Pay no attention to that man behind the curtain. The Great Oz has spoken...!
SO FINALLY, the great day came and went when the US Federal Reserve would once again ride into action, writes Sean Corrigan for the Cobden Centre.
Not daring to be left behind by the European Central Bank's perverse vaunting of its new 'unlimited' programme of bond purchases, the Fed is also too impatient to attend the continually postponed policy shifts so long expected from both the People's Bank of China and the Bank of Japan.
A few months of less-than-stellar macro numbers, coupled with a lull in the rise of the price indices which was helped along by the last cyclical downturn of commodity prices (alas, for the ordinary American housewife, long since reversed), and the Mighty Oz was free to rummage deep into his carpetbag of gewgaws and conjuror's props once more.
The rationale for this latest enormity is, frankly, hard to determine. Unless it's Ben Bernanke's eagerness to present whoever might replace him under an incoming Republican administration with a fait accompli and so to ensure his legacy as the worst US economic 'experimenter' to be empowered since the dark days of Roosevelt himself (he of the breakfast egg Gold Price fixing, the alphabet soup price and wage dictatorship, and the enforced famine of mandated crop and livestock destruction).
So, when we received a little insight into the fevered mind of the Chairman – coming in the form of what he told an interlocutor from Reuters, when asked to explain how exactly he envisaged that his new, open-ended, $45-billion a month QE programme would work – our first urge was to utter the obsecration: 'Spare us, Lord, from the scheming of idiot savants!'
Apart from the fact that Blackhawk Ben here seemed to hew to a particularly crude version of the Phillips curve largely disavowed by even the most unreconstructed mainstreamers (one which imagines that extra jobs can be bought if only prices can be made to rise fast enough), after five years of ever more desperate flailing to restore false, boom-time levels of activity, he appeared to have staked his all on bursting the piñata of the labour market by smacking it with the rough-hewn pole of the so-called 'wealth effect.'
As he told the journalist in September's post-Fed committee decision Q&A:
"The tools we have involve affecting financial asset prices...Those are the tools of monetary policy. There are a number of different channels. Mortgage rates, other interest rates, corporate bond rates. Also the prices of various assets...for example, the prices of homes.
"To the extent that the prices of homes begin to rise, consumers will feel wealthier, they'll begin to feel more disposed to spend. If home prices are rising they may feel more may be more willing to buy home because they think they'll make a better return on that purchase. So house prices is [sic] one vehicle...
"Stock prices – many people own stocks directly or indirectly. The issue here is whether improving asset prices will make people more willing to spend...
"One of the main concerns that firms have is that there is not enough demand...if people feel their financial position is better...they'll be more likely to spend, and that's going to provide the demand firms need in order to be willing to hire and to invest..."
These few, brief sentences contain such a miasma of error that it is hard to know where to begin if we are to restore a fresh breeze of economic rationale to this swamp of non sequiturs and wilful misunderstandings. It is not enough that crude, Krugmanite Keynesianism clings to the cheap parlour trick of using money illusion to fool unemployed wage-earners into lowering the reservation price of their labour, but now we must battle against banal, Bernankite Bubble-blowing – the hope that money illusion will fool cash-constrained asset owners instead.
To show what we mean, indulge us while we parse the Chairman's words. Because what was really said was that:
"If we can artificially suppress interest rates to a low enough level, lots of people will forget that they got themselves into the current mess by borrowing too much the last time we did this and so they will begin to do so again – especially the would-be home-owners and condo-flippers.
"If the price of homes begins to rise, those who have already borrowed to buy one will feel better off even though: (a) they will earn not one red cent in extra income because of that appreciation and (b) if they do manage to register a one-off capital gain, it can only come at the expense of the purchaser, whose acquisition of a durable store of shelter services will therefore involve a much greater, zero-sum call on his resources than otherwise would have been the case.
"The stock market should also rise just because there's more easy money chasing after a parking place. Naturally, we at the Fed could care less about the quaint notion that equities should represent a sensibly valued claim on a company's estimated stream of residual earnings, or that capital markets need genuine prices if they are to serve any useful social function by allocating scarce savings to the prospectively best investment projects.
"To the contrary, from our perspective, if Joe Soap wants to splash out to celebrate the entirely notional, potentially only nominal, and probably ephemeral gains on his 401k which we can bring about – without wondering whether the increase represents any lasting contribution to the aimed-for security of his retirement – well, in the long run, we're all dead, aren't we?
"Companies don't have enough 'demand', don't you know, so if we can only get people to wave their cheque books at them, they will be so sure of being able to profit from this that they will offer every one of their new customers a job, on the spot!
"Incidentally, we Keynesians are big on portraying consumer demand as being the driver of the economy, even though we've never quite been able to explain why it is that the 'demand' inherent in the existence of millions of hungry people in the world – all pathetically eager for an extra morsel of food – has not automatically brought about the necessary increase in agricultural output, investment, and employment in precisely the same manner that we are now presuming will be the case for, say, WalMart once we start buying in its customers' mortgages."
Like most macromancers, what our esteemed Chairman is missing here is any concept of how a business actually functions, of how it and its peers interrelate in the overall structure of the economy, and of the critical role played by capital and time in the division of labour and the provision of goods. He is also prey to the superficial fallacy – a kind of inverted Say's Law – that consumption somehow dictates the amount (rather than merely the composition) of production, something that has not been the case ever since Adam was condemned to earn his daily bread in the sweat of his brow and to till the ground from when he was taken.
Thus, rather than being fooled by the mantra that '(personal) consumption is two-thirds of the economy', one should be clear about the distinction that its (imputation-boosted) count is actually only two-thirds of the highly-subjective statistical shorthand which is GDP – and that this is not the same thing at all! Gloves may well comprise 100% of the clothing I put on my hands in winter, but if they are all I don when I go out snow-shoeing, I'm not likely to get very far before some Good Samaritan of the Alps finds my half-frozen form and has to send forthwith for the nearest brandy-carrying St. Bernard so as to revive me.
This is a matter to which we have already devoted a great deal of time, but a brief synopsis here is probably in order.
Take, for example, the four years from 2006-9 inclusive which saw US GDP average just under $14 trillion while cash PCE came in at a mean $8.5 trillion (ergo, validating the shibboleth that the latter number equates to 60% or so of the first). Mainstream thinking may stop short here, smugly satisfied with this trivial – and circular – QED, but this is not even half the story.
We say this because, over the period in question, aggregate business revenues – i.e., the best representation of the overall circulation of goods and services throughout the economy – amounted to no less than $33 trillion a year (the vast bulk of which receipts were subsequently disbursed again, whether as above-the-line costs, below-the-line outlays, interest, dividends, or taxes).
Thus, not only was the 'economy' almost 2 ½ times as large as the GDP count, but every $1 of that supposedly crucial personal outlay was matched by $3 of business-to-business spending.
So, if Mr, Bernanke really wants to get 'demand' going, the foregoing drops a heavy hint that he would be three times as effective as he has been if he and his masters in Washington could manage to do something (or, conversely, to stop doing much of what they counter-productively have been doing) which ends up promoting greater managerial/entrepreneurial belief that not only can profits be made, but that, once made, more of them will be retained by their rightful owners.
It should also be recognised that the vast bulk of that $25 trillion in business-to-business (B2B) expenditures is every bit as discretionary as the outlays of the most finicky of shoppers: no businessman can be compelled to keep his store open, or his factory running, if he finds the game not worth the candle, even though mundane economic analysis tends to assume without question that, far from being an adaptive, calculating, he is an unthinking automaton who can very much be relied upon to do just that, irrespective of his estimated remuneration.
More fundamentally still, it is the relationship (strictly, the ratio) between his receipts and his disbursements wherein the lies the difference between our hero's commercial success – and so, his role in hiring, commissioning and the onward generation of orders for his suppliers – and his failure – hence, his sad duty to undertake lay-offs, cut-backs, and cancellations. Even absent net, new investment to improve and deepen the capital stocks and so raise real incomes, the overwhelming preponderance of that $25 trillion (in fact, all of it less an average $1.5 trillion before – and only $250 billion after – depreciation) represents a voluntary sacrifice of the enjoyment of present goods, undertaken merely to keep things running as they are.
The idea that such a delicate network of relative prices and differential cash-flows can be not only maintained, but enhanced, by the clumsy process of artificially forcing arbitrary quantities of money and credit into the system is at best naïve and at worst astrological in its pseudo-rationality. At root, such gross interventions as these, no matter how greatly they excite the raptures of the mainstream inflationists, ensure nothing more than the confusion of those critical accounting algorithms which help ensure that capital and labour are not being squandered. This is so because, not having the noble pedigree of the free, unhampered market, the infusions – being nothing more than the bastard offspring of the central planners' hubristic conception – bear no definitive relationship to the generation and subsequent movement of the real goods and services whose value-giving exchange it is the sole purpose of these media to facilitate, both across space and through time.
To see this, take the simple – if extreme – example of the post-Lehman crisis itself. According to the newly-respectable brotherhood of NGDP targeters – those economists wanting to boost nominal gross domestic product via inflation, whatsoever the cost to real output – the Fed 'only' had to ensure that the gross flow of money out of the funnel at the end of the economy (the $14 trillion per annum, principally in the form of final, exhaustive spending) remained unaltered and all would have been well.
But look at the facts of what did happen that year as the economy swirled around the ragged edges of a maelstrom of total collapse. Total domestic, non-MFI credit rose a modest 2.9% as the private component of this fell 2.5% while Leviathan's appetite grew by a monster 13.7% (counting GSEs in with government itself). Meanwhile, M1 jumped 18.1%, 'Austrian' Money Supply (M1+, if you will) rose 25%, and M2 added a more modest 9.1%. Confusion confounded, you might say, since we are being exhorted to act to control one or more of these aggregates, depending upon which particular 'new' monetary school you choose to believe. But the difficulties do not end there, for worse was to come in the 'real' economy.
Here, the hallowed NGDP measure fell 3.7%, implying the Fed should have added X, or maybe Y, or Z in order to offset the switch in emphasis from credit to money and the concurrent slowdown in the immediate use or 'velocity' of that money.
But this was not the end of it, for private-sector NGDP (the important bit) fell a greater 5.7%, while the total business revenue measure which we have argued above is the real key variable, slumped to a crushing 11.5% loss. Within this the disparities were even more marked. Revenues among the extractive industries plunged 50.6% at one end of the spectrum as those accruing to health & social care rose 4.4% at the other. For profits – and hence, for both the means and the incentive to expand output and employment – the spread was even more extreme for the trailing four quarters to our two end-dates, ranging from a 73% contraction for the extractive sector to a 68% gain for the utilities (which, in part, benefited from the formers' woes in the shape of cheaper energy inputs, again underlining the point that it is relative costs and prices which count, not absolute ones).
Again, we have to ask the targeters and reflationists: how, where, and when was the central authority supposed to have intervened in order to lessen the economic pain; and how do we know that same pain was not either intensified or prolonged, rather than mitigated, by the actions which were taken since these could not have done other than to have interfered with the market's attempts to find proper clearing prices, to excise dead capital stock, and to marshal its combined entrepreneurial abilities for the task of laying down new capital where the evaporation of the prior bubble had revealed it to be truly useful (and, by extension, profitable) to do so?
If the Bernanke Fed had any answers then – or, indeed if it has since achieved sufficient enlightenment to justify its present burst of activism – we should be delighted to hear them. Our breath is not being held.
As a practical matter, it should be noted that the final data which we use to plot these changes have only just begun to be made available on a delayed quarterly basis and, even then, a full check on their validity awaits the glacial progress of the statisticians at the IRS, whose findings can be up to four years in arrears!
Though we must always exercise caution regarding any use of aggregates, a reasonable proxy is therefore what we need if we are to monitor developments, albeit using the broadest of brushes. For us the widely-ignored business sales data fits the bill for overall activity, while the ratio of its sub-components—retail sales versus those made in the manufacturing and wholesale sectors gives us an idea of gross saving/investment v end-consumption. Another way of showing this is to plot the monthly personal consumption estimates against those for business revenues. As the plot shows, this latter is highly variable and has been in decline ever since the financialization of the economy began in earnest in the early-1980s.
A falling ratio implies, to an Austrian, that a greater degree of time preference appears to be developing and hence, a higher natural rate of interest (the ratio of intertemporal prices) has come to prevail.
In contrast, an examination of the path of BAA bond yields shows that market rates (after subtracting consumer price changes) have been steadily falling over time, due to a toxic mix of loose money and abundant speculative leverage. The gap between what should be and what is, is therefore a widening one, suggesting that a mix of overconsumption and malinvestment, fuelled by increased non-productive indebtedness, is to be expected.
Chronic and often highly elevated current account deficits (not to mention the dire fiscal situation) testify to the overconsumption element, while the series of ever-more violent booms and busts, coupled with lacklustre real net investment and stagnant real wages, are symptomatic of the second, while the level of debt itself should itself need no further comment.
Given this malign constellation of factors, the Fed's eagerness to suppress all interest returns for at least the next three years and for as far out the curve as its tainted grasp can extend is not likely to do anything to restore a much-needed touch of balance to the world's largest (and formerly most vibrant) economy.
Bond yields have already been forced far too low, making stocks seem relatively well-valued, even as the underlying conditions deteriorate and the fatal dependency on the sweet nEurotoxin of stimulus deepens its grip on the patient. By progressively suppressing the economy's intrinsically-generated price signals in this fashion, a wholesale paralysis of the system may one day result.
What Bernanke's intellect cannot seem to encompass is the thought that if a man has lost weight through an illness related to his previously poor dietary regime, it will simply not do to try to fill out his now-baggy suit by tempting him back into over-indulgence. Some glimmerings of this idea do surface in the occasional expression of doubt about just how large such shadowy entities as the 'output gap' or the 'structural growth rate' may still be in the aftermath of 2008's debacle, but none of these misgivings ever seem to penetrate the cranium of a man who thinks he can meaningfully reduce unemployment by stimulating junk finance in all its many forms.
It is not only that Bernanke's policies will inevitably assist the zombie companies and the obsolescent industries to absorb scarce resources (not least on bank balance sheets) to a much greater degree than is justified, thereby denying greater returns both to their better-positioned rivals and to those nascent endeavours which could better reflect unalloyed consumer preferences and whose growth could come to replace yesterday's failures as tomorrows' providers of income. There is also the danger that lax money misleads even today's supramarginal businesses into over-estimating the depth and duration of demand for their products, ultimately undermining many otherwise sound undertakings and reducing these, too, when the cycle next turns, to the ranks of the Living Dead.
Gather ye rosebuds will ye may, for the bloom on this Fed rally, too, will eventually wither and fall.
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