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n an article for Bloomberg View last week titled “Why It’s Smart to Worry About ETFs”, Noah Smith wrote the following prescient truth: “No one knows the basic laws that govern asset markets, so there’s a tendency to use new technologies until they fail, then start over.” As we explored in WILTW June 1, 2017, algorithmic accountability has become a rising concern among technologists as we stand at the precipice of the machine-learning age. For more than a decade, blind faith in the impartiality of math has suppressed proper accounting for the inevitable biases and vulnerabilities baked into the algorithms that dominate the Digital Age. In no sector could this faith prove more costly than finance.

The rise of passive investing has been well-reported, yet the statistics remain staggering. According to Bloomberg, Vanguard saw net inflows of $2 billion per day during the first quarter of this year. According to The Wall Street Journal, quantitative hedge funds are now responsible for 27% of all U.S. stock trades by investors, up from 14% in 2013. Based on a recent Bernstein Research prediction, 50% of all assets under management in the U.S. will be passively managed by early 2018.

In these pages, we have time and again expressed concern about the potential distortions passive investing is creating. Today, evidence is everywhere in the U.S. economy — record low volatility despite a news cycle defined by turbulence; a stock market controlled by extreme top-heaviness; and many no-growth companies seeing ever-increasing valuation divergences. As always, the key questions are when will passive strategies backfire, what will prove the trigger, and how can we mitigate the damage to our portfolios? The better we understand the baked-in biases of algorithmic investing, the closer we can come to answers.

Over the last year, few have sounded the passive alarm as loudly as Steven Bregman, co-founder of investment advisor Horizon Kinetics. He believes record ETF inflows have generated “the greatest bubble ever” — “a massive systemic risk to which everyone who believes they are well-diversified in the conventional sense are now exposed.”

Bregman explained his rationale in a speech at a Grant’s conference in October:

“In the past two years, the most outstanding mutual fund and holding- company managers of the past couple of decades, each with different styles, with limited overlap in their portfolios, collectively and simultaneously underperformed the S&P 500…There is no precedent for this. It’s never happened before. It is important to understand why. Is it really because they invested poorly? In other words, were they the anomaly for underperforming — and is it reasonable to believe that they all lost their touch at the same time, they all got stupid together? Or was it the S&P 500 that was the anomaly for outperforming? One part of the answer we know… If active managers behave in a dysfunctional manner, it will eventually be reflected in underperformance relative to their benchmark, and they can be dismissed. If the passive investors behave dysfunctionally, by definition this cannot be reflected in underperformance, since the indices are the benchmark.”

At the heart of passive “dysfunction” are two key algorithmic biases: the marginalization of price discovery and the herd effect. Because shares are not bought individually, ETFs neglect company-by-company due diligence. This is not a problem when active managers can serve as a counterbalance. However, the more capital that floods into ETFs, the less power active managers possess to force algorithmic realignments. In fact, active managers are incentivized to join the herd—they underperform if they challenge ETF movements based on price discovery. This allows the herd to crowd assets and escalate their power without accountability to fundamentals.

With Exxon as his example, Bregman puts the crisis of price discovery in a real- world context:

“Aside from being 25% of the iShares U.S. Energy ETF, 22% of the Vanguard Energy ETF, and so forth, Exxon is simultaneously a Dividend Growth stock and a Deep Value stock. It is in the USA Quality Factor ETF and in the Weak Dollar U.S. Equity ETF. Get this: It’s both a Momentum Tilt stock and a Low Volatility stock. It sounds like a vaudeville act…Say in 2013, on a bench in a train station, you came upon a page torn from an ExxonMobil financial statement that a time traveler from 2016 had inadvertently left behind. There it is before you: detailed, factual knowledge of Exxon’s results three years into the future. You’d know everything except, like a morality fable, the stock price: oil prices down 50%, revenue down 46%, earnings down 75%, the dividend-payout ratio almost 3x earnings. If you shorted, you would have lost money…There is no factor in the algorithm for valuation. No analyst at the ETF organizer—or at the Pension Fund that might be investing—is concerned about it; it’s not in the job description. There is, really, no price discovery. And if there’s no price discovery, is there really a market?”

We see a similar dynamic at play with quants. Competitive advantage comes from finding data points and correlations that give an edge. However, incomplete or esoteric data can mislead algorithms. So the pool of valuable insights is self-limiting. Meaning, the more money quants manage, the more the same inputs and formulas are utilized, crowding certain assets. This dynamic is what caused the “quant meltdown” of 2007. Since, quants have become more sophisticated as they integrate machine learning, yet the risk of overusing algorithmic strategies remains.

Writing about the bubble-threat quants pose, Wolf Street’s Wolf Richter pinpoints the herd problem:

“It seems algos are programmed with a bias to buy. Individual stocks have risen to ludicrous levels that leave rational humans scratching their heads. But since everything always goes up, and even small dips are big buying opportunities for these algos, machine learning teaches algos precisely that, and it becomes a self-propagating machine, until something trips a limit somewhere.”

As Richter suggests, there’s a flip side to the self-propagating coin. If algorithms have a bias to buy, they can also have a bias to sell. As we explored in WILTW February 11, 2016, we are concerned about how passive strategies will react to a severe market shock. If a key sector failure, a geopolitical crisis, or even an unknown, “black box” bias pulls an algorithmic risk trigger, will the herd run all at once? With such a concentrated market, an increasing amount of assets in weak hands have the power to create a devastating “sell” cascade—a risk tech giant stocks demonstrated over the past week.

With leverage on the rise, the potential for a “sell” cascade appears particularly threatening. Quant algorithms are designed to read market tranquility as a buy-sign for risky assets—another bias of concern. Currently, this is pushing leverage higher. As reported by The Financial Times, Morgan Stanley calculates that equity exposure of risk parity funds is now at its highest level since its records began in 1999.

This risk is compounded by the ETF transparency-problem. Because assets are bundled, it may take dangerously long to identify a toxic asset. And once toxicity is identified, the average investor may not be able to differentiate between healthy and infected ETFs. (A similar problem exacerbated market volatility during the subprime mortgage crisis a decade ago.) As Noah Smith writes, this could create a liquidity crisis: “Liquidity in the ETF market might suddenly dry up, as everyone tries to figure out which ETFs have lots of junk and which ones don’t.”

J.P. Morgan estimated this week that passive and quantitative investors now account for 60% of equity assets, which compares to less than 30% a decade ago. Moreover, they estimate that only 10% of trading volumes now originate from fundamental discretionary traders. This unprecedented rate of change no doubt opens the door to unaccountability, miscalculation and in turn, unforeseen consequence. We will continue to track developments closely as we try and pinpoint tipping points and safe havens. As we’ve discussed time and again with algorithms, advancement and transparency are most-often opposing forces. If we don’t pry open the passive black box, we will miss the biases hidden within. And given the power passive strategies have rapidly accrued, perpetuating blind faith could prove devastating.

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Many mainstream economists, perhaps a majority of those who have an opinion, are opposed to tying a central bank’s hands with any explicit monetary rule. A clear majority oppose the gold standard, at least according to an often-cited survey. Why is that?

First some preliminaries. By a “gold standard” I mean a monetary system in which gold is the basic money. So many grains of gold define the unit of account (e.g. the dollar) and gold coins or bullion serve as the medium of redemption for paper currency and deposits. By an “automatic” or “classical” gold standard I mean one in which there is no significant central-bank interference with the functioning of the market production and arbitrage mechanisms that equilibrate the stock of monetary gold with the demand to hold monetary gold. The United States was part of an international classical gold standard between 1879 (the year that the dollar’s redeemability in gold finally resumed following its suspension during the Civil War) and 1914 (the First World War).

Why isn’t the gold standard more popular with current-day economists? Milton Friedman once hypothesized that monetary economists are loath to criticize central banks because central banks are by far their largest employer. Providing some evidence for the hypothesis, I have elsewhere suggested that career incentives give monetary economists a status-quo bias. Most understandably focus their expertise on serving the current regime and disregard alternative regimes that would dispense with their services. They face negative payoffs to considering whether the current regime is the best monetary regime.

Here I want to propose an alternative hypothesis, which complements rather than replaces the employment-incentive hypothesis. I propose that many mainstream economists today instinctively oppose the idea of the self-regulating gold standard because they have been trained as social engineers. They consider the aim of scientific economics, as of engineering, to be prediction and control of phenomena (not just explanation). They are experts, and an automatically self-governing gold standard does not make use of their expertise. They prefer a regime that values them. They avert their eyes from the possibility that they are trying to optimize a Ptolemaic system, and so prefer not to study its alternatives.

The actual track record of the classical gold standard is superior in major respects to that of the modern fiat-money alternative. Compared to fiat standards, classical gold standards kept inflation lower (indeed near zero), made the price level more predictable (deepening financial markets), involved lower gold-extraction costs (when we count the gold extracted to provide coins and bullion to private hedgers under fiat standards), and provided stronger fiscal discipline. The classical gold standard regime in the US (1879-1914), despite a weak banking system, did no worseon cyclical stability, unemployment, or real growth.

The classical gold standard’s near-zero secular inflation rate was not an accident. It was the systemic result of the slow growth of the monetary gold stock. Hugh Rockoff (1984, p. 621) foundthat between 1839 and 1929 the annual gold mining output (averaged by decade) ran between 1.07 and 3.79 percent of the existing stock, with the one exception of the 1849-59 decade (6.39 percent growth under the impact of Californian and Australian discoveries). Furthermore, an occasion of high demand for gold (for example a large country joining the international gold standard), by raising the purchasing power of gold, would stimulate gold production and thereby bring the purchasing power back to its flat trend over the longer term.

A recent example of a poorly grounded historical critique is provided by textbook authors Stephen Cecchetti and Kermit Schoenholtz. They imagine that the gold standard determined money growth and inflation in the US until 1933, and so they count against the gold standard the US inflation rate in excess of 20% during the First World War (specifically 1917), followed by deflation in excess of 10% a few years later (1921). These rates were actually produced by the policies of the Federal Reserve System, which began operations in 1914. The classical gold standard had ended during the Great War, abandoned by all the European combatants, and did not constrain the Fed in these years. Cecchetti and Schoenholtz are thus mistaken in condemning “the gold standard” for producing a highly volatile inflation rate. (They do find, but do not emphasize, that average inflation was much lower and real growth slightly higher under gold.) They also mistakenly blame “the gold standard” — not the Federal Reserve policies that prevailed, nor the regulatory restrictions responsible for the weak state of the US banking system — for the US banking panics of 1930, 1931, and 1933. Studies of the Fed’s balance sheet and activities during the 1930s have found that it had plenty of gold (Bordo, Choudhri and Schwartz, 1999; Hsieh and Romer, 2006, Timberlake 2008). The “tight” monetary policies it pursued were not forced on it by lack of more abundant gold reserves.

There are of course serious economic historians who have done valuable research on the performance of the classical gold standard and yet remain critics. Their main lines of criticism are two. First, they too lump the classical gold standard together with the very different interwar period and mistakenly attribute the chaos of the interwar period to the gold standard mechanisms that remained, rather than to central bank interference with those mechanisms. In rebuttal Richard Timberlake has pertinently asked how, if it was the mechanisms of the gold standard (and not central banks’ attempts to manage them) that destabilized the world economy during the interwar period, those same mechanisms managed to maintain stability before the First World War (when central banks intervened less or, as in the United States, did not exist)? Here, I suggest, a strong pre-commitment to expert guidance acts like a pair of blinders. Wearing those blinders, even if it is seen that the prewar system differed from and outperformed the interwar system, it cannot be seen that this was because the former was comparatively self-regulating and the latter was comparatively expert-guided.

Second, it is always possible to argue in defense of expert guidance that even the classical gold standard was second-best to an ideally managed fiat money where experts call the shots. Even if central bankers operated on the wrong theory during the 1920s, during the Great Depression, and under Bretton Woods, not to mention during the Great Inflation and the Great Recession, today they operate (or can be gotten to operate) on the right theory.

In the worldview of economics as social engineering, monetary policy-making by experts must almost by definition be better than a naturally evolved or self-regulating monetary system without top-down guidance. After all, the experts could always choose to mimic the self-regulating system in the unlikely event that it were the best of all options. (In the most recent issue of Gold Investor, Alan Greenspan claims that mimicking the gold standard actually was his policy as Fed chairman.) As experts they sincerely believe that “we can do better” by taking advantage of expert guidance. How can expert guidance do anything but help?

Expert-guided monetary policy can fail in at least three well-known ways to improve on a market-guided monetary system. First, experts can persist in using erroneous models (consider the decades in which the Phillips Curve reigned) or lack the timely information they would need to improve outcomes. These were the reasons Milton Friedman cited to explain why the Fed’s use of discretion has amplified rather than dampened business cycles in practice. Second, policy-makers can set experts to devising policies to meet goals that are not the public’s goals. This is James Buchanan’s case for placing constraints on monetary policy at the constitutional level. Third, where the public understands that the central bank has no pre-commitments, chronically suboptimal outcomes can result even when the central bank has full information and the most benign intentions. This problem was famously emphasized by Finn E. Kydland and Edward C. Prescott (1977).

These lessons have not been fully absorbed. A central bank that announces its own inflation target (as the Fed has), and especially one that retains a “dual mandate” to respond to real variables like the unemployment rate or the estimated output gap, retains discretion. It is free to change or abandon its inflation-rate target, with or without a new announcement. Retaining discretion — the option to change policy in this way – carries a cost. The money-using public, uncertain about what the central bank experts will decide to do, will hedge more and invest less in capital formation than they would with a credibly committed regime. A commodity standard — especially without a central bank to undermine the redemption commitments of currency and deposit issuers — more completely removes policy uncertainty and with it overall uncertainty.

Speculation about the pre-analytic outlook of monetary policy experts could be dismissed as mere armchair psychology if we had no textual evidence about their outlook. Consider, then, a recent speech by Federal Reserve Vice Chairman Stanley Fischer. At a May 5, 2017 conference at the Hoover Institution, Fischer addressed the contrast between “Committee Decisions and Monetary Policy Rules.” Fischer posed the question: Why should we have “monetary policy decisions … made by a committee rather than by a rule?” His reply: “The answer is that opinions — even on monetary policy — differ among experts.” Consequently we “prefer committees in which decisions are made by discussion among the experts” who try to persuade one another. It is taken for granted that a consensus among experts is the best guide to monetary policy-making we can have.

Fischer continued:

Emphasis on a single rule as the basis for monetary policy implies that the truth has been found, despite the record over time of major shifts in monetary policy — from the gold standard, to the Bretton Woods fixed but changeable exchange rate rule, to Keynesian approaches, to monetary targeting, to the modern frameworks of inflation targeting and the dual mandate of the Fed, and more. We should not make our monetary policy decisions based on that assumption. Rather, we need our policymakers to be continually on the lookout for structural changes in the economy and for disturbances to the economy that come from hitherto unexpected sources.

In this passage Fischer suggested that historical shifts in monetary policy fashion warn us against adopting a non-discretionary regime because they indicate that no “true” regime has been found. But how so? That governments during the First World War chose to abandon the gold standard (in order to print money to finance their war efforts), and that they subsequently failed to do what was necessary to return to a sustainable gold parity (devalue or deflate), does not imply that the mechanisms of the gold standard — rather than government policies that overrode them — must have failed. Observed changes in regimes and policies do not imply that each new policy was an improvement over its predecessor — unless we take it for granted that all changes were all wise adaptations to exogenously changing circumstances. Unless, that is, we assume that the experts guiding monetary policies have never yet failed us.

Fischer further suggested that a monetary regime is not to be evaluated just by the economy’s performance, but by how policy is made: a regime is per se better the more it incorporates the latest scientific findings of experts about the current structure of the economy and the latest models of how policy can best respond to disturbances. If we accept this as true, then we need not pay much if any attention to the gold standard’s actual performance record. But if instead we are going to judge regimes largely by their performance, then replacing the automatic gold standard by the Federal Reserve’s ever-increasing discretion cannot simply be presumed a good thing. We need to consult the evidence. And the evidence since 1914 suggests otherwise.

Contrary to Fischer, there is no good reason to presume that expert-guided monetary regimes get progressively better over time, because there is no filter for replacing mistaken experts with better experts. We have no test of the successful exercise of expertise in monetary policy (meaning, superiority at correctly diagnosing and treating exogenous monetary disturbances, while avoiding the introduction of money-supply disturbances) apart from ex post evaluation of performance. The Fed’s performance does not show continuous improvement. As previously noted, it doesn’t even show improvement over the pre-Fed regime in the US.

A fair explanation for the Fed’s poor track record is Milton Friedman’s: the information necessary for successful expert guidance of monetary policy is simply not available in a timely fashion. Those who recognize this point will be open to considering the merits of moving, to quote the title a highly pertinent article by Leland B. Yeager, “toward forecast-free monetary institutions.” Experts who firmly believe in expert guidance of monetary policy, of course, will not recognize the point. They will accordingly overlook the successful track record of the automatic gold standard (without central bank management) as a forecast-free monetary institution.

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Furthermore, the effective float of 10-year and longer U.S. notes and bonds is relatively small and greatly distorts the bond market signal.   We have written about this several times.

…how small the actual float of longer-term marketable U.S. Treasury securities is available to traders and investors. The data show the Fed owns about 35 percent of Treasury securities with maturities 10-years or longer. Note the data only include notes and bonds and excludes T-Bills.

The Fed’s holdings combined with foreign ownership of longer maturities — more than 1-year — exceeds 80 percent of marketable Treasuries outstanding. The Fed combined with just foreign official holdings, mainly, foreign central banks, is 65 percent of maturities longer than 1-year. Thus, almost 2/3rds of tradeable Treasuries longer than 1-year are held by entities with no sensitivity to market forces.  –  GMM, March 2017

Given the small float of tradeable Treasury notes and bonds,  the market is subject to both massive short squeezes if it gets too far offside and rapid ramps if traders algos try and game duration.

Information Positive Feedback Loop
Many in the market,  we fear, are being hoodwinked by the flattening yield curve, however.  It’s purely the result of technicals and not economic fundamentals.

Nevertheless,  some still look to the badly distorted bond market as a signal of the health of the economy and act accordingly.   Such as delaying capital spending;  becoming more risk averse;  and cutting back on consumption, for example.

A flatter yeld curve also makes bank lending less profitable.

This could thus lead to what George Soros calls “reflexivity“,  a feedback loop where the negative, but false, signal from the bond market actually causes an economic slowdown or leads to a recession.   So much for efficient markets.

Recall the famous line of one prominent market strategist during the dark days of the great recession,

“ We’re in a depression. That is what the bond market is telling us.”

Or the ubiquitous,  “what is the bond market telling us?”    Come on, man!

The Fed Needs To Start Selling Longer Dated Securities
It would, therefore,  behoove the Fed to sell some of its longer dated Treasury holdings in order to steepen the yield curve.

The follwing table shows the Federal Reserve’s holdings of U.S. Treasury securites and the total Treasury outstandings for each year.  This table does not include T-Bills.

If the Fed were to just let its balance sheet “run off” — that is not rollover maturing notes and bonds — it would cause additional pressure on short-term interest rates even as policy rates are rising.  It could also  potentially invert or further distort the front-end of the yield curve and destablize the money markets.

Looking at the data in 2018 and 2019  large maturities are coming due, of which, the Fed holds about 25 percent of the total of Treasuries maturing.

Rolling a portion of these maturities and selling longer-dated securities would probably cause less disruption in the market and be a more optimal strategy of reducing the Fed balance sheet.

Notes and Bonds_June13

Announcement Effect
Just announcing the fact the Fed was contemplating such a strategy of unloading longer dated Treasuries first would cause the yield curve to steepen.   The market would  begin to front run the Fed.  Bill Gross & Co. would kick into action and start “selling what the Fed wants to sell.”

And because there are so relatively few Treasuries outstanding with maturities longer than 10-years,  it is unlikely it would cause the bond market debacle, which many believe is coming.  The total stock of Treasury securities with maturities longer than 10-years is smaller than the combined market capitalization of just Apple, Google, and Amazon, for example.

If bonds become too oversold, the Fed could easily engineer a short squeeze to bring the yield curve back to where it desires.

Recall, the Fed losing control of the yield curve prior to the financial crisis to foreign central banks recyling capital flows back into the U.S. bond market is what Alan Greenspan singles out as the major cause of the housing bubble.   The Fed moved the funds rate up 425 bps and the 10-year and mortgage rates barely budged.

During the 2004-07 tightening cycle, the era of the Greenspan bond market conundrum, for example, the 10-year yield managed to rise only a maximum of 64 bps during the entire cycle from a beginning yield of 4.62 percent to a cycle high yield of 5.26 percent. This as Greenspan raised the fed funds rate by 4.25 percent, from 1.0 percent to 5.25 percent.  – GMM, March 2017

The major risk is that foreigners begin to sell.  But where will they go?

Spanish 10-years at 1.43 percent?  German 10-year bunds at 0.266 percent?  How about a 10-year Japanese JGB at 0.067 percent?    In fact,  low foreign yields and the ensuing portfolio effect is keeping the U.S. 10-year note well anchored below 2.60 percent and another factor distorting the yield curve.

Central banks could also be forced to sell some of their $4 trillion U.S. Treasury holdings if global currencies come under pressure via-a-vis the dollar.  To maintain currency stability, monetary authorities could be forced to intervene in their foreign exchange markets.

Such was the case with China over the past few years, which experienced a major bout of capital flight.  The PBOC suffered a loss of FX reserves close to a trillion dollars, some of which were held in U.S Treasuries.

Credit and Equity Markets
That is where we could have some short-term problems and overshooting.   But our sense, many are waiting to pounce on a sell-off in the spread and equity markets.   Too many pensions are underfunded and too many seniors are yield strarved.

Having some dry powder makes sense.    It’s coming and you will have to act fast.

A sustained spike in inflation?

Tilt!  Game over, comrades.

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Because of the secular headwinds facing global economies, currently labeled as the “New Normal” or “Secular Stagnation”, investors have resorted to “making money with money” as opposed to old-fashioned capitalism when money and profits were made with capital investment in the real economy.

How is money made with money? Think of it simply as an extension of maturity and risk – all beginning with those $20 or maybe $100 bills in your purse or stashed safely in the cookie jar at home. Since cash yields nothing, and in fact depreciates in value day to day given even low 1%-2% inflation, savers/investors exchange cash for alternative choices involving less liquid, longer maturity, and in some cases more risky assets. A bank deposit that earns interest but offers ATM accessibility in measured amounts would be a first step. The available yield – more than 0% but hardly attractive given bank fees and the like – would be a first example of making money with available cash.

But capitalism, or should I say finance-based capitalism, requires more return in order to be profitable for its savers/investors. The next step, for individuals and institutions alike, might be a 6-month CD or a 90-day Treasury bill where yields suddenly approach 1% (at least in the U.S. In Euroland and Japan they are negative but that’s another story). But 1% will not pay the bills for most savers or financial institutions where investors demand compounding returns of 6%, 7% or 8% +, so alternative assets further out the risk/liquidity/maturity spectrum come into play. Corporate bonds, stocks, and private equity are legitimate extensions from non-yielding cash that are part of modern day finance-based capitalism. Savers/investors make money with their money (cash) as long as economies grow and inflation stays reasonably conservative. There is nothing new in all of this, but it helps to outline the fundamental process to understand why today’s economy is so different from that of decades ago and why it induces risks that were not present before.

Those differences and risks primarily are a result of secular headwinds whose effects are difficult to observe in the short run – much like global warming. “New Normal” high debt, aging demographics, and deglobalization along with technological displacement of labor are the primary culprits. Excessive debt/aging populations/trade-restrictive government policies and the increasing use of machines (robots) instead of people, create a counterforce to creative capitalism in the real economy, which worked quite well until the beginning of the 21st century. Investors in the real economy (not only large corporations but small businesses and startups) sense future headwinds that will thwart historic consumer demand and they therefore slow down investment. Productivity – which is the main driver of economic growth and long-term profits – slows down. Productivity in fact, in the U.S. and almost everywhere in the developed world has flat-lined for nearly five years now and has increased by only 1% annually since 2000 and the aftermath of the Dot-Com recession.

So instead of making money by investing in the real economy, savers/investors increasingly are steered toward making money in the financial economy – making money with money. And that, thanks to nearly $8 trillion of QE asset purchases from major central banks and the holding of short-term borrowing rates near zero or even negative, has made this secular shift in monetary policy extremely profitable. Bank margins have been lowered but their stocks and almost all other stocks have soared here in the U.S. and globally. Investors have discovered that making money with money is a profitable enterprise and have exchanged the support of central banks for the old-time religion of productivity growth as a driver of their strategy. The real economy has been usurped by the financial economy. Long live the financed-based economy!

But asset prices and their growth rates are ultimately dependent on the real economy and, the real economy’s growth rate is stunted by secular forces which monetary and even future fiscal policies seem unable to reverse. In fact, as I have mentioned many times in prior Investment Outlooks, monetary policy may now be a negative influence in terms of future economic growth. Zombie corporations are being kept alive as opposed to destroyed as with the Schumpeterian/Darwinian “survival of the fittest” capitalism of the 20th century. Standard business models forming capitalism’s foundation, such as insurance companies, pension funds, and banking, are threatened by the low yields that have in turn, produced high asset prices. These sectors in fact, have long-term maturities and durations of their liabilities, and their assets have not risen enough to cover prior guarantees, so we see Puerto Rico, Detroit, and perhaps Illinois in future years defaulting in one way or the other on their promises to constituents. Faulty finance-based capitalism supported by the increasingly destructive monetary policy begins to erode, not support the real economy.

So instead of making money by investing in the real economy, savers/investors increasingly are steered towards making money in the financial economy – making money with money.

My point in all of this is that making money with money is an inherently acceptable ingredient in historical capitalistic models, but ultimately it must then be channeled into the real economy to keep the cycle going. Capitalism’s arteries are now clogged or even blocked by secular forces which when combined with low/negative yielding “safe” assets promise to stunt U.S. and global growth far below historical norms. Ultimately investors must recognize this risk along with increasingly poorly hedged liabilities and low growth resulting from “New Normal” secular headwinds in developed economies. Add global warming to this list, and you have the potential for low asset returns in which the now successful strategy of “making money with money” is seriously threatened. How soon this takes place is of course the investor’s dilemma, and the policymakers’ conundrum. But don’t be mesmerized by the blue skies created by central bank QE and near perpetually low interest rates. All markets are increasingly at risk.

Money will currently be made, or at least conservatively preserved, by acknowledging the exhaustion of “making money with money”. Strategies involving risk reduction should ultimately outperform “faux” surefire winners generated by central bank printing of money. It’s the real economy that counts and global real economic growth is and should continue to be below par.

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The Trumpster unleashes more rumours and uncertainty:

One of President Donald Trump’s close friends set off a frenzy on Monday night when he told PBS that the president is “weighing” whether or not to fire Robert Mueller, the special counsel overseeing the Russia investigation.

“He’s weighing that option,” said Chris Ruddy, Newsmax CEO and friend of Trump on PBS NewsHour Monday evening.

Ruddy was seen leaving the West Wing on Monday, but White House press secretary Sean Spicer later said Ruddy had not spoken with Trump about the issue while he was at the White House.

Trump’s reported consideration of firing Mueller comes just weeks after Deputy Attorney General Rod Rosenstein appointed him to lead the FBI’s probe into Russia’s election interference and whether any Trump campaign associates colluded with Moscow.

Legal experts, members of Congress, former government officials, and even Ruddy reacted swiftly on Monday night, most with the same message: Don’t do it.

“I personally think it would be a very significant mistake — even though I don’t think there’s a justification … for a special counsel in this case,” Ruddy said.

“Firing Bob Mueller as special counsel would be an order of magnitude more seismic than firing Jim Comey,” said Andrew Wright, a professor of constitutional law at Savannah Law School. “It would be insane even by Trump-era standards.”

“It would be a disaster,” Republican Sen. Lindsey Graham told Politico. “There’s no reason to fire Mueller. What’s he done to be fired?”

“If President fired Bob Mueller, Congress would immediately re-establish independent counsel and appoint Bob Mueller. Don’t waste our time,” said Rep. Adam Schiff, ranking member of the House Intelligence Committee.

Richard Painter, the top White House ethics lawyer under President George W. Bush, said Trump’s consideration “had better be fake news or this presidency will be over very soon.”

Ruddy’s comments came amid a drumbeat of calls from Trump’s supporters and conservative allies for Mueller to step down — despite their initial support for him. It followed former FBI Director James Comey’s testimony last week that he ordered a friend, a Columbia Law professor, to give the press a memo detailing Comey’s detailing of Trump’s request that the FBI drop the investigation into former national security adviser Michael Flynn.

The calls also come as Mueller has been staffing up with top attorneys specializing in criminal law and fraud.

“Republicans are delusional if they think the special counsel is going to be fair,” former House Speaker and prominent Trump surrogate Newt Gingrich tweeted Monday. “Look who he is hiring. Check FEC reports. Time to rethink.”

Gingrich told CBS on Tuesday morning that Trump called him Monday night to discuss Gingrich’s feeling that Mueller has been playing “a rigged game.”

‘It’s chaos that he can put to bed’

It is not clear that Trump could fire Mueller unilaterally and without good reason, however.

“As I understand it, the special counsel regulations require termination only ‘for cause,’” Wright said. “The president would have to convince Rosenstein that there are grounds for termination. If Rosenstein refused, Trump would have to fire Rosenstein. Sound familiar? It would be Saturday Night Massacre city.”

The Saturday Night Massacre refers to the resignations of Attorney General Elliot Richardson and Deputy Attorney General William Ruckelshaus on October 20, 1973, after they refused to follow President Richard Nixon’s orders and fire the special prosecutor investigating Watergate, Archibald Cox.

“If Rosenstein did remove Mueller, then the investigation would revert to Rosenstein on the org chart,” Wright said. “But the political, congressional, and media environment would be just white hot crazy.’”

Democratic Rep. Eric Swalwell, a member of the House Intelligence Committee, said in an interview that he can’t understand why Trump doesn’t just put the speculation to rest.

“He is unnecessarily allowing it to fester, and that is creating more chaos around the Russia investigation,” Swalwell said on Tuesday. “It’s chaos that he can put to bed by just saying that he does not intend to fire the special counsel.”

Swalwell added that Trump seems to have turned questions surrounding the Russia probe into “a guessing game,” beginning with his unfounded claim in early March that President Barack Obama “wire tapped” Trump Tower phones. Last month, he suggested in a tweet that there may be “tapes” of his conversations with Comey.

“This is all beginning to look intentional,” Swalwell said. “It seems that he could answer many of the serious questions out there, but instead he’s turned this into a guessing game. The cost of this chaos is that he has brought Washington to a halt at a time that both parties would be better served working on the issues they were elected to address.”

When it comes to examining whether Trump sought to obstruct the FBI’s investigation into Russia’s election interference and whether the Trump campaign played a role, the president’s pattern of behaviour and past statements about the probe will likely come back to haunt him, experts say.

“You may be the first president in history to go down because you can’t stop inappropriately talking about an investigation that, if you just were quiet, would clear you,” Graham said Sunday of Trump.

Bob Bauer, who was a White House counsel under President Barack Obama, wrote last month that “what is most remarkable is that the president has willingly created this self-portrait.”

“As scandals in the making go, this one may become famous for featuring the president as the principal witness against himself: he seems committed to uncovering any cover-up,” Bauer said.


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Fortunately for workers, businesses, and the economy, employment relationships are positive-sum: the value of the goods and services produced together is greater than the cost. However, to make work rewarding for firm and worker alike—to make markets truly competitive—requires at a minimum that the rules governing the employment relationship be fair and clear. Unfortunately, our labor markets sometimes fall short of this ideal.

Recently, there has been much discussion of worker bargaining power and the ways that some firms try to suppress it, thereby holding down wages. This should be a concern even for those who are not typically inclined to see workers as needing protection. In an effort to protect themselves from open competition, some firms are happy to use government power to their own advantage, but to the detriment of society overall. In a previous article, I discussed concerns regarding non-compete agreements, which can have exactly this effect by preventing workers from taking jobs at competing employers. Moreover, to the extent that firms are successful in reducing worker bargaining power, it may be the taxpayer who is called upon to make up the difference for low-wage workers.

Non-competes are far from the only legal tool subject to abuse. Another potentially problematic labor market institution is the so-called pre-dispute arbitration agreement. Under the Federal Arbitration Act, firms may require as a condition of employment that workers surrender their right to pursue grievances within the court system, instead submitting to binding arbitration.

To be sure, binding arbitration has a number of benefits. For the employer, arbitration promises a private forum for what could otherwise be an embarrassing public spectacle. There may also be benefits for society as a whole, given that speedy, inexpensive resolution of disputes is valuable to everyone. More speculatively, making it harder to legally fire workers has been linked with declining dynamism in the labor market, and binding arbitration could mitigate this problem.

But for workers, there are also some serious downsides. Arbitrators can be less sympathetic than a jury, for one thing. To the extent that arbitrators are chosen by the employer, there are obvious concerns: an arbitrator who tends to rule in favor of employers may be more likely to get repeat business. It is useful to contrast this with the situation that often exists in a collective bargaining context, where unions and employers jointly choose both arbitrators and the terms of arbitration.

Finally, new hires are being asked to sign away their rights well before any dispute actually arises, and before they have an incentive to familiarize themselves with the terms of the mandatory arbitration agreement. As with non-compete agreements, it is likely that workers are ill-informed about both what they have signed up for and the extent to which it is even enforceable.

That enforceability is now under some close scrutiny. Earlier this year, the Supreme Court announced that it will rule on whether employment-related pre-dispute agreements can preclude worker participation in class-action lawsuits. Legislation has been recently introduced that would invalidate pre-disputeagreements in employment-related matters, while still allowing for workers and firms to agree to binding arbitration after a dispute has arisen.

As policy evolves—and with so many unresolved questions about the costs and benefits of pre-dispute employment arbitration—it is striking how little data there is to inform the debate. We do not have a clear sense of how widespread the agreements are, what their detailed provisions are, or how often they are enforced. Without this information, it will be difficult for policymakers to make sound decisions that benefit workers and the economy. Efforts should begin now to develop more reliable, comprehensive data about pre-dispute employment agreements, non-competes, and other labor market institutions that determine workers’ fates.

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The next debt ceiling fight fast approaches:

Debt-ceiling fights, especially amid massive deficit increases following the 2008 financial crisis, have become more difficult and politically contentious.

Perhaps the most famous came in 2011, when it appeared that Republican leadership in the House did not have enough votes from its conference to pass the debt ceiling bill just hours before it was set to be breached. Obama, in an interview in January, called the moment the most nerve-wracking of his presidency and said he had prepared a speech in case the US went into partial default on its debt.

Obama’s fear was warranted, given the massive impact failing to raise the debt ceiling would have on not only the finances of the federal government, but also the global economy.