Can Kickers United—–Why It’s Getting Downright Hazardous Out There

It’s getting downright hazardous out there, and not just because the robo-machines were slamming the “sell” key today. The real danger comes from the loose assemblage of official institutions which claim to be running the world.

They might better be referred to as “can kickers united.” It is now blindingly obvious that they have lapsed into empty ritualism, contrivance and double-talk in the face of a global economy and financial system that is becoming more unstable and incendiary by the day.

Who in their right mind would pile $95 billion of new debt on the busted remnants of Greece? Likewise, how can Japan possibly consider enacting still another round of fiscal stimulus, as did Prime Minister Abe’s chief advisor recently, when it already has one quadrillion yen of debt? And what geniuses are trying to fix the bankrupt finances of China’s local governments by swapping trillions of crushing bank loans for equivalent mountains of new municipal bonds?

But it is on the home front where kicking the can has been taken to an egregious extreme. By what rational calculus can it be said, as the Fed did in its meeting minutes today, that 80 months of free money has not quite yet done the job?  And that is exactly what these mountebanks had to say:

The Committee concluded that, although it had seen further progress, the economic conditions warranting an increase in the target range for the federal funds rate had not yet been met. Members generally agreed that additional information on the outlook would be necessary before deciding to implement an increase in the target range.


Say again!  We are now 74 months into a so-called “recovery” cycle that is well longer than the post-war average, yet the Fed is still manning the emergency fire hoses:

Historical Length of Recoveries - Click to enlarge

Even its own research department at the St. Louis Fed has just confessed that the whole rigmarole of QE and ZIRP has had no favorable impact on the main street economy. In a White Paper dissecting Fed actions since the financial crisis, Stephen D. Williamson, vice president of the St. Louis Fed opined that,

…….. the zero interest rates in place since 2008 that were designed to spark good inflation actually have resulted in just the opposite. And he believes the “forward guidance” the Fed has used to communicate its intentions has instead been a muddle of broken vows that has served only to confuse investors. Finally, he asserts that quantitative easing, or the monthly debt purchases that swelled the central bank’s balance sheet past the $4.5 trillion mark, have at best a tenuous link to actual economic improvements……..”There is no work, to my knowledge, that establishes a link from QE to the ultimate goals of the Fed—inflation and real economic activity. Indeed, casual evidence suggests that QE has been ineffective in increasing inflation,” Williamson wrote.

Self-evidently there is no main street emergency, but it is undeniable that ZIRP is the mother’s milk of Wall Street speculation. After all, the money market is where dealers and hedge fund gamblers finance themselves and put on their carry trades. By contrast, no businessman with productive inventories of raw materials, work-in-process or finished goods would be foolish enough to fund his working capital in the overnight markets.

Speculators in tradable financial assets, however, are thrilled to do that all day and night. They know that the shills who run the central bank’s printing press would never allow the money market to be parched for liquidity or allow a temporary surge in the overnight rate to clear the markets of rank speculation. Bernanke’s hair on fire panic in September 2008 proved that beyond a shadow of a doubt.

They also know that the Keynesian scholastics on the FOMC are so utterly naïve that they believe telegraphing to traders exactly what they intend to do for months in advance is an effective form of “policy”. Well, thank you Ben, Janet, et. al. for removing risk entirely from the oldest sin of finance—–that is, borrowing short and hot and investing long and less liquid.

So the Wall Street gamblers back up their trucks and load-up all they can get of whatever is on offer in the casino. As long as it has a yield or a short-run appreciation potential, it is a no brainer to fund such “assets” in the zero rate money markets with repo, options and more exotic forms of bespoke leverage.

This creates unspeakable windfalls to the fast money which plays in the casino, of course. And it also generates enormous incentives for rampant gambling in the capital markets and an endless inflation of financial asset prices. Indeed, it sucks prodigious sums of capital, credit and collateral into the gambling enterprise that is enabled by contemporary Keynesian central banking, while depriving the real economy of true risk capital.

Needless to say, for the third time this century the Fed’s feckless money printers have generated a bubble extreme. In fact, the aggregate market cap of the Wilshire 5000 at 133% of GDP is now higher relative to national income than even during the dotcom bubble (112%) and the housing blow-off (104%).

Screen Shot 2015 08 18 at 8.31.39 AM

But that’s what ZIRP does—-it inflates financial bubbles. It can do no other because the Fed’s monetary emissions have no effective routes into the real economy of borrowing and spending. It’s more than obvious by now, for example, that the household credit channel of monetary policy transmission is broken and done.

US households reached peak leverage in 2008, and have been struggling ever since to work out from under the mountain of debt that was created after Alan Greenspan arrived in the Eccles Building in 1987, and thereafter discovered that the printing press in the Fed’s basement could make him an enormously popular man about town.

But does it take a PhD in econometrics to read the obvious message of the above chart on total household debt? In round terms, Greenspan took it from $2 trillion to $14 trillion during his ill-fated tenure, but then it stopped rising because household balance sheets were saturated.

Accordingly, during the entire 80 months of ZIRP our brilliant monetary politburo has been pushing on  a string. At the end of Q1 2015 there was still less mortgage, credit card, auto, student and other consumer loans outstanding than there were in Q4 of 2007.

And might well there should be. For the prior 40 years, the ratio of household debt to wage and salary income had climbed straight upward like a rocket. This hostaging of main street balance sheets was, in fact, the one time parlor trick of Keynesian monetary policy.

During these four decades, when debt was rising to nearly 220% of GDP from a historic norm of under 75%, households were able to shop until they dropped—–and also buy bigger and better houses on mortgage. They accomplished this by augmenting spending from their current production and income with incremental outlays from their borrowings.

But that brought main street American to the condition of “peak debt” on the eve of the financial crisis. As is evident in the graph below, households have been endeavoring to walk their leverage back from the brink ever since. But at the current 180% leverage ratio they are still way above what had historically proven to be the sustainable and healthy.

Household Leverage Ratio - Click to enlarge

In any event, it means that household spending is now tethered to the tepid rate of growth in output and wage incomes. In that context, the Fed’s 80 months of zero interest rates has been pointless.
It did not and could not encourage incremental leverage. What it did do is merely subsidize the most imprudent of household borrowers——-those who got in way over their heads in the run-up to the financial crisis.

At the end of the day, ZIRP is really not even a monetary policy. In fact, it constitutes a giant, capricious transfer of income and wealth by an agency of the state to borrowers and gamblers at the expense of savers and producers.

Indeed, not a net dime of the massive $3.5 trillion of new liabilities created on the Fed’s balance sheet during that period ever escaped the canyons of Wall Steet.

So read the Fed’s minutes of its latest meeting and weep. These fools are waving their arms at invisible Humphrey Hawkins goal posts and claim to be making steady, measureable progress toward the end zone.

The truth is, the Fed’s endless blathering about its 2% inflation target is a colossal hoax. In the first place there is no evidence whatsoever that real output and wealth increase faster at 2.0% inflation than they do at 1.0%—-or at any inflation rate at all. In fact, the Fed’s claim that it is still well shy of achieving its inflation target is the overriding reason why it keeps shoving zero cost credit into the money market.

Well, here is a chart of inflation since the year 2010. The heavily medicated CPI less food and energy published by the BLS has risen at a 1.9% compound rate and the core consumer goods component of the PPI has risen at a 2.5% annual rate.  Only the PCE less food and energy has fallen appreciably below the Fed’s ostensible target, and that’s entirely due to the phony housing deflators on which it is constructed.


As my colleague Lee Adler definitively documents in an adjoining piece, the Washington statistical mills have been under-measuring housing inflation since switching methodologies in the early 1980s. Lee claims this was to save money on indexed government transfer programs, and he is right. I was there. Washington is guilty as charged!

The crux of the matter is that the BLS now uses a fictitious construct called Owner’s Equivalent Rent (OER) to represent housing costs for the majority of main street households which own their own homes. But OER is arrived at by periodically surveying a tiny sample of owners and asking them what they would rent their castles for were they to move out and go into the landlord business!

And then to add insult to injury, the BLS takes the results of this survey and “trends” (i.e. manipulates) it by other data on “contract rents”, which has its own shortcomings, as Lee explained yesterday:

The problem with that is that leases are typically indexed to CPI, or capped at 2-3% per year increases. Tenants who have been in their apartments for years see their rents going up 2-3% and that’s what they report. So this component of CPI magically looks like CPI most of the time, except when the gap becomes so large that landlords begin to push harder for bigger increases in long term leases. This lag factor eventually causes OER to play catch up to reality, but it never catches up completely. Since 2000, OER has risen at a compound annual growth rate of +2.5%.

Meanwhile, market rent, which is the actual price paid by tenants in the marketplace, and is the true state of price level inflation, has been rising much faster. Over the past 15 years rents have risen at a compound annual growth rate of +3.7%.

As is evident in Lee’s chart, the gap amounts to 1.2 percentage points annually over the last 15 years.

Market Rent vs. OER Long Term

What does this mean for the Fed’s vaunted 2% inflation target? In a word, they are already there, and have been for years!

In the table below, we have substituted the honest commercial data on “asking rents” shown above into the standard BLS consumer price index.

Given that housing represents 26% of this index, it is not surprising that  an accurate measure of housing inflation changes the picture quite significantly and cumulates over time.

CPI Vs. Market Rent Adjusted CPI

CPI Vs. Market Rent Adjusted

In short, it’s kind of hard to say that 45% inflation in 15 years is not enough. Yet the official CPI adjusted for an accurate housing inflation rate computes to 2.5% per annum.

And surely it cannot be said that the somewhat lower inflation “run rate” of the last few arbitrarily chosen months changes the above picture in any relevant way. Even Milton Friedman said monetary policy works with a “lag”.

In truth, all of the Fed’s gumming about the so-called inflation shortfall is just ritual incantation. The real reason it doesn’t raise rates is that it fears that the first rate increase in nearly a decade will trigger a Wall Street hissy fit.

From the looks of things, it is fixing to get one anyway.

David Stockman's Contra Corner
Click above logo for original story.


Be the first to comment

Leave a Reply

Your email address will not be published.