Normalizing The Abnormal

by | Apr 27, 2017 | Economy, Keith, Politics | 0 comments

It has now been more than eight and a half years since the collapse of Lehman Brothers and the meltdown of AIG. In the wake of those calamities the Treasury Department and the Federal Reserve took extraordinary action in order to prevent the global credit markets from locking up entirely. Unfortunately that extraordinary action has continued each and every day since then. More than eight years down the road and central banks are still injecting liquidity into the global financial system at a rate of $200 billion per month in order to keep the credit markets solvent. The Federal Reserve still a balance sheet of $4.5 trillion while central banks around the world have already purchased more than a trillion dollars worth of assets just so far in 2017 – and we are not even half way through the year.

Once again, we have fixed nothing.
The governments and central banks around the world, led by the Federal Reserve, have created a liquidity trap. The very problem these central banks, including the Federal Reserve, set out to save us from in 2008 is the very problem which they have exacerbated which is why they are still required to keep interest rates at historical lows, cannot unwind their balance sheets and are still purchasing assets at a heart stopping pace. Every financial crisis has at its’ root illiquidity and the liquidity trap has created a near constant liquidity fear for the past eight years which is why the central banks cannot normalize. Here is what Jeffrey P. Snider said, “That, too, is in important factor because it was liquidity at the very least the QE’s were supposed to fix. The path of balance sheet expansion into the real economy was always murky to begin with, no direct channel would ever exist between the purchase of MBS or UST into the wage rates of ordinary Americans. It was thought to work through expectations more than anything else. But the trillions of bank reserves, so-called money printing, surely would cure all financial liquidity risk. And yet, that is the most prominent feature of the financial landscape apart from the stock market. Everywhere you look there are expressed abnormal (for all history before 2007) liquidity preferences; from eurodollar futures to German federal paper the story is the same – persisting fear of illiquidity, “dollars” most of all. If Bernanke could not get even that right through four QE’s and $2.5 trillion in reserves, the one thing closest to what everyone assumed was this central bank’s wheelhouse, then his views on stocks are likely to be, again, contrarian.”

Where has all of this liquidity gone? It has not gone into expanding corporations, new products and increased employment and wages. It is primarily gone to equities and real estate. Just this morning it was announced that the global market cap has reached $50 trillion. EPS is reaching historical heights – again Jeffrey P. Snider: “”Dr. Bernanke noted that corporate earnings have risen at the same time; he believes corporate earnings will continue to grow and “catch up” to asset prices.” Obviously, given his track record, that is a chilling statement of contrarian purposes. Kidding aside, it is interesting that he of all people would feel comfortable enough in making such a claim. For one, that is exactly the market problem at the moment. It is priced for enormous growth, way out in front of actual earnings which for nearly three years now have failed $100 (for the S&P 500). In order for EPS to “catch up” will require the kind of growth you actually find in a recovery, at the very least a short burst of intense activity that creates all the follow-on effects that he once talked about igniting through QE. But that isn’t what he actually said in his interview. Like Janet Yellen, Bernanke sees only vague improvement, so unsure that he felt compelled to qualify it further.”

For each and every year that Obama was President more American businesses went out of business than were created. It is not looking as though the first year of Trump will be any better. Just this morning the Atlanta Federal Reserve revised their first quarter GDP growth down to 0.2% while JP Morgan estimates first quarter GDP growth at 0.3%. There is no growth in the economy – yet the Dow Jones and Nasdaq are screaming and real estate prices have now exceeded the high water mark of 2006-07. That should send chills down your spine.
The net effect of the actions of the central banks over the last eight and half years is to communicate that the central banks will not allow the markets to suffer a significant decline – let alone fail. One of the consequences of this communication has been the belief that it is much safer to invest your money in real estate or the stock market than it is to invest your money in starting a new business or expanding an existing business. Consequently capital has flowed out of business expansion and creation and into equities and real estate. The net effect of this market distortion has been, due to the decline in business creation and expansion, a decline in the corresponding creation of full time private sector jobs.
On the other hand shadow banking has thrived under this monetary regime – derivatives received a deluge of blame for the disaster of September 2008. At that time the notional value of derivatives was on the order of $240 trillion. What is the notional value of derivatives today? About $550 trillion. Again, we have fixed nothing. That should also send a chill down your spine.
Despite this, people continue to argue what a great idea Dodd-Frank was. Yes, Dodd-Frank is a great piece of legislation – if you are a Wall Street bank.
Even though the last eight years has been the greatest credit expansion in history – the United States has lost something on the order of nine million full time private sector jobs over that same timeframe. There is an obtuseness to this that is in no small measure at the root of our discontent. Raúl Ilargi Meijer said it well – “But as these maps show, it’s not about Le Pen, or Trump, or Nigel Farage. It’s about people being left behind in ever larger numbers, susceptible to voices other than the ones they’ve known for a long time and who never listened to them. And nothing is being done to address these people’s claims; on the contrary, things are only getting worse for them. I saw a headline today that said ECB president Mario Draghi’s “Stimulus Could Blunt Populism as Unemployment Declines”. There’s only one possible reaction to that: what happens when he stops his stimulus?”

Indeed, what happens when all of this stimulus stops? If you are in a position to profit from this mind bending credit bubble you are doing very well. If you are not in that position then you are very likely growing poorer by the day. This situation is true in Europe, in the United States, in Canada, in Japan and in China. Unfortunately the profit from this credit bubble to a large degree has been consigned to specific geographical boundaries – causing many people to draw the mistaken implication that the profit from the credit bubble equates into a superior cultural model being prevalent in these geographical locations.

It is difficult to imagine a more lethal mistake to make than believing that profit from a credit bubble equates to superior culture yet here we are.
Buckle up…