Doug Noland: Drone Money

It was obvious the Fed had really blown it. That this academic, and recently appointed Fed governor, referred to the “bubble poppers” from the late-twenties and their role in fomenting the Great Depression made it difficult not to be disdainful. I underestimated both the man and the world’s gullibility.

Moreover, the resulting catastrophe ensured a momentous transformation in policy doctrine. The Fed turned to directly targeting asset market inflation. And Bernanke’s decision to exploit financial market manipulation as the primary mechanism for (financial and economic) system reflation over time ensured the Fed would evolve into the unqualified “arbiter of security values.”

In particular, to maintain downward pressure on longer-term interest rates, the Federal Open Market Committee (FOMC) likely will provide forward guidance about the economic conditions it would need to see before it considers raising its overnight target rate. And it likely will clarify its plans for further securities purchases (quantitative easing). It is possible, though not certain, that the FOMC will also implement yield-curve control by targeting medium-term interest rates.” Ben Bernanke and Janet Yellen, Testimony on COVID-19 and Response to Economic Crisis, July 17, 2020.

With highly speculative securities markets having fully recovered COVID losses – and Nasdaq sporting a 17% y-t-d gain – why the talk of more QE? And with 10-year yields at 0.63% and financial conditions extraordinarily loose, what’s the purpose for discussing the pegging of Treasury bond prices (aka “yield curve control”)? Aren’t the markets already conspicuously over-liquefied?

Let us suppose now that one day a helicopter flies over this community and drops an additional $1,000 in bills from the sky, which is, of course, hastily collected by members of the community. Let us suppose further that everyone is convinced that this is a unique event which will never be repeated.” Milton Friedman, “The Optimum Quantity of Money,” 1969.

It was Dr. Ben Bernanke that, in the wake of the “tech” Bubble collapse, elevated Friedman’s academic thought experiment to a revolutionary policy proposal. And in this runaway real world experiment, “often repeated” supplanted Friedman’s “will never be repeated” – and it changed everything.

The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper‐money system, a determined government can always generate higher spending and hence positive inflation.” Ben Bernanke, “Deflation: Making Sure ‘It’ Doesn’t Happen Here,” 2002.

To be clear, the probability of so-called helicopter money being used in the United States in the foreseeable future seems extremely low… Nevertheless, it’s important that markets and the public appreciate that, should worst-case recession or deflation scenarios occur, governments do have tools to respond.” Ben Bernanke, “What Tools Does the Fed Have Left? Part 3: Helicopter Money,” 2016.

“From what I have seen thus far, Dr. Bernanke is well on his way to creating a place for himself in economic history.” Doug Noland, “Death to the Bubble Poppers,” November 22, 2002.

I didn’t take Bernanke all that seriously when he arrived at the Fed back in 2002. My thinking at the time: How could any central banker openly contemplating using the “government printing press” and “helicopter money” ever be taken seriously?

The raging policy debate in 2002 was how to counter so-called “deflationary forces.” But there was as well the critical issue of the Federal Reserve having failed to safeguard financial stability. The Greenspan Fed actively promoted (and backstopped) the financial markets – while ignoring resulting late-nineties Bubble excess.

It was obvious the Fed had really blown it. That this academic, and recently appointed Fed governor, referred to the “bubble poppers” from the late-twenties and their role in fomenting the Great Depression made it difficult not to be disdainful. I underestimated both the man and the world’s gullibility.

Bernanke 2002: “I think it is extraordinarily dangerous for the Fed to make itself the arbiter of security values. And I think, moreover, that if the Fed tries to, quote, ‘pop bubbles,’ it’s likely that it creates disasters.”

Over his long career, Dr. Bernanke has accumulated a remarkable body of work, replete with historical revisionism and dangerously flawed doctrine. A few Bernanke sentences from 2002, in particular, changed the course of history.

Bernanke: “The first part of the prescription implies that the Fed should use monetary policy to target the economy, not the asset markets. As I will argue today, I think for the Fed to be an ‘arbiter of security speculation or values’ is neither desirable nor feasible… The second part of my prescription is for the Fed to use its regulatory, supervisory, and lender-of-last-resort powers to protect and defend the financial system.”

Clearly, the so-called macro-prudential regulatory framework was an abject failure throughout the mortgage finance Bubble period. Moreover, the resulting catastrophe ensured a momentous transformation in policy doctrine. The Fed turned to directly targeting asset market inflation. And Bernanke’s decision to exploit financial market manipulation as the primary mechanism for (financial and economic) system reflation over time ensured the Fed would evolve into the unqualified “arbiter of security values.” After excoriating the “Bubble poppers,” Bernanke’s Fed unleashed dynamics that would have the Federal Reserve and global central bankers desperately resuscitating Bubble excess some 18 years later.

Milton Friedman never contemplated “helicopter money” being used – not for spending on goods and services in the real economy – for, among other things, to fund Robinhood trading accounts ( helping raise the price level… of Tesla’s stock). Friedman did a lot of thinking over many decades, yet I’m rather confident the thought of the Fed injecting $3 TN into the securities markets over a limited number of weeks never crossed his mind. Ditto the Fed monetizing Trillions of deficit spending in a few months’ time.

Ben Bernanke has never grasped speculative dynamics and financial structure evolution. He fails to appreciate the great danger that was associated with late-twenties speculative leveraging and the impact massive expansion of speculation-related liquidity had on financial and economic structure (especially late in the cycle!). As we’ve been witnessing, central bankers either must develop a policy course to rein in excess – or they will invariably become hostage to it. Future historians will look back at central banks using financial markets as their primary stimulus mechanism with contempt.

Cracks were more discernible this week. New daily U.S. COVID cases surpassed 70,000, with no end in sight. Many states – including economic heavyweights California, Florida and Texas – are being forced to clamp down. Trillions of additional fiscal stimulus will be forthcoming. New infections surged over 1.6 million globally over the past week. The U.S./China cold war chilled markedly. Chinese stocks reversed sharply lower this week, as policymakers confront the dilemma of massive monetary stimulus reigniting a stock market mania. In Europe, EU officials begin a contentious meeting with leadership hoping to muster a COVID stimulus giveaway within a backdrop of sharply lower infections and economic dislocation.

The Shanghai Composite sank 5% this week, with the CSI 300 down 4.4%. An official signaled the People’s Bank of China is not currently inclined to add additional stimulus. Beijing must appreciate that resurgent stock and property Bubbles only add to already acute systemic risks. And with 600 million Chinese earning monthly incomes of less than $140, inequality in China is a festering issue.

A Bloomberg headline from earlier in the week: “A Spate of Bank Runs Breaks Out in China, Fueled by Social Media.” At this point, panic is limited to a few smaller banks, although the entire banking system now faces mounting loan quality issues. The above Bloomberg article includes the ominous sentence: “Confidence in the $43 trillion banking system is eroding among the nation’s more than 1 billion account holders, threatening a cornerstone of China’s rise into an economic powerhouse.”

Banking system vulnerability is a global issue.

July 14 – Wall Street Journal (Ben Eisen and David Benoit): “The largest U.S. banks signaled that the worst of the coronavirus recession is yet to come, opting to stow away tens of billions of dollars to prepare for an expected wave of loan losses… ‘This is not a normal recession,’ said James Dimon, JPMorgan’s chief executive. ‘The recessionary part of this you’re going to see down the road.’ For years after the last financial crisis, banks made big profits lending to consumers and companies eager to take advantage of low interest rates. Heading into the current collapse, Americans had taken on record amounts of auto loans, credit-card debt and student loans. Corporate debt also reached record levels.”

We’re early in the pandemic; early in the crisis; and early the global economic downturn. I would heed Jamie Dimon’s warning. Most loan portfolios will show major deterioration over time. Yet the huge boost to reserves for future loan losses announced this week by the major banks was largely ignored by the markets. No surprise, considering the marketplace has been disregarding the spike in COVID infections and the move by states and municipalities to slow or reverse reopening measures.

Equities are instead predisposed to rally on positive vaccine news. “Risk on” got another boost Wednesday from Moderna’s release of “promising” details from its phase 1 vaccine trials. All 45 of the healthy adults in the trial developed antibody responses. That most vaccine recipients experienced side effects was irrelevant to the markets. At this point, the company does not know if the immune response is adequate to provide COVID immunity – or antibody longevity.

July 17 – San Francisco Chronicle (Peter Fimrite): “Disturbing new revelations that permanent immunity to the coronavirus may not be possible have jeopardized vaccine development and reinforced a decision by scientists at UCSF and affiliated laboratories to focus exclusively on treatments. Several recent studies conducted around the world indicate that the human body does not retain the antibodies that build up during infections, meaning there may be no lasting immunity to COVID-19 after people recover. Strong antibodies are also crucial in the development of vaccines. So molecular biologists fear the only way left to control the disease may be to treat the symptoms after people are infected to prevent the most debilitating effects, including inflammation, blood clots and death. ‘I just don’t see a vaccine coming anytime soon,’ said Nevan Krogan, a molecular biologist and director of UCSF’s Quantitative Biosciences Institute, which works in partnership with 100 research laboratories. ‘People do have antibodies, but the antibodies are waning quickly.’ And if antibodies diminish, ‘then there is a good chance the immunity from a vaccine would wane too.’”

I profess no vaccine expertise. Yet from my reading and listening, I’ll offer a few observations. The general public will question the safety of rapidly developed vaccines. Understandably, at this point trust is thin. And for a disease that causes only mild symptoms for the majority of those infected, a large swath of the population (i.e. young people) will be willing to take their chances. Vaccines with side effects will be a tough sell for many. Moreover, the issue of antibody duration will be crucial – and there could well be little clarity on this issue for vaccines rushed to market early next year.

Markets are content to disregard the risk of vaccine ineffectiveness. After all, COVID resurgence ensures further rounds of fiscal stimulus. Thursday from Nancy Pelosi (via CNBC): “They know there’s going to be a bill. First it was going to be no bill. And then it was going to be some little bill. Now it’s $1.3 trillion. That’s not enough.”

The Federal deficit surged to a record $864 billion in June, crushing April’s $738 billion. The deficit reached an unprecedented $2.74 TN through nine months – and $3.0 TN over 12 months. The CBO had projected a fiscal year deficit of $3.7 TN – though additional stimulus bills could push the deficit closer to $5.0 TN – or approaching 25% of GDP.

People are hurting and deserve help. My issue is we ran enormous deficits even as the economy was booming with the unemployment rate down to 60-year lows. The Fed inflated historic market Bubbles, creating acute financial and economic fragility. Reckless fiscal and monetary stimulus fueled a Bubble Economy replete with deep structural maladjustment.

Years and decades of flawed policies cultivated the current predicament: The real economy will require ongoing massive fiscal spending, while inflated assets Bubbles will demand ongoing massive monetary stimulus. It’s a fuzzy black hole lately coming into clearer focus. Markets – staring maniacally into the abyss – are plagued by visions of endless liquidity and ever higher securities prices. Myriad major problems come with runaway “helicopter money” – although this is a misnomer.

Indeed, the whole notion of “helicopter money” is dangerously flawed. The idle masses, eyes locked skyward, anxiously awaiting the next helicopter drop. Little attention was paid at first to the swarm of Drones zooming by. Suspicions were raised, however, when the choppers began arriving more infrequently and with less bountiful drops. It was at this point when more attention was paid to the fleet of sophisticated drones covertly delivering their monetary cargo to “special interests,” the well-connected and powerful. Anger and desperation grew both with “Drone Money” and the daily jumbo cargo flights to the market exchanges.

Original Post 18 July 2020

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Categories: Doug Noland, Perspectives