Rabobank: “The Key Reason We Are In This Mess Is Due To Volcker”

Submitted by Michael Every of Rabobank

Tall Tales

Markets were relatively quiet Monday, with key bond yields drifting lower to reverse Friday’s payrolls-induced spike, and the USD likewise reversing some its gain. Even equities ended slightly lower.

Perhaps the most eye-catching news was the sad death of former Fed Chair Paul Volcker. Besides his post-2008 regulatory ‘Volcker Rule’ being infamous to those working in markets, “Tall Paul” is being eulogised as the man “who broke the back of US inflation in the 1980s”. Even before his death others had stated that if there were a Nobel Prize for government serviced that his name would be on that list.

For those weaned on ultra-low rates and central-bank liquidity on demand, it must seem odd that once upon a time there was a Fed Chair prepared to raise rates to eye-watering levels regardless of the cost, who worked for tighter regulation after leaving office, and who publicly wanted to see big banks broken up. By contrast, yesterday saw the current Fed pump in another USD25bn in a 28-day repo operation yesterday – and USD43bn was bid for that USD25bn on offer (so many people so short of cash: is it all really a year-end squeeze?); and let’s not forget the weekend had that USD150,000 banana taped to a wall (up USD30,000 in a day because of the controversy over the first USD120,000 banana being eaten). For all the chatter that Jay Powell ‘was going to be the next Volcker’, the truth is that lower for longer will be lower forever if markets continue to require permanent liquidity support, which they still do a decade after the actual crisis ended.

However to think that we need a Volcker now is a “Tall tale”. Why? Because one also needs to underline that, ironically, the key reason we are in this mess is due to Volcker. He didn’t just break the back of US inflation: he also deliberately broke the back of US labour power. Recall that at the time of soaring US inflation the economy was dealing with the aftermath of an oil shock, the collapse of the Bretton Woods system, the messy end of the expensive Vietnam War, and the start of the US political mania for tax cuts for the wealthy as a cure-all. Most countries would have seen high inflation against that backdrop – and lots of potential policy-combinations might have worked as a palliative. (Tax hikes for the rich, for example, or an early refusal to allow the USD to assume its current global role as absorber of excess global capital and production.)

Volcker decided that the working class needed to pay the price of victory against inflation. He explicitly aimed at breaking the power of organised labour, and just after being appointed as FOMC Chair declared “The standard of living of the average American has to decline”. When looking at the trend of median rea- wage stagnation in the US–something now broadly acknowledged as the root cause of most of our socio-economic problems, and of our distorted markets–this started with the first oil shock, and became entrenched under Volcker. Subsequent Fed Chairs, and indeed most central banks, may no longer be tough on rates and may doll out liquidity like candy – but not to workers, only to banks (and soon, perhaps, to shadow banks). Whatever the Fed does or doesn’t say at this week’s meeting, don’t expect that to change.

Which brings us neatly to the week’s other main event. In the UK, the Labour Party is running on as ‘anti-Volcker’ an economic manifesto as possible, and has been flailing in the polls. However, a viral clip of PM Boris Johnson, a renowned teller of tall tales, refusing to look at an image of a four-year old boy being treated for pneumonia on a hospital floor due to lack of beds is the exact opposite of what a Tory government which presided over a decade of austerity would want to see as the campaign lumbers to the finishing line; it wants the focus on a points-based immigration system post-Brexit (which is moderately ‘anti-Volcker’ in theory, although where used in Australia is still about as Volcker as it gets). Indeed, the Telegraph today claims an internal Tory memo warns Jeremy Corbyn is “much closer” to becoming PM than voters think due to tactical voting – which that viral clip might just encourage. Let’s see if GBP wants to look at the image of PM Corbyn today.

But it’s not just a UK issue. The same Telegraph is also reporting “Germany’s Hard-Left ‘Corbyn Problem’ Is Only Just Beginning”, as the coalition SPD’s base has been captured by hard-Left activists who wish to repudiate key policies such as the Hartz IV labour reforms, and to embrace a 2% wealth tax, a rent freeze, a 30% rise in the minimum wage, a much higher carbon tax, and to shift to massive fiscal expansion on social housing and infrastructure. It goes without saying that these are all also still potentially on the table in the US 2020 election.

Sending a message that suddenly the world is looking fine and dandy–or flagging that that an anti-Volcker tide is rising?–10-year JGBs just popped above zero for the first time since March, taking trillions of USD of negative-yielding debt off the global balance sheet. And in China we saw CPI and PPI, where the former rose to 4.5% y/y, higher than expected, but PPI actually came in stronger than expected at -1.4% y/y, which is useful in pushing real rates lower on both a CPI and PPI basis. One could see the latter as another marginal sign that the Chinese economy is picking up – for now.

Meanwhile, US Agriculture Secretary Perdue that he does not believe the next tranche of USD160bn tariffs will be put in place against China this weekend, even as Jim Cramer of Mad Money tweets he thinks Trump is better off playing the long game and not signing on to a weak phase one deal.

In short, markets can eulogise Volcker while secretly praying we never see his like again. Most central banks also don’t want to be Volckers anymore. They agree there is a risk of global ‘Japanification’ in 2020 despite the recent uptick, meaning even looser policy ahead, and some are girding their loins by reinventing themselves as ‘green champions’ to justify it. But just as they cannot imagine a world where they would have to raise rates like Volcker did, they cannot imagine that they might have to fight a different war if the political climate shifts in a different ‘anti-Volcker’ direction that re-empowers labour vs. capital.