Sunday, July 14, 2013

Until QE3 Do Us Part

 If we are careless, we’ll look at the last two weeks of market volatility and conclude that as goes Ben Bernanke’s bipolar Fed-speak, so goes the economy.  At his Wednesday conversation with economists, Ben told the National Bureau of Economic Research:

 “I think transparency in central banking is kind of like truth-telling in everyday life.  You got to be consistent about it.  You can’t be opportunistic about it.”

He went on to clarify:

“I think if you think about the recent developments and the information that we’ve provided to the public about our thinking — I guess I would ask you to consider the counterfactual, if we hadn’t said anything. The information we provided about, for example, our contingent data-dependent plans for the asset purchase program, we’re actually pretty close to our understanding of what markets expected for that program. But suppose we had said nothing and that time had passed and that market perceptions had drifted away from our own thinking and our own expectations for policy. In addition, during that time, again in the counterfactual where we don’t provide any information, it’s very likely that more highly levered risk-taking positions might build up, reflecting, again, some expectation of an infinite asset purchase program.”

Transparency is kinda like truth-telling.  If you’re not really transparent, are we to expect that the premium on the truth is kinda like your opacity?  The ‘accommodative’ monetary policy that the Fed continues to pursue is disguised under the argument that zero interest rate environments and asset purchase manipulations at $85 billion a month will stimulate employment and build momentum in the economy.  In reality, Ben’s obsession has more to do with cheap money to support wealth dislocation by enhanced leverage than it does with unemployment.  Cheap leverage for private equity buy-outs and M&A do not stimulate employment.  To the contrary, leveraged transactions typically lead to consolidation efficiency and job cuts.

To justify his ‘optimistic’ view on the economy, Ben pointed to housing – another asset bubble in the making courtesy of artificially low interest rates – and debt-financed automobile purchases.  The former is particularly fascinating given the fact that the Fed is buying a lot of mortgage securitizations.  The lower the interest rates, the lower the terminal asset value of the mortgages that they’re buying.  Now if they were a buy-and-hold investor, this would be problematic.  But they’re not.  They’re a buy-while-intervention-is-expedient investor and they’ll be a dump-when-politically-expedient seller.  In other words, the quality of the assets they’re creating through the illusion of low interest and the 30 years that those assets will be ‘underwater’ from a yield perspective doesn’t bother them.  But it should be highly troubling to the public for two reasons.

First, manipulation of the mortgage securitization market is a contributing factor to the 2008 recession.  Cheap money (then it was second mortgages being “cheaper” than consumer credit) doesn’t create stable economic conditions.  If buyers are only buying because credit is cheap, then manufacturers are prone to establish a “normal” condition that’s not resilient in economic shocks.  This problem has manifest several times in the past 15 years.  But that’s the least of what should be worrisome.  Far more problematic is the perfect storm that the Fed’s policy has put in motion for pensioners and retirees over the next 15 years.  Let me explain.

Investments in liquid stocks have seen an apparent growth over the past 5 years.  With prices rising from their 2008 lows and with leverage-fueled dividends, apparent asset value has increased.  This should be seen as good news.  However, lurking beneath the surface of this ‘growth’ has been a leverage Charybdis waiting to yawn its terrible mouth open to unleash a deadly whirlpool into which the populace can fall.  While profits rose on the corporate down-sizing efficiencies and cheap leverage, top-line organic revenue has not followed suit.  Made worse by ‘accommodative’ monetary policies in other G-20 countries (something Ben also addressed obliquely), exporters face highly volatile markets and are not growing new business as quickly as their perceived ‘value’ has inflated.  In other words, we didn’t get more workers more productive over the past 5 years.  Rather we got fewer workers more efficient.  Second, long-term assets (the fixed income kind) have been depressed.  From your CDs that barely cover the postage to report on their meager performance to your 401(k) fixed income accounts with PIMCO and Templeton, what was modeled to generate 2-3% has barely eked out half that value after fees (which haven’t changed enough to compensate for the degradation in performance).  And at the bottom of the yawning chasm – far beyond the watchful gaze of most investors – insurance companies (life, mortgage, and pension) have been holding onto loads of cash that has not kept up with the mandatory returns that they need to fulfill their future obligations. 

This last point is the one that could really take out the next generation.  What made the first hundred years of the Federal Reserve work was its inextricable accommodation to match asset duration between the banking and life insurance and (insured) mortgage sector.  Take away life and property insurance and you don’t have the U.S. real estate market.  Take away these markets and you don’t have long-term investments.  And have insurance companies fail to keep up with their actuarial investment requirements and you don’t have liquid insurers in a decade or so.  Conspicuously missing from the Chairman’s comments were any references to the Pujo Committee and its investigations leading up the authorization of the Fed.  What was supposed to be a mechanism to break the banking monopoly on financial and monetary policy in 1912 actually turned into a mechanism which now is entirely an asset monopolist on both the U.S. Treasury and the mortgage market fronts.  And worst of all, this particular monopolist is actually undermining the future in triplicate.

Preservation of the current interest rate environment has not worked nor will it in the indeterminate future.  In fact, the longer it persists, the bigger the implosion.  This ‘bubble’ won’t pop – instead it is a giant vacuum that will suck future economic interests into a downward spiral.  We’ll have to make up new names – not Recession and Depression but Coriolis and Charybdis.  And, to be clear, the present course has been set for so long that we’ll necessarily have to pay to unwind it.  And that, unlike Ben’s speech, is not conditional, situational truth.  It’s the cold, hard facts.  At the undoing of QE3, equities will fall, insurers will default, and real estate will collapse again.  And we’ll keep sharing this fate until we embrace an economy that fosters productivity-based policies rather than monetary manipulative accommodation.

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Thank you for your comment. I look forward to considering this in the expanding dialogue. Dave