|The Eccles Building|
By David Stockman
Yesterday the Fed signaled that interest rates would stay near zero until 2024, but that was apparently not enough. As one money manager sotted with Monetary Cool-Aid bleated,
“The Fed said it would keep rates low for ages. But that’s not enough,” said James Athey, senior investment manager at Aberdeen Standard Investments. “Not taking away is no longer sufficient for this
market. You need to do more, more, more.”
The Fed did say that it would continue buying $120 billion of government and GSE paper per month for the indefinite future. That amounts to monetizing $1.44 trillion per year, meaning that in less than two years the Fed’s balance sheet will vault above the $10 trillion mark.
For want of doubt, that would essentially amount to $10 trillion of official financial fraud—95% of which would have been accomplished since the turn of the century when the Fed’s balance sheet stood at just $500 billion after the first 86 years of its existence.
Likewise, how do you get “more” on the rate front when during the last 152 months (since February 2008) the Fed’s policy target rate (brown line) has been below the running inflation rate (purple line) in all except seven months. That means rates were negative in real terms 95% of the time.
And now they are pledging to tack onto that at least another 40 months of deeply negative real rates. That is to say, the geniuses in the Eccles Building are promising nearly 17 years running in which the Wall Street money market will function as a candy store for dealers, speculators and carry traders.
After all, the overnight and short-term money markets are not where operating businesses borrow to fund their working capital or where households borrow to finance the purchase of new autos, washing machines and trips to Disney World. Instead, that’s
where Wall Street dealers fund their massive inventories of inflated stocks and bonds, speculators obtain repo funding of their asset books and options writers implicitly fund the carry cost of open positions.
Long ago Wall Street was transformed from an honest capital and money market into a giant gambling casino, but the prospective 17 straight years of negative real rates are now morphing it into a veritable devils workshop. Our lunatic central bankers apparently will not stop egging on the traders and speculators until the actually blow-up the entire financial system.
Moreover, when we say negative real rates, we are not talking about marginalia, or money rates that are a few basis points under the inflation water-line. As is evident in the chart, we are already back to the extreme of January 2012, when the gap between CPI inflation (2.60%) and the effective Federal funds rate (0.08%) was –252 basis points.
Of course, that bit of insanity was justified as a once in one-hundred years expedient to kick-start an economy that had been mauled by the Great Recession. But here we are back at a real yield in the money markets of -250 basis points, meaning that the 12-year average real money market rate stands at negative -135 basis points, and will be extended at the level or even deeper for another three years.
Fed Funds Target Versus Trimmed Mean CPI, 2008-2020
The above chart is tantamount to a criminal indictment of today’s Keynesian central bankers. It means that savers are being savagely punished and expropriated, even as speculators skim massive dead-weight rents from the the securities markets. It amounts to a stupendous wealth transfer from the productive masses to the top 10% and 1% of households, which own 88% and 55% of these vastly inflated financial assets, respectively.
Of course, the lunatics domiciled in the Eccles Building pay no never mind to the chart above or to the capricious and destructive wealth transfer to the already rich which they intermediate. That’s because deeply embedded in their oppressive group-think is the erroneous presumption that “lower for longer” supports the main street economy, thereby fostering more growth and jobs than would otherwise happen on the free market left to its own devices .
As we show below, however, prolonged negative real money market rates manifestly do not engender enhanced economic performance on main street; the presumption that it does is just Keynesian catechism, not an empirically based truth.
So when central bankers appear to embrace a little froth on Wall Street in return for an upgrade to the main street economy, it involves no actual trade-off at all. The “better economy” is just the imaginary product of ritual incantation in the Eccles Building,
while the Wall Street “froth” actually amounts to massive, systematic and ultimately fatal inflation of financial asset prices that can only end in a destructive crack-up boom.
One of the reasons today’s Keynesian central bankers fail to see the destructive folly of sustained negative real money market rates is that they are obsessed with inflation shortfalls from their arbitrary 2.00% target. That apparently blinds them to the absolute level of inflation and its relationship to money market rates that have been pegged close to the zero bound for more than a decade.
But the question, of course, is which is the greater danger? To wit, deeply negative money market rates, which will now be in place for nearly 17 years running, or modest shortfalls from a 2.00% inflation target, which the great Paul Volcker himself debunked as financial nonsense?
We have long argued that the 16% trimmed mean CPI is the best available trend measure of consumer inflation, and on this metric here is what you get: Namely, an average per annum increase of 1.93% since February 2008 per the chart above. Accordingly, for that meaningless 7 basis point shortfall from target, the Fed offered traders and speculators funding themselves in the money markets negative real interest rates that averaged -135 basis points over the last 12.5 years.
Moreover, that preposterous outcome remains true even if you use the Fed’s preferred sawed-off inflation measuring stick called the core PCE deflator. As shown below, for nearly the entire period since the financial crisis, the pegged money market rate has been well below the year-over-year trend of the core PCE deflator, as well.
In this case, the core PCE deflator rose by about 1.6%per annum, implying a 40 basis point shortfall from the 2.00% inflation target, but also resulted in an average negative real interest rate of -100 basis points over the period.
Folks, a 40 basis point shortfall on the shortest measuring stick in town is flat-out meaningless. But -100 basis points of after inflation carry is the very mother’s milk of rampant speculative excess on Wall Street.
Fed Funds Target Versus Core PCE Deflator, 2008-2020
The evidence is overwhelming that these massive gifts to Wall Street speculators imparted no economic goodness whatsoever to main street. Again, the best measure of peak-to-peak economic growth is real final sales because it removes the distorting effect of inventory fluctuations on the starting and end points of measurement.
On a cycle peak-to-peak basis, the per annum growth rate of real final sales has deteriorated steadily and sharply since 1953:
• Four cycle average, Q2 1953-Q4 1973: 3.65%;
• Four cycle average Q4 1973-Q1 2001: 3.29%;
• Housing boom, Q1 2001-Q4 2007: 2.56%;
• QE regime, Q4 2007-Q1 2020: 1.57%.
We find it remarkable that while the Fed’s money-pumping policies since 2008 have generated a trend economic growth rate equal to just 43% of the 1953-1973 average that the denizens of the Eccles Building have the gall to congratulate themselves on a job well done, and propose to double-down in the years just ahead.
Nor can there be any doubt that the far higher economic growth rates of the earlier periods shown above occurred notwithstanding significantly positive real money market rates for most of the 45-year high growth era before 2001.
Indeed, the chart below has the red line (Fed funds rate) and black line (PCE deflator) flipped upside down compared to the one above for 2008-2020. During the earlier 45- year period more than 90% of the time money market rates were positive in real terms,and often substantially so, averaging +200-400 basis points for much of the period after Volcker vanquished double-digit inflation in the early 1980s.
PCE Deflator Versus Fed Funds Rate, 1955-2000
Here’s the thing. JayPo and his merry band of money-printers have now decamped into an alternate universe.
They actually do believe that the Fed constitutes some kind of all-powerful monetary politburo; and that it possesses the tools to optimize the performance of an infinitely complex $20 trillion economy, which, in turn, ebbs and flows within the framework of an $85 trillion global GDP wherein product, labor, capital and money markets all around the planet are deeply interconnected by modern financial and communications technologies.
So we think they are smoking something. And that especially goes for Chairman Powell, who yesterday sounded like some latter day King Canute, commanding the waves of policy-imposed deflation and economic contraction now afflicting the US economy to retreat by the sound of his voice alone.
“This very strong forward guidance, very powerful forward
guidance that we have announced today will provide strong support for the economy,” Chairman Jerome Powell told reporters. To drive the point home, he used the word “powerful” 10 times in the press conference.
Puleeze. Open mouth policy via “forward guidance” is the most hideous ploy yet in the Fed’s unending campaign to essentially destroy honest price discovery in the money and capital markets. It represents group-think gone off the deep-end.
The truth is, in today’s massive, intricately interconnected global economy, central banking in one country is an anachronism. The Fed’s purportedly sacred remit via the Humphrey-Hawkins inflation and unemployment targets are absolutely pointless because they can’t even be measured accurately, let alone delivered to the decimal point by Fed action.
That is to say, the U-3 unemployment rate is a joke in an hours and gigs based world where the price of labor and the quantities supplied in the domestic market are driven by the China Price for Goods, the India Price for Services, the Mexican Price for assemblies and the Pilates Studio Price for domestic services.
Likewise, the Fed’s vaunted PCE deflator is not even a fixed basket price index that measures the purchasing power of money over any reasonable period of time. It’s just an accounting device for the green eye-shades at the Commerce Department who are charged with confecting and calculating a dubious aggregate called the Real Gross Domestic Product.
There is only one way back to stable, sustainable capitalist prosperity, but there is not a snowball’s chance in the hot place that either candidate in the upcoming presidential election fiasco has a clue. That’s because the Wall Street gamblers and the Washington spenders alike prefer things just as they are—even if they are drifting toward the drink at an accelerating pace.
To wit, the plug needs to be pulled on the Fed’s macroeconomic management remit because it’s impossible to implement in today’s world and unnecessary, to boot. Capitalism will grow on the free market at whatever pace its collective participants desire, and the money and capital markets can price financial assets far more accurately and flexibly than the camarilla of 12 monetary central planners now sitting on the FOMC.
How can the above be accomplished?
• Repeal Humphrey-Hawkins and all other macroeconomic targets and return the Fed to the modest role of functioning as a “bankers bank” as designed by the great Carter Glass way back in 1913;
• Abolish the Open Market Committee and all forms of active meddling in the price discovery process in the money and capital markets;
• Empower a small group of true green eye-shade technicians in the Eccles Building to lend to the banking system at a penalty spread above the open market interest rate against good collateral of short duration.
That would do it!
David Stockman was Director of the Office of Management and Budget under President Ronald Reagan. After leaving the White House, Stockman had a 20-year career on Wall Street.