, where the government has completely hijacked the monetary policy of the Bank of Korea. Texas Representative Ron Paul, a Republican, is leading an effort in Congress to repeal the Fed's immunity to audits of monetary policy, which could expose any clandestine intervention in the stock index futures market by the Fed and its agents on Wall Street.
Still, there's a deep-seeded suspicion in the gold market, that at some point, the Fed will resume its massive money printing operations, in order to prevent a surge in Treasury bond yields, sparking the next big round of inflation. Greenspan mostly lingered far behind the inflation curve when he was Fed chief, and never saw a bubble he didn't like. According to the commodities markets, the break-out of inflation has already begun and is buoying gold above $1100 an ounce.