Consider that the US authorities are battling against the $34trn of gross debt added by the private sector since the start of Greenspan's tenure as Fed chairman in 1987. This is a formidable obstacle to quantitative easing as it added only $9trn to income and has therefore left the private sector with misgivings as to its on-going ability to service such a huge quantum of liabilities, never mind add to such exposure. The crucial question is how much of this lift in income is a recurring flow, a product of wise investment spending, and how much was debt fuelled asset speculation with little capability of servicing interest payments and principal repayment. This is especially pertinent because, as the chart reveals, despite the helicopter money drop of last year, the ratio of private sector liabilities to Fed-induced base or fiat money (M2) remains elevated by historic standards. For instance, it is twice the level that prevailed in the 1960s and three times the level of the 1950s.
No one has really addressed this issue except Professor Steve Keen in Australia, who is starting to win much justified acclaim. He compellingly argues that some form of aggregate demand analysis is especially apt in describing why the Fed's initial dalliance with $2trn was insufficient. Defining demand, or total spending in the economy, as nominal GDP plus the change in gross public and private sector debt, total spending in the US shrunk from $18.2trn in the year concluding in the summer of 2007 to just $13.9trn this year. Effectively, the US economy has spent $4.3trn less on the purchase of goods, services and assets (houses, shares, hedge funds, private equity investments, etc.) despite the rise in gross debt from $47.5trn to $52trn. In other words, monetary and fiscal accommodation have been overwhelmed by the 10% contraction (much of it involuntary and taking the form of default) in the private sector's debt-to-GDP ratio from its peak of3xin early 2009.
Recognising this vulnerability, the actions of the Fed since the onset of the crisis are easier to comprehend. With such a large quantum of debt it was imperative to reduce the cost of servicing it. Policy rates were cut to zero. However, the Fed's aggressive interest rate cuts had only a mild impact on the servicing of household debt in America with its preponderance of callable fixed rate mortgages. The effect was more pronounced in the UK where mortgage lending was predominantly variable and rates were previously priced off the one-year swap with only modest additional term and counterparty premium. Arguably, the institutional differences
between the two countries' mortgage markets made QE almost inevitable, in the US at least. Last year the Fed bid for probably a third of the outstanding stock of ten year Treasuries; the Fed's holdings climbed from $450bn in early 2008 to $767bn at present day. But they had to concentrate the majority of their ammunition on purchasing mortgage backed securities, buying over a trillion dollars' worth, to ensure that the cost of servicing the household sector's debt would not rise on the back of elevated risk aversion in the banking sector. I salute this round of easing.
Fooling All of the People, All of the Time
Unfortunately, in my humble opinion, the additional monetary stimulus, takes the Fed back to dancing around a bubbling cauldron rubbing two chicken bones together. For flush with their success in having reversed the negative trend in nominal GDP, the Fed's ambitions seem to have soared. Bernanke has publicly reasoned that they should go further and boost the economy's animal spirits in order to increase aggregate demand in the economy. The implicit thought process is that if they could only encourage the private sector to believe that the trend in rising asset prices will endure then perhaps speculators will once more volunteer to risk taking on more debt, secure [?!] in the belief that higher future asset prices will allow for it to be repaid in full. This reasoning, whereby the stock market acts as a contributory factor to GDP growth, invokes parallels with Thomas Huxley's The Principal Subjects of Education. Sometimes it seems that next to being unequivocally correct in this world, the Fed has concluded that the next best of all things is to be clearly and definitely wrong.
Capturing this unrepetentantly bullish autumnal mood, the Greek finance minister, in Washington for the annual IMF meeting, opined that, "smart money is realising Greek bonds are a good investment." Remember this is the same guy who said, and I quote, "we are deluding ourselves as a country in thinking we have a tax system!" Politicians and their central banking cousins are of course the ultimate expression of the prevailing consensus. The finance minister had no doubt been buoyed by the decline in Greek ten-year bond yields from 11.7% at the end of August to just below 9% and the FOMC's confidence was likewise lifted by the slide in the ten-year yield from 4% in April 2009 to less than 2.5% in the weeks preceding their last meeting. But with Greek yields back at their highs, Ireland sinking into the mire, the solvency of the entire European banking sector in question and Treasury ten-year yields challenging 3%, it makes me think that the character Vernon God Little, from DBC Pierre's novel had it right when he said:
What I'm learning is the world laughs through its ass every day,
Then just lies double time when the sh*t goes down...
The Rule of Society by the Wealthy
My greatest complaint however is that the Fed is producing a plutocracy by demonstrating that they are willing to go to all lengths to prevent a market inspired liquidation of the economy's bad debts. This is what happened in Weimar Germany. Huge private fortunes were amassed during a time of little economic prosperity, exactly what has transpired in recent years in Britain and America with the rise of hedge funds and private equity firms. Success with money has become intimately connected with inflation – people have got rich not through productive, wealth-creating activity, but because they bought a house or stock at a time when general asset prices were rising. We have confused talent with being bullish.
Into this fray stepped a prominent and hugely successful (if somewhat uncomfortably brash) hedge fund manager who proclaimed himself the leader of this red-light gang. In his call to arms he claimed that making money was "so easy" and "you can't lose." You see, he has influential friends at the
Fed, at the People's' Bank of China, at the Bank of Japan, at the Bank of England, the IMF and the ECB. He has so many friends...if the economy improves from this uncertain economic patch, supposedly a mid-cycle breather, then equities will make him money. But if it reverses back into its torpor, and he gets caught on CCTV in places he shouldn't be, then don't worry. His friends will bail him out with their monetary largess; heads he wins, tails he wins. I believe his swagger and confidence moved the market (the global MSCI jumped 9.1% in dollar terms in September). But what is good for my exceptionally talented hedge fund friend is not necessarily good for the rest of us. Let us consider the malady afflicting Europe.
Angela of the North
The euro project has not gone according to plan. It reminds me of the story of the James Bond character Q, based on the British intelligence officer Charles Fraser-Smith. It was he who invented a compass for spies hidden in a button that unscrewed clockwise. The contraption was based on the simple yet brilliant theory that the unswerving logic of the German mind would never guess that something might unscrew the wrong way. This is really what happened with the Euro. New member states were supposed to take lower interest rates and invest their resources wisely to improve and deepen their productive capacity. Instead, they used the advantage to finance speculative asset bubbles. The world screwed them the wrong way. The Germans are unhappy.
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