Powell, Greenspan and Whatever it Takes

By Doug Noland

Fed Chairman Powell is in a tough spot, one made no easier now that he’s on the receiving end of disapproving presidential tweets. The global Bubble has begun to falter, which only exacerbates divergences between various markets and economies. The U.S. is booming, while China struggles and EM economies now stumble into the dark downside of an epic cycle. The U.S. economy and markets beckon for tighter financial conditions, while higher U.S. rates pose significant danger to fragile global markets already confronting a major tightening of financial conditions.

Powell played it safe in Jackson Hole. I imagine he’d have preferred to sit this one out. As such, his presentation was too heavy on rationalization and justification. The FOMC is trapped in Greenspan-style “baby steps,” and it is curious that the Fed Chairman would choose to praise Alan Greenspan for his nineties policy approach:

“Under Chairman Greenspan’s leadership, the committee converged on a risk-management strategy that can be distilled into a simple request: ‘Let’s wait one more meeting; if there are clearer signs of inflation, we will commence tightening.’ Meeting after meeting, the committee held off on rate increases while believing that signs of rising inflation would soon appear. And meeting after meeting, inflation gradually declined.”

If the Greenspan Fed had in fact adopted a “risk management strategy,” it was a failed attempt. It’s too easy these days to disregard the highly disruptive boom and bust cycles that have been prominent in U.S. and global markets (and economies) over recent decades. And here we are today, the Federal Reserve still accommodating Bubble Dynamics because of its failure to respond to financial developments and contain excess back in the nineties.

The bursting of the nineties “tech” and corporate debt Bubbles spurred the Greenspan Fed to slash rates to 1% by June 2003. At that time, double-digit mortgage Credit was already fueling self-reinforcing home price inflation. Short rates were then “baby stepped” upward until June 2004 and remained below 4% all the way into late-2005. The lesson not learned from that episode was that small, gradual telegraphed rate increases are ineffective in the face of an inflating Bubble. Such a policy course ensured a progressive loosening of financial conditions when tightening was clearly required from a risk management perspective.

Accommodating the nineties Bubble basically ensured the Greenspan Fed would later adopt even more aggressive post-Bubble accommodation. Indeed, the Fed specifically targeted mortgage finance as the source of reflationary Credit. This greatly compounded the fateful error from earlier in the Greenspan era: nurturing market-based Credit and financial speculation in response to banking system impairment following the collapse of late-eighties (“decade of greed”) Bubbles.

The financial world changed momentously during the nineties. Out with the staid bank loan, in with dynamic market-based finance: Asset-backed securities, MBS, GSE Credit, money-market funds, derivatives and Wall Street “structured finance”. In with repurchase agreements (“repos”) and essentially unlimited cheap market-based securities Credit. In short, out with reserve and capital requirements that traditionally restrained Credit growth; in with unfettered asset-based finance the likes the world had never experienced.

From Powell’s opening paragraph: “Fifteen years ago, during the period now referred to as the Great Moderation, the topic of this symposium was ‘Adapting to a Changing Economy.’ In opening the proceedings, then-Chairman Alan Greenspan famously declared that ‘uncertainty is not just an important feature of the monetary policy landscape; it is the defining characteristic of that landscape.'”

The Fed and global central banks never successfully adapted to the new paradigm they themselves had championed. Unfettered market-based and speculative finance beckoned for more stringent monetary management. Yet the Fed, fretting the instability and associated uncertainties, erred on the side of easy “money.” And, despite it all, this error compounds to this day.

The “great moderation” period saw powerful inflation dynamics take hold throughout the securities and asset markets, at home and abroad. This new finance had a strong inflationary bias that created a propensity for inflating powerful Bubbles. Asset inflation and Bubbles emerged as the most consequential form of inflation, yet central banks were too content to take Credit for the so-called “great moderation” in consumer price inflation (that clearly had much more to do with profound changes in finance, technologies, globalization and the nature of economic output – rather than effective monetary management).

As the nineties unfolded, policy focused on the “real economy sphere” – the New Paradigm, electrifying technological innovation and the so-called “productivity miracle” – along with various measures omnipotent central bankers would employ to support such obviously constructive advancements. Policymakers should have instead been fixated on momentous “financial sphere” developments, and how the associated structural loosening of financial conditions warranted a counterbalance of tighter monetary policy and a more stringent regulatory regime.

Adopting the view that the New Paradigm favored a more permissive approach to monetary management, Greenspan got it dreadfully wrong. In the end, perhaps the most consequential analysis in the history of central banking was deeply flawed. The “maestro’s” asymmetrical monetary policy approach was instrumental in bolstering inflationary psychology throughout the markets, with the Greenspan “put” repeatedly resuscitating vulnerable Bubbles. All the while, huge infrastructure was being erected to support the worldwide enterprise of financial speculation, and the Greenspan Fed gave an enthusiastic thumbs up.

Ironically, the free-market ideologue sowed the seeds for unsound markets increasingly incapable of self-correction and adjustment. Asset inflation: the most dangerous form of inflation specifically because there are powerful constituencies beholden to it and essentially none in opposition.

In the sixties, Alan Greenspan was said to have explained to his fellow Ayn Rand colleagues that the Great Depression was the result of the Federal Reserve repeatedly placing “coins in the fuse box.” Ironically, Greenspan initiated a process that has seen the Fed and global central bankers resorting to coins to circumvent market forces for going on three decades – culminating with “whatever it takes” directing the one-way, free-flow of “money” into the securities markets.

I try to cut Chairman Powell some slack. I understand he’s trapped in gradualism and flawed central bank doctrine, more generally. But I was hoping he would over time initiate a retreat from the Greenspan/Bernanke/Yellen market “put.” Powell: “I am confident that the FOMC would resolutely ‘do whatever it takes’ should inflation expectations drift materially up or down or should crisis again threaten.” Why is this language necessary on a day with the S&P500 and Nasdaq trading to all-time highs?

Bond yields (and the dollar) dropped on the release of Powell’s speech. The market essentially presumes zero probability of the Fed ever aggressively tightening policy under any circumstance. Aggressive cuts and market support, well that’s an altogether different story. I would argue that the prospect for a return of aggressive QE and zero rates is fundamental to ongoing extraordinarily low market yields along with the flat yield curve. Greenspan’s “asymmetrical” globally on steroids.

Low yields clearly support price Bubbles in equities, real estate and asset markets more generally. And the longer Bubbles inflate the more confident speculators become that future “activist” policy measures will bolster bond and fixed-income prices. The comprehensive “whatever it takes” central banking “put” provides unprecedented Bubble support – and, I would argue, amounts to yet another highly destabilizing and dangerous policy error. The egregious masquerading as conventional mainstream. To be sure, the problem with discretionary monetary policy is that one mistake invariably leads to bigger – and inevitably much bigger – mistakes.

“Changing Market Structures and Implications for Monetary Policy” is the theme for the 2018 Jackson Hole symposium. Pro-Bubble central bank monetary policy doctrine has for much too long been instrumental in fostering unstable market structures. Chairman Powell missed an opportunity to dial back the “whatever it takes” central bank approach to backstopping unsound securities markets. It’s been a full decade since the crisis, for heaven’s sake.

The nineties were on my mind throughout the week. An odd coincidence that Powell’s Jackson Hole presentation harkened back to Alan Greenspan and the nineties. In what is being called “the longest bull market in history,” the duration of the current bull run this week surpassed the previous record, October 1990 through March 2000.

One person’s record bull is another’s greatest Bubble. GSE Credit and corporate debt were key sources of fuel for the nineties Bubble. And each bursting Bubble is to be reflated by a more formidable Bubble inflation. The post-nineties reflation was led by booming mortgage finance, much of it of the (money-like) “AAA” GSE and Wall Street structured finance ilk. The 2008 collapse of this much grander Bubble provoked unprecedented reflationary measures. This historic reflation went to the very foundation of global finance, sovereign debt and central bank Credit. It has corrupted the very heart of contemporary “money.”

The problem with “money” is that it enjoys insatiable demand, creating the potential for extraordinarily dangerous Bubbles. “Whatever it takes” has deeply perverted market structure across the globe. Myriad risks have been inflated and totally distorted. Today’s market view holds that central bankers will not tolerate a crisis. Perceived risk remains extraordinarily low, as illustrated by Friday’s closing VIX price of 11.99. But true underlying risk is sky high and rising – market, economic, policy, political and geopolitical. Market structure and global imbalances, among others, are accidents in the making.

When this Bubble bursts, there will be no new source of “money” sufficient to fuel the next round of reflation. It’s sovereign debt and central bank Credit for the duration. In the meantime, loose monetary policy will continue to accommodate an unprecedented expansion of government borrowings. As EM is now recognizing, the market mechanism for disciplining profligate borrowers doesn’t function until it’s too late. While the global Bubble falters at the periphery (Brazilian real down 4.7% this week!), boom-time excesses run unabated at the core.

Powell: “Whatever the cause, in the run-up to the past two recessions, destabilizing excesses appeared mainly in financial markets rather than in inflation. Thus, risk management suggests looking beyond inflation for signs of excesses.”

A risk management approach would be working to extricate extreme central bank “activism” from the markets. Financial markets should stand on their own; the market mechanism needs to be operable. But rates, once again, remain too accommodative. Moreover, this is no time to be reminiscing about Alan Greenspan or trumpeting “whatever it takes.” A missed opportunity Chairman Powell – and an important one at that.

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Gary

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