Thursday, February 28, 2019

Why The Fed's Doom-Loop Will Take The US Economy Down, Part 2

By David Stockman

As we indicated in Part 1, central banking essentially ceased to be about Money (and monetary policy) in October 1987 when Greenspan panicked on Black Monday and pulled out the monetary and institutional stops to rescue Wall Street.

Thereafter, it was ostensibly about Economy, but not really. Economy was the pretext for coddling, propping and pleasuring Wall Street pursuant to a de novo theory of "wealth effects" management, which, in turn, was supposed to soup-up the GDP.

Needless to say, the quantitative model-clutching PhDs and do-gooder apparatchiks who thereafter populated the Eccles Building were playing with fire.

As they drifted further and further away from traditional tenets about Money and backstopping the commercial banking system, it was possible to concoct virtually any cockamamie theory of Economy that could justify plenary intrusion into the price- setting process of the money and capital markets of Wall Street.

Moreover, the content-free, indefinitely rubbery statutory remit known as Humphrey- Hawkins gave high-minded sounding cover to the utter nonsense which ensued.

For instance, there is no way to know what "maximum employment" is in an open global economy functioning during an internet-based day and age when what was historically known as a "job" is no longer a meaningful or even plausible unit of account. Scheduling hundreds of thousands of cashiers by 15 minute intervals at Walmart and its ilk or deploying 60,000 free lancers by the gig on Task Rabbit cannot possibly be captured by the BLS' primitive, archaic metrics.

Nevertheless, in its January minutes the Fed implied that currently its proximate "maximum employment" target is 4.3% on the BLS U-3 unemployment measure, but that's patently ridiculous. The US economy is not even remotely close to Full Employment because massive welfare state and regulatory policies militate against it. For instance, there are 40-50 billion annual hours sequestered in studentdom; and supported outside of the BLS measured labor force by upwards of $2 trillion of student grants and loans since 2007 alone.

But changes in policy and circumstances can cause billions of these hours to ebb and flow in and out of the BLS measured labor force for reasons that have absolutely nothing to do with the Fed's policy rate target or any of its other heavy handed intrusions in the money and capital markets.

Likewise, at the turn of the century when the U-3 rate was last at under 4.0%, there were about 10 billion labor hours sequestered in Social Security disability, but that number has since soared to more than 20 billion hours owing to a major relaxation of administrative procedures and case law standards for eligibility.

Crucially, however, there is nothing firm and fixed over time about the disability sequester of labor hours. Billions of these hours can drift in an out of the money economy and the black market/off-the-books economy for reasons that have nothing to do with the machinations of the FOMC.

Indeed, the 12 members of the FOMC might as well be standing out on Independence Avenue waving their arms in order to keep marauding elephants from over-running the Eccles Building!

That's about how useful U-3 is as a measure of labor market or macroeconomic conditions; and it's a reminder that "maximum employment" is just an Economy cover story for what the Fed really does: Manipulate financial asset prices and kow-tow to the Wall Street gamblers whenever they have a hissy-fit.

In the real world, by contrast, it is self-evident that the potential labor supply from both domestic and off-shore sources is virtually limitless. Accordingly, the only thing needed to mobilize more employed hours is the labor pricing system, not the monetary politburo's (FOMC) machinations in the financial markets.

At a high enough wage rate, you will get housewives out of the kitchen, students off their duffs, more volunteers for over-time, and, if need be, more peasants out of the Chinese or Vietnamese rice paddies. In today's globally networked, traded and welfare-enabled world, there will never be a physical shortage of labor hours---just the right price to bring latent hours into monetized production.

To be sure, the latent hours now sequestered in Federally subsidized basket-weaving classes or playing shuffle-board on early retirement or disability do raise market- clearing wage levels at the margin. But you can solve that problem but cutting welfare benefits, not giving the Fed an Economy mandate that is nothing more than an excuse to randomly and destructively fiddle with interest rates and financial asset prices.

After all, the point of over-riding what used to be the free market on Wall Street in pre- Greenspanian times is to falsify them by the lights of 12 people who can't possibly know what they are doing; and have no effective tools to manage the real Economy, anyway (see below).

Stated differently, falsifying the price of money, bonds and equities only fosters increasingly destructive gambling, bubbles and malinvestments in the financial system, not higher production, employment and prosperity on main street.

The truth of the matter, of course, is that there is no need for central bankers at all when it comes to economic growth, jobs, incomes and prosperity. That's because Say's Law is as valid today as it has always been.

Work, effort, production and enterprise are what create both current income and future growth. Demand flows from supply and spending flows from income; capitalism doesn't need any U-3 obsessed central bankers to make it all happen.
Likewise, the labor pricing system in a $20 trillion economy has it hands down over the 12 PhDs, bankers and Washington apparatchiks who sit on the FOMC.

If the market is heavy with latent labor hours, real wage rates will come down; and if it's light, real wage rates will rise sufficiently to attract the needed hours.
In fact, now that most of the monopoly industrial unions have been broken or defanged- --even the old Keynesian saw about "sticky" wages is self-evidently inoperative. The truth is, there is nothing about the contemporary labor market that requires the helping hand of the Federal Reserve at all.

Moreover, there is no even theoretical possibility of runaway wage inflation of the type that industrial unions led by the UAW and Steelworkers were able to generate in the late 1960s. That because virtually every manner of goods produced in the US economy and a growing portion of services can now be supplied from off-shore, and often at far lower wage rates---even adjusted for productivity and transportation----than paid by domestic suppliers.

Accordingly, we think there is a far more insightful and accurate way to look at labor utilization and to assess whether or not the Fed's heavy-handed intrusions in the money and capital markets have accomplished anything at all.

Spoiler alert: The $4.0 trillion of asset purchases by the Fed between the year 2000 (when its balance sheet was about $500 billion) and the recent peak when it hit $4.5 trillion accomplished exactly nothing on the maximum employment node of the Economy front.

That is to say, back in the year 2000 (the last time U-3 hit 3.7%) what we consider to be the comprehensive unemployment rate was 34.6%. Today it stands at 40.0%.

To be sure, many factors drive whether potential labor hours get sequestered outside of the monetized economy in housework, studentdom, on the welfare rolls, in the black market drug trade or in mom's basement.

But the interest rate on overnight fed funds is surely the least of them; nor, self- evidently, was the Fed's massive, fraudulent monetization of $4 trillion of US Treasury and related debt in the interim.

Thus, in December 2000, there were 175.5 million adults aged 20-69 in the US--- meaning that the implied potential labor force amounted to 351 billion labor hour per annum assuming all adults are theoretically capable of a standard work year of 2000 hours.

During that same month, however, the BLS measured just 229.5 billion hours actually employed in the non-farm economy at an annual rate. Accordingly, comprehensive unemployment amounted to 121.5 billion hours or 34.6% of the potential available hours.

By contrast, the adult population 20-69 years of age is now 212.3 million and available hours total 424.6 billion per annum. Against that, the BLS most recent measure shows 255.6 billion hours actually employed---implying 169 billion unemployed labor hours and a 40.0% comprehensive unemployment rate.
Stated differently, between the two 3.7-4.0% anchor points on the U-3 unemployment metric during the last 18 years, the level of unemployed US labor has increased by nearly 48 billion hours per annum, and the rate has risen commensurately.

We dwell on the Fed's ludicrous pretension that it can and has achieved Full Employment because today we had another Fed head gumming about the second Economy target---inflation---that is even more far-fetched.

In fact, this blithering fool even suggested that to insure American workers, savers and retirees are punished with sufficient inflation, the Fed should consider adopting Japan's insane policy of pegging its 10-year bond rate----with an open-ended promise to buy any all offers at that target yield.

We are referring here to relatively new Fed head, Richard Clarida. And for those under the mistaken impression that Barrack Obama was the sole source of America's economic mess and that Donald Trump can MAGA, it should be remembered that this whack job was appointed by the Donald, not Barry.

Worse still, he is the former chairman of the Columbia University economics department, high ranking Treasury official in the George W. Bush Administration and Global Strategic Advisor to the world's largest bond fund, PIMCO.

That is to say, the Keynesian group think has become nearly universal.

Not surprisingly, Clarida's academic specialty centered on dynamic stochastic general equilibrium modeling (DSGE), which is the true incarnation of voodoo economics in the present world. Also, not surprisingly, he apparently passed muster with the low-interest man in the Oval Office because his research made exactly that case.

As summarized in his Wikipedia page,
He has written on the monetary policy implications of the low-inflation period created by the 2008 financial crisis. He also introduced in 2014 the concept of a “new neutral” for Fed monetary policy which predicted a substantial decline in r*, the interest rate consistent with full employment and stable inflation. Whereas before the crisis r* was thought to be above 4 percent, Clarida wrote in 2014 that r* was now closer to 2 percent than to 4 percent.
You could call that discovery prescient, even if it does amount to statistical and analytical hogwash.

During the 11-years before the pre-crisis peak in Q4 2007, for example, the Fed's favorite sawed-off inflation measure, the PCE deflator, rose at a 2.04% annualized rate. By contrast, during the 11 years since then, the CAGR posted at 1.54% per annum--- meaning that there has been a mere 50 bps (basis points) downshift from the pre-crisis to the post-crisis trend, not a radical change in the inflation regime as implied in Clarida's purported discovery about an invisible ether called r*.

It's actually just noise and rounding errors, especially given the arbitrary weightings and inherent imprecision of statistical baskets consisting of thousands of individual prices. Yet among another of the Economy obsessed PhDs who have taken over the central bank, the above essentially meaningless difference is enough to support a 50% reduction in the Fed's so-called neutral interest rate bogey, and the pure absurdity which flows therefrom.

To wit, Clarida like central bankers everywhere today treats the 2.00% inflation target as virtually sacred scripture, although there is no empirical or logical basis for it at all. Indeed, the idea that low-inflation or deflation will cause consumers to withhold spending was massively disproved by the plunging prices of the computer age long ago.

Nevertheless, Clarida also contends as per the above that the neutral money rate is also 2.00%, which means, apparently, that the money market should be cost free in real terms forever, and that savers who want to stay liquid deserve to rot in zero return purgatory for just as long.

Nor do we exaggerate. When it comes to the idiotic idea of too little inflation, here is what the man said today, and also what the Fed should do about it.
Speaking at a monetary policy conference sponsored by the University of Chicago Booth School of Business, Clarida contrasted what amounts to the current strategy — treating persistent shortfalls of inflation from the 2% target as “bygones” — to “makeup” strategies, where the Fed could target average inflation over a multiyear period or target price levels.
Another question Clarida says the Fed is seeking to answer is whether to expand its tool kit. For instance, he said, the Fed could take a page from the Bank of Japan’s playbook and establish a temporary ceiling for Treasury yields at longer maturities by standing ready to purchase them.
As to the inflation shortfall and price level targeting point, here is the PCE deflator indexed to 100 in the year 2000. The chart shows that at its current reading of 138.3 that the compound rise in the PCE deflator has clocked in at 1.82% since 2000; and that to achieve Clarida's full monte 2.00% under the price level targeting solution it would currently need to post at 142.3.

So there you have it. Can anyone in their right mind believe that the US economy would have behaved any differently over the last 18 years, or be any more prosperous today, if the PCE deflator stood at 142.3 last fall rather than the 138.3 actually recorded.

The truth is, this is puzzle palace obscurantism. Unfortunately, it rules the day among central bankers, and is the basis for their next big assault on honest price discovery on Wall Street and sustainable prosperity on main street.

We are referring to price level targeting and bond-rate pegging---as if the massive interest rate repression that we have already experienced has not done enough damage.

Stated differently, the Federal government is lurching into a massive crisis of national solvency and the corporate and household sectors have already buried themselves under $15 trillion of debt each owing to the Fed's false price signal that rising debt scan be rolled over perpetually at lower and lower rates.

Now this clown actually wants to emulate the sheer insanity of the BOJ, which has pushed nearly all of the government of Japan's monumental debt into negative nominal yields.

Still, for the want of doubt Part 3 will detail exactly how this Greenspan/Bernanke/Yellen/Powell/Clarida style of ostensibly Economy based central banking is fueling massive speculation on Wall Street; and why the resulting Doom- Loop will eventually take down what remains of main street prosperity.

David Stockman was Director of the Office of Management and Budget under President Ronald Reagan. After leaving the White House, Stockman had a 20-year career on Wall Street.

The above originally appeared at David Stockman's Contra Corner.

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