Strange Bedfellows

Strange Bedfellows

“The pen is mightier than the sword.”

    - Edward Bulwer-Lytton

"I believe that banking institutions are more dangerous to our liberties than standing armies."
    -  Thomas Jefferson

By J.M. Hamilton  10-3-15

There’s nothing boring about the Fed and Janet &Co.  Between the charts, graphs, moving economic targets, and promises to – maybe someday – wind down of the Fed’s extraordinary efforts, as a result of the 2008 Wall Street crisis…. lies a highly volatile stock market and American politics.  It seems that every time the Fed Chair speaks, or proceeding her speech, the market either experiences a taper tantrum, or spikes up in delight, post-speech, that the banker gravy train (i.e. free money at near zero percent interest) will continue.  Any talk of taking away the punch bowl and the market turns surly, and the VIX soars.  Apparently, Wall Street, bankers, and shadow banking like their money free and easy, not that this translates into easier lending terms, write downs, or debt restructuring for the 99%.  Nice.  (Ms. Yellen’s latest speech appears to be the exception to the rule, when the stock market continued its recent descent, unabated, from Denali like valuations.)

Politicians too, particularly the party in power, like a stock market with an upward trajectory, keeps the big name donors and the plutocracy happy; and if the economy is less than stellar, and unemployment is high, an ascending stock market is a pleasant distraction.  But nearly a decade into the Fed’s easy money policies, a rather nasty habit is developing, not unlike an addiction.  Interest rates have been down for so long, nobody truly knows what the ramifications will be when the Fed starts raising interest rates again.   

One thing we do know: there will be consequences, both intended and unintended.  However, we can glean some information from history and by observing the factions for and against a rate hike.

All of which brings us to the premise of today’s piece:  Politics, economics, and finance make for strange bedfellows.  We don’t see it too often in American politics, and perhaps less in economics and finance, but every now and then, when the moon is full and the stars are aligned, two diametrically opposed camps come together.  Political camps that generally loathe each other – economic schools of thought that generally agree to disagree – on occasion are united by a similar theme.  We can see this now, particularly in politics, with the wave of outsider populist rising in the 2016 POTUS campaign polls.  Messrs. Sanders and Trump immediately come to mind.  A couple of iconoclasts have tapped into a nerve, often written about on this web site, a populist revolt against the crony economy, and an establishment that has neglected the country and the American people.

Political alignment is unusual, but rarer still, how often does one see Keynesians/liberals, or salt water economist, aligned with the Wall Street banker crowd, in support of the continuation of the Fed’s easy money policies?  And yet, that’s exactly what we have today…. Liberals and more than a few bankers and corporate executives, aligned and praying that the Fed keeps the pedal to the metal just a little while longer (Their Augustian prayer: Please Lord make me chaste, but several decades from now, and preferably when I'm dead).  As alluded to above, we can learn a great deal from the arguments/motives put forth by both camps as to the pending fallout, and also get some sense of the tremendous pressure that the Federal Reserve is under.

Let’s start with the Liberals, whose arguments some of us are generally sympathetic too.  Here goes:

·      The poor and the middle class, what remains of it, will bear the brunt of a rate hike.

·      State and Federal government borrowing costs will rise, as will the debt service load, which mean less revenue to be redistributed to those in need and still struggling, in a sub-par economy.

·      The majority of mortgages are, to this very day, adjustable, so a rate hike means higher monthly mortgage payments; add in adjustable subprime automobile notes (currently in vogue), and the lower middle class stands to be hit by rising interest rates, particularly folks who are still upside down on their mortgages.

·      Higher monthly interest payments for mortgages, car loans, and student loans, means less discretionary income and less aggregate demand, which may create headwinds for the economy.  In short, more money going to those – least in need – bankers, shadow banking, and private equity firms (Many of these financial entities, hedge funds and private equity, have waded into the housing market, post crisis, and bought up much of the distressed property at fire side sales prices, courtesy of GSEs, and turned said properties into rental units – so expect rents to climb too).

·      The U.S. economy is not fully healed, and with slowdowns in China and in emerging markets, now is not the time to raise rates.  This point touches upon an argument currently making the rounds, that the world economy is now so interconnected that the Federal Reserve is, and should be, the world’s central bank (here, look to the IMF’s counsel to the Fed and repeated warnings).

·      Let’s face it, egos and politics play a role in all this too.  If the Fed does hike rates, and there is a subsequent economic down turn, members of the Fed will be blamed as will Fed policy; and such a down turn, could possibly cost the Democratic Party, particularly one Bernie Sanders, a trip to the White House.  Alas, for liberals, there will never be a convenient time to raise interest rates.

These are all legitimate arguments and rational concerns.

And now, the Wall Street, and corporate suite, arguments for the continuation of the Fed’s easy money policies.  Some of these are arguments you aren’t likely to hear every day in the financial press or main stream news media, but then, one does not read JMH to hear mainstream arguments.  So here goes:

·      Our economy is debt fueled, and the less expensive the debt, the lower the cost of doing business for banks and corporations.

·      Private Equity, Wall Street, shadow banking, and M&A are fueled by inexpensive debt…. Raise interests rates, and profit margins for all debt fueled business takes a hit, particularly for those businesses already carrying a significant amount of debt (observe: businesses that are highly leveraged are particularly prone to rate hikes).

·      During these uncertain times, and with employment and the consumer not fully recovered, translating into lower top line growth than what we would expect at this stage in the recovery, many corporations have turned to financial engineering to raise stock valuations.  A great deal of this financial engineering (i.e. stock buyback, M&A, corporate restructuring – layoffs, and regulatory, labor, and tax arbitrage) and globalization was, and is, financed by the Fed’s easy money policies.

·      When the Fed raises interest rates, the dollar will rise versus foreign currencies, which means foreign multinational earnings – reported back in dollars – will slump and take a hit.

·      If and when the Fed raises interest rates, capital flows will stream to the U.S., and already cratering emerging markets, and BRICS, will struggle that much harder, particularly to pay back loans denominated in U.S. dollars.

·      Globally, nearly all central banks are engaged in the currency devaluation game.  Therefore, America/The Fed must play the same game, so that the U.S. can continue to remain export competitive.

Ironic isn’t it?  Two worlds, one liberal – striving to look out for the poor, and another - monopolist and pro-Street - solely interested in profit taking, making the same case, albeit by differing logic and circuitous argumentation (that the Fed – nearly a decade into this fiasco - should not prematurely hike interest rates).  Again, all legitimate arguments and rational concerns, given the grave problems this nation faces.  And just to be clear, there are many liberals and banker/raider/corporate types, who do not agree with the Fed’s dovish policies.

So what are the counterarguments?  And why are some of the aforementioned arguments problematic?

·      Probably the greatest fable told about the ’08 financial crisis was that the Fed’s extraordinary efforts would be a temporary measure to address the withdrawal of liquidity from markets, and to allow time for both the consumer and the government to pay down their debt.

·      Now, seven to eight years later (and with the Fed expanding its own balance sheet by 4 to 5 trillion dollars), public and private sector debt, combined, has risen in China, across the E.U., Japan, and in America – to unsustainable sums, well past the 200% threshold.  And collectively, globally, central banks are still doing back flips, in an attempt to keep their respective economies and stock markets afloat.

·      In essence, Fed policy, long known to be a tool of the plutocracy and the financial elite, was used to paper over a financial crisis, and bailout the plutocracy and Wall Street on the backs of the poor and the middle class, who were faced with austerity.  In essence, Messrs. Bernanke, Geithner, Paulson, and Mme. Yellen kept the pitch forks at bay, and in the process created trillions of taxpayer backed liabilities out of thin air.

·      The bailout was highly successful for less than one percent of the population, and everyone else was left to fend for themselves (when similar actions are taken w/ tax policy, it’s called “trickle down").  The rich grew wealthier, as the Fed pumped up asset prices (particularly the stock market), and Wall Street banks grew more concentrated and today, control assets worth at least 65% of national GDP.  Moreover, the financial weapons of mass destruction that left a smoldering Hiroshima in the global economy, derivatives and swaps, have continued to expand exponentially offshore, in Merry ol’ London (700 trillion in notional value and counting).  And the U.S. taxpayer is still on the hook.

·      One of the greatest crimes perpetrated by Federal Reserve policies is that none of the lessons from the crisis were learned, so quick was the Fed to rush in, and provide a smoke screen.  In short the very structural problems the nation faced in 2008 have only exacerbated over the following years:  the crony economy; a morally bankrupt political system that is for sale to the highest bidder; monopolies and cartels in nearly every sector of the economy, preying upon the public; wars w/out end financed by the Fed & a credit card empire – funded by you guessed it, the Fed; and a political party – dominated by billionaires -  that still believes in fairy tales, like laissez faire and trickle down economics, and "free trade."  And we wonder why U.S. economic mobility is in decline, and wage and wealth inequality are on the rise.

·      Indeed, a crisis is a terrible thing to waste, because – thanks to the Fed - rather than address the structural issues that ordinary American’s face daily, eight years later the same problems exist, only worse: the poor have become poorer; the middle class - that made this country great – is beset on all sides by the malefactors of privilege & wealth; and the uber wealthy – in a perpetual game of chance called Wall Street speculation – continue to grossly mismanage the country.  Why start up a new business and create jobs, when the Robber Barons are allowed, by our government, to run money printing and job killing monopolies and cartels?

·      As if the printing up of trillions of dollars in debt to bailout the elite wasn’t enough, the Federal Reserve also shafted the middle and upper middle class by artificially suppressing interest rates, in one of the greatest transfers of wealth, and crime sprees, known.  In short, the Robber Barons of Wall Street, Banks, Hedge Funds, and Private Equity, all received free money via Fed suppressed interest rates, a secondary bailout that exists to this very day.  Conversely, the Fed took away legitimate interest income from: savers, retirees, the elderly, people who do not want to gamble in a corrupt and manipulated stock market, and pension funds and 401Ks.  This interest income was effectively transferred to the aforementioned usual suspects.  Which brings up a legitimate question: At the end of the day, has the Federal Reserve any conscience or sense of decency?  Thanks to the Fed’s revolving door and the riches Wall Street has to offer, apparently not. 

·      As for the diminishment in government services, as a result of a prospective Fed rate hike, well that would actually force the Congress of the United States to govern and be held accountable.  The Fed has enabled the world’s greatest deliberative body, so that it can campaign 24/7, instead of making very hard choices.  How much longer will a Republican Party last, which is already staring into the precipice, when it starts cutting social services – like social security and Medicare, so that the nation can continue to finance foreign wars, its empire, the private contractors at the MIC/surveillance state, and tax cuts for the wealthy?  Thanks to the Fed, the GOP doesn’t have to make those choices; thanks to the Fed, a dying political party rages on.  Ironically, the biggest welfare states are Red states.

·      Moreover, how much longer can the Fed, or global central banks, continue to finance, by printing money, a national debt that has spun out of control and is essentially a Ponzi scheme?  Write downs and haircuts are in order for irresponsible lenders, and have been for a long time…. As they say on the farm, "It’s nut cutting time."  And woe be unto the bond/debt holders.

·      As for the corporations and financial engineering, their focus – thanks to Fed largess – has been myopic.   Short term fixes like stock buybacks and M&A - financed by debt - rarely if ever address real macro and micro problems, like inadequate wages – resulting in low aggregate demand, raging income and wealthy inequality, upgrades in consumer service/CAPEX, a dearth of R&D spending, and the lack of top line growth.  These are all heady issues that will require thinking, and government intervention into the market place: like mandating the payment of a living wage; caps on profit taking, like a windfall profits tax; regulations to save capitalism from predatory monopolies and cartels; the breakup of said monopolies and cartels; and the establishment of global labor, regulatory, and tax equilibrium (so as to eliminate arbitrage and nation states being played off of one another in a race to the bottom).

·      My guess is once the Fed raises interest rates, if ever, global central banks will be forced to do the same, in varying degrees, to eliminate capital flows out of their respective countries, which should help to restore some semblance of equilibrium in exports and imports.

The bottom line, the U.S. central bank has a lot to answer for (unlike every other Federal branch of government, there are no checks and balances), and it too, needs to be reformed.  As with any political institution, without oversight and control, it becomes corrupt.  The Fed, perhaps, is the most powerful branch of government in these United States, and few Americans understand it, and it is not subject to the democratic process.   And the fat cats on Wall Street, and in multinational suites, like it that way. 

Most economist – especially Keynes – recognize that monetary policy is a very crude substitute for well-managed fiscal policies’ ability to address economic crisis, and smooth out the bumps in the road created by capitalism. 

As such, the greatest failing of the Fed over the last eight years was not the effort expended, but that its efforts were directed towards bailing out perpetrators of the crisis, at the expense of everyone else.  In order for an activist monetary policy to truly be effective, it should be directed at the 99%/the demand side of the curve.  The Fed could have done this by embracing the unorthodox:  quantitative easing focused upon financing consumer debt write downs, residential debt/mortgage restructuring (especially since most mortgages are held by government/taxpayer owned enterprises), and desperately needed financing for infrastructure improvements.  In this manner, all would have benefited from the Fed’s extraordinary measures, as opposed to an elite few.

P.S. 

J.M.H. has warned about a potential bond/debt bubble created by the Fed and global central banks, where yields – for a tsunami of debt - inadequately reflect the risk involved, and fail to accurately account for the underlying risk/reward.  By raising interest rates gradually, the Fed may be able to take some of the pressure off this bubble, or it may find itself wading into another illiquid market and providing yet another massive bailout. 

Whatever the Fed does with interest rates, in terms of debt bubble creation and the inevitable collapse, it may be too late.  As such, the Fed may decide “damn the torpedoes – full steam ahead” is the best policy, leaving desperately needed political reform, and economic restructuring unaddressed and for another crisis.  After all, under current campaign finance law, a crisis may lead the Congress to reform, but only the plutocracy can make the Congress enact reform.

Finally, once again, we saw this week that it wasn’t ninja jihadis Americans have to fear, but yet another Caucasian mental defective with a damaged Y chromosome.  Let us pray that the next narcissist/nihilist with a pathological sense of entitlement - to mete out death to the general public - takes his own life before he can harm others.  It’s a shame these losers aren’t educated, or stable, enough to realize that the pen is mightier than the sword; and that everyone remembers Christ, Gandhi, and MLK, but nobody remembers the malcontents who killed them. 

(Correction:  CNN reports the assailant was of mixed race, with a Caucasian father, and a Republican.)

Copyright JM Hamilton Publishing 2015