Lessons of 2004
Doug Nolan
Saturday, July 18, 2015
I’ve had similar feelings before, though I recall being less apprehensive. The years 1999 and 2007 are etched upon my mind. The bustling of automobiles and trucks on the roads. Crowded retailers.
Full restaurants and airliners. Economic data supporting the bullish view that times are good. Ebullient markets that had grown content to disregard what should have been conspicuous warning signs.
The fundamental problem I’ve had over the years remains unresolved: The underlying finance fueling the economic boom is not good. Very few – then as now - appreciated that finance was in reality fatefully unsound. In the past, U.S. finance was my primary focus. Nowadays it’s global.
In Thursday’s press conference, ECB president Mario Draghi repeated the contemporary central bank mantra: The ECB is ready to respond to any “tightening of financial conditions.” His wording was almost identical to that uttered by Bernanke back during a period of 2013 market unrest. This phrase has changed the markets and the world – altered history. Global central bankers remain determined to backstop the markets – even near all-time highs. And such comments at this point fail to even raise an eyebrow.
How did a little country like Greece come to accumulate several hundred billion of debt that it cannot service (let alone ever repay)? The answer lies in a dysfunctional global financial “system” and hopelessly unsound global finance on an unprecedented scale. It’s not really about the euro and European integration. The Germans are not to blame. Or, are the euro and German policies as well responsible for the Chinese Bubble, Japan, the energy sector boom and bust, Puerto Rico, Brazil, Argentina and so on?
In an eighteen hour meeting that ran into Monday morning, European leaders agreed to a framework for a third bailout that would leave Greece in the euro. A compromise was reached, although Greek leadership is opposed to it as much as the Germans. The IMF argues the obvious: the new agreement, even if the Greeks follow through on commitments, is not viable. Greece has way too much debt and the ongoing cost of stabilizing the Greek banks and the economy is massive and unknowable. Previous bailout “money” has gone to money heaven. Current bailout funds will vanish more quickly.
The Germans have been absolutely pilloried over the Greek fiasco. German finance minister Schauble continues to argue the case that it would be in Greece’s best interest to pursue a debt writedown outside of the euro. As I wrote last week, the “Greek” crisis will not be resolved anytime soon. I still have no sense for the timing of Grexit.
I’m apparently one of the few that finds irony in the Germans today being on the receiving end of much of the blame for Greek and European woe. They, after all, have been virtually the lone voice over the years warning of the risks of unsound money and Credit. They lost the debate (first to the U.S. and then to their European partners and the world), and yet now the Germans are held responsible for the consequences. They are the bad guys for are arguing against printing endless quantities of “money” and tossing them down the Greek rat hole. It is the Germans and their “hard money” colleagues in Europe that have fought to keep the Draghi ECB from completely discarding the last vestiges of sound “money” principles.
All the while, the emboldened adherents to inflationism miss no opportunity to attack, ridicule and discredit. And who will foot the bill for Greece’s new $90bn plus bailout? The dogmatic (or worse) Germans be damned. Just print.
Highlighting comments made Wednesday by Kansas City Fed president Esther George, the FT ran the headline “Fed Risks Repeat of Rate Rise Mistakes – Some Experts Say US Central Bank Has Not Learnt From the Lessons of 2004.” “By moving too slowly in 2004, the Fed under then-chairman Alan Greenspan allowed core inflation to move ‘persistently’ above 2%, and the labour market to overheat ‘amid one of the most historic credit bubbles in US history’, she said. Today things may look different, but ‘economic trends and experience suggest otherwise’, she warned darkly, urging the central bank to act now.”
I will darkly warn that the current “rate rise mistake” goes so far beyond 2004 that they’re only faintly comparable. The article quoted Jim O’Sullivan from High Frequency Economics: “They are a bit behind the curve.” Having chronicled and criticized Fed policy throughout that period, policies over recent years bring new meaning to the entire notion of central bankers waiting too long to tighten.
It was a catastrophic error for the Greenspan and Bernanke Feds to target mortgage Credit growth for policies to reflate consumer spending and economic growth. It was at the time experimental New Age central bank management. And I do believe it was a case of a flawed analytical framework and being slow to recognize excesses and Bubble momentum. Things got away from them. The economic community could not conceptualize the degree of market, financial system and economic fragility that was building. The Fed moved belatedly and timidly. They did, however, at least attempt to actually tighten policy.
After the mortgage finance Bubble boom and bust experience, there is no excuse for policymakers leaving rates near zero for going on seven years now. The doctrine of targeting higher assets should have been disgraced. Moreover, I would posit that a promoter of asset price inflation sacrifices its capacity to be an effective financial regulator.
Importantly, the scope of today’s global Bubble ensures that policies are now locked in ultra-loose. When the Fed (with a $2.1 TN balance sheet) was discussing its “exit strategy” back in 2011, I countered that there’d be “No Exit.” This week, with chair Yellen discussing tightening in a “prudent and gradual” manner, I can confidently predict that there will be No Tightening.
Global financial markets have grown only more dominant over economies. Speculation has taken more control over global finance. Moreover, market-based Credit and leveraging have come to play an only more profound role in system-wide Credit growth and “wealth creation.” Sustaining this scheme is possible only in ultra-loose.
There’s always an ebb and flow to markets. Greed and Fear are such powerful emotions. It’s also inherent to over-liquefied securities markets to “over shoot” – for excesses that mount on the euphoric upside to be inevitably rectified on the depressing downside. As such, there are serious issues when securities markets inflate to multiples of real economies. Recognizing that Credit is inherently unstable, there are extremely serious problems when market-based Credit comes to dominate a nation’s financial system - and then the world. It was previously unthinkable that central banks would perpetuate ultra-loose monetary policies for years specifically to spur asset price inflation and market-based Credit expansion.
A few years back the world had already passed the point where a bout of de-risking/de-leveraging would have major consequences for markets and economies. And this gets to the serious issues I have with central bankers “pushing back against a tightening of financial conditions.” Such language basically signals that central bankers will not tolerate market “ebbing” – for any semblance of market self-regulation and adjustment. And it was a similar dynamic in the late-twenties that nurtured a historic Bubble that crashed fatefully in 1929.
With the Germans, 2004 and deflationary pressures in the news this week, I was again reminded of comments from eminent German economist Otmar Issing back in 2004. The ECB’s Chief Economist wrote a WSJ op-ed, “Money and Credit,” in a pushback to Fed policies that were clearly promoting asset Bubbles (CBB “Issing v. Greenspan, February 20, 2004).
Issing from the WSJ: “Huge swings in asset valuations can imply significant misallocations of resources in the economy and furthermore create problems for monetary policy. Not every strong decline in asset prices causes deflation, but all major deflations in the world were related to a sudden, continuing and substantial fall in values of assets. The consequences for banks, companies and households can be tremendous… Prevention is the best way to minimize costs for society from a longer-term perspective. Central banks are confronted with this responsibility, but there is no easy answer to this challenge. So far, only some tentative conclusions can be drawn. First, in their communication, central banks should certainly avoid contributing to unsustainable collective euphoria and might even signal concerns about developments in the valuation of assets. Second, the argument that monetary policy should consider a rather long horizon is strengthened by the need to take into account movements of asset prices.”
“Huge swings in asset valuations can imply significant misallocations of resources in the economy and furthermore create problems for monetary policy.” He was prescient. More than 11 years ago Dr. Issing recognized the key issue for 2015. “Prevention is the best way to minimize costs for society” went unheeded – in Greece, the U.S., China and the world. “All major deflations in the world were related to a sudden, continuing and substantial fall in values of assets.” Time will tell.
It was another market week with well-defined Bubble Dynamics. With Grexit at least off the table for a number of weeks, speculation ran wild. Stocks reversed sharply higher, and the more speculative the stock or sector the more spectacular the move. Biotech stocks (BTK) surged 6.2%. The Morgan Stanley High Tech Index jumped 5.0%. Google added $65bn of market capitalization - on Friday alone. The Nasdaq Composite ended the week at another all-time record high. MarketWatch: “Nasdaq surge is triggering tech-bubble flashbacks.”
Flashbacks indeed. I’ve argued that Bubbles are actually more rational than the crazy manias portrayed in historical accounts. And as speculators, traders and others this week jumped on board inflating tech and biotech Bubbles, there was desperate liquidation of precious metals, energy and commodities generally. Gold sank to the low since 2010. Copper and platinum fell to the lows since 2009. The HUI gold stock index sank 9.3%, underperforming Biotechs by 1,550 bps in as single week. There was, once again, prominent career risk in being short stocks or long commodities. Those who hedged risk fell behind the pack.
At this point, central bank efforts to sustain the Bubble rather conspicuously feed Bubble excess. And in the post-Bubble post-Mortem, there will be a strong case to be made that central bank measures to fight deflation risks were self-defeating. The end result was only bigger Bubbles, greater resource misallocation, more acute fragility and heightened risk of a global deflationary bust.
Kings dollar and renminbi jumped 2.3% this week. And while this further enriched the “carry trade” Crowd, this dynamic is increasingly detrimental to global growth. It cannot be encouraging that the commodity currencies were again hammered. The bulls can continue to fixate on equities as the signal that all is well. I suspect the more accurate indicator comes from commodities and currencies: the global financial “system” is in the midst of precarious late-cycle dysfunctionality. Excess liquidity flows unchecked into myriad unsustainable Bubbles, only exacerbating The Haves vs. The Have Nots Dilemma on myriad levels.
Chinese shares rallied further. Yet there were articles supporting the view that foreign investor confidence has been badly shaken. Chinese shares have stung a number of hedge funds. Credit data confirmed an uptick in Credit expansion, but there are doubts that rapid Credit growth can be sustained now that stocks have faltered. The stakes are tremendously high in China – for Chinese and global markets, and for the Chinese and global economy.
July 17 – Bloomberg (Ye Xie): “Capital outflows from developing countries reached $120 billion last quarter, the most since 2009, fueled by an exodus from China amid concern over the strength of the country’s economy, according to JPMorgan… It was a reversal from the first quarter when emerging markets had $80 billion of inflows, analysts led by Nikolaos Panigirtzoglou wrote… Investors pulled $142 billion from China between April and June. That extended the total outflow from the world’s second-largest economy over the past five quarters to $520 billion, wiping out all the inflows since 2011 when the country’s growth started to slow, the analysts said.
The fundamental problem I’ve had over the years remains unresolved: The underlying finance fueling the economic boom is not good. Very few – then as now - appreciated that finance was in reality fatefully unsound. In the past, U.S. finance was my primary focus. Nowadays it’s global.
In Thursday’s press conference, ECB president Mario Draghi repeated the contemporary central bank mantra: The ECB is ready to respond to any “tightening of financial conditions.” His wording was almost identical to that uttered by Bernanke back during a period of 2013 market unrest. This phrase has changed the markets and the world – altered history. Global central bankers remain determined to backstop the markets – even near all-time highs. And such comments at this point fail to even raise an eyebrow.
How did a little country like Greece come to accumulate several hundred billion of debt that it cannot service (let alone ever repay)? The answer lies in a dysfunctional global financial “system” and hopelessly unsound global finance on an unprecedented scale. It’s not really about the euro and European integration. The Germans are not to blame. Or, are the euro and German policies as well responsible for the Chinese Bubble, Japan, the energy sector boom and bust, Puerto Rico, Brazil, Argentina and so on?
In an eighteen hour meeting that ran into Monday morning, European leaders agreed to a framework for a third bailout that would leave Greece in the euro. A compromise was reached, although Greek leadership is opposed to it as much as the Germans. The IMF argues the obvious: the new agreement, even if the Greeks follow through on commitments, is not viable. Greece has way too much debt and the ongoing cost of stabilizing the Greek banks and the economy is massive and unknowable. Previous bailout “money” has gone to money heaven. Current bailout funds will vanish more quickly.
The Germans have been absolutely pilloried over the Greek fiasco. German finance minister Schauble continues to argue the case that it would be in Greece’s best interest to pursue a debt writedown outside of the euro. As I wrote last week, the “Greek” crisis will not be resolved anytime soon. I still have no sense for the timing of Grexit.
I’m apparently one of the few that finds irony in the Germans today being on the receiving end of much of the blame for Greek and European woe. They, after all, have been virtually the lone voice over the years warning of the risks of unsound money and Credit. They lost the debate (first to the U.S. and then to their European partners and the world), and yet now the Germans are held responsible for the consequences. They are the bad guys for are arguing against printing endless quantities of “money” and tossing them down the Greek rat hole. It is the Germans and their “hard money” colleagues in Europe that have fought to keep the Draghi ECB from completely discarding the last vestiges of sound “money” principles.
All the while, the emboldened adherents to inflationism miss no opportunity to attack, ridicule and discredit. And who will foot the bill for Greece’s new $90bn plus bailout? The dogmatic (or worse) Germans be damned. Just print.
Highlighting comments made Wednesday by Kansas City Fed president Esther George, the FT ran the headline “Fed Risks Repeat of Rate Rise Mistakes – Some Experts Say US Central Bank Has Not Learnt From the Lessons of 2004.” “By moving too slowly in 2004, the Fed under then-chairman Alan Greenspan allowed core inflation to move ‘persistently’ above 2%, and the labour market to overheat ‘amid one of the most historic credit bubbles in US history’, she said. Today things may look different, but ‘economic trends and experience suggest otherwise’, she warned darkly, urging the central bank to act now.”
I will darkly warn that the current “rate rise mistake” goes so far beyond 2004 that they’re only faintly comparable. The article quoted Jim O’Sullivan from High Frequency Economics: “They are a bit behind the curve.” Having chronicled and criticized Fed policy throughout that period, policies over recent years bring new meaning to the entire notion of central bankers waiting too long to tighten.
It was a catastrophic error for the Greenspan and Bernanke Feds to target mortgage Credit growth for policies to reflate consumer spending and economic growth. It was at the time experimental New Age central bank management. And I do believe it was a case of a flawed analytical framework and being slow to recognize excesses and Bubble momentum. Things got away from them. The economic community could not conceptualize the degree of market, financial system and economic fragility that was building. The Fed moved belatedly and timidly. They did, however, at least attempt to actually tighten policy.
After the mortgage finance Bubble boom and bust experience, there is no excuse for policymakers leaving rates near zero for going on seven years now. The doctrine of targeting higher assets should have been disgraced. Moreover, I would posit that a promoter of asset price inflation sacrifices its capacity to be an effective financial regulator.
Importantly, the scope of today’s global Bubble ensures that policies are now locked in ultra-loose. When the Fed (with a $2.1 TN balance sheet) was discussing its “exit strategy” back in 2011, I countered that there’d be “No Exit.” This week, with chair Yellen discussing tightening in a “prudent and gradual” manner, I can confidently predict that there will be No Tightening.
Global financial markets have grown only more dominant over economies. Speculation has taken more control over global finance. Moreover, market-based Credit and leveraging have come to play an only more profound role in system-wide Credit growth and “wealth creation.” Sustaining this scheme is possible only in ultra-loose.
There’s always an ebb and flow to markets. Greed and Fear are such powerful emotions. It’s also inherent to over-liquefied securities markets to “over shoot” – for excesses that mount on the euphoric upside to be inevitably rectified on the depressing downside. As such, there are serious issues when securities markets inflate to multiples of real economies. Recognizing that Credit is inherently unstable, there are extremely serious problems when market-based Credit comes to dominate a nation’s financial system - and then the world. It was previously unthinkable that central banks would perpetuate ultra-loose monetary policies for years specifically to spur asset price inflation and market-based Credit expansion.
A few years back the world had already passed the point where a bout of de-risking/de-leveraging would have major consequences for markets and economies. And this gets to the serious issues I have with central bankers “pushing back against a tightening of financial conditions.” Such language basically signals that central bankers will not tolerate market “ebbing” – for any semblance of market self-regulation and adjustment. And it was a similar dynamic in the late-twenties that nurtured a historic Bubble that crashed fatefully in 1929.
With the Germans, 2004 and deflationary pressures in the news this week, I was again reminded of comments from eminent German economist Otmar Issing back in 2004. The ECB’s Chief Economist wrote a WSJ op-ed, “Money and Credit,” in a pushback to Fed policies that were clearly promoting asset Bubbles (CBB “Issing v. Greenspan, February 20, 2004).
Issing from the WSJ: “Huge swings in asset valuations can imply significant misallocations of resources in the economy and furthermore create problems for monetary policy. Not every strong decline in asset prices causes deflation, but all major deflations in the world were related to a sudden, continuing and substantial fall in values of assets. The consequences for banks, companies and households can be tremendous… Prevention is the best way to minimize costs for society from a longer-term perspective. Central banks are confronted with this responsibility, but there is no easy answer to this challenge. So far, only some tentative conclusions can be drawn. First, in their communication, central banks should certainly avoid contributing to unsustainable collective euphoria and might even signal concerns about developments in the valuation of assets. Second, the argument that monetary policy should consider a rather long horizon is strengthened by the need to take into account movements of asset prices.”
“Huge swings in asset valuations can imply significant misallocations of resources in the economy and furthermore create problems for monetary policy.” He was prescient. More than 11 years ago Dr. Issing recognized the key issue for 2015. “Prevention is the best way to minimize costs for society” went unheeded – in Greece, the U.S., China and the world. “All major deflations in the world were related to a sudden, continuing and substantial fall in values of assets.” Time will tell.
It was another market week with well-defined Bubble Dynamics. With Grexit at least off the table for a number of weeks, speculation ran wild. Stocks reversed sharply higher, and the more speculative the stock or sector the more spectacular the move. Biotech stocks (BTK) surged 6.2%. The Morgan Stanley High Tech Index jumped 5.0%. Google added $65bn of market capitalization - on Friday alone. The Nasdaq Composite ended the week at another all-time record high. MarketWatch: “Nasdaq surge is triggering tech-bubble flashbacks.”
Flashbacks indeed. I’ve argued that Bubbles are actually more rational than the crazy manias portrayed in historical accounts. And as speculators, traders and others this week jumped on board inflating tech and biotech Bubbles, there was desperate liquidation of precious metals, energy and commodities generally. Gold sank to the low since 2010. Copper and platinum fell to the lows since 2009. The HUI gold stock index sank 9.3%, underperforming Biotechs by 1,550 bps in as single week. There was, once again, prominent career risk in being short stocks or long commodities. Those who hedged risk fell behind the pack.
At this point, central bank efforts to sustain the Bubble rather conspicuously feed Bubble excess. And in the post-Bubble post-Mortem, there will be a strong case to be made that central bank measures to fight deflation risks were self-defeating. The end result was only bigger Bubbles, greater resource misallocation, more acute fragility and heightened risk of a global deflationary bust.
Kings dollar and renminbi jumped 2.3% this week. And while this further enriched the “carry trade” Crowd, this dynamic is increasingly detrimental to global growth. It cannot be encouraging that the commodity currencies were again hammered. The bulls can continue to fixate on equities as the signal that all is well. I suspect the more accurate indicator comes from commodities and currencies: the global financial “system” is in the midst of precarious late-cycle dysfunctionality. Excess liquidity flows unchecked into myriad unsustainable Bubbles, only exacerbating The Haves vs. The Have Nots Dilemma on myriad levels.
Chinese shares rallied further. Yet there were articles supporting the view that foreign investor confidence has been badly shaken. Chinese shares have stung a number of hedge funds. Credit data confirmed an uptick in Credit expansion, but there are doubts that rapid Credit growth can be sustained now that stocks have faltered. The stakes are tremendously high in China – for Chinese and global markets, and for the Chinese and global economy.
July 17 – Bloomberg (Ye Xie): “Capital outflows from developing countries reached $120 billion last quarter, the most since 2009, fueled by an exodus from China amid concern over the strength of the country’s economy, according to JPMorgan… It was a reversal from the first quarter when emerging markets had $80 billion of inflows, analysts led by Nikolaos Panigirtzoglou wrote… Investors pulled $142 billion from China between April and June. That extended the total outflow from the world’s second-largest economy over the past five quarters to $520 billion, wiping out all the inflows since 2011 when the country’s growth started to slow, the analysts said.
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