And the band plays on...

I think Doug Noland’s (almost) weekly piece is a must-read. This time through he touches on Janet Yellen’s recent confirmation hearings before the Senate, picking up on a very interesting exchange with Senator Bob Corker…

Senator Robert Corker: “We talked a little bit about the Fed in the early summer began to talk about moderating the pace at which it was going to be making purchases. And the market had a pretty stringent reaction. It was like… the Federal Reserve appeared as if it had touched a hot stove and that this policy was going to greatly affect, if you will, the wealth effect that you were trying to create… And so the Fed jumped back. And it seemed to me - and I think you discussed this a little bit in the office - that the Fed had become a prisoner to its own policy. That to really try to step away from QE3 was really going to shatter possibly the markets and therefore take away from the wealth effect. And I wonder if you could talk a little bit about some of the discussions that were taking place during that time.”

Yellen: “Well, Senator, I don’t think that the Fed ever can be or should be a prisoner of the markets…”

Senator Robert Corker: “But to a degree in this case, it did affect the Fed, did it not?”

Yellen: “Well, we do have to take account of what is happening in the markets, what impact market conditions are likely to have on spending and the economic outlook. So it is the case, and we highlighted this in our statement, when we saw a big jump in rates - a jump that was greater than we would have anticipated from the statements that we made in May and June - and particularly saw mortgage interest rates rise in the space of a few months by over a hundred basis points, we had to ask ourselves whether or not that tightening of conditions in a sector where we were seeing a recovery and a recovery that could really - recovery in housing that could drive a broader recovery in the economy - we did have to ask ourselves whether or not that could potentially threaten what we were trying to achieve. But overall, we are not a prisoner of the markets. I continue to feel that we’re seeing an improvement in the labor market, which was the goal of the program. And we will continue to evaluate incoming data and to make decisions on the program in that light going forward.”

Yellen acknowledges that the move up in rates, after hints of a taper, took the Fed by surprise. In other words, they started to lose control and the response was to immediately back off any kind of hawkish stance. And that supports two ideas: (1) that the move in rates was not about an improving economy as the goldilocks crowd tried to suggest; and (2) the Fed’s machinations can never stop unless they are prepared for rates to march much higher.

More advice from economists

An interesting read over at Stratfor (behind the paywall) about the investigation launched into Germany’s trade surplus. A common refrain in looking at the problems of the Southern European countries is that a Germany which increases domestic demand and endures a bit of inflation will help the EU to survive. But, a few data points to consider:

-Since 2007, the German surplus has mainly been a function of increased exports to non-EU countries. So, while it may be true that the Germans have benefitted from the common currency and access to the EU and Eurozone markets, the sustainability of that surplus is not solely dependent on those factors.

-The other suggestion is that the Germans need to raise wages in order to encourage domestic demand, thereby helping the export sectors of other EU states. But, German wages are already 32% higher than the EU average (even though they have not grown as fast over the past 10 years) and a weaker currency probably only helps those countries from which Germany already has a high level of imports – and they are not really the countries that need the additional help right now (save for France).

All of which means, the only obvious manner to grow wages (as per some economic theory) is through more government spending. Which means the German taxpayer has to bail out the EU. Maybe the benefits outweigh the costs, but remember that the Germans have a deep understanding of what fiscal recklessness can lead to.

Small Bites

A few things that I noticed around the internet…

-I liked this article by Bob Murphy that examines the economic problems with Obamacare and why we are headed for a single payer and medical rationing down the road.

-Here’s a piece where Scott Sumner responds to the WSJ op-ed by Andrew Huszar from earlier this week. As you’ll recall, Sumner is a fan of NGDP targeting and supports the large-scale QE programs. But when he writes the following…

“Huszar doesn’t seem to realize that financial-market reactions are the best indication of how these programs are working, indeed the only reliable indication. Everything else (such as borrowing costs) is meaningless without a counterfactual.”

…does anyone else see some inconsistencies in logic? I mean, if it’s really about aggregate demand and GDP growth, why have both metrics continued to stall even as the QE programs have gotten larger? In fact, the financial markets have shown little to no correlation with economic realities.

-Moving on to Japan, this Bloomberg article examines how the BOJ has basically overwhelmed the JGB market and that pricing signals have essentially disappeared. For which there are definite consequences:

“’The JGB market is dead with only the BOJ driving bond prices,” said Tetsuya Miura, the chief bond strategist at Tokyo-based Mizuho, one of the 23 primary dealers obliged to bid at government auctions. “These low yields are responsible for the lack of fiscal reform in the face of Japan’s worsening finances. Policy makers think they can keep borrowing without problems.’”

Interesting Reads

-A peak into how Spanish banks have managed to avoid NPLs even as the economy is in the shitter. The secret…refinance loans that will never get repaid at lower rates.

-The second piece excerpts from Ray Dalio at Bridgewater Associates. Basically, he thinks the Fed has created another bubble in financial assets and QE is losing steam in terms of its effect.

-Next is a piece that looks at how Blackstone and Goldman (among others) are looking to buy single family homes in Spain. Their strategy resembles what they did in the U.S., where they became the market and caused prices to rise. But, at a certain point, that strategy runs out of steam and the market stops going up when they stop buying.

-The final installment is John Hussman’s weekly note. He points out the same things that he always does – this market is overvalued, overbought and overbullish. And while it may stay that way for a while longer, it would be foolish to think that it can go on forever.

October Jobs

The BLS report came out with 204,000 new jobs for the month, nearly double the consensus estimate.

However…

-The household survey showed a drop of 623,000 full-time workers and 127,000 part-time workers – so much for trying to extrapolate the September numbers that showed an unexpected (and apparently one-time) surge in full-time workers

-No shock, but nearly half the headline number consisted of low-wage jobs (retail, hotel, temps)

-The participation rate dropped to 62.8%, reflecting a loss of 932,000 people from the labor force and the lowest rate since 1978

But, by all means, let’s get very excited about a robust recovery.

P.S.

As a nice follow-up to my post on Friday, Doug Noland’s weekly piece came out and it is, as usual, a good read. He specifically touches on the subject of monetary velocity and the lack of inflation as measured by CPI. An excerpt:

“The conventional view holds that massive QE has not caused inflation because the Fed’s monetary fuel has remained unused as “reserves” on bank balance sheets. From this viewpoint, inflation risks lurk somewhere out in the future: when the banks eventually lend these “reserves” and the monetary fuel finally makes its way into the real economy. Moreover, the optimistic view holds that the Fed has the tools to adeptly manage any future inflation issue.

I take a much different view. QE is anything but benign. The Fed’s monetary fuel certainly doesn’t just sit inertly on bank balance sheets. Indeed, this monetary inflation is immediately unleashed upon the financial markets, with the newly created “money” setting off a chain-reaction of transactions, flows and market impacts. Over time, this dynamic foments huge distortions in marketplace liquidity, risk perceptions, speculative financial flows, asset prices and market stability. And, somehow, when Fed officials discuss QE they avoid any mention of what have become conspicuous inflationary effects on securities prices.

Fundamentally, the repeated injection of Fed liquidity over time – and especially at key junctures - into the financial markets has created Bubbles increasingly vulnerable to even subtle changes in market perceptions and/or changes to the risk-taking and speculative leveraging backdrop. This is the essence of the so-called “addiction” induced by the Fed’s historic monetary inflation.”

Also, Jack Crooks over at Currency Currents notes the following since the 2008 crisis started:

-Government debt has increased $30 trillion
-Central Bank balance sheets have grown $10 trillion
-Private debt has grown $22 trillion
-Stock market capitalizations have risen by $26 trillion

And with all of that, global GDP has grown $8 trillion.  In other words, financial assets have increased 11 times relative to underlying real assets upon which those financial assets are supposed to be a claim.  Unsustainable.  Even if you just focus on central bank balance sheets, you still don't see any one-for-one correlation.  Not good.

Around the Web

-I read Scott Sumner’s blog today and he has a new post about reforms to the healthcare system that marry well with the good ideas in David Goldhill’s book. Specifically, the main reform should be to provide everyone with a health savings account and then insurance (perhaps even a single payer) for catastrophic events. It brings in market concepts (as individuals have to be thoughtful about spending for the non-existential stuff) and yet still satisfies those who endorse state intervention and an end to private insurance.

-Speaking of Sumner, he gets credit for pointing out that fiscal stimulus is not a game-changer in the way that some would like us to believe. Specifically, the Fed is always in a position to temper the fiscal side through its conduct of monetary policy and manipulation of rates. In other words, the Fed is much more important. Which then got me thinking about the counter-argument, which is that while the Fed can print money, it ultimately has no control over its velocity. In other words, they can only play defense. Both sides agree, though, that expectations are very important.

So, what do I think? I continue to read a lot of people who believe in a deflationary threat. But, in that battle between inflation and deflation, the Fed always gets another turn at bat. So, if it’s inflation they want, it’s inflation they’ll get. But, how do you work through the issue of velocity?

And here’s where the ephemeral “expectations” piece matters. As we continue to struggle through a low growth, weak employment world, two things should eventually happen: (1) people will realize that the Fed does not have a handle on things and is trapped in the current policy stance; and (2) as the desired results continue to be elusive, the Fed will amp up (rather than taper) its efforts. Between those two realities, dynamics will change as well as the expectations for inflation. And the Fed won’t be able to do a thing about it, unless they are finally prepared to enable the recession/depression that they have tried so hard to prevent.