Swan Song Of The Central Bankers, Part 2: Yellen’s “My Girl”

Authored by David Stockman via Contra Corner blog,

If you wonder why things are going to get a lot worse before they get better—just consider the following tidbit from this week’s political gleanings. It essentially cements the case that Washington is heading straight into a bond market conflagration that will wreak havoc on the Wall Street end of the Acela Corridor.

It seems that the secret force inside the White House for Janet Yellen’s reappointment last year, and source of Trump’s favorable nods in her direction on several occasions, was none other than the scourge of the Yellen-loving Washington/Wall Street ruling class, Steve Bannon.

That’s right. In another new insider account of the Trump White House, we learn that:

…….the former White House chief strategist and nationalist standard-bearer revealed that he urged Trump to reappoint former Fed Chairwoman Janet Yellen….The former chief strategist had expressed concerns that a more hawkish Fed chairman could hinder economic growth.

“The Breitbart posse is in love with Janet Yellen. If we get behind her, that is the signal of signals — the realignment of American politics, ” Bannon told the book’s author, Bloomberg’s Joshua Green, in September, several months before he stepped down from the conservative media outlet. “Yellen’s my girl.”

As it happened, of course, Bannon got his walking papers. But Trump did end up with his “girl”, albeit attired in Jerome Powell’s trousers and tie.

Still, the implications are staggering: The cult of central banking has now thoroughly buffaloed politicians from one end of the ideological spectrum to the other. Apparently, even the most intellectualized voice of anti-establishment populism of recent times does not know that “low interest rates” are not a gift for the state to properly give; and most certainly not the key to sustainable long-term growth.

Indeed, if there were one single thing a Republican government could do to stop the nation’s slide toward economic stasis, it would be to liberate the delicate mainspring of capitalism—-the money and capital markets—-from the suffocating and deforming rule of central bankers. The latter have destroyed honest price discovery, yet free market pricing of credit, carry, capital and risk is the sine qua none of vibrant capitalism and broad societal prosperity.

To be sure, the mainstream GOP lost track of that cardinal truth decades ago during the reign of Richard Nixon. Tricky Dick famously slammed shut the US gold window at Camp David in August 1971, thereby defaulting on the US obligation to keep the dollar convertible at $35 per ounce and the world currency system anchored to the ultimate monetary asset.

But the subsequent drift to fiat currency, dirty floats and the massive, worldwide expansion of central bank credit wasn’t really Nixon’s doing—-even if it did, in the first instance, conveniently liberate the Fed to gun the US economy into Nixon’s short-lived landslide of 1972.

In truth, however, the evil genius behind the catastrophic error of Camp David was Milton Friedman, and his errand boy in Nixon’s cabinet, George Schultz. The two were apostles of the free market when it came to commodities, wages, rents, goods, services and most anything else including gambling, prostitution and drugs. But not money.

Friedman had been dead wrong about the Fed’s culpability for the Great Depression of 1930-1933, and from that error he erected a theory of state control of money that eventually evolved into today’s baleful regime of Keynesian central banking.

To be sure, Friedman had an austere view of the job of central bankers that was akin to the Maytag repairman commercial of the era. They were to mostly sit around the Eccles Building reading book reviews and playing scrabble, while occasionally nudging the monetary deals to keep M1 growing at precisely 3.00% per annum. Get that modest job done right and you would have ebullient capitalist prosperity forever, world without end.

The problem with this Friedmanite monetary postulate was two-fold: It was wrong in theory and impossible in practice!

Thus, there is no possible fixed rule of monetary growth. As demographics, technology, enterprise and social mores change, among others, only the market can discern their impact on the optimum quantity and velocity of money.

Likewise, in response to banking innovation the parameters of any given monetary aggregate can change substantially, making consistent measurement impossible. That happened, in fact, when overnight sweep accounts proliferated in the mid-1990s, thereby causing the level of “demand deposits” to drop by 50% or more and the growth rate of Friedman’s M1 to be thrown into a cocked hat.

Worse still, there was no chance that politicians on both end of Pennsylvania Avenue could possibly identify, nominate and confirm for service on the Federal Reserve Board the kind of monetary eunuchs Friedman’s theory implied. Inexorably, therefore, the Fed became populated not with 3.00% M1 purists, but with bankers, academics and lifetime government apparatchik with an ax to grind.

Arthur Burns was the first Fed chairman out of the gate after Camp David, and after obsequiously submitting to Nixon’s demands for a booming election year economy in 1972, he spent the rest of his term attempting to repair his reputation—-sending the US economy through violent cycles of boom and boost during the mid-1970s.

Then came William Miller, erstwhile manufacturer of gears, pumps, helicopters and golf carts, who thought inflation was caused by high oil prices, not the prodigious expansion of central bank credit over which he presided. Fortunately, however, Paul Volcker knew better, mercilessly crushed the roaring commodity and wage inflation with 20% interest rates and earned the undying enmity of GOP pols, who tricked the Gipper into getting rid of him at the first opportunity (August 1987).

Ironically, Ronald Reagan was a monetary antediluvian who really did believe in the gold standard. But, unfortunately, had neglected to read the fine print addendum to Alan Greenspan’s resume. That was the place where he claimed to be a life-long hard money man whose goldbug views had never waivered from the days of Ayn Rand’s salons, but had merely “evolved”.

As he told your editor at the time, he saw no reason why the FOMC couldn’t be a next best substitute for the gold standard itself. Incidentally, at this same time in the summer of 1987, he also offered to sell his well-known economic consulting firm, Townsend-Greenspan, to your editor.

As it happened, the due diligence didn’t pan out. It seems that Townsend-Greenspan persistently lost money selling macroeconomic forecasts to corporate America, which were generally wrong.

Alas, the money-making side of the firm was a prodigious flow of speech honorariums—a talent that didn’t attach to the business unit on offer, and which was destined to become the essence of the Maestro of central banking.

Needless to say, Greenspan’s talent for financial bloviation was every bit as efficacious in the Imperial City as it had been during his decades hustling the Fortune 100. At length, he transformed Friedman’s Maytag repairmen into a monetary politburo, and the Fed into an all-powerful vehicle of monetary central planning.

In truth, there had never really been a dimes worth of difference between “saltwater” Keynesians of the Samuelson-Heller-Tobin generation and the “freshwater” monetarists of the Friedman school. At the core, they both believed that capitalism tended toward business cycle instability, and that unchecked this instability would eventually plunge the economy into a deathly depressionary spiral.

In truth, capitalism makes errors and proficiently and timely corrects them. There is no cycling toward the drain or death wish toward depression. Moreover, as we demonstrated at length in The Great Deformation, the 1930’s was a consequence of the monetary policy aberrations of the Great War and the Roaring Twenties, not the alleged cyclical instability of capitalism.

In any event, the only original difference back in the day (1955-1987) was that first generation Keynesians thought activist counter-cyclical fiscal policy would cure this endemic maladay, while Friedman thought rule-bound monetary policy would do the trick.

In this context, Greenspan became the great synthesizer and evangelist, too.

He essentially tossed Friedman’s 3% rule on the scrap heap in a fog of technical mumbo jumbo about the immeasurability of the monetary aggregates—-even as took up the old fashioned mantle of Humphrey-Hawkins full employment as the essential mission of the Fed. And then he sold the whole package to the hapless GOP establishment.

Henceforth, rather than being narrowly focussed on relative price stability and financial discipline as had been the Fed under the post-war greats—-William McChesney Martin and Paul Volcker—the central bank’s remit became plenary. Even the level of the stock market and the paper net worth of  American society became fair game for its focus and intervention—–matters which were unthinkable even when Nixon’s posse struck down the old monetary order at Camp David.

The final inflection point came after the first Greenspan bubble crashed in the great dotcom meltdown of April 2000 and after. By all rights, the US economy should have taken its lumps after the unsustainable debt and financial asset fueled binges of the 1990’s.

But Greenspan was now in full-Humphrey-Hawkins modality, determined to use the crude tools of money market price-pegging and Fed balance sheet expansion to prevent a macroeconomic correction (aka recession). At length, he lowered the funds rate for 30 straight months, pushing it from 6.5% in November 2000 to an unheard of 1.0% by June 2003.

Thereafter, logically and inexorably, came the great mortgage bubble, rampant housing price inflation, the Wall Street securitization and derivatives orgy and the Great Financial Crisis that flowed therefrom. By the time the dust had settled on Greenspan’s exit in January 2006, the balance sheet of the Fed had grown from $200 billion to nearly $700 billion during his 19-year tenure.

By contrast, by the lights of Friedman’s fixed rule it should have been only $350 billion (3% per year); and under a regime of sound money it probably would not have grown at all.

As we will address further in Part 3, the rise of the Asian mercantile exporters after 1980 meant that the US needed to pursue secular deflation of costs, prices and wages in order to remain competitive with the newly mobilized labor forces from the rice paddies of East Asia, not inflate its general price level by nearly 50% as it did during Greenspan’s tenure. And the former is exactly what would have happened under a sound money regime, such as the classic gold standard.

More importantly, not only did Greenspan implant an out-and-out Keynesian policy regime in the Eccles Building, but he also transplanted it into the mainstream Republican party itself. After all, you can’t find a more by the books Keynesian than Ben Bernanke. Yet Greenspan ushered Bubbles Ben into the George W. Bush White House from his perch at the Fed to become the President’s chief economic advisor.

From there it was a short-leap to the Chairmanship of the Fed, and his hair-on-fire money-pumping campaign when the market again tried to correct the Fed’s rampant housing and credit bubbles in September 2008.

Fittingly, Bernanke’s PhD had been supervised at MIT by Stanley Fischer, the leading second generation Keynesian economist of the modern era; and the topic had been the Fed’s error, according to Milton Friedman, of not flooding the market with liquidity and buying up all the government bonds in sight during 1930-1932!

In that context, Janet Yellen, the 1970 PhD student of James Tobin, fit into the Fed’s top chair like a hand-in-glove. It was now a completely Keynesian/statist institution, and while she didn’t get a second term, she might as well have.

During his ceremonial swearing-in yesterday, here is what the Yellen in trousers and tie had to say:

When I joined the Board of Governors in 2012, unemployment was 8.2 percent. Many millions of Americans were still suffering from the ravages of the crisis. Since then, monetary policy has continued to support a full recovery in labor markets and a return to our inflation target; we have made great progress in moving much closer to those statutory objectives. In addition, the financial system is incomparably stronger and safer, with much higher capital and liquidity, better risk management, and other improvements.

Much credit for these results should go to Chairman Bernanke and Chair Yellen. I am grateful for their leadership and for their example and advice as colleagues. But there is more to the story than successful leadership. The success of our institution is really the result of the way all of us carry out our responsibilities. We approach every issue through a rigorous evaluation of the facts, theory, empirical analysis and relevant research.

Nothing could be farther from the truth. The foundation of the US economy has been battered and bruised by 30 years of central bank suffocation. And, as we will elaborate upon in Part 3, there is no better evidence than the utter collapse of the net national savings rate.

The latter measures it all: To wit, it’s the sum of household, corporate and government net savings or dissavings. Compared to an average of 11% of national income during the heyday of US economic prosperity between 1954 and 1970, it has been in steady decline—which accelerated sharply after the era of Bubble Finance incepted in 1987.

At present, the net national savings rate is barely 2%, but with the ill-timed explosion of Trumpian/GOP fiscal deficits, it is destined toward the zero bound and through to the negative side.

So there is this: An economy that does not generate net national savings can’t grow or even remain stable over the longer run. You can’t borrow from the rest of the world forever.

And that get’s us to the great stinking skunk in the woodpile. The same Keynesians at the Fed who presided over the fiasco depicted in the chart below, have now determined to embark on a crushing regime of QT (quantitative tightening) in order to reload their dry powder and insure their hold on plenary financial power when the US economy next hits the skids.

We think they are way too late. That’s why there will be financial mayhem in the years ahead.

However, by appointing Jerome Powell, Donald Trump, the bet noire of the ruling Keynesian-statist establishment, will end up bringing down the financial house of cards Washington has built over the last three decades.

At least that much the Donald will surely accomplish before he is finally shown the way to his one-way trip on the Dick Nixon Memorial Helicopter.

If we are lucky, both eventualities will materialize some time soon.

 

 

 

via Zero Hedge http://ift.tt/2Bymin8 Tyler Durden

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