Screen Shot 2015-11-18 at 4.55.47 PM

Social Disruption to Follow Prolonged Stagnation
By Jeffrey Snider
It’s an amazing state of affairs, that seven full years after the official end of the Great Recession we can’t move beyond “stimulus.” Some economists and policymakers prefer instead to marvel at only that length of time, an unusually long period of expansion without cyclical interruption. Recessions before the 1990’s used to be more frequent, so the lack of one since 2009 is for these people success. The problem is the word “expansion”; though the NBER hasn’t declared a cyclical peak during all that time what did occur wasn’t in any way like a recovery or even modest growth. Thus, there continues to be great angst about “stimulus” and its more recent and more appropriate twin – stagnation.

Democratic Presidential nominee Hillary Clinton recently unveiled her economic plan, which really didn’t change much from the initial proposals she floated late last year. There are minimum wage hikes and tax increases, but its centerpiece appears to be $250 billion for “public works.” Clinton even went so far as to mention Ike, calling for, “the biggest infrastructure investment since Dwight Eisenhower’s interstate highway system.” The nostalgia is cute, but the sound bite only works if you forget 2009.
One need only mention the words “shovel ready” to the American public to put to rest any notions of “stimulus.” If there was one great benefit to the American Recovery and Reinvestment Act, it was that it empirically showed the nuttiness of core Keynesian beliefs. For all the talk of multipliers and quantitative precision, the “stimulus bill” remains far more of a punchline no matter how many times its proponents claim it would have been much worse without it. The most direct consequence of any “stimulus” has been its effect on the memory of those supporting it; rather than address the ARRA’s obvious failures, as evidenced by stagnation itself and continued appeal to nothing but more of the same, those that would do it again either count on collective memory failure, as apparently Clinton, or that they themselves have blocked it out from their own recollection.

This is not a partisan issue, however, especially as the elite groping for answers turns in all sorts of directions. There was, of course, the flirtation with NIRP earlier this year, a madness that, for the time being, seems to have subsided thanks to once more empirical refutation. One need only review the Bank of Japan’s January decree in that direction to gain enough sense about why it isn’t much talked about anymore (though that doesn’t mean there aren’t policymakers still convinced, no matter what, that it would work here). In its place in recent weeks has been Milton Friedman’s “helicopter.”

Here, too, the effect of such “stimulus” has been to shorten memories. The ARRA received all the attention and scorn, but lest we forget it was not the first. The Bush Administration, supported enthusiastically by Congress, the Federal Reserve and orthodox economists engaged in a tax rebate scheme during the first half of 2008. The government essentially paid people for being people, only it was distributed through tax credits rather than physical cash. Economists, undoubtedly, will object to the format as not being a proper “helicopter” but common sense prevails.

It may not have lingered long in our collective consciousness because of its actual purpose – to make sure the US didn’t fall into recession in 2008. Thus, it has been collectively rendered a minor footnote to the bigger events of the day. At the time it was being proposed and debated, however, the mainstream had no clear sense of financial and economic conditions at the time (owing to orthodox economics and its insidious dependency on econometrics that can’t model anything but a straight line). They truly believed that between the Fed’s rate cut “accommodation” and some big dose of fiscal “stimulus” the fallout from the cresting housing bust in the real economy would be limited; all their models told them so.

On January 18, 2008, President Bush spoke to the increasingly wary and anxious nation, saying that, “this growth package must be big enough to make a difference in an economy as large and dynamic as ours.” According to his economic advisors, the “shot in the arm” was estimated to be effective at around 1% of GDP, or about $140 billion in current dollars. About a week later, Congress and the President announced their compromise and the intent to deliver $600 each to individual tax filers, $1,200 to married couples, and an additional $300 for any children (phased out for incomes over $75,000 for singles, and $150,000 for couples).

Republican House Minority Leader John Boehner proudly declared, “You know, many Americans believe that Washington is broken, but I think this agreement will show the American people that we can fix it…” Those are, of course, famous last words, “fix it.” Real GDP in Q1 2008 had contracted, though the degree to which it did has been the subject of far too many revisions to recount – an element of this entire “stimulus” enterprise that its advocates never raise. As of the latest estimates (subject to another benchmark revision later this month), the decline in Q1 GDP that year was a rather large 2.7%. The Bush tax rebate “stimulus” was almost entirely delivered in Q2, starting with tax filings in April.

GDP for that quarter rebounded to (again, as of the latest estimates) +2.0%. Even if we assume that the burst of growth amidst the financial chaos was the work of the rebate alone (which is a dubious proposition), it still failed spectacularly. The very next quarter, Q3, GDP was down again by nearly -2% and then the big collapse thereafter. Being as charitable as we can possibly be, the best that can be said of the helicopter “stimulus” in 2008 was a one-quarter rebound; no lasting effects, no multipliers that, “will help keep economic sectors that are going through adjustments, such as the housing market, from adversely affecting other parts of our economy” as President Bush projected in his January 2008 remarks.

Economists will tell us it wasn’t big enough, or that the size of the problem they were facing was inestimable. Those are, however, not excuses, as they actually further disqualify the whole idea. If you can’t even measure the problem, then you can’t claim to know how to solve it. To the unbiased, the Great Recession and really the degree of eurodollar constraint were all a foregone conclusion. All “stimulus” failed in 2008, monetary as well as fiscal, because they were inappropriate responses to the true problem. The fact that they couldn’t measure it was actually the least of their concerns. That is why “stimulus” has left the global economy facing (at best) stagnation seven years later despite the constant, insistent intrusion of especially central banks.

In short, they keep applying a word that doesn’t apply. This is not conjecture; we have lived the living economic laboratory for nearly a decade, as if the Japanese experience in the decades preceding that weren’t enough evidence. The “stimulus” equation is really quite simple; they can’t do what they claim they can do because they don’t know what they are doing. Though I would like to take credit for making such a well-founded accusation, I am actually paraphrasing an expressed doubt of Alan Greenspan who made just that kind of connection long before at the June 2003 FOMC meeting.

Based on the Japanese’ first experiment with QE starting in 2001,along with the unusually weak recovery in the US after the dot-com recession despite his “ultra-low” rate stewardship, then-Chairman Greenspan expressed in words what should have been widespread and lasting reservation.

What is useful, as has been discussed, is to build up our general knowledge so that when we are confronted with the need to respond with a twenty-minute lead time-which may be all the time we will have-we have enough background understanding to enable us to make informed decisions. We need to know how the system tends to work to be able to make the necessary judgments without asking one of our skilled technical practitioners to go off and run three correlations between X, Y, and Z. So I think the notion of building up our knowledge generally as a basis for functioning effectively is exceptionally important…Even if we never have to use the knowledge for the purpose of fighting deflation, I will bet that we will find it useful for other purposes.

The Fed never did what Greenspan proposed, leaving Bernanke’s FOMC to exactly the fate as Greenspan described; starting in August 2007, the Fed’s staff were left running X, Y, and Z correlations to try to forecast world conditions without precedent to the narrow orthodox paradigm. It was left to the fiscal side, as well, to craft “stimulus” measures similarly in the dark. The “maestro” was saying that policymakers better be sure they can actually do what they say they can do long before they ever have to do it. They didn’t and forever proved they couldn’t.

It’s infuriating that in the four years between that FOMC meeting and the start of the crisis in the summer 2007 that the Federal Reserve instead just went back to sleep. But for that brief moment of invigorating doubt, they deliberately chose to believe the housing bubble was their answer; indeed the answer. It’s downright criminal, however, that many of these same people working in positions of authority have remained asleep for so long despite the massive, unmistakable wake-up call of the panic and Great Recession. This is not a partisan issue, but it is a political one as we see the world over where governments continue to be locked into the stagnation spiral; shifting only from monetary “stimulus” to fiscal “stimulus” and back again without ever a single thing ever being stimulated (except media appearances for retired officials in order to continue to propagate the fictions).

The reception this week to hints of more “helicopter” money has been striking in that regard, particularly coming from Japan. Perspective has been lost because, frankly, the world is fatigued of nothing but constant crisis and downbeat assessments. Again, there hasn’t been declared recession in the many years since, but this economy is actually worse than that case would have been. The slow, strangling decay has left the world in a precarious position unlike typical cyclical swings, even the more severe versions. There are serious elements apparently ready to embrace the most unserious long shots. Stock markets, in particular, seem particularly susceptible to these outbreaks of unproven hope, quite in opposition to the discounting mechanism that is typically assigned to them.

US markets hit new highs this week, backed (perhaps, no one really knows what drives day-to-day swings) by the prospect not really of the Bank of Japan doing it, but that the BoJ doing something “different” will lead other central banks and governments to follow. But, again, this is not in any way different, it’s just the shortened memory of unrestrainable emotion. We know this rather well by the fact that new highs for the S&P 500 aren’t as fruitful or convincing as they were just a few years ago; meaning the overall market verdict is at least more complex, if not facing in the other direction.

At the very start, despite this new high, it represents a 1-year change (through Wednesday’s close) of not even 3%. Dating back really two years, stocks in the US have gone mostly sideways with increasing volatility. Despite the rally in shares across the globe, other indices are not quite as positive in their comparison; the broader NYSE Composite is down 2% over the past year, while, importantly, the S&P 500 Buyback Index is nearly 5% lower. That last index is meaningful in the more financial context, as it is constructed of the 100 most active repurchase companies out of the 500. Before February 2015, the index vastly outperformed the overall S&P; since then, it has significantly and consistently underperformed. The distinction may be simple leverage – companies that borrowed heavily to buy back shares were at one time applauded and celebrated, but under less certain financial conditions suddenly are questioned and induce debt-focused wariness.

Underperforming the buyback shares have been the financial shares, particularly the investment banking models of Wall Street and global eurodollar connection. Despite the big rally since late June, the stock price of Goldman Sachs, for example, remains 26% less than its high reached just about a year ago; shares of Bank of America and its Merrill Lynch subcomponent are also down 26% since last July. The relative distaste is far greater in European banking equities, suggesting the commonality of funding and eurodollar money. In other words, unlike the S&P 500 but more like the S&P 500 Buyback Index, even stock markets are overall less faithful to the “stimulus” sentiment than they once were (particularly after QE3), with those segments and activities more exposed financially notably lagging quite far behind.

In financial markets, where discounting is an actual process rather than lip service, uncertainties are far, far more extreme. The US Treasury bond yield curve has shriveled in just the last year as much or more than it did between August 8, 2007, and the ultimate panic low in March 2009 – even though the FOMC voted to “raise rates” back in December. That monetary policy symbolism has only been partially respected at the shortest maturities, really only T-bills. The CMT yield for the 2-year note (Wednesday’s close) was unchanged from a year ago but everything to the right of it in the outer maturities has found rates collapsing and the time premium of longer-term money disappearing – the very nature of what “stimulus” is supposed to be.

As dramatic as the treasury curve has been, and I don’t want to understate it, the eurodollar curve has been unbelievable. Quoted prices of eurodollar futures don’t directly translate into expectations for future money rates (a eurodollar futures contract is the right to a 3-month eurodollar deposit at whatever 3-month LIBOR is at that time; the contract is settled as 100 minus 3-month LIBOR), but we don’t need to do complex bootstrapping to interpret the movements in any specific contract or the overall shape of the eurodollar futures curve.

The June 2018 maturity, a contract that I consider to be an important benchmark straddling between where monetary policy “should” operate and the open market expectations of it beyond, has been inordinately bid over the past twelve months. On July 14, 2015, the settled price was 97.715; a year later (Wednesday’s close) it was 99.015, having traded as high as 99.20 not long ago. What that means in terms of the specific market expectation for 3-month LIBOR in June 2018 doesn’t really matter; in truth, it is an unequivocal statement that the biggest money market in the world has taken hold of the dramatically elevated risk of never achieving “lift off” of interest rates and policy normalization. I can write “never” because the shriveling of the eurodollar curve further down has been even more extreme. The June 2021 contract went from a price of 96.66 to 98.515 in just one year. The worst parts of 2009 were nowhere near this flat and uninspired.

The amount of destruction in expected time value of money is indescribable – except in terms of how the funding, and treasury, market views “stimulus.” This death of time value is the death of money itself in the real economy; a singular “tightness” that ironically Milton Friedman’s helicopter was actually intended to overcome.

The main problem, and the one reflected in these shriveled curves, is that the helicopter is at first still imprecise but more so geographically constrained. The eurodollar is a global currency that has greatly and negatively affected the entire world economy. The helicopter in Japan will do nothing for Brazil or China, just as the Bush rebates had no effect on them in 2008. Indeed, it was never supposed to; at the time it was increasingly accepted that the US housing problem would be limited in reach to the US economy, or at most developed market economies. The word “decouple” suddenly appeared in orthodox vocabulary, as this June 2008 IMF “study” exhibits:

These dramatic changes in the world economic order have prompted questions about the relevance of the conventional wisdom that when the U.S. economy sneezes, the rest of the world catches a cold. Indeed, a fierce debate is raging about whether global business cycles are converging or whether emerging markets have managed to decouple from fluctuations in U.S. business cycles.

That the IMF or any institution, and there were many, would embrace decoupling only shows yet again how little these places understood the world economy of the 21st century. The Great Recession was always a global recession, transmitted on global contagion of contracting global eurodollar money. Decouple was as much fantasy as the Bush “helicopter”, both failing on the same account. As even the authors of the IMF paper sensed when it was written, they note in their conclusions that though they supported the decoupling thesis on macroeconomic grounds they were unwilling to treat with financial decoupling, or the possibility of a global monetary noose as it really became.

From this perspective, the answer would seem to be a global “stimulus” response. That, too, would be a huge mistake for familiar reasons starting with the measurement problem. Despite Greenspan’s warning in 2003, nobody has any idea how any kind of global “stimulus” would work, let alone having figured out the “right” size or really true nature of the monetary problem to begin with. The Fed’s staff, or any central bank’s for that matter, can’t just go in the back and run X, Y, and Z simulations because there isn’t even a basis for them; all the models still view the world as if it were 1950. Global “stimulus” would be starting from less than zero.

If the problem is money, and the credit and funding markets curves prove without doubt that it is, then the answer is stable money. The eurodollar system, as if the past ten years hasn’t already shown, is no longer workable. “Stimulus” by its very nature is a status quo option, a temporary injection meant to buy time until likewise temporary negative factors dissipate. Again, the fact that seven years later authorities all over the world are still talking about, and actively experimenting with, more “stimulus” shows that temporary doesn’t apply and never did. The answer to the world’s economic problem is in the eurodollar’s replacement.

There is enormous potential if it were ever done and done correctly. Having been suppressed by financial and monetary irregularity for so long, there is pent up demand that would be, in my view, unleashed should monetary stability ever return; a real recovery that might even make the Reagan recovery of the early 1980’s look small. The primary impediment is policymakers and the governments that support them no matter what. That is what the bond and funding markets are saying; that governments will never change, and that “stimulus” is all that will ever be allowed, over and over and over again. Hope is being squeezed out of every curve by an ideology that immorally refuses to wake up.

At the end of prolonged stagnation, especially on a global scale, awaits social disruption, political chaos and even the unthinkable. Brexit, Trump, Sanders, Brazil, etc., are the first rounds. How much time is left? The clock has been ticking for already nearly nine years, dating to the start of the eurodollar rupture on August 9, 2007, but in all likelihood long before that; Greenspan’s June 2003 discussion being a prominent marker in that respect. The longer people and politicians continue to remain numb and allow the status quo to (try to) continue, the further in that direction we will all travel. From this perspective, new highs for the S&P 500, no matter how small in relevant context, seem downright counterproductive. Hope does not lay in central banks suddenly getting it right; hope is actually where the bond market is, realizing they have no answers and forcing them out of the way.