Dissent in the Ranks

Amid all the polemic it has inspired, perhaps the best summing up of current US policy was the verdict delivered by Germany’s famously irascible finance minister, Wolfgang Schaeuble, when he rather undiplomatically snorted that: ‘Bei allem Respekt, mein Endruck ist die Verienigten Staaten sind ratlos” – ‘However you look at it, my impression is that the US is in a state of desperation.’

In the heated to and fro which has ensued we have been treated to the rather singular spectacle of a lifelong, bureaucratic statist like ‘Fuzzy’ Zoeller half-admitting that even some form of suitable bastardized (i.e., neutered) gold standard would be better than the chaos which prevails today and, conversely, we have wearily had to endure the inevitable, disparaging, inflationist response from that insufferable bien pensant, the FT’s Martin Wolf.

But the polarisation of views hardly ends there, for it rages deep within the sancta of the Underconsumptionist Temple of the Marriner Eccles building itself.  Blackhawk Ben himself has, of course, been defiantly unapologetic about his actions, even to the extent of telling a college audience that soaring commodity prices were not an issue since ‘final demand’ was too weak for firms to ‘pass these costs on’ – a shrug of the shoulders hardly likely to be shared by those struggling businessmen whose margins would thereby be squeezed (and whose payrolls potentially further reduced) if the Chairman’s prognosis were to break all precedent and actually come to pass.

It was also the height of either incomprehension or disingenuousness when he claimed that he had not indulged in ‘printing money’, but had simply undertaken an ‘asset swap’ of securities for deposits. Well, yes, but what else do we class as money if not bank demand liabilities and currency, these usually propped up on the basis of the claims those same banks hold against the Fed?

The fact that these reserves have not been pyramided up, post-Crisis, with the usual gay abandon is not entirely to the point for it should not go unremarked that – ‘broken multipliers’ notwithstanding – money supply proper has risen 20% in the two years since LEH went under – a percentage increase it took the previous five years to accomplish, at a compound annual growth rate all of 2 ½ times slower.

Also defending his particular brand of mindless mechanicalism, St. Louis Fed president Bullard was out touting his spurious, Fisher relation-Taylor Rule, intersecting-lines approach to why he thinks the last vestiges of common sense should be abandoned in the name of not allowing the US to turn into Japan  – something which, in complete opposition to the tenor of the argument he is advancing, is only likely to happen if Bullard and his ilk maintain their insistence on treating symptoms, via a zombie-nursing ZIRP, rather than addressing causes, by liquidating the debilitating overhang of old mistakes with the aid of a sensible, freely-determined cost of financial capital .

To gauge the unworldly nature of his model-supersedes-reality thinking, consider that he exulted in the fact that TIPs yields went down after the infamous Bernanke speech, while the inflation rates implied in the gaps between these and straight bonds went up.  Since, in theory, this not only reduced ‘real’ rates, but demonstrated heightened inflation expectations had arisen, to our man this was a triumph of reverse-engineering a recovery.

Unnoticed was the drawback that these two factors rather tend to cancel out when it comes to the dirty business of actually paying the interest due on a loan! We almost hesitate to bring Mr. Bullard’s attention to it, but, in fact, 10-year Treasury yields are once more above the level at which they sat when this boss cleared his throat to announce that the helicopters were being fired up, back on August 27^th.

In contrast to such a Half a League Onward mentality, Governor Warsh – up to now a consistent QuantEaser – did offer some verbal sops to responsible policy in trying to suggest that the ‘adjustability’ feature of the package which so enthused markets after the FOMC might not be a one-way ticket to ever more monetization.

But it was left to Dallas president Fisher to nail his 95 theses to the church door in a speech which largely echoed the observations we made in our Oct 22^nd edition – ‘Of Superdollars, Spin & Summits’ – in pointing out how utterly inappropriate it was to engage in yet more massive intervention when asset and commodity markets were already on fire and in stating the truth that the real economy was languishing under burdens which were largely unrelated to the question of how low interest rates currently were ( though, of course, not unrelated to the artificially low level at which they were being held well into the previous Boom).

But if confusion reins within the Fed, just look at the parlous state of the Bank of England’s analysis, as evidenced in its latest Inflation Report. In essence, this argued that inflation will go up, then down – or down, then up – or a long way up/down or down/up, yet carries a 50:50 chance of being unchanged!!!  Well, that certainly clarifies the grounds on which King & Co. twiddle the levers and knobs to jockey the nation’s economy about.

While assuring his listeners that he would not hesitate to ‘take action if necessary’ if there was appreciably more ‘up’ than ‘down’, the Governor rather spoiled the admonitory effect by then saying that rising prices were the result of a ‘sequence of shocks’ (economist speak for ‘the bad fairy did it’, or ‘the dog ate my homework’) to which it was ‘not sensible’ to respond.

Is it so hard for our Overlords to realise that it no longer serves to pass such half truths off as reasoning? That we might just work out that, agreed, the supply of money has no role to play if, say, bread prices jump as long as other prices fall to reflect the change in relative demand, but that if other things rise alongside it, it can only be because too much moolah has been stuffed in our trousers, fostering the dangerous illusion that we can have our cake and eat it, too?

In all this, the Bank is relying on that other false comfort of ‘spare capacity’ to limit the scale of future CPI increases. But this can only help if that capacity is being withheld at existing prices and can be restored to active use as they rise. If, instead, it is – or has become – largely valueless – obsolete or superabundant plant, non-versatile equipment, overbuilt, badly-located shopping centres, churlish and ill-educated welfare drones – any excess of money injected into the system will rapidly find itself enhancing the demand for the things which are still wanted and for whose production all too few of that ‘reserve army’ of un- or under-employed factors may be easily redirected.

This, in fact, may be why the UK trade gap is running at levels which exceed the Boom’s peak deficit and this despite a trade-weighted index for sterling which has declined more than a fifth to plumb its lowest levels ever. And wherein lies the source of this excess domestic appetite for goods and services? Why, that same government whose prodigality was so facilitated by the BoE’s bond-buying, of course!

It is instructive to note that in the 18 months from the great collapse of 2008, UK householders have been net lenders (or net debt repayers) of £28 bln (though they had already slipped back into their old, profligate ways in the June quarter); Private non-financial corporations squirreled away £97 bln and financial companies chipped in with £71 bln for a £196 bln, 9.3% of GDP, private ‘deleveraging’.

Alas and alack, the government managed to squander all this and more by incurring £224 bln, 10.6% of GDP, in extra net liabilities, the £28 bln difference between the two being made up by the country’s foreign suppliers, hence contributing mightily to that widening trade gap. It appears that much of Britain’s putative ‘spare capacity’ in fact lies well offshore its sceptr’d isle, beyond the BoE’s fief.

All of this may be somewhat academic if the week’s numbers trigger an intensification of the pace of China’s retreat from ‘moderately easy’ (i.e. perilously loose) money to ‘normal and prudent’ (just easy enough). Certainly there were a few straws in the wind in a trade release which attracted attention for its wider surplus, but which contained the perhaps more salient feature of a sharpish drop in imports.

Since the world’s biggest buyer of so many industrial inputs acquires them only to process and re-export later, this would be an ominous sign for global activity, were this datum not just to be an outlier.

That might just be the case if we are to take at face value the gloss being put – with unusual candour – on the Central Committee’s latest Five-Year Plan, due for implementation in 2011. According to an in-depth briefing given to Caixin magazine by Vice Minister Liu He, who was instrumental in drafting it, much emphasis was placed on the fact that the ‘external environment has changed’ in the wake of the economic crisis. In response, the avowed intent is to bring about three shifts in emphasis:-

…the transformation of the aggregate demand structure, which means shifting from economic growth that relies on exports and investment to a model of balanced consumption, exports and investment… transforming the supply structure from a model of growth driven by secondary industry to a model of balanced growth driven by primary, secondary and tertiary industries, with the service industry in particular playing a larger role… the transformation of factor inputs, from quantitative expansion to comprehensive growth relying on knowledge, technology, management, etc..

In theory, this policy will focus on better integrating the rural hinterland into the new urban centres; on encouraging SME formation; on fostering a growing, middle-income consumer class; and on downplaying the growth-at-all-costs thrust of much current policy. As Liu himself summed up:-

This proposal includes one very important sentence: Develop imports to achieve economic balance and structural adjustment, and promote fundamental balance in trade accounts. That’s a big change from the old pursuit of trade surplus and export as a means to accumulate foreign currency

But fine words butter no parsnips, so two major caveats must apply to these revelations.

Firstly, we must resist the Western impulse to deify the sage Confucian planners of China and to over-estimate their ability to effect such changes in a top-down manner, rather than providing market mechanisms and a sound legal and institutional framework within which this can flourish as entrepreneurs build wealth from the bottom up. Even absent the disadvantages of our alternating, populist vote-grubbers in the manner of planning for anything other than the incumbents’ re-election, change by diktat, if too closely specified at the centre, is hardly likely to succeed in its aims.

Secondly, we have to worry about whether the centre has either the resolve or the means to push through meaningful reform in the face of the entrenched local power structures and the SOE oligopolies with whom they often collude in order to feather their own in nests in frustration of Beijing’s will. After all, it has taken the best part of a year to stop these two from end-running measures aimed at cooling the property bubble, with questionable success thus far.

If – and the conditional is a large one –there really is a palpable change of focus in this manner, the ramifications could be significant. At the very least it suggests there will be no more use of cheap money and underpriced resources to re-export pre-imported goods with scant value added to them (indeed, with value subtracted from them were the accounts rendered fully and accurately).

It also suggests less blind duplication of investment and construction projects domestically in the name of Output for Output’s sake and hence with the principal aim of securing a gold star in the career record of the officiating apparatchik.

If this meant that China was to become a lesser sink of expensive commodities and a concomitantly lesser source of cheap manufactured goods; less, too, an accumulator of – and an embarrassed disposer of – others’ depreciating paper promises to pay, the world could be a very different place in the next five years from the one built into the monetary hallucinations of Occidental policy makers and global financial market speculators, both.