In my last post I pointed out that an obscure action by a small central bank had caused huge reverberations around the world. Swiss stocks were trashed, Polish mortgagees found the burdens of paying off their mortgages suddenly much heavier, Denmark had to drop its interest rates three times (now four times, into seriously negative territory) in an attempt to maintain its peg to the euro. Since that post appeared, currency speculators have attacked other nations, prominently including the UAE.(1)
Of course, unless you’re trading currencies – which I sure as hell hope you’re not – all this might seem like little more than a curiosity, like the guy in the Upper Amazon Basin who has four thumbs. Currency markets are enormously complex, but my point is a very simple one: once investors lose confidence in central banks, it’s a long way to the bottom. The policy panic that clobbered Switzerland and is now infesting Denmark, the UAE, Saudi Arabia and other nations, is nothing – nothing – compared to the panic that will infect the globe when confidence is lost in the Big Three: the Fed, the ECB and the BOJ.
The reason confidence hasn’t been lost already is that:
* in, the US, wealthy investors and global financial firms have loved QE, since it caused stock prices to soar, and Congress has loved QE because it removed any pressure on them to do anything;
* in Europe, the ECB didn’t do anything until recently except threaten to do it, so they haven’t been tested, but soon will be;
* in Japan, everyone is waiting, but less and less patiently, for Prime Minister Abe to launch his third “arrow.”
But let’s take a hard look at what the Fed has actually accomplished with QE, judged not by exacting Curtesian standards, but by the lax standards of the Fed itself.
The Fed hoped to accomplish two objectives with QE, reflecting its tripartite mission: first, it wanted to boost inflation up to its 2% target, thus fulfilling its stable prices mandate; it wanted to boost the US economy so more jobs would be created, thus fulfilling its maximum employment mandate; and it blithely ignored its mandate to ensure moderate long-term interest rates.
So the Fed already has one strike against it, having clobbered already too-low interest rates and made them even lower.
How’d the boys and girls at the Fed do on the inflation front? Strike two, I’m afraid. Inflation at this writing is exactly where it was when QE was launched in the US. Despite the billions in bond buying binges, inflation hasn’t budged.
As far as maximum employment is concerned, the Fed itself admits that while unemployment numbers have come down, the jobs that have been created are of poor quality and millions of people remain un- or under-employed. There is no wage pressure whatever.(2) Strike three.
So what exactly did the Fed accomplish by QE? A roaring stock market! Suppose that, when it was launching QE, the Fed had announced that it didn’t plan to push inflation up to its target and it didn’t plan to create full employment, but it simply planned to make wealthy investors even wealthier? If they’d said it, they’d have been crucified, but, strangely enough, by merely doing it they’ve been applauded.
The result has been a vast increase in economic inequality in the US, so much so that many traditional measures of economic activity are no longer meaningful. Consider consumer spending. You can read in the papers that consumer spending is up, but what’s behind the numbers is that the wealthiest 5% of Americans are spending like drunken sailors, while the other 95% are actually spending less.(3)
The one thing the Fed has going for it, according to the Fed, is that the US is growing faster than other developed countries. But – hello – the US always grows faster than Europe and Japan. We didn’t need unconventional monetary policies to accomplish that modest achievement. The problem is that we’re barely growing – 2.6% per annum in 4Q14. Following a deep recession, the US economy always – always – grows at a very rapid pace, making up for lost time.
But not this time. Under QE, US growth has seen its slowest stretch in modern US history, going all the way back to when GDP records began to be kept in 1930. In other words, including the Depression. When will people stop congratulating the Fed on producing 2.6% growth seven years after the crunch and start recognizing that the Fed is the problem?
Yeah, sure, you are thinking, that’s just the opinion of Greg Curtis, Jim Grant,(4) Paul Singer(5) and 313 million poor, working class and middle income Americans. What about everybody else?
Everybody else is about to join us in losing confidence in our central bankers, not because they’re as smart as Curtis, Grant, Singer and 313 million Americans, but because we are about to leave the realm of opinion and enter the terrifying world of actual facts. We can argue all day about whether the Fed did the best it could do under trying circumstances, or whether the Fed has abysmally mismanaged the economy. But QE is also happening in Japan and Europe. As I’ll show in the my next post, the awful facts are about to stare us in the face and our ability to maintain confidence in the central bankers will come to a shattering end.
(1) According to the Wall Street Journal, Guggenheim Partners has made a leveraged bet against the UAE dirham, hoping the country won’t be able to maintain its peg to the US$. Because most investors believe the peg will remain, options that it won’t are very cheap.
(2) The problem here is that the financial crisis exposed – as financial crises tend to do – some serious structural inefficiencies in the American economy. Because American policymakers (the Fed, Congress, regulators) had all been put to sleep by boom times, those structural problems were solved via crisis, rather than via evolutionary changes in the economy. The result was an instant and explosive growth in unemployment. But a large proportion of the newly unemployed weren’t unemployed temporarily, they were unemployed structurally in the sense that – it’s a hard thing to say – they shouldn’t have been employed in those capacities in the first place. One huge problem with unconventional central banker meddling was that QE prevented the economy from mending itself normally. As will happen in Europe, QE removed any incentive economic actors had to make hard changes.
(3) On January 29, the Wall Street Journal published a chart illustrating this awkward phenomenon. See “Two-Tier Economy Reshapes US Marketplace,” p. 1.
(4) See James Grant, The Forgotten Depression: 1921 – The Crash that Cured Itself. Grant’s point is that even serious economic collapses generally cure themselves quickly as long as governments and central bankers don’t do the wrong things, as they did during the Great Depression and following the Great Contraction in 2008.
(5) “With euro interest rates at record lows, we cannot imagine that the ECB’s recently announced QE program will improve Europe’s serious economic situation. On the other hand, QE might have unpredictable and large negative repercussions if it triggers a generalized loss of confidence.” (Emphasis added.) Quoted from Elliott’s investor letter by CNBC’s Lawrence Delevingne, available at http://www.cnbc.com/id/102389608. Paul Singer, in case you don’t know, runs Elliott Management Corp., one of the largest hedge funds in the world, with AUM of @ $25 billion.
Next up: A Dark Harbinger? (Part 3)
[To subscribe or unsubscribe, drop me a note at GregoryCurtisBlog@gmail.com.]
Please note that this post is intended to provide interested persons with an insight on the capital markets and is not intended to promote any manager or firm, nor does it intend to advertise their performance. All opinions expressed are those of Gregory Curtis and do not necessarily represent the views of Greycourt & Co., Inc., the wealth management firm with which he is associated. The information in this report is not intended to address the needs of any particular investor.