A response to “Reflections on RBI-Government relationship”

I went through your post carefully and found it a very good and useful summary of the last six years of this government’s tense relation with the RBI, and how both sides made errors of judgement, both on their own and each other’s roles, and how that created trouble for the Indian economy.

RBI is not an independent body, but an autonomous one. Dr. Y.V. Reddy has made that clear in several of his speeches. RBI remains one of the islands of excellence in our body politic, simply because it has managed to do some good for our country without being explicitly corrupt. It values keeping its nose clean than pick fights with the sovereign over matters of fiscal excesses/governance of PSU banks and being an agent of change in a preemptive manner, unless two things happened:

(i) An encroachment on RBI’s powers (think of the FSDC episode)

(ii) A general hostility towards any major change in way things are run within RBI, almost an insider/outsider approach which is often seen with incoming governors being ‘institutionalised’ in a year.

The major difference between the RBI of last 10 years and the one from 1990-2008 was that outsiders began coming in the latter period (starting from Dr. Gokarn, who was the first outsider to be appointed to the RBI coming from outside the civil service. Unfortunately, he was a victim of the conflict between the government and RBI, as chronicled by Dr. Subbarao in his book. Some of the people who came in perhaps did not fully appreciate the symbiotic relationship between government and RBI, especially in the wake of the hubris – on the part of the government – of navigating the 2008 crisis without much damage.

Specifically, with respect to the last six years, like you, I was very welcoming of the inflation targeting framework in 2014 and firmly believed that solving inflation was the number one priority. But, there was almost a religious zeal across the economist community back then even when fiscal policies were being run tight and we never course-corrected monetary policy from that.

The biggest error in judgement, I think, came from this idea that the media and RBI’s external leadership could coerce a popular government into submission by making public pronouncements. It probably did more damage to RBI than to the individuals, who made it all about themselves. Hence rather than shielding the institution, they went about making martyrs of themselves, whether it was Dr. Rajan or Dr. Patel or Dr. Acharya.

If one goes back and looks at their pronouncements on inflation, growth and fiscal, nothing fundamentally has worked out in the way they pronounced, largely because of policies partly run by RBI in terms of shrinking its balance sheet in % of GDP terms by almost 4 pp (from 24% of GDP in 2013 to less than 20% by end-2018), despite RBI’s foreign reserves growing by almost 50% and the currency depreciating as well. This coupled with fiscal policy being largely contractionary (at least till late 2017) turned out to be a double whammy for the economy. 2018 was a slight exception largely given an external wind which positively affected India and partly on account of a relatively low base too. However, by and large, RBI’s policy actions during that period compounded issues, despite low income growth and low credit creation. In sum, the monetary policy committee systematically over-predicted inflation, kept policy tight and dragged economic activity down.

 As you very pertinently note, the erroneous GDP data has done tremendous damage to India as well, much more than we realise. Yet, RBI, even as it cast aspersion on the accuracy of the data (RBI thought that GDP growth was being overestimated under the new methodology), chose to ignore the high frequency indicators which were signalling more modest growth and set policy purely on inflation, in a puritanical or perverse (or both) manner, shifting goalposts as it saw fit to run tight monetary policies (remember the debate on WPI vs CPI between Dr. Arvind Subramanian and RBI).

One area which you alluded to but not delved into completely, I thought, was the problem of material leverage in the NBFC sector, which was a direct consequence of demonetisation and excess liquidity in banking system that followed. It was completely done under the watch of Dr. Patel and Dr. Acharya. Payments banks and lack of follow-through on Dr. P.J. Nayak Committee report were other major failures. Most of these things were troublesome and required patient diplomacy with the government to push them through on part of the RBI, rather than making throwaway public comments. This “us vs them” mentality escalated into multiple conflicts – whether on the infamous February circular or with respect to board nominees – culminating ultimately in the resignation of several outside leaders.

While I sympathise with the individual thoughts of these excellent economists and thinkers, looking back, I realise that the system is not beholden to them and this idea that an individual’s departure would trigger runs on currency or money markets – like many, I was guilty of thinking  that when Dr. Rajan left – has been conclusively disproved. In fact, I would argue that Shaktikanta Das has been gracious, cooperative and patient in understanding issues in the system and has gone about mitigating several open threads left for him to solve. The jury is still out on him but, in my personal view, he is doing quite well.

Note: I have respected the sender’s preference for anonymity but yet wanted to post it given the highly thoughtful (in my view) observations made.

As I was posting this, my young friend Sriram Balasubramanian had forwarded a comment by Sriram Ramakrishnan, resident Editor at Economic Times, Mumbai, on the books by Dr. Urjit Patel and Dr. Viral Acharya and on the topic of government-RBI relationship. He deals rather well with the allegation that the government had set out to wreck the Insolvency and Bankruptcy code. Read here.

Reflections on RBI-Government relationship

There has been much grist to the mill in the ‘elite’ circles in the last week or so with the impending release of books in quick succession – perhaps, arranged that way? – by Dr. Viral Acharya and Dr. Urjit Patel. They were respectively Deputy Governor and Governor of the Reserve Bank of India. Their terms considerably overlapped.

In general, Dr. Patel carried with him a reputation for being a fiscal hawk and Dr. Acharya has dealt with banking sector restructuring issues and has had a stellar academic career.

I have mentioned it more than once in my blog posts that Viral responded positively to my request to put all data from RBI quarterly industrial outlook inflation expectations, consumer confidence surveys in downloadable excel formats. It was done. It is very useful to crosscheck macroeconomic trends with such survey data.

I read the extracts of Viral’s interview with Ira Dugal. There is an online launch of his book on the 31st July. Dr. Subbarao is presiding over the launch function. Dr. Y.V. Reddy had written the foreword for his book which, I gather, is a collection of his speeches while in office as the Deputy Governor of the Reserve Bank of India.

(1) The NDA Government of 2014-19 was actually too fiscally tight in the first 24 months of its rule when it did pro-cyclical tightening due to the fiscal situation it inherited from the previous government.

(2) It either believed in it itself or was sold a lemon by those who advocated demonetisation – on the extent of unaccounted wealth that would be realised. What is under-reported is the bank-client nexus that resulted in most cash being returned as accounted. In a way, this nexus shows up in the rise in bank frauds amounts every year. (Parenthetically, it makes the case for privatisation stronger and for opening the bank license taps more freely).

(3) Having done the demonetisation and seen it not deliver the cash that they expected, the design of GST could have been simpler. I wrote this in my first blog post after demonetisation on Nov. 9, 2016. I had also anticipated a fairly large GDP shock.

(4) Given that the Union Government was guaranteeing 14% CAGR for five years to State governments, it had the moral right to push through a simpler design. May be, they had their own reasons for not holding firm, for the sake of consensus.

(5) Having done (2) and (3) and given the track record of the Indian State in implementation historically, analysts too erred big time in predicting substantial GDP gains after GST. This too is under-scrutinised as a reason for the Government believing that GDP growth would simply accelerate, post-GST implementation.

(6) Then came the Insolvency and Bankruptcy Code too.  All of these forced behavioural change on the part of businesses and households in short succession and even now, all these changes are barely three years old, not to mention the pursuit of tax revenues, the reluctance to put GAAR and retrospective taxation behind us firmly and anti-corruption drive in bureaucracy.

(7) In the end, (2), (3) and (6) were negative GDP shocks. The Government did not have enough time for a growth recovery and a feel-good factor arising out of natural economic activity before the elections. So, it did open the fiscal taps – farm loan waivers, LPG, construction of toilets, affordable homes, MGNREGA allocations, etc. Therefore, the fiscal space deteriorated. But, this was not egregious in and of itself but together with the negative growth shock in India on account of the three things above and the global growth slowdown (in developed countries and in the EM space in particular), the fiscal ratios worsened more significantly than they would otherwise have.

(8) Further, (and this was not necessarily political at that stage), MoSPI with its new base year (2011-12), new methodology and new dataset (MCA 21) over-estimated growth for 2016-17. I still believe it was not politically motivated but a statistical estimation and methodological error. What could have been avoided was both the form and substance of the downward growth revisions for 2005-06 to 2011-12. More accurate (more reliable) growth estimation would have induced some fiscal restraint in the 2018 budget and in the interim budget for 2019.

Tax revenues were either not in flowing in, to the extent reported growth rates would have warranted or the zealous tax revenue mobilisation in the face of the above negative growth shocks further aggravated the growth outcome.

(9) Now, let us examine what the Reserve Bank of India did in these years. The RBI cut interest rate only once in 2017 in the face of the massive liquidity shock. The RBI tightened interest rates twice in 2018 even as economic growth was slowing. The inflation rate averaged 3.3% in 2017 and 3.97% in 2018. Of course, the Federal Reserve was tightening in 2017 and in 2018 and RBI might have been worried about the rupee in the face of the appreciating dollar given external debt repayment obligations. But, there was room for nuance because choking off economic growth would not make external debt servicing any easier.

RBI’s response to IL&FS collapse was not to provide liquidity (it was a Systemically Important NBFC) but to obsess too much on avoiding moral hazard. But, addressing systemic impact and fixing accountability can and should be two different things. RBI got both mixed up.

Further, its role in not identifying the fault lines in IL&FS early enough as the regulator is not being subject to scrutiny unless there are aspects to the story that indicate that RBI was hamstrung by other considerations.

Frankly, there has to be a conversation on whether the RBI’s monetary policy committee interpreted the inflation targeting mandate too narrowly in 2017 and in 2018.

(10) In any case, the suitability of the inflation targeting regime for a developing country which has a large food component in the CPI basket has to be examined afresh. That lends an anti-farmer, anti-rural bias to the inflation targeting framework. While a central bank in a developing country is expected to be as much focused on facilitating economic growth as it should be on curbing high inflation (there is no agreement among economists on what constitutes ‘high’ inflation). The Monetary Policy Committee of the Reserve Bank of India, in its five years of existence, has, more often than not, interpreted the ‘Flexible Inflation Targeting’ regime too narrowly and too inflexibly.

Disclosure: I wrote in a Mint column sometime in 2014 welcoming the inflation targeting regime given the history of double-digit inflation over the previous five years. But, it is one thing that can and must be reviewed now, in the light of the inflexible attitudes surrounding the Flexible Inflation Targeting regime. However, in June 2017, I argued for two important changes to the inflation targeting regime.

(11) On the RBI circular of February 2018 on the recognition of non-performing assets, the unhappiness of the Government might have stemmed from the process followed as much as the content of it. Second, it did run the risk of being pro-cyclical in terms of accentuating the growth slowdown. It did not recognise that the Government itself was the cause of non-performance of certain banking assets with its own contractual compliance failures. Here, ‘Government’ means Union and State governments.

The Union Government felt that the circular of February 2018 was ‘excessive use of force’ and the Supreme Court found that circular to be unconstitutional. The Government’s view of the circular was, thus, vindicated by the Court’s judgement. My column on the Supreme Court’s judgement is here.

Disclosure: I wrote a column in February 2018 praising the RBI’s circular. But, subsequent discussions with several people on the ground helped me understand the situation better. Hence, the column that I wrote after the Supreme Court judgement.

(12) The government’s focus on RBI’s excess reserves and its dividend policies were partly due to the short-term pressure and partly due to structural considerations that others like the previous CEA too had highlighted.

(13) Finally, based on history, it is right to be cautious about pursuit of policies that might be construed as deviations from the path of fiscal prudence, financial stability, etc. such as deficit spending, deficit monetisation and restructuring, etc. However, the more the growth rate declines and stays low, these outcomes would be in the list of endangered species anyway.

Economic orthodoxies are not religious edicts but context-specific practices. Advanced nations which espoused them are demonstrating them yet again just as they did in response to 2007-08 crisis while they preached something different to the Asian nations in 1997-98.

So, a judgement call has to be taken now on certain policies which, going by past record, are risky but which might be essential now. To reiterate, pursuing them with the usual political economy risk of excesses might be a less risky proposition than not pursuing them and risking long-term economic damage.

(14) Yes, the time has come to relook at the government’s occupation of the commanding heights of the economy. The Finance Minister hinted as much in the Atma Nirbhar Bharat Presentation in May 2020 about government-owned entities in strategic and non-strategic sectors. Hence, that would apply to the banking sector too.

Additional (unrelated) points:

(15) Amidst the clamour for restructuring of loans and import protection, the government should hold the line on governance standards in the private sector especially in the treatment of MSME suppliers and environmental compliance; on productivity and export performance on the part of large non-financial business entities.

(16) Relentless focus on the Ease of Starting a Business and Doing Business at the Union and State Governments’ levels is critical. Teamlease has given an excellent starting point for the exercise.

(17) Related to both of the above is the issue of augmenting state capacity (in numerical terms in critical areas like health, law and order, to name just two) and enforcing accountability for service outcomes. If the latter starts with the top echelons of bureaucracy setting an example, then there is a better chance of lasting success.

Retired policymakers would be making a signal contribution to future policymaking and to the nation if they write self-critically on their roles, their acts of omission and commission, on the failings of the institution that they served in, etc.

For example, Dr. Subbarao wrote in a recent column:

India is inflation prone. Note that after the global financial crisis when inflation “died” everywhere, we were hit with a high and stubborn bout of inflation. In hindsight, it is clear that the RBI, on my watch, failed to tighten policy in good time. [Link]

Of course, I am not going into the causes of high inflation in India post-2008. But, it takes enormous moral courage to write what Dr. Subbarao wrote there. Hats off. That lends enormous credibility to his views, even if we don’t agree with them partially or fully.

Can God really save America from the Federal Reserve?

My friend Rohit Rajendran forwarded me the article written by one Mr. Steven Rattner (‘God Help Us if Judy Shelton Joins the Fed’, New York Times, 22nd July 2020). He apparently served as a counsellor to the Treasury Secretary in the Obama Administration. He wants the U.S. Congress to reject the nomination of Ms. Judy Shelton to the Federal Reserve Board. In his words, her views on the monetary system are discredited. Quite what are those?

(1) She has supported the abolition of the Federal Reserve itself

(2) She wants monetary policy set by the price of gold, a long-abandoned approach

(3) Her view that interest rates should be “rules based” 

(4) Her past opposition to the Fed buying bonds to help stimulate the economy

(5) Her notion that the Fed must consult with Congress, rather than act independently 

(6) She has questioned the accuracy of government statistics. She wants a single currency for North America.

(7) Until her confirmation hearing, she backed getting rid of federal deposit insurance, a key protection for individual savers. Her long opposition to low-interest rates notwithstanding, last year she flip-flopped to Mr. Trump’s view that low rates are, in fact, a great idea.

Now, let me respond to these seven criticisms:

(1) The first in the above list makes her the ideal candidate to serve on the Federal Reserve Board. Every institution needs a devil’s advocate that would hold it closer to its stated, time-tested and cherished values. Only those who constantly question the relevance of an institution will be able to hold its feet to the fire.

If one wanted to avoid ‘groupthink’ (God knows the Federal Reserve has suffered from it in the run-up to the crisis of 2008), then such a person who questions the relevance of the institution must be fast-tracked.

Jim Bianco wrote for Bloomberg in 2019 when the President was considering Stephen Moore and Herman Cain for the Federal Reserve Board:

Consider the history of voting patterns. From Jan. 28, 2004 to March 22, 2019, the Fed held 124 FOMC meetings. The five rotating regional Fed Presidents dissented from agreed upon policy 57 times. By contrast, the Governors dissented just once, when Mark Olson voted against the Sept. 20, 2005 interest-rate increase….

…. Since 2004 the Governors have voted with the Chairman 649 to 1! This practice desperately needs to end.

Appointing Moore and Cain would be a step in the right direction. They are true outsiders but able to take on the role of policy maker. Moore is an accomplished economics policy analyst. Cain was a successful businessman and former Chairman of the Kansas City Fed. Their backgrounds suggest they can bring unique views, which the Fed needs, and a strong streak of independence, which the Governors do. [Link]

Neither Stephen Moore nor Herman Cain made it to the Federal Reserve Board. The cabal was preserved.

(2) and (3) can be clubbed. They call for a non-discretionary but rule-based monetary policy and money creation. What a blasphemy! ‘The Gold Standard’ is being held out as a villain mostly by American mainstream economics-academics because they have little familiarity with economic reality.

The late Ron McKinnon had said in his famous paper, ‘The Rules of the Game’ that the Gold Standard could be suspended if circumstances warranted and then restored when conditions were right. ‘The Gold Standard’ is unfairly vilified as being responsible for the Great Depression. The excesses of the Gilded Age that preceded the Great Depression had nothing to do with it!

I have consistently argued that the benefits-costs of the fiat money regime must be continually re-assessed. Post-2000, 2008 and now 2020, it is clear that the costs are far exceeding the benefits. The benefits, if any, are short-term but the costs are substantial and spread out over time. Gulzar Natarajan and I had argued on this eloquently in our book, ‘The Rise of Finance: Causes, Consequences and Cures’.

The Federal Reserve has not stimulated the economy but financial markets, time and again. Even technical resistance levels for the S&P 500 are policy triggers or triggers for press releases (even if they are repetitions of announcements already made) carefully timed to reverse a decline in the index intra-day. In the second quarter, profits of investment banks had held up because of the trading commissions that the monetary policy decisions of the Federal Reserve precipitated. In the meantime, unemployment persists and the data are sobering.

The number of unemployed – permanent job losers (Table A-11 of the monthly BLS Household Survey) is now 2.825 million as of June 2020 (as of my checking on 24th July 2020). It was 1.36 million in February 2020. So, it is a long way off from where it was in February or in March (1.556 million). Whereas, the S&P 500 index is within touching distance of its level in March and the Nasdaq Composite Index had overshot its previous high.

Check out the tweet of David Rosenberg, former Chief Economist for North America at Bank of America-Merrill Lynch:

We have reached a stage where four stocks in the S&P 500 now exceed the entire market cap of the TOPIX! There is a huge bubble, not just in valuations but also in market concentration. May be a good time to start diversifying. [Link]

Quite whom has the Federal Reserve helped?

Has the Federal Reserve bought bonds to stimulate the economy or the financial market or the bonuses on Wall Street? So, what is wrong with (4)? On (5), the Fed is only nominally independent. It is already subservient to the interests of Wall Street. 

David Rosenberg again”

For investment banks, Jay Powell is your best buddy. Just like the “Powell Pivot” last year (the temerity to raise the funds rate to such a scary level as 2.5%!), the trading revenue gains he just handed the 5 biggest US investment banks are now a remarkable $33B! For the ages. [Link]

As for the interest rates having to follow some rules, why not? What has following the models achieved? Let us check with Binyamin Applebaum wrote in New York Times in 2012:

The transcripts of the 2006 meetings, released after a standard five-year delay, clearly show some of the nation’s pre-eminent economic minds did not fully understand the basic mechanics of the economy that they were charged with shepherding. The problem was not a lack of information; it was a lack of comprehension, born in part of their deep confidence in economic forecasting models that turned out to be broken.

The leverage in the economy has gone up. Home prices are far higher than they were – both nominally and in real terms – than they were prior to the bust in 2008. U.S. savings rate was still down in the dumps before the government’s stimulus cheques boosted disposable incomes in April and in May. 

That is why the objection to her appointment should be for dialling down her opposition to Federal Deposit Insurance and to low interest rates and not for the seven reasons listed above.

Mr. Rattner is worried that someone like Judy Shelton could, one day, become the Federal Reserve Chairperson. But, if Mr. Powell – who flattered briefly to deceive – continues with his solicitous behaviour towards financial markets, he should be more worried for the future status of the U.S. dollar. Indeed, based on the policy plank of the Democratic Presidential candidate, the likelihood that the US dollar would be toast as a global reserve currency by 2030 is non-trivial.

The resultant risk premium tagged on to America’s borrowing costs, once it is stripped of its extraordinary privilege (not a typo) would add far more misery to the average American household’s financial burden than any welfare cheques (produced out of thin air?) that a Democratic administration could send them.

Mr. Rattner is worried that, if Trump were to be re-elected as President, 

he will have the chance to nominate a new chair of the Fed when Jerome Powell’s term expires in 2022.

Let us remind him of the politically motivated appointments made by previous Democratic Presidents. Jim Bianco wrote the following when he was discussing Stephen Moore and Herman Cain in 2019:

The idea that they are too political is a partisan argument not consistently applied. We do not recall the same thing being said when President Barack Obama was considering Larry Summers, the former Clinton administration Treasury Secretary for the job of Fed Chairman. Nor was their serious pushback when current Fed Governor Lael Brainard was writing checks to Hillary Clinton’s campaign and rumored to be her pick as Treasury Secretary. Or in 1997, when President Bill Clinton nominated Alice Rivlin, his director of the Office of Management & Budget. [Link]

Instead of calling on Republican Senators to show some spine, he would have been better off counselling the Federal Reserve Board to show spine with respect to financial markets and show long-term vision. If they have a horizon shorter than a Presidential election cycle, they don’t deserve to be independent. Well, they may not even deserve to exist as an institution.

If Mr. Rattner’s comment is an indication of what Democrats are thinking, I doubt if even God can save America from the Federal Reserve that would do their bidding.

The lockdown death of a 20-year-old day trader

This is an extract from the FT big read on the unfortunate and tragic suicide of a 20-year old student who took to day trading, thought he ran up a big loss (nearly three-quarters of a million of dollars) and committed suicide.

Mr Munger was not far off. Research by neuroscientist Hans Breiter shows the same part of the brain activated by drugs like cocaine is also triggered when a person anticipates a financial gain. That has been supercharged in the new era of online trading platforms….

… “The parallels between video games and day trading is becoming closer and closer,” says Andrew Lo, a finance professor at Massachusetts Institute of Technology. “For many gamers, particularly the younger ones who are not used to trading and don’t fully understand the impact of significant losses and gains on their psychophysiology, it could have some significant adverse consequences.” According to Prof Lo’s studies of traders, the consequences include fear, anxiety, regret, frustration and disappointment, and even symptoms of post-traumatic stress disorder for those who made large losses early in their careers. [Link]

Wondering why there is no mention of the role the Federal Reserve’s monetary policy in the article on the inducement to speculation or gambling which is what day-trading is all about. It is just plain lottery. In a lottery, the loss is limited to the price one pays for buying the lottery ticket. In some of the trades here, the losses can be substantial.

Being a traitor

My friend Rohit Rajendran shared the article by Sebastian Mallaby in ‘Foreign Affairs’.

Essentially it is about the fear of the return of inflation and whether the central bank would be able to stop it. But, it is not about the President of USA vs. Chairman, FRB of USA. It is about Wall Street/Asset Prices/Boomers who are breathing down hard on Chairman, FRB. Will he/she stand up to them as well as the President of the USA? That is the salient question. By posing the question as one of President vs. Chairman, FRB, he grossly oversimplifies the problem although not atypical of the scholarship of the times.

Deflationary bust, first and inflationary bust later

Extracts from an interview Louis Gave had with NZZ.CH (ht: Jesse Felder twitter handle):

Things have value for two reasons, either because they are productive, or because they are rare. Today, governments tell us to stay at home, while at the same time central banks are printing money like never before. In this environment, it’s pretty hard to be productive. So the money ends up flowing towards things that are rare.

Our economies are like super optimized athletes that have just received a big hit. How quickly can they be back on their feet? My fear is it will take longer than many market participants think. I’m not so optimistic that in a year’s time we’ll be back to normal.

The system is rigged, we’re going to make sure that asset prices will never fall, and we’re just going to print more money. Over time, that’s a terrible message. It kills growth and productivity. [Link]

This following point requires separate exposition

If I am a BBB issuer in the US, and the Fed will buy my paper almost regardless, why would I ever go to a bank to borrow money again? Those are unintended consequences. They may have solved the immediate crisis, but they planted the seed for another problem down the road.

See this comment, from another article:

“The reason why U.S. investment grade companies are able to issue at such scale is primarily that the Fed announced plans to buy corporate bonds in the primary and secondary markets. That turned everyone else into a buyer – before the Fed has bought a single bond,” Hans Mikkelsen, head of high grade credit strategy at Bank of America, wrote, ahead of Powell’s remarks. [Link]

Individual investors with time on hand, working from home, with zero commissions, have piled on to the market [Link]. Investors Intelligence Bulls now 46.6. Highest since late Feb. [Link]

What’s undeniable, though, is that retail’s fingerprints have been all over the rebound, raising questions over whether or not a true capitulation ever happened…..

…. At Charles Schwab, clients opened a record 609,000 new brokerage accounts, with almost half of them created in March alone. The firm saw 27 of its 30 most-active trading days ever, including every session in March, Schwab said. Omaha, Nebraska-based TD Ameritrade observed record trading, account openings and net new assets of $45 billion –about 60% of which came from retail clients, as opposed to institutions. [Link]

It is a different (and delightful irony) story that the investment strategist at Charles Schwab has this to say about what is facing the market and the economy:

“We really are in uncharted territory,” said Liz Ann Sonders, chief investment strategist at Charles Schwab. “We have a monster mash-up of the Great Depression in size, the crash of 1987 in speed, and 9-11 attack in terms of fear.” [Link]

Back to Louis Gave:

What do we know for sure? Well, we know that pretty much the entire Western world is going through a monetary and fiscal expansion like never before. Basically, they are introducing universal basic income financed by Modern Monetary Theory. UBI funded by MMT: That’s a game changer. [Link]

I agree with him. Eventually, this ought to be inflationary. But, when does the ‘eventually’ arrive? Good question. This chart shows that it might be a while. Do we have to pass through the ‘deflationary bust’ first like in Japan before we get to the inflationary bust of the Seventies? In other words, to borrow from Albert Edwards, the ‘Ice Age’ may not be over yet.

Source: https://twitter.com/VrntPerception/status/1255888544230445057?s=20

What else?

Gold. Gold has been outperforming pretty much every asset class since January 2018. This outperformance makes sense, given the current fiscal and monetary policy. A third very visible trend is the structural outperformance of technology. Again, you have to distinguish between tech for consumers and for corporates. The outperformance of tech for consumers makes sense to me. We all sit at home, order Amazon packages and play video games. I’m willing to go along with that. [Link]

On European Equities:

European equities underperformed on the way up and underperformed on the way down. That’s terrible. European banks continue to plunge to new lows. This is never a healthy sign for an economy. For an economy and a financial market to prosper, you need a healthy financial sector. It’s your beating heart. The reality is Europe has decided that in order to save the Euro, negative interest rates are necessary all over Europe. That’s killing the financial system. As long as we have negative interest rates in Europe, we can’t have a healthy financial system. And without a healthy financial system, I don’t see how Europe can ever hope to outperform. Sure, there are some good individual companies in Europe. But as a whole, the market sucks. [Link]

Copper is a germ killer:

Another good attribute of copper: Germs don’t like it. Germs stay on iron and other metals, but not on copper. So we might see that countries that can afford it will use more copper for things such as door handles, hospital doors and so on. This is what happened after the Spanish Flu: We started putting copper everywhere, which is why Art Deco looks so cool, because it has copper everywhere. That actually came out of the Spanish Flu and the knowledge that copper is a germ killer. [Link]

Powell’s mission accomplished

“The signaling effect of what the Fed is doing is powerful,” said Jack Janasiewicz, a portfolio manager at Natixis Advisors. “It was enough to shift sentiment, and when we start to feel better about things, we start buying. Worst-case scenario, if things really fall apart, the Fed will step in.” [Link]

this is quite funny – the last sentence:

“If they now provide a significant amount of support to get those firms that were heavily leveraged through this, everybody will assume that they will do it next time,” said William English, the former director of the Division of Monetary Affairs at the Fed Board who is now a professor at the Yale School of Management. “They will have to be clear that they are only doing this with gritted teeth.” [Link]

From the Wall Street Journal:

sales of so-called structured products geared toward individual investors—including bets on stocks repackaged into bonds—hit a decade high in March. [Link]

Many analysts and traders said they have been struck by the extent to which some of these markets appear on the road to recovering their full health, just weeks after trading was frozen with the news that many jurisdictions across the U.S. had imposed stay-at-home orders and similar measures. [Link]


The nation’s largest used-car retailer, CarMax Inc., successfully priced bonds a week later.

Enrique Mayor-Mora, chief financial officer of CarMax, said the company was “pleased with investor demand,” which allowed it to sell more debt than it had originally planned.

The heavy interest comes even though the market has grown riskier in light of the coronavirus pandemic. Subprime auto debt including some of Santander’s is backed by some of the riskiest borrowers with typically lower credit scores.

Santander recently disclosed that there was a sharp uptick in the number of people seeking payment extensions on their auto loans. About 7.5% of the loans backing its debt had received a payment extension in March, up from roughly 1% in February, according to JPMorgan. [Link]

They are back:

Issuance of structured products geared toward individual investors hit a decade high in March, the most volatile month in the stock market’s history, according to industry publication Prospect News. [Link]

No more hands to wring on the Federal Reserve

Sometimes, writers used to say that someone cried their heart out that their eyes had gone dry. No more tears left. Similarly, I have no more words to expend on the disproportionate responses of the US Federal Reserve. They are now locked into the ever-increasing downward spiral of monetary support to all areas of financial markets that are also increasingly fiscal in nature. The denouement is that the global monetary regime ruptures and that a new regime is needed.

The Federal Reserve press release did not explicitly state the funding of sub-investment grade bonds but they were tucked away in the PDF attachments below the press release. Clever.

For all the actions taken by the Federal Reserve since March, pl. see this blog post by Lance Roberts. It is a ‘must-read’ otherwise too.

Note that it does not mean that RMB takes the place of the US dollar. But, there would be disruptions and instability.

From a FT commentary on the Federal Reserve actions of 9th April 2020:

… the expansion of the Fed’s crisis-fighting toolkit to encompass riskier debt — including debt issued by companies owned by private equity firms — will be controversial. One investment industry insider argued it was tantamount to an indirect bailout of the private equity industry. 

“If you think people were upset about bailing out banks where the CEOs were making $50m a year, how are they going to feel about bailing out private equity firms where the CEOs make $500m a year?” said another investor. 

Some investors in the municipal bond market also chafed at the Fed’s initiative, saying the central bank had not yet gone far enough to support states and cities.  [Link]

Clearly, interventions that were meant to support the real economy had extended into interventions to support ‘fallen angels’ and even Exchange Traded Funds. What is the economic payoff to this? What is the threat to systemic stability if the junk bond ETFs failed?

Ed Harrison of ‘Credit Writedowns’ wrote the following:

I don’t like any of this. But this is the situation we find ourselves in. There are no good choices here.

Nevertheless, while I can understand the Fed’s decision to protect fallen angels, I see with the Fed’s decision to buy high yield ETFs as a step too far. These are risk assets. And the Fed is taking the risk away. Long after the exigencies of the day have passed, these decisions will have lasting consequences. 

Moreover, where do you draw the line? Why has the Fed left the leveraged loan market untouched? Aren’t those companies just as innocent as the ones in the high yield ETFs? Don’t tell me it’s the fact that its an ETF that matters here. That’s a fig leaf and you know it. [Link]

Writing a day after the Fed announcement (a cincidence?), this short blog post at the Federal Reserve Bank of St. Louis concedes why and always the Fed acts?

The stock market’s wild ride was doubtless one consideration that prompted the government and the Federal Reserve to take actions in March to shore up the economy and facilitate the functioning of financial markets. Congress and President Trump responded with two modest emergency spending packages on March 6 and March 18, suspension of payments on student debt, and finally a $2 trillion stimulus bill, which was passed on March 25 and signed on March 27, 2020. [Link]

James Grant of the eponymous ‘Grant’s Interest Rate Observer’ was his usual pungent best when he wrote for WSJ:

If not for the buildup of the financial excesses of the past 10 years, fewer such monetary kitchen sinks would likely have had to be deployed. No pandemic explains the central bank’s massive infusions into the so-called repo market that followed this past September’s unscripted spike in borrowing costs. For still obscure reasons, a banking system that apparently is more than adequately capitalized was unable to meet a sudden demand for funds on behalf of the dealers who warehouse immense portfolios of government debt. [Link]

Too much leverage caused the 2008 global financial crisis. Central banks responded with policy measures that incentivised accumulation of further debt and increased moral hazard. The result is the leverage crisis of 2020. Covid-19 was only the last straw.

To be sure, the Federal Reserve is not done yet. They can buy stock ETFs and then stocks themselves. Then, there is direct funding of US Treasury borrowing. There is nominal GDP targeting and negative rates.

Wow! The Federal Reserve is far from having run out of ammunition. They have enough instruments to respond to the next pandemic! They are far from done! Bring ’em on!

Critics will have thrown in the towel far earlier and far more easily than the Federal Reserve would.

The clue to why the public is alienated from elites

Ms. Tett of Financial Times is a perceptive commentator on financial markets and matters. Her personal experience story also reveals a person who understands how human mind works. That is why it it is disappointing and sad that such a writer fails to address the fundamental problem with the state of financial markets, asset prices and the behaviour of market participants, etc.

I had already commented in detail on her piece dated 20th March 2020. Liquidity mismatches exacerbated by leverage (sizes of positions are too big) have required massive central bank interventions.

At one level, central bankers are being praised for putting out the fire. But, there are two problems: these interventions are encouragement to the arsonists to set even bigger fires because they benefit pillaging the house before it is burnt down and the cost of putting out the fire is borne by someone else. Second, the central banks themselves have created the condition for the fires to erupt and arsonists to go on a rampage with their actions since 1987. Each episode of central bank intervention has been bigger than the previous one, creating more leverage, bigger moral hazard and greater instability, requiring even bigger interventions.

Her article of March 20th failed to zero in on central bank monetary policy behaviour as the real cause behind liquidity mismatches and outsized leverage. The tradition continues in her piece dated April 16th. The article i full of positive sentiments about the Fed chairperson.

Sample these:

Mr Powell had forged most of his career in the camera-shy world of corporate law. Colleagues described him as “pragmatic”, “self-effacing”, “genial”, “humble” and “cautious”

Mr Powell is fast becoming the least cautious — or dull — Fed chair in history….

….What is even more startling is his apparent freedom to innovate. That is partly because Mr Powell has forged a close working relationship with Steven Mnuchin, the Treasury secretary. … [Link]

That Treasury prices are now relatively stable is a big victory. So is the easing of conditions in the municipal, corporate and mortgage markets.

The caveats do come but they are mild slaps on the wrist in comparison to these:

These wild experiments are also creating unprecedented moral hazard; or, more accurately, amplifying the hazard that has haunted the financial system since 2008.

After all, the main reason why hedge funds had amassed crazy risks before the virus hit was that money was ridiculously cheap. Similarly, the Fed has had to scramble to prevent a corporate credit freeze precisely because so many weak companies are so loaded with debt that they could barely service even before a shock. [Link]

Her praise with a caveat:

Is this brave? I think yes. It is wise? Probably, given the ghastly alternatives, but if — and only if — Messrs Powell and Mnuchin mitigate some of this moral hazard.

So, what is the track record in the US Federal Reserve mitigating the moral hazard?

2010: QE1 ends, credit conditions tighten slightly as the new economy recovery showed strains. The Fed quickly acts to inject more liquidity with QE2. Given credit spreads and conditions were close to normal levels, the excess liquidity only had one place to go – the stock market. 

2011: QE2 ends as the world is hit with a double-threat. Japan is impacted by a massive tsunami and the U.S. Government is enthralled in the midst of a “debt-ceiling debate.” Again, despite credit spreads and conditions being near normal levels, the Fed jumps in with “Operation Twist.” The economy quickly found its footing in Q3 of 2010, and with no crisis to absorb the liquidity, it flowed into the stock market.

2012: One of the byproducts of the “debt ceiling debate” was a bipartisan commission tasked with finding $1 trillion in spending cuts to reduce the deficit. This was known as the “fiscal cliff.” In late 2012, Ben Bernanke panicked and launched QE3 to preempt a “fiscal cliff” crisis. However, no crisis occurred, leaving the trillion-plus in liquidity with nowhere to go but the stock market.

2016: With the market down 20% from the peak over fears of a disorderly “Brexit,” Janet Yellen calls on the BOE and ECB to launch a Euro-QE program. Once again, the “Brexit” crisis never happened, and the only place for all of the excess liquidity to go was into the equity markets.

2019: In mid-summer, the Fed is faced with an “overnight liquidity shortage” for hedge funds. This was the first sign of trouble, but credit markets were not showing any real signs of strain. With credit markets operating normally, the liquidity flowed into asset prices, pushing markets to all-time highs. [Link]

The finale from Ms. Tett:

Fed officials fear that the looming potential economic shock could be worse than the US public and equity investors expect. That is scary. Sadly, it is also realistic. [Link]

The Federal Reserve (ECB, BoE and SNB included) is always praised for bold action because now it is inevitable. In good times, they never mitigate or remove the moral hazard. That goes unscrutinised.

Creating moral hazard of bigger and unprecedented scale each time there is a crisis would have invited severe comments, opprobrium and editorials had they been done by, say, President Trump. But, if it is by ‘one of us’, it is just about a mild slap on the wrist.

The FT did the same thing for Neil Ferguson of the Imperial College. His model had massively overpredicted the fatalities from H1N1 in 2009. He sits in an oversight body and in the overseen bodies too. There is massive conflict of interest and yet, no criticism.

The Wall Street Journal did far better:

The Fed isn’t scrimping on the firepower, but the details released Thursday are disappointing, and perhaps even dangerous to a robust recovery. The Fed is rescuing weaker credits as well as the strong, is diving ever-deeper into risky assets, and is putting Wall Street ahead of companies across Middle America. [Link]

The systematic bias of the elites had lost them credibility with the masses and their failure to detect and understand the alienation of the masses from their views and their incestuous patronage and protection of ‘people like us’ has made them poor analysts and forecasters too. Yet, they march on unflinchingly.

A bit rich

“Non-financial corporations entered this crisis with enormous debt loads, and that is a vulnerability. They had borrowed excessively” and they did it not so much for productive purposes like investment, but for buying back stocks and paying dividends to shareholders, Ms. Yellen said. And while these firms borrowed, investors also let their guards down in their hunt for high yields, the former central bank official said.

The corporate borrowing binge “creates risk to the economy. And I’m afraid we’ll see that in spades in the coming months, because it may trigger a wave of corporate defaults. Even where a company avoids default, highly indebted firms usually cut back a lot on investment and hiring, and that will make the recovery more difficult,” the former central banker said [Link]

This is a bit rich coming from the former Federal Reserve Chairperson because the monetary policy that she pursued, her predecessors pursued and the one that was foisted or handed down to her successor played a big role in this.