By Jeffrey P. Snider
For something that central bankers and economists were so sure wasn't ever going to be troubling, oil seems to have become something of a communicable financial disease at the outset of 2016. If 2015 was somewhat sour and disappointing, 2016 was supposed to leave no doubt; it is, just not in the manner predicted. This morning's headlines tell you all you need to know:
Global Stocks Slide on Oil Rout
China shares slip as oil slides, outweighing stimulus hopes
Oil slump rocks markets again in historic equity rout
Global Stocks on Brink of Bear Market as Oil Slides; Ruble Sinks
Emerging Markets Roiled as Stock Selloff Surpasses Asian Crisis
It's not so much that these media outlets are reporting what they are reporting, reality has intruded after all, but rather where were these same reporters and media channels last year? Oil prices ended 2014 in a rout, but there was no widespread angst, more so just confusion about the seeming disparity between what markets were beginning to process and what the mainstream proclaimed as inarguable (recovery). Undoubtedly, the widespread trend to discount oil and bond markets at the start of 2015 was due to deference to Federal Reserve officials; not their history, mind you, which is more tragic and error-prone, but solely their credentials.
You can find any number of representative articles, but this one filed by Reuters on January 16, 2015, is very representative of that time. Headlined, Unfazed by Market Swings, Fed Sticks to mid-2015 Hike Scenario, we are all assured of "transitory."
Tumbling oil prices have strengthened rather than weakened the Federal Reserve's resolve to start raising interest rates around midyear even as volatile markets and a softening U.S. inflation outlook made investors push back the timing of the "liftoff."
Interviews with senior Fed officials and advisors suggest they remain confident the U.S. economy will be ready for a modest policy tightening in the June-September period, while any subsequent rate hikes will probably be slow and depend on how markets will behave.
While they are hard-pressed to explain why bond yields have fallen so low, their confidence in the recovery stems in part from in-house analysis that shows falling oil prices are clearly positive for the U.S. economy.
That last sentence in highly revealing in the weakness at the root of orthodox economics, which is a fusion of Keynesianism into a monetary, central bank setting. It would be easy enough to simply point out how ghastly ill-suited a philosophy, that not low oil prices but crashing oil prices were somehow good, but there is a necessary reckoning demanded by all this in order that we don't repeat these same mistakes for a fourth time; becoming Japan in the process.
At that moment in January 2015, cursory examination might suggest that the Fed had it all right. Less than a month before, the BEA had estimated Q3 2014 GDP in its final revision at 5%. That followed Q2 which was then supposed at more than 4%, making what looked like the strongest two-quarter period for economic growth in some time; the best of the cycle that was continuing to stretch on. For oil prices to crash during that same time seemed illogical, thus only "supply" could be considered. From that perspective, a booming economy with an overflow of cheap oil, how much better could it get?
The problem in financial markets wasn't just oil, however, it was commodities and the bond market (and, I should add, gold). Commodity prices had peaked years before, in the re-flaring crisis of 2011 (a "dollar" event). The treasury curve had been flattening ever since November 20, 2013. And market-based inflation expectations continued to drop, especially at the end of 2014. If oil prices were either transitory or helpful, longer run inflation expectations (5-year/5-year forwards) should have remained anchored just as they had throughout 2007 and 2008. Markets were declaring something very much amiss during the euphoria of 5% GDP.
We got a very close sense of that on October 15, 2014, when the treasury market crashed, not in selling but buying. This was not in any way regular or resilient market behavior, as Janet Yellen had been fond of declaring then. In other words, credit markets were not just politely disagreeing with GDP, they were outright declaring it wrong. I wrote on November 14, 2014, that:
I think that credit markets have started to appreciate the fix that the Fed has gotten itself into, defined now between an economy that won't respond even to four huge QE's and the unwelcome appearance of certain "risk" markets that did all too well. There is only one way out of that trap, namely to try to convince "the economy" that everything is awesome so that it doesn't fall apart at the same time you are trying to let some air out of the bubble(s). That certainly sounds like what Bullard (and Yellen too, if you listen closely) is saying without saying, only credit markets aren't giving much chance for threading such an awfully small needle.
Though we didn't know yet at that time GDP was going to be 5% (it isn't that high anymore, "residual seasonality" stole some in order to get the series of Q1's more satisfactory to economists' grouped opinion about weakness), what that meant was that 5% GDP didn't mean what it was taken to mean, no matter what the final number. That starts with the idea of what GDP actually measures; the immediacy of activity without any regard to source and intent. Every activity is treated exactly the same no matter how or why.
The real economy does not work in that fashion. An economic system is always striving for efficiency, and artificial deviations have to be dealt with at some point. An inefficient system cannot surpass its critical state; we may not know when it will try to find efficiency again, but it must. That phase shift from criticality is typically recession; Keynesians think it possible to undertake another phase shift, by introducing spending for the sake of spending, thus "pump priming" and producing enough hysteresis to generate forward momentum into a full recovery. This is "stimulus."
In general terms, "stimulus" is the idea that you can introduce generic activity of great inefficiency in order to produce an efficient and sustainable economic advance. You start with a great many negative factors, redistribution, and then expect artificial negativity to lead directly to organic positive growth. What happened instead, as was readily apparent by the middle of 2014, was something of a bifurcated economy. Redistribution benefited a very narrow proportion of Americans (and wherever else QE and QE-like methods were implemented) and it was expected by economists that increased spending tied the fortunate cohort would eventually bring up those in the unfortunate decay of the benighted recessionary rest. Like a pyramid scheme, those on top would eventually trickle down enough spending activity that it would slowly bring up the whole.
Because the Great Recession was so large, slowly was the operative term even in the orthodoxy. It was those GDP readings in 2014 that convinced them that enough time had passed that their efforts were finally paying off.
Had they surveyed much beyond the surface of genericism, they would have seen the more logical truth in true economics. Redistribution does not lead to a general rise, top-down, but instead produces the opposite. After the payroll report for December 2014, released on January 9, 2015, it was the labor force activity, or lack of activity, that for me suggested this contrary process:
Again, there may actually be an expansion of full-time jobs available right now, but that isn't nearly enough. Given the conspicuous indifference of the labor force, I highly doubt any payroll expansion is anything more than a plug line in the BLS regressions or, in a more real context, the continuation of asset inflation incongruence - the only jobs that show up are the lowest paying to service the asymmetry of the bifurcated economy. That would certainly make the most sense in an economy that only seems to partly grow (and partly shrink, which is the bond market's growing doubt).
Even in the euphoria over mid-2014's GDP there were enough doubts within the details (unemployment too) to suggest exactly that - only part of the economy was growing, and more and more were showing the tendency to if not yet shrink then at least act as a systemic drag. With such an anchor it was only a matter of time before the weight of redistributory malfunction dragged down the whole economy. The bond market seemed increasingly aware of that possibility where stocks and economists wistfully surged toward what they thought QE's ultimate completion.
When the negativity in bonds finally spilled over (in a complex process with the "dollar" right in the middle as the central axis) into oil, that left little doubt that the economic anchor of inefficiency was now the one driving force - the whole economy, the world over, was being pulled down by its gravity. For orthodox economics, all that is supposed to matter is the short run; Keynes said we are all dead in the long run, so do whatever now and not worry about later. Even the media is starting to sense that we have to live and work in the long run, too.