Our readers who hate central banks may like this macro view more than the prior, in which we reflected on bigger picture drivers (i.e. bigger than central bankers) behind the general ugly state of things.
To recognize there are deeper tides than monetary policy is not to deny the bad or dumb stuff that central bankers are doing. It of course further remains true that, if central bankers are firemen who provide emergency liquidity, Wall Street banks - who enjoy the protection and cover of central banks by grand design - are the greedy jerk pyromaniacs who typically start fires in the first place.
The response to the 2008 financial crisis was unquestionably an unbridled orgy of greed, incompetence and corruption… costing taxpayers still untold trillions (not least in missing savings)… the entire crisis itself fueled by corruption.
So yes, we are thoroughly disgusted by central bankers… to about the same degree we are disgusted by politicians in general.
There are rare "good" central bankers (Volcker) and epically awful ones (Greenspan), just as there are good and awful politicians. It is an ironic twist of modern democracy, and modern markets, that we cannot "throw the bums out" without simultaneously finding other bums to replace them.
Her name is Helga Pataki in the "Hey Arnold" cartoon series, but let us dub her Crappylocks. She is the butt-ugly sister of Goldilocks, and her presence is due to central bank policies.
While technology and globalization trends are structurally widening the divide between "haves" and "have-nots," the policy of central banks is making that divide far worse, even as artificially low interest rates keep markets propped up.
This is roughly how it works: The Federal Reserve keeps rates near zero to help stimulate the economy. For lack of better policy tools, this is its best trick.
The maneuver then winds up stimulating Wall Street instead of Main Street. As icing on the cake, the near-zero interest rate itself helps perpetuate economic stagnation… which further keeps Wall Street "up" and Main Street "down." To the degree that the recovery is slower and weaker than it should be, Wall Street enjoys an artificial stimulus that lasts longer than it should. The central bank then continues to keep rates low because the recovery is weak.
We call it a "Crappylocks" market, as opposed to a Goldilocks market, because the crappy situation for workers is just right for paper assets. Until it all goes to hell that is.
Holding a key interest rate near zero for years on end is not a very wise thing to do. It is the forest ranger equivalent of zealous fire suppression while failing to clear a massive build-up of dead dry underbrush, resulting in an all-but guaranteed inferno of larger proportions later.
But the Fed surely feels it doesn't have a choice: It is just responding to crisis conditions with the tools it has on hand. If you trace cause and effect back far enough, you wind up with greedy politicians bought off by Wall Street, happily allowing commercial banks and investment banks to combine (the end of Glass-Steagall), embracing self-supervision and so on.
What's done is done, so the Fed says "Welp, here we are" and has to make the best of a bad situation… which means managing in the moment as best it can (while waiting for the next domino to fall).
It is certainly a dumb way to run things… but there are so many big winners in the present system it will almost certainly not change - especially when the losers (taxpayers, workers, etc.) don't understand the games being played in the first place.
Ed Yardeni argues that artificially low interest rates screw up the US economic recovery in at least three ways:
- Risk averse savers increase their saving (to compensate for lack of yield). Yardeni notes the pace of personal saving post-2008 has been double that of the 1990s and 2000-05. This is the "money in a mattress" effect: Reduced velocity is deflationary as worried savers hoard cash rather than spend.
- "Ultra-easy money" led Wall Street investors to bid up US home prices, making them unaffordable for 1st-time buyers. If home prices are rising because Wall Street is hoovering up inventory with cheap financing, the US middle class faces rising costs without the benefit of home equity appreciation.
- Low corporate bond yields encourage share buybacks and M&A far more so than investments in plant & equipment. Near-zero rates facilitate cheap blue-chip borrowing, which means corporate America has decided to invest upwards of 95% of its total profits in buying back stock, financing big mergers, paying out dividends, and so on. This is wonderful news for investors, not so much for US workers. If profits are spent on plant and equipment, jobs are created. Financial engineering to boost a share price is just not the same thing.
Idealized economic theory says that it doesn't matter where the money goes… that in the end it's all the same, one man's savings is another man's spending and so on.
This idea never really made much sense. If an extra thousand dollars goes to Bill Gates, it is likely to sit in his accounts (or get reinvested in already overvalued risk assets).
If that same $1,000 goes to a strapped single parent working two jobs, it is more likely to be spent on goods and services. Monetary velocity is roughly the speed at which money moves through an economy. The more readily that capital is spent, earned and respent, the more it contributes to growth.
To the degree it simply sits in bank vaults or passive index funds, on the other hand, it's like a stagnant pool of water. In theory, at least, invested dollars should be deployed by companies receiving the investment. But this is exactly what is NOT happening, via near-zero rates and rampant financial engineering to satisfy activists.
As of May 29th, Reuters reports, US dealmaking had seen its strongest start to the year since records began in 1980, up 52 percent year on year to $746.9 billion from Jan. 1st 2015. At the same time, activists are driving the financial engineering binge to get shares up. As the Wall Street Journal reports:
U.S. businesses, feeling heat from activist investors, are slashing long-term spending and returning billions of dollars to shareholders, a fundamental shift in the way they are deploying capital.
Data show a broad array of companies have been plowing more cash into dividends and stock buybacks, while spending less on investments such as new factories and research and development.
Activist investors have been pushing for such changes, but it isn't just their target companies that are shifting gears. More businesses sitting on large piles of extra cash are deciding to satisfy investors by giving some of it back. Rock-bottom interest rates have made it cheap to borrow to buy back shares, which can boost a company's stock price…
Historically speaking, JPMorgan's global chief economist reports, capital spending by businesses has accounted for an eighth of all spending in the US economy, making it a critically important driver.
As the WSJ notes, that capital often orients to "payments to contractors and suppliers who pay wages to middle and low-income workers." If the same capital is diverted to stock gains and dividends, that is nice for those who own equities… but not the same thing.
Central bank distortions, deliberately intended to cause "wealth effects," wind up propping up paper assets while suppressing low and middle income wages and savings rates… not to mention shutting out small business borrowers (as banks would rather lend to the blue chip hogs at the trough, taking all they can at hurdle rates above zero, simply because why not, buybacks and mergers will help keep the activists at bay).
Nor is it just the US worker/consumer feeling repressed. "It would be difficult to overstate the recent downside surprise in global consumer spending," observes JPMorgan senior economist Joseph Lupton. "Something has gone wrong with the global consumer, and the course of the global expansion over the next year depends on whether the recent stumble in spending growth a temporary soft patch or indicative of underappreciated headwinds."
Might we suggest what has "gone wrong" with today's global consumer also has to do with artificially low interest rates, now a reality world-wide? In emerging markets in particular, there is newfound worry over a lack of consumer spending via the low-price "oil windfall."
Cheaper crude oil should've unleashed new waves of spending across the globe by now - but by and large it has not. A head-scratching lack of global productivity has further been blamed.
Consumers aren't spending as they "should," and productivity levels are stagnating… thus incenting the perpetuation of low rates for longer, which fuels more "money in the mattress" type deflationary saving, cash hoarding, financial engineering and so on. Crappylocks indeed…
The "winner take all" effect as recently described, in which a few players win huge via technology and globalization, is part of the equation too.
A new paper from the National Bureau of Economic Research argues that, from 1982 to 2012, the divergence between top 1 percent wages and those at the middle of the pack was not due to superstar workers, but rather "super firms" where everyone in the company earned better pay. "There's this view out there that the main reason inequality is rising is because of super managers," one of the paper's co-authors tells Bloomberg. "We're arguing that it's the rise of super firms."
This dovetails with what's happening in markets. One is not likely to find disgruntled workers at the likes of Google (NASDAQ:GOOG) (NASDAQ:GOOGL), Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT) or Facebook (NASDAQ:FB).
Everyone across the board is paid far better than average, with better-than-average benefits - a result made possible by the world - beating efficiency of these companies (in serving a world - wide customer base with a relatively tiny base of workers). Nor is it surprising that the rise of "super firms" would lead to lower productivity economy-wide, or the appearance of such, as more competitors are put out of business (and workers' hands idled who don't work for the "super firms").
Technology on the whole is deflationary, in the sense that innovation and efficiency means falling prices (or delivering significantly more value at comparable price points, a similar thing) while displacing human workers. This somewhat harsh reality is reinforcing the Crappylocks trend.
So how, then, does Crappylocks end? That depends on which happens first: Profit margins contract… real inflation makes a comeback… or the world slips back into crisis or recession.
The above was excerpted from our May 29th Strategic Intelligence Report.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.