Monstrous non-sense

Martin Sandbu, I think, outdoes himself in his latest column. He says that central banks were not loose enough in the years following the crisis as, even after the latest Trump tax cut stimulus in the US, inflation rates are not picking up and therefore, spare capacity was much higher. If only central banks had been bolder, the negative output gap would have closed much earlier!

The certitude here is indeed breathtaking. It took my breath away for a minute. I just did not know where to begin.

The simple truth is that monetary policy has been completely orthogonal to the real economy developments after the crisis. The economies of America and Europe have recovered on their own because monetary policy has been so loose for so long that such a belated recovery cannot be attributed to policy effectiveness.

It is wrong to argue that central banks had not done enough. By April 2010, the S&P 500 had nearly doubled (up 81%) from its low in February 2009. The 10-year bond yield had crashed from 4.0% to 2.0%. Everytime it threatened to rise above 4.0%, the Federal Reserve did QE2 and QE3. It did not raise rates in 2014. In 2015 and in 2016, it raised rates by 25 basis points each – 0.5% in total in two years! Mr. Sandbu thinks that they were not bold enough?!

Monetary policy operates through financial market variables. Where was the wealth effect from these reactions in bond yields and in the stock market? Nothing.

Had the Federal Reserve been more reckless, it would have sent financial assets to even greater heights but to what effect on the real economy?

It would have only widened the inequality and the angst among the middle and lower classes. Hasn’t he seen the UK Housing Affordability Index released by the Office for National Statistics for 2017?

On average, full-time workers could expect to pay around 7.8 times their annual workplace-based earnings on purchasing a home in England and Wales in 2017, a significant increase of 2.4% since 2016.

Workplace-based housing affordability significantly worsened in England between 2016 and 2017, but there were no significant changes in Wales.

Housing affordability has worsened significantly in 69 local authorities in England and Wales over the last five years, with over three-quarters of these being in London, the South East and the East.

All but five London boroughs had significant worsening of affordability since 2012.

House prices and earnings increased in all English regions and Wales, but the two regions with the largest increase in house prices (the East (10%) and the South East (6.9%)), were the two regions with the significant differences over the year. This suggests that house prices are driving the significant worsening in affordability.

The affordability ratio has more than doubled for every property type in England from 1997 to 2017. [Link]

Right after the Brexit vote, the Bank of England had taken out a pre-emptive monetary policy accommodation insurance on top of the ultra-loose monetary policy that prevailed. Yet, Mr. Sandbu thinks that policy wast not loose enough!

Given continuously worsening affordability caused by asset price increases which are a consequence of monetary policy, does he reckon with the social and economic costs of his implicit recommendation that central bankers should have been more reckless than they already were? May be, Brexit would have been forced on David Cameron than him calling for a referendum on the matter.

May be, Trump would have won with an even bigger margin or Bernie Sanders would have won the Democratic Primaries notwithstanding all the attempts to stop him from winning it.

The Chicago Fed Financial Conditions Index is hovering near the easiest despite the Federal Reserve hiking interest rates gradually since 2015 (data as of July 27, 2018 was available at the time of writing this blog post). It only shows that the normalisation is proceeding at such a glacial pace that it is hardly registering on the financial conditions.

Graeme Wheeler, then Governor of the Reserve Bank of New Zealand said this in October 2015:

Monetary policy is, however, relatively powerless to influence the decisions that determine long-run economic performance and distributional outcomes. For example, over the long run, monetary policy can do little to generate higher spending by households and firms. Even in the shorter term, monetary policy’s influence may be low in an environment where debt levels are high and where there is considerable uncertainty about economic prospects.

Monetary policy can influence risk-taking in asset markets, but this does not necessarily translate into risk taking in long term real assets – requiring the investment and entrepreneurial decisions that underpin productivity growth and hence long-run improvements in living standards. [Link]

A gentleman (Ben Carlson) had posted a comment under Martin Sandbu’s column implicitly supporting him by providing a link to his blog post.

My comments on that are as follows:

(1) The Fed’s remit is, officially, not the stock market index

(2) Earnings improvements were a functioning of low interest rates as top lines did not improve much for quite some time after 2009. Federal Reserve policy was powerless to influence aggregate demand and real economy. See Graeme Wheeler’s comments.

(3) Most ordinary people save through bank deposits. They were robbed of their incomes even as asset prices went up.

(4) Household debt has fallen but corporate and other debt have risen significantly. Overall leverage of the U.S. economy has only increased despite the crisis having been caused by leverage

(5) The improvement in household networth says nothing about its distribution. For that, check out the work (‘A lost generation’) by the Federal Reserve Bank of St. Louis on whose networth has improved. Mr. Ben Carlson’s stock market performance would not make a difference to them.

(6) If one taunts the Fed sceptics that their criticism was a reflection of ‘sour grapes’, it is equally possible that one’s approval of Fed policy is a reflection of their personal riches. Social and public welfare consequences be damned.

Resilience of human irrationality, a I wrote in my MINT column two weeks ago, is remarkably strong.

Wrong solution for a distant problem

I was happy to read Harsh Vora’s piece and it is good that he was thinking far ahead – 10 to 20 years down the line.

I just have the following comments:

The case for freer capital flows, however, does not follow from his argument. If global economies are in a far advanced state of demographic decline – which they are – how do freer l capital flows help overcome the low natural rate of interest problem induced by the aging of the population?

Second, in India’s case, it will still be a developing nation and potential GDP growth improvements will occur through many other channels. In advanced nations, their potential growth is already exhausted. It is between 0.0% and 2.0%. The demographic transition to old age compounds the situation. It is not so in India.

Third, even if the supposed benefit of freer capital flows is that it allows the country to circumvent the domestic interest rate ceiling imposed by aging population is true, it comes with other bigger costs. Monetary policy autonomy is gone, in the presence of capital flows. It is the famous impossible trinity. In fact, it is an impossible duality. The exchange rate regime does not matter at all.

It might amount to burning down the house to get read of the bed bug.

Policy tweak by Bank of Japan

Andy Mukherjee has a good piece on why BoJ might need a rethink. Its unconventional monetary policy is rendered ineffective by their effect on the banks that are supposed to implement the policy by lending aggressively! Bank profitability is at risk. They can make money only by taking on more risk in distant lands. There is simply no ‘Net Interest Margin’ at such ridiculously low interest rates. American banks’ RoA is far better, as Andy writes. Why would investors prefer Japanese banks?

Read Andy Mukherjee’s column here.

The Bank of Japan (BoJ) has released its monetary policy statement and it is here. As far as I can tell, it does not address the issue/risk raised by Andy Mukherjee. If anything, it reflects a foolhardy/brave ‘no mud on my face’ attitude after falling flat with its current policies.

It has basically tried to ‘reassure’ markets that there is no tapering of bond purchases – stealth or real. It has doubled down on its current policy stance.

That, despite all these years of powerful and persistent qualitative and quantitative easing, the inflation target remains as elusive as ever:

Prices have continued to show relatively weak developments compared to the economic and employment conditions…and it is likely to take more time than expected to achieve the price stability target of  2 per cent.

It is even possible to question if the appropriate price stability target for a population with negative demographic impulses and potential growth of 0.0% is something lower than 2.0%.

Of course, as Andy points out in a private change, there appears to be two tiny but may be significant tweaks. They may be deliberately underplaying them and overplaying continuity to ‘reassure’ markets:

(1) Yields may move upward and downward to some extent mainly depending on developments in economic activity and prices.

(2) The Bank (BoJ),  …., will reduce the size of the ‘Policy Rate Balance in financial institutions’ current account balances at the Bank – to which a negative interest rate is applied – from the current level of about 10 trillion yen on average.

Third, it has also agreed to increase the purchases of of ETFs linked to Topix stock index than Nikkei 225.

On the announcement of BoJ monetary policy decision, the US dollar spiked against the Japanese yen. Some profit-taking has set in now. On a one-year basis, US dollar is trading at the upper end of the range; on  a two-year basis, the US dollar is trading at the upper end of the range; on a five year basis, in the middle of the range (95-125) and on a ten-year basis; closer to the upper end of the range (75-125). The risk is that the USDJPY trades closer to the upper end of recent ranges at all horizons.

That may draw Trump’s ire and he may direct it at the Federal Reserve for doing the right thing (even if only gradually and belatedly) because others are persisting with their wrong and non-working policies!

Unfortunate and unnecessary comment

President Trump’s comments on the Federal Reserve monetary policy  were unfortunate and unnecessary. It also went against what he said on the campaign trail about ultra-low interest rates. Higher Federal Funds rate is overdue. It is only 0.0% in real terms. In this particular instance, political independence of the Federal Reserve goes hand in hand with independence from the financial sector. All the more reason for a President who claimed that he wanted to drain the swamp to desist from criticising the Federal Reserve.

By the same token, he was wrong to criticise the EU fine on Google. Google is not in his corner and will not be. Second, he is also forgetting the fact that the tech. sector market concentration is rather a big reality.

Those who have access should read the interview of Henry Kissinger with FT as part of  ‘Lunch with FT’. He refused to take Edward Luce’ bait to criticise President Trump or his summit with Putin. On the contrary, he thought that the summit was overdue.

What he said about Trump was rather interesting:

I think Trump may be one of those figures in history who appears from time to time to mark the end of an era and to force it to give up its old pretences.

Dodd-Frank and Matt Taibbi

Matt Taibbi will, forever, be remembered for the label, ‘Vampire Squid’ that he came up with, for Goldman Sachs. No matter what else he writes.  In passing, I should mention that Pratap Bhanu Mehta will be remembered for writing, ‘While we were silent’ in 2013 no matter how many times we disagree with what he writes.

Matt Taibbi’s take on the two major political parties in the United States features flawed logic. In fact, it contradicts his earlier piece on how Democrats helped pass the Bill that diluted the Dodd-Frank Act. More on that later.

The reality is that one can smell Republicans (the political party in the USA)/Conservatives from a distance: they want status quo to continue. No disturbances or perturbations (a jargon that economists love to use) to the staus quo. ‘Do not interfere’ is their message to the government – on social and on economic affairs.

Democrats, on the other hand, were supposed to be the party of the underdogs. Instead, they favoured Wall Street interests. They repealed Glass-Steagall and they helped pass Commodities Futures Modernisation Act that kept many financial products out of regulatory purview. They became a party of elites, by stealth. That is fradulent. In fact, he should go back and re-read his own piece, titled, ‘Obama’s Big sellout’ written in December 2009 or early 2010. It is no longer available in the ‘Rolling Stone’ site. But, I found an extract here.

Hence, calling Republicans a party of ‘open con’ does not cut it. It was and is open, all right. It is no con game. We know their agenda.

He then wrote a piece about “The Economic Growth, Regulatory Relief and Consumer Protection Act (Pub.L. 115–174, S. 2155), signed into United States federal law by President Donald Trump on May 24, 2018.”. It amended the Dodd-Frank Act or the Financial Stability Act, 2010.

He was right on some of the factual details. The word, ‘may’ has been changed to ‘shall’ in one place. True. Some limits have been increased from 50bn. to 100 bn. to 250 bn. US dollars, etc. But, he did omit some key aspects that lead us to a different interpretation.

The amendments do include the following:

(b) Rule Of Construction.—Nothing in subsection (a) shall be construed to limit—

(1) the authority of the Board of Governors of the Federal Reserve System, in prescribing prudential standards under section 165 of the Financial Stability Act of 2010 (12 U.S.C. 5365) or any other law, to tailor or differentiate among companies on an individual basis or by category, taking into consideration their capital structure, riskiness, complexity, financial activities (including financial activities of their subsidiaries), size, and any other risk-related factors that the Board of Governors deems appropriate; or

(2) the supervisory, regulatory, or enforcement authority of an appropriate Federal banking agency to further the safe and sound operation of an institution under the supervision of the appropriate Federal banking agency. [Link]

There is also a provision for ‘globally systemically important bank holding companies’:

(f) Global Systemically Important Bank Holding Companies.—Any bank holding company, regardless of asset size, that has been identified as a global systemically important BHC under section 217.402 of title 12, Code of Federal Regulations, shall be considered a bank holding company with total consolidated assets equal to or greater than $250,000,000,000 with respect to the application of standards or requirements under. [Link]

In plain English, S.2155 does not prevent the Federal Reserve from exercising its authority with respect to Bank Holding Companies where it deems necessary. The real issue is whether the Federal Reserve is keen. See here and here.

Amendments to the Dodd-Frank Act will not cause the next crash. That train has already left the station. If at all they do cause banks to take on more risks, it will be because theri capital requirements have not been raised enough and because the Federal Reserve has allowed monetary policy to remain too loose and interest rates to remain too low for too long.

Ultimately, it is all about appropriate pricing of capital and pricing it too cheaply and way below fair, risk-adjusted level is the biggest gift that the Federal Reserve continues to shower on the financial industry.

In another article, Taibbi makes the case for a Financial Transactions Tax in the United States. I endorse that, wholheartedly. He is right. But, he is pushing the envelope on facts when he writes that the European Union has already ’embraced’ it. That simply is not true. I wish it were true. It isn’t.

Read what he writes here and decide for yourself:

A financial transactions tax might help incentivize Wall Street to once again emphasize true long-term investment, as opposed to spending all day moving piles of money around. As with Medicare-for-all, it might take a while for Americans to accept an idea already embraced in Europe. [Link]

It is still in the works. Lo and behold, Brexit is supposed to have gummed it up, because it will be difficult to enforce in the UK that won’t be part of the European Union and hence financial transctions would migrate there. That is the logic for the dealy. So, FTT in Europe is still coming.

The lesson is that it has become impossible to read anyone and take what they write at face value, without doing some fact-checking oneself. Well, if you are reading this, remember that it applies to this blogger too!

So, caveat emptor!

The twin hats of Andrew Haldane

My good friend Amol Agrawal (what an amazing and inveterate blogger, he is!) had a blog post on a recent speech by Andrew Haldane of the Bank of England (BoE) on the low  or non-existent productivity growth in the United Kingdom. I left the following comment on his blog post. It is slightly updated here.

I can understand you being excited about a speech by Andrew Haldane. He still does not fail to impress and provoke thinking. But, look carefully. What is institutional infrastructure for diffusion? What is the agency or agencies to be created? In the private or in the public sector? Who would fnance it? How would it be assessed? What would it take to judge that it has done a good job (or not) of diffusing innovation? I guess that the speech is silent on these. Otherwise, you might have blogged on it. I confess that I am yet to go through the speech.

But, there is another more important point to make with respect to Mr. Haldane. He failed to connect the dots of his own speeches, research and what went on before 2008. He produced such insightful research on banks and finance before 2012 that it is a great pity that he did not carry those insights wit him on to his new job. He behaved rather differently and disappointingly after he became the Chief Economist of BoE from being the Director in charge of Financial Stability.

He continued to insist on interest rates being kept too low for too long. To what effect? To what consequences? In fact, the lack fo productivity diffusion is an indictment of the low interest rate policy. Where is the incentive to do the hard work on productivity improvements and undertake investments that enhance them when easy money can be made speculating on high-end properties in London suburbs which is what low interest rates facilitate?

He knows of the BoE research that showed very clearly that banks create money. [Prof. Richard Werner at the University of Southampton has done further excellent empirical work on it. He calls the last century of economics teaching and learning wasted effort! Check out his papers.]

He knows again from BoE Research that most middle-class and lower middle-class Englanders have only interest-bearing deposit accounts as their financial assets. Low interest rates hurt them. Low interest rates help those who buy financial assets and real estate assets with debt. They borrow cheaply and big and the discounted value of future cash flows on equities is inflated by the low funding cost. Of course, it is not just the short end of the interest rate curve that remained low for long but even the entire yield curve with BoE Asset purchases.

To what end? How much his research helped him or influenced him to make public policy decisions and choices that enhanced public welfare?

In short, much as I admired and still admire his reserach, his hard work, his evidence based conclusions, etc., he scores rather poorly as a public policy exponent and technocrat.

Please do read Paul Tucker’s ‘Unelected power’. It is dense. I have only done four chapters. Not easy. But, worth it.

Why ‘they’ will never admit to ‘this’?

This ‘Wall Street Journal’ article is so familiar. As the Federal Reserve meets to raise interest rates, such a chorus always rises, no matter how ill-informed it is. Will the Federal Reserve trigger a recession becasue its rate hike will invert the yield curve? Will the Federal Reserve cause the stock market to crash?

It is all the Federal Reserve. There is one sliver of truth to that. It is and it has been the Federal Reserve. They set up the bubble with their extremely lax monetary policy – rates that remain too low for too long. Bubbles form and bubbles always burst. There has to be some trigger. The Federal Reserve’s belated tightening is the most obvious choice.

So, it is always the case that monetary policy normalisation causes the stock market to crash. Abnormal monetary policy – rates that are too low for long – causes bubbles to form and then they have to crash.

It is far easier to blame the Federal Reserve for causing asset prices to go down that make the wealthy feel poorer rather than blame oneself for ignoring risks and letting asset prices move too far ahead of and away from fundamental or blame fundamentals for keeping the punchbowl always topped up, no matter how ‘rowdy’ the party is.

This tweet captures the above well:

Let’s Be Clear. Many suggest recessions happen due to Fed tightening. Incorrect. Recessions happen AFTER bubbles created by extreme Fed loose policies are blown to be systemic. Recessions happen due to tightening TOO LATE. [Link]

Humans are reason-able. That is, we are capable of reason but as has been the case from the time we began to use ‘reason’, we have applied it to the cause of supporting our ‘un-reason’ or our prejudices.