Hobson's Choice
Doug Nolan
More than two months have passed since the August “flash crash.” Fragilities illuminated during that bout of market turmoil still reverberate. Sure, global markets have rallied back strongly. Bullish news, analysis and sentiment have followed suit, as they do. The poor bears have again been bullied into submission, as the punchy bulls have somehow become further emboldened. The optimists are even more deeply convinced of U.S., Chinese and global resilience (the 2008 crisis “100-year flood” thesis). Fears of China, EM and global tumult were way overblown, they now contend. As anticipated, global officials remain in full control. All is rosy again, except for the fact that global central bankers behave as if they’re utterly terrified of something.
The way I see it, underlying system fragility has become so acute that central bankers are convinced that they must now forcefully (“shock and awe,” “beat expectations,” etc.) react to any fledgling market “risk off” dynamic. Risk aversion and de-leveraging must not gather momentum. If fragilities are not thwarted early, they could easily unfold into something difficult to control. Such an outcome would risk a break in market confidence that central banks have everything well under control – faith that is now fully embedded in the pricing and structure for tens of Trillions of securities and hundreds of Trillions of associated derivatives – everywhere. With options at this point limited, the so-called “risk management” approach dictates that central banks err on the side of using their limited armaments forcibly and preemptively.
With today’s extraordinary global backdrop in mind, I’m this week noting a few definitions of “Hobson’s Choice”:
“An apparently free choice that actually offers no alternative.” (The American Heritage Dictionary of Idioms)
“A situation in which it seems that you can choose between different things or actions, but there is really only one thing that you can take or do.” (Cambridge Idioms Dictionary)
“No choice at all, take it or leave it.” (Endangered Phrases by Steven D. Price)
There are subtleties in these definitions, just as there are subtleties in financial Bubbles.
The way I see it, underlying system fragility has become so acute that central bankers are convinced that they must now forcefully (“shock and awe,” “beat expectations,” etc.) react to any fledgling market “risk off” dynamic. Risk aversion and de-leveraging must not gather momentum. If fragilities are not thwarted early, they could easily unfold into something difficult to control. Such an outcome would risk a break in market confidence that central banks have everything well under control – faith that is now fully embedded in the pricing and structure for tens of Trillions of securities and hundreds of Trillions of associated derivatives – everywhere. With options at this point limited, the so-called “risk management” approach dictates that central banks err on the side of using their limited armaments forcibly and preemptively.
With today’s extraordinary global backdrop in mind, I’m this week noting a few definitions of “Hobson’s Choice”:
“An apparently free choice that actually offers no alternative.” (The American Heritage Dictionary of Idioms)
“A situation in which it seems that you can choose between different things or actions, but there is really only one thing that you can take or do.” (Cambridge Idioms Dictionary)
“No choice at all, take it or leave it.” (Endangered Phrases by Steven D. Price)
There are subtleties in these definitions, just as there are subtleties in financial Bubbles.
Importantly, over time Bubbles embody a degree of risk where they stealthily begin to dictate ongoing monetary accommodation. These days, global market Bubbles have reached the point where their message to global central bankers is direct and unmistakable: “No choice at all, take it or leave it.” “Keep expanding monetary stimulus or it all comes crashing down – and that’s you Yellen, Draghi, Kuroda, PBOC – all of you…”
As Ben Bernanke’s book tour lingers on, there are comments to add to the debate. From an interview with the Financial Times’ Martin Wolf: Wolf: “… We have to recognise that neither he nor the Fed expected the meltdown. Does the blame for these mistakes lie in pre-crisis monetary policy, particularly the targeting of inflation, with which he is closely associated? Had interest rates not been kept too low for too long in the early 2000s?”
Bernanke: “The first part of a response is to ask whether monetary policy was, in fact, a major contributor to the housing bubble and all that happened. Serious studies that look at it don’t find that to be the case. People such as Bob Shiller [a Nobel laureate currently serving as a Sterling professor of economics at Yale University], who has a lot of credibility on this topic, says that: it wasn’t monetary policy at all; it came from a mania, a psychological phenomenon, that took off from the tech boom and moved into housing.”
Mortgage Credit almost doubled in six years. Home prices inflated dramatically throughout much of the country, with prices about doubling in key markets (i.e. California). Egregious lending excess was conspicuous. Speculative excess throughout ABS, MBS, GSE debt securities and mortgage-related derivates (i.e. CDOs) were only slightly less conspicuous.
Why did the Fed fail to impose some monetary restraint (recall that Fed funds remained below 2% for several years of double-digit annual mortgage Credit growth)? Because they had (once again) badly missed their timing. A Bernanke-inspired policy course was determined to see reflationary measures gain robust momentum. The Fed believed the benefits of prolonging aggressive accommodation greatly outweighed minimal risks (CPI and inflation expectations were contained!). Meanwhile, mortgage finance Bubble excess reached a scale where the Fed would not risk the un-reflationary consequences of piercing the Bubble. Financial and economic vulnerability were too acute for our central bank to take such institutional risk.
Then, one might ask, why exactly had the Fed been so unwilling earlier in the cycle to restrain obviously overheating mortgage and housing marketplaces? This is a critical yet somehow completely neglected issue. Well, it’s because the Federal Reserve had specifically targeted mortgage Credit growth and housing inflation as the reflationary drivers for the post-technology Bubble recovery. Though apparently lost in history, manipulating mortgage Credit and housing markets were the primary (Bernanke’s “helicopter money”) mechanism for the Fed’s war against deflation risk.
The Bubble was of the Fed’s making, and our central bank lost control. It became a Hobson’s Choice issue in the eyes of the Fed, and they fully accommodated the Bubble. Historical revisionism seeks to portray Bernanke as the hero that saved the world.
These days, the Fed and global central bankers face a similar but much more precarious Bubble Dynamic: The Fed specifically targeted higher securities market prices as its prevailing post-mortgage finance Bubble (“helicopter money”) reflationary mechanism. This ensured that the Fed would again be unwilling to impose any monetary restraint before it would then become too risky to remove accommodation (Einstein’s definition of insanity?). In concert, global central bankers now aggressively accommodate financial Bubbles.
Global markets have the Yellen Fed petrified of even a little 25 bps baby-step nudge up from zero rates. Despite booming bond market Bubbles, a huge rise in stock prices, generally loose financial conditions and expanding economic recovery, the Draghi ECB Thursday signaled additional monetary stimulus was forthcoming (above the current $60bn monthly QE and near-zero rates). Global markets were overjoyed. In the face of much trumpeted financial and economic stabilization, booming corporate debt markets and significant ongoing Credit growth, Chinese officials moved Friday to again cut lending rates and reserve ratios. Markets were more overjoyed.
The halcyon days have returned. Powered by strong earnings from heavyweights Amazon, Microsoft and Google, the Nasdaq 100 (NDX) surged 4.2% this week. The NDX has now rallied 22% off August lows to within about a percent of all-time highs. The S&P500 gained 2.1% this week, closing just a couple percent below record highs. Bloomberg headline: “Junk Bond ETFs Break Monthly Flow Record With a Week to Spare.” And to be clear, that’s an inflow record.
Friday morning from Bloomberg: “$100 Billion Rally Coming in Google, Microsoft, Amazon Shares.” Tech Bubble 2.0 is raging, fueled by the loosest financial conditions imaginable – spurred along by speculative market dynamics and a global industry arms race arguably on a much grander scale than that of the late-nineties. Friday evening from the New York Times: “America’s Heartland Feels a Chill From Collapsing Commodity Prices.” The impact from the faltering global Bubble is spreading. Fed Bubble accommodation ensured incredible wealth has been freely lavished upon Silicon Valley, exacerbating the issue of “the haves and have nots” locally, regionally, nationally and internationally.
It’s certainly worth noting that market strength continues to narrow. The broader market this week badly lagged tech – especially big tech. In a financial management world desperate for relative performance, Fed-induced market rallies compel market participants to jump aboard the big outperformers. It’s exciting – dangerous late-cycle financial market dynamics.
There is as well a powerful real economy dynamic at work. For the most part, the bull vs. bear argument has the economy either rather robust or on the cusp of recession. Most importantly, the U.S. economy is badly imbalanced. Segments and sectors are absolutely booming. Monetary policy is recklessly loose, with cheap liquidity apparently to fuel excess until Bubbles have finally run their course. Meanwhile, vast swaths of the economy suffer from structural stagnation, the aftermath of previous boom/bust dynamics. Here monetary accommodation has little impact. And this stagnation plays a major role in seemingly benign aggregate consumer inflation and economic output data.
Yet when it comes monetary stimulus fueling Bubbles and exacerbating structural imbalances, the U.S. is overshadowed by China. Spurred by a surge in state-directed bank lending, total Credit (“total social financing”) jumped back over $200bn in September. There are also indications that post-stock market Bubble reflationary measures have pushed China’s corporate debt Bubble to only more precarious excess. While many contend that the Chinese economy, markets and currency have stabilized, I see it much more in terms of ongoing unsustainable Credit excess.
Chinese officials missed their timing for reining in Bubble excess by years. It’s now a Hobson’s Choice of throwing everything at the faltering boom. Brief thoughts: The Chinese will need a couple Trillion (in U.S. dollars) of new Credit over the next year, then the year after and so on. Throwing enormous amounts of new Credit at a terribly maladjusted system will ensure epic maladjustment and a Credit Time Bomb. Normally, such dynamics ensure significant currency debasement. I would think in terms of a Credit and Currency Peg Time Bomb.
October 18 – Financial Times (Gabriel Wildau): “It seems a long time ago that China was piling up foreign exchange reserves at a record pace as economists fretted about global imbalances from Beijing gobbling up US Treasury bonds. Now investors are wondering how long China’s dwindling forex reserves — down to $3.5tn from a peak of $4tn in June 2014 — can hold out. Capital is flowing out of China at a record pace and the central bank is drawing down reserves to support the renminbi after its recent dramatic fall. A lack of clarity over how China calculates its reserves and how much is readily available to deploy at short notice has intensified these concerns. As growth slows and bad debt rises, investors have viewed China’s massive forex pile… as the ultimate guarantor of financial stability. The prospect that reserves could be quickly exhausted raises doubts about the government’s ability to ward off crisis. It also limits the central bank’s ability to continue foreign exchange intervention, which may have cost as much as $200bn in August alone.”
Thus far, the markets have been incredibly tolerant of erratic Chinese policymaking. “We don’t care how you do it, just stabilize your markets and economy.” But at the end of the day, I see a lack of trust weighing on the Chinese currency. China’s Hobson’s Choice: aggressively inflate Credit or not. And this will put the currency at risk – the currency peg at risk. Currency controls, state-directed currency manipulation and derivatives to mask “capital” flight only increase the risk of financial accidents. Commodities and developed sovereign debt markets seem to confirm that China is not out of the woods.
FT’s Wolf: “I ask him whether he is confident that the improvement in the resilience of the banks is adequate. ‘It’s a fool’s game to predict that everything is going to be fine, because either it is fine, in which case nobody remembers your prediction, or something happens, and then …’ They remember your prediction, I interject. Bernanke continues: ‘My mentor, Dale Jorgenson [of Harvard], used to say — and Larry Summers used to say this, too — that, ‘If you never miss a plane, you’re spending too much time in airports.’ If you absolutely rule out any possibility of any kind of financial crisis, then probably you’re reducing risk too much, in terms of the growth and innovation in the economy.’”
Miss your plane and you reschedule a later flight. And the issue is certainly not ruling out “any possibility of any kind of financial crisis.” By now we should recognize that failed experimental monetary management was the leading culprit in the so-called “worst financial crisis since the Great Depression.” So what’s at risk today from much more egregious monetary experimentation? With runaway Bubbles at risk or faltering around the globe, central bankers are left with a choice of pushing ever forward with monetary inflation and market manipulation – or coming clean. Clearly they believe they have no choice at all.
As Ben Bernanke’s book tour lingers on, there are comments to add to the debate. From an interview with the Financial Times’ Martin Wolf: Wolf: “… We have to recognise that neither he nor the Fed expected the meltdown. Does the blame for these mistakes lie in pre-crisis monetary policy, particularly the targeting of inflation, with which he is closely associated? Had interest rates not been kept too low for too long in the early 2000s?”
Bernanke: “The first part of a response is to ask whether monetary policy was, in fact, a major contributor to the housing bubble and all that happened. Serious studies that look at it don’t find that to be the case. People such as Bob Shiller [a Nobel laureate currently serving as a Sterling professor of economics at Yale University], who has a lot of credibility on this topic, says that: it wasn’t monetary policy at all; it came from a mania, a psychological phenomenon, that took off from the tech boom and moved into housing.”
Mortgage Credit almost doubled in six years. Home prices inflated dramatically throughout much of the country, with prices about doubling in key markets (i.e. California). Egregious lending excess was conspicuous. Speculative excess throughout ABS, MBS, GSE debt securities and mortgage-related derivates (i.e. CDOs) were only slightly less conspicuous.
Why did the Fed fail to impose some monetary restraint (recall that Fed funds remained below 2% for several years of double-digit annual mortgage Credit growth)? Because they had (once again) badly missed their timing. A Bernanke-inspired policy course was determined to see reflationary measures gain robust momentum. The Fed believed the benefits of prolonging aggressive accommodation greatly outweighed minimal risks (CPI and inflation expectations were contained!). Meanwhile, mortgage finance Bubble excess reached a scale where the Fed would not risk the un-reflationary consequences of piercing the Bubble. Financial and economic vulnerability were too acute for our central bank to take such institutional risk.
Then, one might ask, why exactly had the Fed been so unwilling earlier in the cycle to restrain obviously overheating mortgage and housing marketplaces? This is a critical yet somehow completely neglected issue. Well, it’s because the Federal Reserve had specifically targeted mortgage Credit growth and housing inflation as the reflationary drivers for the post-technology Bubble recovery. Though apparently lost in history, manipulating mortgage Credit and housing markets were the primary (Bernanke’s “helicopter money”) mechanism for the Fed’s war against deflation risk.
The Bubble was of the Fed’s making, and our central bank lost control. It became a Hobson’s Choice issue in the eyes of the Fed, and they fully accommodated the Bubble. Historical revisionism seeks to portray Bernanke as the hero that saved the world.
These days, the Fed and global central bankers face a similar but much more precarious Bubble Dynamic: The Fed specifically targeted higher securities market prices as its prevailing post-mortgage finance Bubble (“helicopter money”) reflationary mechanism. This ensured that the Fed would again be unwilling to impose any monetary restraint before it would then become too risky to remove accommodation (Einstein’s definition of insanity?). In concert, global central bankers now aggressively accommodate financial Bubbles.
Global markets have the Yellen Fed petrified of even a little 25 bps baby-step nudge up from zero rates. Despite booming bond market Bubbles, a huge rise in stock prices, generally loose financial conditions and expanding economic recovery, the Draghi ECB Thursday signaled additional monetary stimulus was forthcoming (above the current $60bn monthly QE and near-zero rates). Global markets were overjoyed. In the face of much trumpeted financial and economic stabilization, booming corporate debt markets and significant ongoing Credit growth, Chinese officials moved Friday to again cut lending rates and reserve ratios. Markets were more overjoyed.
The halcyon days have returned. Powered by strong earnings from heavyweights Amazon, Microsoft and Google, the Nasdaq 100 (NDX) surged 4.2% this week. The NDX has now rallied 22% off August lows to within about a percent of all-time highs. The S&P500 gained 2.1% this week, closing just a couple percent below record highs. Bloomberg headline: “Junk Bond ETFs Break Monthly Flow Record With a Week to Spare.” And to be clear, that’s an inflow record.
Friday morning from Bloomberg: “$100 Billion Rally Coming in Google, Microsoft, Amazon Shares.” Tech Bubble 2.0 is raging, fueled by the loosest financial conditions imaginable – spurred along by speculative market dynamics and a global industry arms race arguably on a much grander scale than that of the late-nineties. Friday evening from the New York Times: “America’s Heartland Feels a Chill From Collapsing Commodity Prices.” The impact from the faltering global Bubble is spreading. Fed Bubble accommodation ensured incredible wealth has been freely lavished upon Silicon Valley, exacerbating the issue of “the haves and have nots” locally, regionally, nationally and internationally.
It’s certainly worth noting that market strength continues to narrow. The broader market this week badly lagged tech – especially big tech. In a financial management world desperate for relative performance, Fed-induced market rallies compel market participants to jump aboard the big outperformers. It’s exciting – dangerous late-cycle financial market dynamics.
There is as well a powerful real economy dynamic at work. For the most part, the bull vs. bear argument has the economy either rather robust or on the cusp of recession. Most importantly, the U.S. economy is badly imbalanced. Segments and sectors are absolutely booming. Monetary policy is recklessly loose, with cheap liquidity apparently to fuel excess until Bubbles have finally run their course. Meanwhile, vast swaths of the economy suffer from structural stagnation, the aftermath of previous boom/bust dynamics. Here monetary accommodation has little impact. And this stagnation plays a major role in seemingly benign aggregate consumer inflation and economic output data.
Yet when it comes monetary stimulus fueling Bubbles and exacerbating structural imbalances, the U.S. is overshadowed by China. Spurred by a surge in state-directed bank lending, total Credit (“total social financing”) jumped back over $200bn in September. There are also indications that post-stock market Bubble reflationary measures have pushed China’s corporate debt Bubble to only more precarious excess. While many contend that the Chinese economy, markets and currency have stabilized, I see it much more in terms of ongoing unsustainable Credit excess.
Chinese officials missed their timing for reining in Bubble excess by years. It’s now a Hobson’s Choice of throwing everything at the faltering boom. Brief thoughts: The Chinese will need a couple Trillion (in U.S. dollars) of new Credit over the next year, then the year after and so on. Throwing enormous amounts of new Credit at a terribly maladjusted system will ensure epic maladjustment and a Credit Time Bomb. Normally, such dynamics ensure significant currency debasement. I would think in terms of a Credit and Currency Peg Time Bomb.
October 18 – Financial Times (Gabriel Wildau): “It seems a long time ago that China was piling up foreign exchange reserves at a record pace as economists fretted about global imbalances from Beijing gobbling up US Treasury bonds. Now investors are wondering how long China’s dwindling forex reserves — down to $3.5tn from a peak of $4tn in June 2014 — can hold out. Capital is flowing out of China at a record pace and the central bank is drawing down reserves to support the renminbi after its recent dramatic fall. A lack of clarity over how China calculates its reserves and how much is readily available to deploy at short notice has intensified these concerns. As growth slows and bad debt rises, investors have viewed China’s massive forex pile… as the ultimate guarantor of financial stability. The prospect that reserves could be quickly exhausted raises doubts about the government’s ability to ward off crisis. It also limits the central bank’s ability to continue foreign exchange intervention, which may have cost as much as $200bn in August alone.”
Thus far, the markets have been incredibly tolerant of erratic Chinese policymaking. “We don’t care how you do it, just stabilize your markets and economy.” But at the end of the day, I see a lack of trust weighing on the Chinese currency. China’s Hobson’s Choice: aggressively inflate Credit or not. And this will put the currency at risk – the currency peg at risk. Currency controls, state-directed currency manipulation and derivatives to mask “capital” flight only increase the risk of financial accidents. Commodities and developed sovereign debt markets seem to confirm that China is not out of the woods.
FT’s Wolf: “I ask him whether he is confident that the improvement in the resilience of the banks is adequate. ‘It’s a fool’s game to predict that everything is going to be fine, because either it is fine, in which case nobody remembers your prediction, or something happens, and then …’ They remember your prediction, I interject. Bernanke continues: ‘My mentor, Dale Jorgenson [of Harvard], used to say — and Larry Summers used to say this, too — that, ‘If you never miss a plane, you’re spending too much time in airports.’ If you absolutely rule out any possibility of any kind of financial crisis, then probably you’re reducing risk too much, in terms of the growth and innovation in the economy.’”
Miss your plane and you reschedule a later flight. And the issue is certainly not ruling out “any possibility of any kind of financial crisis.” By now we should recognize that failed experimental monetary management was the leading culprit in the so-called “worst financial crisis since the Great Depression.” So what’s at risk today from much more egregious monetary experimentation? With runaway Bubbles at risk or faltering around the globe, central bankers are left with a choice of pushing ever forward with monetary inflation and market manipulation – or coming clean. Clearly they believe they have no choice at all.
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