The good doctor on what’s in vogue among wonks in Washington.
"Policy traction" is an expression that lately has come into fashion. In essence, it is about the relationship between the size of the monetary and fiscal stimulus injected into an economy… and their effect on economic growth and employment.
In the past three years America has experienced an interest rate collapse, a record fiscal stimulus and the loosest monetary policy imaginable fueling money and credit creation at a scale that has no precedent in history. Has it really worked?
Well, in one way it had fabulous traction. It engendered the greatest credit and debt bubble in history. Total outstanding debt, financial and non-financial, in the United States has ballooned by almost $6,500 billion since 2000, as against GDP growth of $1,238 billion. For each dollar added to GDP, there were about six dollars added to indebtedness.
And it had fabulous traction in a second way: The runaway money and credit creation went with a vengeance into asset markets – stocks, bonds and housing. When the equity bubble popped in early 2000, the consumer simply moved on to the housing bubble that had been waiting in the wings, helped by the Fed-inspired bond bubble driving mortgage rates sharply downward.
Their joint result was the unprecedented mortgage finance excess. While businesses were slashing the consumer’s income growth, he offset this income loss largely by stepping up his borrowing.
Policy Traction: A Failure to Create a Recovery
Yet in the course of 2002 it became clear that the lowest short-term interest rates in nearly half a century were failing to create the customary strong economic recovery. In June, the Fed cut its interest rate for the 13th time, to 1%, a 45-year low. In the following month, it admitted in its report to Congress the fact that the economic performance during the first half of the year had remained sub-par.
On the other hand, however, the Fed stressed the success of its easing by mentioning the recent rise in stock prices, the sharp narrowing of credit spreads on corporate debt, the strong housing and mortgage refinancing market and rising consumer sentiment.
What, in fact, had emerged was an unprecedented dichotomy in the effects of the Fed’s most aggressive monetary easing between economy and financial markets. Instead of jump-starting consumer and business spending, the extreme monetary looseness and rock-bottom short-term interest rates generated multiple, price bubbles in the stock, bond, mortgage and housing market.
Without great discussion, the U.S. economy has been shifting to a growth model that radically differs from past experience. In the old model that has ruled for centuries, monetary easing was conceived to work directly on the real economy, and it could be counted on to promptly do so. But it was a world with low debts and strong employment and income growth.
Most importantly, it was a world in which financial systems of very limited size principally served as mere conduits for channeling savings into capital investment, creating national wealth in the form of productive plant and equipment, and commercial and residential buildings.
Faced with an economy that responded poorly to its aggressive monetary easing, and with very little scope for further cuts in short-term interest rates, a desperate Fed reacted in an unconventional way. Internally, it was obviously considering an attempt to increase policy traction by bringing long-term rates down as well.
Wanting to avoid direct intervention, it apparently decided to put America’s highly vigilant, huge, financial and speculative community before the cart, by using nothing more than simple opportune rhetoric. Repeated public talk by Mr. Greenspan and other Fed members of looming deflation in the economy was one bit of bait. Simultaneous talk of two new policy considerations was the other.
Policy Traction: Play America’s Yield Curve
The first idea, was to repeat in public an explicit commitment to maintain the existing rock-bottom short-term rate peg of 1% as far "as the eye can see"; and the other one, was public hints that "unconventional" measures, like direct purchases in the market, were being considered to push long-term rates further down as well.
It was really an unreserved invitation to investors and speculators around the world for greater engagement in playing America’s yield curve with heavily leveraged carry trade. Many heard and acted promptly. In just six weeks, U.S. 10-year yields fell from 3.9% to 3.1%.
It should, by the way, be clear that this manipulated indirect intervention vastly outdid what the Fed could have possibly done with direct purchases. We have no idea about the scale of the purchases that suddenly flooded the U.S. bond market, but it was without question in the range of several hundred billion dollars.
What followed is well known: A frenzied stampede of the financial community into the highly leveraged bond carry trade sent bond yields plummeting, pulling in their wake highly correlated mortgage rates sharply downward with them. In the same vein, the loose money helped to boost house prices.
Given in addition extremely aggressive mortgage lending institutions, eager to lend prodigiously against rising house prices, consumer borrowing just went parabolic.
All in all, four interrelated bubbles have kept the U.S. economy going after the bursting of the stock market bubble in 2000: rising house prices, falling bond yields and mortgage rates, and soaring mortgage loans feeding the consumer spending binge. Yet the key role fell manifestly to the bond bubble. By pulling mortgage rates precipitously down, it provided the big bait that lured house owners to capture the offered big savings in current interest rate service by refinancing and increasing their mortgage.
U.S. economic growth, therefore, is no longer based on saving and investment. Its essence is that credit excess provides soaring collateral for still more credit excess creating still more asset inflation for still more borrowing and spending excess. It seems like a perpetual motion machine that just goes on cranking out wealth and spending.
The traction that these policies have so far achieved, and its probable economic and financial effects in the longer run, have therefore become the most important issue in the current development in the United States.
The true name of this game is bubble-driven growth… and all bubbles end by bursting.
for The Daily Reckoning
March 24, 2004
Editor’s note: Former Fed Chairman Paul Volcker once said: "Sometimes I think that the job of central bankers is to prove Kurt Richebächer wrong." A regular contributor to The Wall Street Journal, Strategic Investment and several other respected financial publications, Dr. Richebächer’s insightful analysis stems from the Austrian School of economics. France’s Le Figaro magazine has done a feature story on him as "the man who predicted the Asian crisis."
This essay was adapted from an article in the March edition of:
The Richebächer Letter
As the good doctor notes above, not only is a continued dollar decline inevitable…it is indefensible by the U.S. powers that be. If you haven’t already hedged your portfolio against the dollar’s devaluation, you should do so today:
Seven Ways To Sell The Dollar
Nothing happened yesterday.
The Dow went nowhere. The S&P went nowhere. The dollar stayed put. Only the price of gold showed any life; it rose up $2.40 — to $420.
Maybe we were right about gold after all…but just a few days early. Maybe the world has seen $400 gold for the last time.
But what do we know? If we knew anything at all we wouldn’t be writing this daily letter. We’d be in some different world altogether.
That is our conclusion after much observation and reflection: nobody knows anything. We all depend on illusion. The key decision you make — and you are probably better off if you never actually realize you’ve made it — is which illusion you care to believe.
Here at the Daily Reckoning we choose to believe the dusty old illusions…the venerable Old Truths that our fathers, grandfathers, remote cousins and monkey ancestors handed down to us…after ruining their lives and burning in Hell for them.
"Do not kill," they said, "or you’ll regret it."
We don’t know if we’d regret it or not. And there are some people we’d like to kill so much it would almost be worth finding out. But, the old timers must have known something. We take their word for it.
Likewise, when they tell us to save our money, not to go to far into debt, not to buy stocks when they are expensive, and not to believe a word that comes out of the mouth of a public office — we cannot argue with them. We don’t know any better or any worse.
The alternative is to pick up some trendy illusion-du-jour. Such as the idea that you can kill people as long as you think they’ve got it coming. Then, heck, you can send a missile chasing a guy in a wheelchair…blow the fellow to kingdom come…and feel good about it.
Or, you can — conveniently — cling to the illusion that you can spend all you want…borrow as much as you can get…and live as far beyond your means as you can get away with — and somehow it will all work out. You can believe that Alan ‘Bubbles’ Greenspan has some special skill or magic that over-rides the experience of centuries…and that George W. Bush is such a genius that he’ll figure out a way the whole nation can live at the expense of foreigners — forever.
People learned — over the course of 50 generations — that the illusion of gold-as-money was a helpful one. Gold — number 79 in the periodic table — is just another commodity…with no inherent ‘value’ of its own. It is found in the earth’s crust along with iron ore and peat. You might as well use it to line the public latrines, as Lenin suggested, as to worship it as something of real worth. It earned no profits. It paid no dividends. It kept its mouth shut.
But gold is rare…and takes time and effort to pull out of the ground. What’s more, it is never destroyed…over the course of history the supply increases, roughly in keeping with the supplies of everything else. Nor could it be artificially replicated…counterfeited…or easily controlled. Thus, it made a perfect medium of exchange…a marvelous store of value…an almost heaven-sent, natural money…a currency you could actually trust.
But in one of the crowning illusions of our time people think they are much smarter than all the generations who came before them. Now, they no longer have any use for the yellow metal. They believe they can hedge their bets with derivatives…and control their money with enlightened central bankers and modern monetary policies. They believe that America’s central bankers can actually create ‘money’ by printing pieces of paper…and that they will create exactly as much as the economy needs to grow and prosper. They imagine Greenspan, Bernanke, McTeer and the whole troop of geniuses…carefully adjusting the knobs and levers of the Great Machine. They do not err. They do not falter. They do not waiver in their duty; they never get sick and never go mad. And like the Starship Enterprise…they imagine that this marvelous new engine — this post-modern, debt-fed consumer economy — defies the laws of gravity and economics….and takes them wherever they want to go.
For the last several years, this illusion has proved useful. Those who believed it have lived well…and even made money in junk bonds and junk stocks. Will it prove durable as well as useful?
We will see, dear reader, we will see.
In the meantime, here’s Addison Wiggin with some thoughts, ideas… conundrums…
Addison Wiggin in Paris…
– While sitting in the waiting room of the Necker children’s hospital yesterday, we read a series of daily newspapers intended for children. They were riveting. We noticed one item we thought the average abused reader of the Daily Reckoning might find mildly astonishing.
– A survey of 10 year old French kids, taken in January, revealed Beyoncé Knowles as their favorite female singer, Justin Timberlake their favorite male performer and… are you ready for this?… George W. Bush was their choice for ‘Man of the Year 2003’. Who would of thunk it, huh? Perhaps the president’s fiscal habits remind them of their late Socialist president Francois Mitterand.
– Larry Summers, successor to Robert Rubin at the Treasury, under the Clinton presidency, was in the news yesterday. We didn’t think all that much of him when he was on the job in Washington. And now that he’s the president of Harvard, we’re even more suspicious. But, by gum, yesterday the words he was speaking seemed to actually make sense. "There is surely something odd about the world’s greatest power," Summers told a group of number crunchers at the officious sounding International Institute of Economics, "being [at the same time] the world’s greatest debtor."
– Sounding a little like the gloomy contingent, who take their wine at the Paradis café, on the rue de la Verrerie in Paris, Summer continued: "There is surely a question that must be asked when, in order to finance prevailing levels of consumption, prevailing levels of investment, it is necessary for the United States to be as dependent as it is on the discretionary acts of what are inevitably political entities in other countries."
– Summer’s beef? According to paraphrased remarks produced by the Reuters news organization: "The United States briefly ran surpluses in the late 1990s, but now relies upon borrowing from abroad through the sale of U.S. Treasury securities to meet day-to-day spending needs. Much of that money comes from Chinese and Japanese purchases of U.S. Treasuries, or Government IOUs, using dollars acquired by exporting consumer goods, electronics and cars to America." Would you get a load of this guy? Where does he get off saying such disparaging remarks about America?
– "It can be argued," Summers admitted [sheepishly, we’re dying to add], "that the incentive for Japan or China to dump Treasury bills at a rapid rate is not very strong given the consequences it could have for their own economies… But it surely cannot be prudent for us as a country to rely on a kind of balance of financial terror to hold back reserve sales that would threaten our stability."
– Did you get that? As if it’s not complicated enough to keep our eye on the balance of trade… in today’s environment, suggests the sitting president of Harvard, we’ve got to maintain a "balance of financial terror"! Shocking as it is, we can’t say we didn’t see this coming.
– [Ed note. Our own Dan Denning has been burrowing beneath the headlines to determine the true motives behind the Chinese desire to keep the yuan pegged to the dollar and the massive acquisition of Treasuries by the central banks in both China and Japan. If you haven’t had the chance, Dan’s suspicions are detailed in this special report:
China’s Deliberate Economic War Against The US
*** It’s a must read. Especially if you want to know who’s really pulling the strings of the US economy. Hint: It isn’t Alan Greenspan or anyone residing on Pennsylvania Avenue in Washington. Of course, at the end of the report you will be given an opportunity to subscribe to Denning’s Strategic Investment. That too, we highly recommend.]
– Summers also suggested that the Bush administration, which has on cutting taxes – without cutting spending – is simply delaying the inevitable "day of reckoning" for America. Any delay in addressing the fiscal crisis will only make the process more "painful and expensive."
– The markets, like politicians surely will, simply ignored the aging elitist academic. In fact, the Dow was so bored by the end of the day it barely registered a pulse. Following a late session sell-off the Dow finished down a solitary point, closing at 10,063. The S&P 500 lost equally as much finishing its day at 1093. The Nasdaq lost 8 points, coming to rest at 1901.
– The dollar rose a penny against the euro to $1.22… but not on its own strength. Rather the euro fell on the numbskull remarks of Jean-Claude Trichet, president of the European Central Bank. After launching a PR campaign to get the likes of French president Jacques Chirac to keep his yap shut regarding a rate cut when the ECB meets April 1st, Trichet indicated he was open to idea yesterday. Currency traders apparently aren’t too keen on the idea…
– And what’s this? Ooh, la, la… another sign financial reckoning day is on the way. The American Bankers Association released a report yesterday showing credit card delinquencies jumped to another record high for the year 2003. "The improving economy [sic] has not yet touched all individuals," said the ABA’s chief economist, "particularly those who continue to look for work and may be relying on credit cards to meet their daily living expenses."
– Where are the jobs, Mr. Greenspan? "Perhaps," suggests the good doctor Richebacher in a guest essay below, "the Fed’s current policy lacks the necessary ‘traction’." More below…
Bill Bonner, back in London…
*** Jobs, jobs, jobs… From the Seattle Times comes word that Silicon Valley is hiring again, but the new talent is being taken on in India. In February, only 21,000 new jobs were added in the U.S. — barely more than 1/10th as many as economists believe ‘normal’ for this period.
A few whiny unemployed people are taking a bus across the country to try to draw a little press attention, says the other Seattle paper. They are willing to be retrained, notes the article, but for what? The economy is simply not adding jobs in any sector. Something should be done, say the travelers.
Both Democrats and Republicans have proposals to do something — all of them, naturally, are moronic.
*** Americans have $6.82 trillion of mortgage debt. Even a small decrease in house prices would leave many of them ‘upside down.’
*** Gas prices at the pump have hit a new high, says Triple A. Too bad, we were planning a long car trip this summer. But wait…here in Europe, we’re used to gas two or three times as expensive. It costs nearly $100 to fill the tank of our new gas-guzzling Nissan Patrol, which Elizabeth uses to pull her horse van. What are Americans complaining about?
*** "I know everybody worries about the price of oil," began a note from our friend, Gregor, "I saw a statistic
yesterday saying that increases in the price of oil gobbled
up 1/2 of the Bush tax refunds…but in the oil crisis of the early 80s, oil went to about $32 are barrel. Predictions were, that by the end of the century, oil would hit one hundred dollars a barrel.
"One 1981 dollar is now worth $2.08. So in constant dollars, today’s oil price, at 38 dollar a barrel, is actually about $19!. So instead of tripling, as predicted, even by the oil companies, oil actually dropped by a third. I know this is a small consolation for the consumer. But as you well know, compared to European prices, gasoline in America is dirt cheap."
*** "The Washington Post reports that the IRS just walked away from $16 billion in delinquent taxes," reports colleague Dan Ferris. "The IRS says it doesn’t have enough personnel to make the 30-second phone calls necessary to get people to pay up (in most cases).
"So it wants to use private collection agencies…
"Collection agencies are becoming one of the great growth industries of the early 21st century in the United States."
[Ed note. Dan recommends a few good collection agencies in his investment advisory:
*** And this from our unpaid correspondent in Pittsburgh…on building democracies…
"For all the worthy criticism of the ‘neocon’ theory behind the US invasion of Iraq, not everybody outside of the E-Ring of the Pentagon thought it was a bad idea.
"Case in point, Daniel, the Iraqi-exile bus driver at the Alamo car rental place at the Detroit airport. Yesterday (Sunday, 21 March) I was somewhat late in getting away from my Navy Reserve duties at Selfridge, Michigan, north of Detroit. I did not have time to change clothes, and I wore my green BDUs ("battle dress uniform") off base, as I drove like a bat out of hell down I-94 to the airport to catch my plane back to Pittsburgh. I turned in the car at Alamo and walked to the shuttle bus to the air terminal, in my greens. Daniel, the driver, walked out and grabbed my bag:
Daniel (noting the obvious): "You are wearing your uniform."
Me: "Yes, I didn’t have time to change."
Daniel: "That is a very beautiful uniform. You should be proud to wear it. It is the uniform of a liberator."
Me: "You are too kind. Thank you."
Daniel: "No, thank you. Thank you to all the soldiers who destroyed Saddam and brought freedom to Iraq. Thank you to all the families of America who gave their children to the cause of freedom, and to the brave people who have suffered such losses for people they do not know."
Me: "I appreciate your sentiments and your gratitude. But other people deserve your thanks far more than I. And it is not over."
Daniel: "It is over enough. Saddam is gone. The Iraqi people will build a new future. America has made the world a better place."
"Daniel and I proceeded to talk as we made our way to the terminal. He is a Christian, born and raised in Baghdad, who left Iraq in the 1980s.
"A number of his family were imprisoned by Saddam. He is very
optimistic about the future of Iraq. He thinks that there is a
relatively small cadre of militant Islamists who want to wreak havoc, and "We will just have to kill them."
Me: "Who do you think should do the killing?"
Daniel: "Americans cannot tell the difference between Iraqis who mean well and those who harbor ill. You will need to hire Iraqis who can tell the difference. They will work with you and do the job. I volunteered to help, but the U.S. government never got back to me."
Me: "That’s too bad."
"Memo to Mr. Rumsfeld — Please call Daniel."