By Doug Noland
Strangely perhaps, but late in the week my thoughts returned to James Carville’s 1992 comment: “I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”
Things have changed so profoundly since then, though I get no sense that many appreciate the momentous ramifications. It seems like ancient history – the bond market king of imposing discipline. Bonds maintained an intimidating watchful eye. No crazy stuff – from politicians, central bankers or corporate managements. The bond market of old would have little tolerance for $1.0 TN deficits, QE or a prolonged boom in BBB corporate debt issuance. Contemporary markets seem to have only a burgeoning desire to tolerate.
July 19 – Reuters (Trevor Hunnicutt and Saqib Iqbal Ahmed): “Donald Trump’s comments that a strong dollar ‘puts us at a disadvantage’ caused an instant fall in the greenback on Thursday and marked another example of the U.S. president commenting directly – and sometimes contradictorily – on the country’s currency. Talking directly about the dollar is a break with typical practice by U.S. presidents, who are wary of being seen as interfering directly with financial markets… ‘There are certain comments most presidents wouldn’t make,’ said Michael O’Rourke, chief market strategist at JonesTrading. ‘They’d defer monetary policy to the Fed and the dollar to the Treasury secretary. But Donald Trump is not most presidents.'”
July 19 – CNBC (Jeff Cox): “President Donald Trump’s move to criticize the Federal Reserve is almost without precedent in a nation that places a high priority on the independence of monetary policy. Almost all of Trump’s predecessors steered clear of Fed critiques in the interest of making sure that interest rates were set to whatever was best for the economy and not to boost anyone’s political fortunes. The Trump administration, of course, has been anything but typical, and the Trump comments, if anything, were consistent with a president who cares little for convention and is willing to speak his mind on virtually anything. ‘Somebody would say, ‘Oh, maybe you shouldn’t say that as president,’ Trump said… ‘I couldn’t care less what they say, because my views haven’t changed.'”
July 19 – Bloomberg (Christopher Condon, Craig Torres and Jeanna Smialek): “President Donald Trump criticized the Federal Reserve’s interest-rate increases, breaking with more than two decades of White House tradition of avoiding comments on monetary policy out of respect for the independence of the U.S. central bank. ‘I’m not thrilled’ the Fed is raising borrowing costs and potentially slowing the economy, he said… ‘I don’t like all of this work that we’re putting into the economy and then I see rates going up.’ The dollar relinquished gains from earlier in the day and Treasury yields dropped following the president’s remarks.”
The 1992 bond market would have recoiled from even the notion of a U.S. President criticizing the Fed, talking down the dollar or kicking sand in the faces of both allies and major foreign holders of our debt. Considering the backdrop, heightened discussion of market complacency is understandable – and long overdue. Why do today’s markets – bonds and otherwise – not respond as they would have traditionally? Why has the idea of markets actually imposing discipline turned into such a humorless joke? Discipline? Heck, there’s not even a reaction.
From the Fed’s Z.1, Total (Debt and Equity) Securities ended this year’s first quarter at a record $89.0 TN, or 446% of GDP. For comparison, Total Securities began 1992 at $13.3 TN, or 215% of GDP – only to end the nineties at 360% of GDP ($34.8TN). The Greenspan Federal Reserve championed a historic shift to “activist” central bank management of “market”-based finance. Pure genius and indeed miraculous. The economy would massively expand the supply of Credit and equities – and no amount of new supply would slow the dramatic inflation in securities prices. Policymakers found themselves with this all-powerful new lever for wealth formulation.
This New Age market finance proved highly unstable. No worries; the Fed would loosen financial conditions with only the wink of a rate cut, as a captive audience of speculators eager to leverage debt securities fixated on every policy twitch. The GSEs were also there to provide increasingly speculative markets a New Age liquidity backstop, with their ballooning balance sheets a harbinger of what was to come from the Federal Reserve and global central bank community. If Fed rate cuts and massive GSE liquidity don’t suffice, there’s always government deficit spending and bailouts.
The Federal Reserve and Washington thoroughly abused market-based finance. Along the way, unsound “money” and deeply flawed policy doctrine ensured markets turned increasingly dysfunctional. Not only did they not provide a disciplining mechanism, they became a complicit tool to Washington’s power grab. The Treasury market essentially became a bet on prospective monetary policy easing. And as Bubble Dynamics increasingly commanded stock and real estate prices, Treasury bonds essentially became the go-to instrument for betting on (or hedging against) bursting Bubbles. “Excess begets excess.” This was especially the case after Dr. Bernanke trumpeted the benefits of “helicopter money” and the “government printing press”.
Long before the financial crisis, I argued that “activist” central banking was on a very slippery slope. The evolution of New Age Finance took a giant leap with chairman Bernanke’s implementation of zero rates and QE. The Fed’s move to reflate the system through inflated market prices essentially ended the securities markets as mechanisms of self-adjustment and correction. Market discipline was dead. Today, financial markets now chiefly operate as a tool of government (“government finance quasi-Capitalism”).
This complex story turned only more convoluted as the world moved aggressively to adopt U.S.-style policies and, not to be left hopelessly behind, market-based finance. Are the profound changes in monetary management and the rise of the “strongman” politician mere coincidence? I would imagine Greenspan and Bernanke quietly abhor the rise of populism. Do they feel any sense of responsibility?
With central bankers so celebrated for blatantly manipulating markets, of course politicians, dictators and the like would insist on getting a piece of the action. Inflating financial markets became essential to power – economic, political and geopolitical. And as finance became integral to economic growth and the global power play, why not use financial sanctions or the threat of financial repercussions to dictate nation-state behavior? And, over time, attaining financial wealth became an absolute prerequisite for wielding geopolitical power and influence.
The old military variety appears almost feeble standing next to the contemporary Financial Arms Race. And if you seek dominance – domestically, regionally and/or internationally – you had better get a tight rein on the securities markets – whether you’re in Washington, Ankara, Moscow or Beijing. Beijing (and it’s “national team”) moved ahead in this regard, but it would appear Washington is today keen to play catch up. As market-based finance has commandeered the world, the centers of global power have moved to take command of the markets.
July 17 – Wall Street Journal (Nick Timiraos): “Federal Reserve Chairman Jerome Powell delivered an upbeat assessment of the economy and said it justified continued interest rate increases. But he opened the door to a potential policy shift and outlined risks if escalating trade tensions result in permanently higher tariffs. Mr. Powell has mostly sidestepped recent questions on trade policy because he says it is outside of the Fed’s responsibilities. He offered words of caution Tuesday… ‘In general, countries that have remained open to trade, that haven’t erected barriers including tariffs, have grown faster. They’ve had higher incomes, higher productivity,’ said Mr. Powell. ‘And countries that have gone in a more protectionist direction have done worse.’ Mr. Powell affirmed the Fed’s plans to continue with gradual rate increases…”
I’d be curious to know if it was Chairman Powell’s trade comments that provoked the first presidential criticism of the Federal Reserve since Richard Nixon. My hunch would be that the administration is crafting a strategy to direct blame at the Federal Reserve in the event the stock market begins to unravel. I cringed Thursday when Larry Kudlow called out Chinese President Xi as personally responsible for the lack of fruitful Chinese trade negotiations. Count me quite skeptical that this kind of pressure will prove an adept negotiating ploy.
This game of chicken is turning more dangerous, and perhaps the administration is preparing to scapegoat the Federal Reserve. I personally find the denigration of U.S. institutions most regrettable. The Fed down the road will have enough problems maintaining public trust and confidence. And with short rates not yet even above 2%, the thought that the Fed is already getting pulled into the muck creates a very uncomfortable feeling. My unease only worsened with the President’s strong dollar “puts us at a disadvantage” comment.
Am I the only one that finds it ironic that Russia recently dumped most of its Treasury holdings? The administration seems to save its vitriol for countries with large holdings our of debt instruments. Call me old fashioned, but I suggest treating one’s creditors with at least a modicum of respect. Ten-year Treasury yields jumped seven bps Friday, as the dollar was being pressured by the President’s comments. If the administration has begun buckling in for a dicey game of chicken, it would be wishful thinking not to contemplate Treasuries and the dollar as possible collateral damage.
It was another extraordinary week. I’ll leave it to others to get political. Looking at recent developments, one would see strong support for the view that the President is imploding. Or, one wouldn’t see… Either way, he appears emboldened and certainly in no mood for backing down on anything. Markets just take it all in – and exhale calmly. Securities markets have grown fond of disruption (will tend to keep central bankers in check). The threat of a trade war is tolerable – so long as we don’t see an actual smash up. Seems reasonable to assume they’re not completely reckless, doesn’t it? The President is, after all, keen for higher markets, as are leaders around the globe. Markets are keen to accommodate.
July 20 – CNBC (Tae Kim): “President Donald Trump said the stock market rally since his election victory gives him the opportunity to be more aggressive in his trade war with China and other countries. ‘This is the time. You know the expression we’re playing with the bank’s money,’ he told CNBC’s Joe Kernen… The president has a big cushion. The S&P 500 is up 31% since Trump’s win on Election Day, Nov. 8, 2016, through Thursday… Trump added the market would likely be much higher if he didn’t escalate the trade issues with China and the rest of the world. ‘We are being taking advantage of and I don’t like it,’ he said. ‘I would have a higher stock market right now. … It could be 80% [since the election] if I didn’t want to do this.'”
“Still dancing” – spoken infamously in the Summer of 2007. Summer 2018: “We’re playing with the bank’s money.” “The bank’s money” as in “the house’s” money at a casino? Or “the bank’s money” as in central bank “money”? Either way, it’s apparently worth risking…
I’m fond of saying how crazy things get near the end of Bubbles. Convinced this is History’s Greatest Bubble, I’ve been anticipating a pretty astonishing variety of “crazy.” Watching this all unfold with increasing trepidation, I sense an important line has been crossed. It’s time to retire “crazy” – find a replacement that conjures up something more foreboding – more disturbing. And markets, well, they’re seemingly fine with it all; at times almost giddy. And that’s the fundamental problem: Dysfunctional markets continue to promote incredibly risky policy behavior – the polar (bear) opposite of imposing discipline.
The central banks’ “slippery slope” has led us to an ominous place. “Strongmen” now believe it’s within their domain to dictate the markets, interest rates and currency levels. All the while, it’s regressed into an unprecedented global Bubble replete with a Global Financial Arms Race. Markets trade as if they fully expect all governments to absolutely, at all cost, safeguard their respective financial wealth (i.e. Bubbles). Remember “the West will never allow a Russian collapse”? And “Washington will never allow a housing bust”? Global policymakers will never allow another major crisis. Well, let’s see how this game of chicken between President Trump and President/General Secretary Xi plays out.
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