Crony Capitalism Strikes Again
How the Federal Reserve is juicing speculators... again.
So Thursday evening’s short-covering panic in the yen forex markets, and the subsequent panicked response by the central banks, wasn’t just a low frequency outlier -- the equivalent of an 8.9 event on the financial Richter scale. Rather, it is the predictable result of the lunatic ZIRP [Zero Interest Rate Policy] monetary policy which has been pursued by the Bank of Japan for more than a decade now -- and with the Fed, Bank of England and European Central Bank not far behind.
For two decades now Japan has suffered from a real estate asset deflation which followed the collapse of its spectacular 1980’s financial bubble -- but not price deflation on consumer goods and services. In fact, Japan’s headline Consumer Price Index was 94.1 in 1990 compared to 99.8 during the last quarter of 2010. Thus, during the past 20 years there has been a slight CPI inflation (0.3% annually) -- notwithstanding the incessant deflation-fear mongering of the Keynesian commentariat.
To be sure, Japan’s so-called “core” CPI is down several points during that long period, but by all accounts the Japanese people have been eating, driving and heating their homes for the past two decades on a regular basis. Accordingly, they have paid slightly more for mostly imported food and energy and slightly less for everything else. But the overall consumer price index has been flat, meaning that real interest rates have been zero for the better part of a decade now.
And that’s the evil. Free money has not reflated domestic real estate because Japan’s bubble era prices were absurdly high and can’t be regained, and because Japanese real estate -- both residential and commercial -- is still heavily burdened with debt which cannot be repaid. Yet market economies -- even Japan’s cartelized kind -- are not disposed to look a gift horse in the mouth: Free money always finds an outlet, and the pathway of choice has been the transformation of the yen into a global “funding” currency.
This sounds antiseptic enough, but it means that in its wisdom the Bank of Japan has invited the whole world -- everyone from Mr. and Mrs. Watanabe to state-of-the-art London hedge fund traders -- to short the yen in order to finance speculations in the Aussie dollar, the big iron and copper miners, cotton futures, the Brent/WTI spread, and an endless procession of like and similar speculative cocktails.
Yet as the speculators rotate endlessly from one risk asset class to the next they can remain supremely confident that their yen carry cost will remain virtually zero. Yen interest rates will not go up because the BOJ is intellectually addicted to ZIRP, and because, in any event, it dare not surprise the market with an interest rate hike, thereby triggering a violent unwind of the very yen carry trades it has fostered.
In short, the BOJ is sitting on a financial fault line. Thursday afternoon’s rip to 76 yen to the dollar was not the work of a fat finger; instead, it represented a real-time measure of the furies bottled up in the financial system due to Japan’s foolish rental of its “funding currency” to global speculators. Having long ago urged the BOJ to embrace this absurd monetary policy, it is not uprising that Bernanke and his confederates have come to the rescue -- for the moment.
It is only a matter of time, however, before the yen explodes under the next bout of short seller’s pressure, and then the lights will really go out on Japan Inc. In the meanwhile, ordinary people the world around will get less food per dollar from Wal-Mart and speculators, basking in the wealth effect, will have even more dollars to spend at Tiffany & Co. (TIF).
In this context, there can also be little doubt that the Fed is trying really hard to transform the dollar into a “funding” currency, too. In the name of fighting a phantom deflation, the nation’s central bank has kept interest rates absurdly low -- transforming the dollar into a weakling even against the misbegotten Euro, and therefore something which speculators can more safely short.
But just like the case of Japan, there is no sign of CPI deflation in the USA. Our headline CPI index has gone from 130.7 in 1990 to 218.1 in 2010 -- marking a 2.6% annual inflation over the past two decades. And, no, it hasn’t slowed down much during the Bernanke era of deflation phobia.
In fact, the headline CPI index has risen at a 2.4% rate in the last ten years, hardly a measureable de-acceleration; and it has gained at a 2.2% rate in the last five years -- a rate at which, as Paul Volcker right observed, the purchasing power of the dollar would be cut in half during the typical American’s working lifetime. Even since the alleged June 2009 recession bottom, the headline CPI has climbed at a 2.1% annual rate.
So there is no deflation -- just a simulacrum of it based on the observation that the CPI less food and energy has randomly fluttered around the flat-line on several recent monthly readings. It is not obvious, of course, that the rise of this index at a 1.1% annual rate during the last 20 months of recovery is a bad thing -- for at that rate we begin to approach the idea of honest money. But the spurious circular logic embedded in the Fed’s focus on this inflationless inflation index is self-evident upon cursory examination of its internals.
Fully 40% of the CPI less food and energy is owner’s equivalent rent -- the one price that is actually deflating and which is doing so precisely due to the Fed’s own policies. Residential rents are falling or flat because the market is being battered with a) millions of involuntary rental supply units owing to the wave of home mortgage foreclosures, and b) an extraordinary shrinkage in the number of rental units demanded due to the doubling-up, and even tripling-up, of destitute households.
Thus, the destructive result of the Fed’s earlier destructive housing and consumer credit bubble became the excuse for embracing a zero interest rate policy which is self-evidently fueling even more destruction; namely, the rape of middle class savers; the current severe food and energy squeeze on lower income households; the illusion in Washington that Uncle Sam can comfortably manage $14 trillion in debt because the interest carry is close enough to zero for government purposes; and the next round of bursting bubbles building up among the risk asset classes.
Moreover, the Fed soldiers on with its serial bubble-making, even though it is evident that the hallowed doctrines of modern monetary theory and the inherently dubious math of Taylor rules have failed completely.
Indeed, the evidence that the Fed no longer has any clue about the transmission pathways which connect the base money it is emitting with reckless abandon (e.g. Federal Reserve credit) to the millions of everyday pricing, hiring, investing and financing outcomes on Main Street sits right on its own balance sheet. Specifically, if the Fed actually knew how to thread the needle to the real economy with printing press money it wouldn’t have needed to manufacture $1 trillion in excess bank reserves -- indolent entries on its own books for which it is now paying interest.
So in the present circumstances, ZIRP and QE2 amount to a monetary Hail Mary. There is no monetary tradition whatsoever that says the way back to U.S. economic health and sustainable growth is thru herding grandma into junk bonds and speculators into the Russell 2000.
Admittedly, the junk bond financed dividends being currently extracted by the Leveraged Buyout Kings from their debt-freighted portfolios may enable them to hire some additional household help and perhaps spur some new jobs at posh restaurants, too. Likewise, the 10% of the population which owns 80% of the financial assets may use their stock market winnings to stimulate some additional hiring at tony shopping malls.
That chairman Bernanke himself has explained in so many words this miracle of speculative GDP levitation, however, does not make it so. The fact is, if transitory wealth effects add to current consumer spending, they can just as readily subtract from it on the occasion of the next “risk-off” stampede to the downside. Indeed, the proof -- if any is needed -- that cheap money fueled asset inflations do not bring sustainable prosperity lies in the still smoldering ruins of the U.S. housing boom.
In truth, the Fed’s current money printing spree has no analytical foundation, and amounts to seat-of-the-pants pursuit of a will-o’-wisp -- the idea of a perpetual bull market. Like the BOJ, the Fed has thus made itself hostage to the global speculative classes, and must repeatedly inject new forms of stimulus to keep the bubbles rising.
This is the only possible explanation for its preposterous decision last week to allow the Big Banks to resume dissipating their meager capital accounts by paying “normalized” dividends and by resuming large-scale stock buybacks. These are the same financial institutions that allegedly nearly brought the global economy to its knees in September 2008, according to the Fed chairman’s own words.
In what is no longer secret testimony to the FCIC (Financial Crisis Inquiry Commission), Bernanke claimed that the Wall Street melt-down “was the worst financial crisis in global history” and that “out of maybe 13... of the most important financial institutions in the United States, 12 were at risk of failure within a period of a week or two.”
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