Doug Noland: Dow 36,000 and Policy Mistakes

Michael Bond comments: Please note the book written on Dow 36,000 came out in 1999 and the SP500 found itself 60% lower nine years later. The statements by the authors about policy not mattering are a sad joke for our times.

From Doug’s analysis, I see the 1999 tech bubble as one of many asset global bubbles due to the much larger bubble – the global credit bubble – that began in the late 90s.. Each policy reaction has been to re-inflate the credit bubble much larger.

The 2008 mortgage bubble impacted the credit markets and too-large-to-fail banks globally. To save the financial system, we ended up with the government debt bubble. As we look ahead at what will save the granddaddy of all credit bubbles (govt debt) there is only two possibilities 1) direct defaults or 2) transition to a money bubble (via printing) to avoid direct defaults.

Default on what? Default on future cash flows to either the bond holders (financial economy) or the social obligations of the people (the economy). The second option is austerity and tends to create a cycle of declining economic production, but the TOP who own 90% of the debt of course prefer option two.

I have my own policy views that directs printing to economic growth while allowing defaults in the corporate world via restructuring. The Fed’s balance sheet is not a problem but must not grow again to save a rotten financial system again. But I am sure it will be used that way once again.

The Fed will use whatever excuse is convenient to continue to suppress interest rates with no regard to its harm to savers or pensions to include this form of fiscal braking. They work for wall street and the status quo of the rotten financial system.

Exerpts from Doug’s article below:

It’s tiring to hear chair Powell repeatedly fall back on the Fed’s “dual mandate of stable prices and full employment”. Give us a break.

“In 1977, Congress amended the Federal Reserve Act, directing the Board of Governors of the Federal Reserve System and the Federal Open Market Committee to ‘maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.’”

In no way did this amendment grant the Fed carte blanch to print Trillions. The crafters of this legislation had in mind the Fed restraining money and Credit growth to ensure monetary and price stability. And for the Fed to use its full-employment mandate these days as justification for zero rates and QE is also making a mockery out of that mandate.

The big central banks this week signaled they will push back again rising rate expectations and market yields – essentially intervening in the markets to quash market adjustment to surging inflation risk. I have major issues with this. For one, market discipline is today all we have between reckless fiscal and monetary policies and any hope for a future without financial and economic chaos. Financial conditions must tighten, or inflation will run wild. Secondly, today’s artificially low rates and manipulated market yields are fueling precarious Bubbles and market manias. There is no justification for continuing with zero rates and huge monthly QE liquidity injections.


DOW 36000 and Policy Mistakes

by Doug Noland

More evidence this week of a historic mania running unchecked. 1999 was crazy, but at least that mania was relatively contained within Internet and technology stocks. It wasn’t fueled by Trillions of central bank monetary inflation. These days, manias are everywhere – at home and abroad, stocks, bonds, derivatives, crypto, houses, etc. The small cap Russell 2000 jumped 6.1% this week, with the Semiconductors (SOX) up 8.8%. The Goldman Sachs Most Short Index surged 11.7%. The Dow powered past 36,000 – and it was Deja Vu All Over Again.

Bloomberg Television’s Romaine Bostick (November 1, 2021): “When you talk about buying and holding, are you doing it within the context of the risk/reward that stocks on their own offer… or are you also looking at it with respect to the type of support – whether implicit or explicit – by monetary policymakers, by fiscal policymakers that has led us to where we are today – where a lot of folks feel like we can’t really go down as long as the Fed is there.”

James A. Glassman, co-author “Dow 36,000…”: “Well, certainly I couldn’t have predicted zero interest rates… My feeling, certainly in the short term and maybe even the medium term, that we ought to pay attention to Fed policy. But if you look at the whole scope of American history, the fact is that the U.S. economy has done consistently well – over and over again. And we make policy mistakes all the time. But markets react, businesses react, and we do really well. And, essentially, an investment in stocks is a bet on the U.S. economy and that has turned out to be a really good bet – no matter who’s in charge – whether it’s Democrats or Republicans. I hate to say, as someone who has devoted his life to policy issues, that policy doesn’t matter. And I think it does. But there’s a certain equilibrium that we come back to. And for investors – long-term investors if you’re thinking about retirement – for you to worry about what Fed policy is today or tomorrow – or what Congress is going to do passing this or that bill – I think that’s a mistake. I really do. Just putting money in on a regular basis and keeping it there makes a whole lot sense… I would have to tell you that I would push for high proportions of stocks in a portfolio… In general, if you’re a long-term investor – and I mean by that ten years or more – I would be as aggressive as possible with owning stocks in a diversified portfolio.”

As Glassman and Kevin Hassett were (in the thick of 1999’s mania) about to publish “Dow 36,000: The New Strategy for Profiting From the Coming Rise in the Stock Market,” I began posting the Credit Bubble Bulletin. I was convinced a major Bubble had overtaken U.S. finance and securities markets – a Bubble fueled by a precarious shift to market-based “Wall Street Finance,” including the GSEs, MBS, ABS, derivatives, the broker/dealers and hedge funds. Moreover, the Fed failed to respond to a momentous loosening of finance and proliferation of leveraged speculation. Indeed, Greenspan’s shift in monetary policy doctrine toward underpinning market-based finance was integral to Bubble development.

From “Dow 36,000’s” introduction: “Single most important fact about stocks at the dawn of the twenty-first century: They are cheap… If you are worried about missing the market’s big move upward, you will discover that it is not too late. Stocks are now in the midst of a one-time-only rise to much higher ground – to the neighborhood of 36,000 on the Dow Jones industrial average.

In 1999, I viewed “Dow 36,000” as emblematic of the period – a testament to the euphoria of the times and reminiscent of Irving Fisher’s “stock prices have reached what looks like a permanently high plateau” (just weeks ahead of the 1929 Crash). With parallels to the “Roaring Twenties”, the technology revolution had nurtured a powerfully captivating bullish narrative. And along with the marketplace and Federal Reserve officials, Glassman and Hassett ignored mounting risks associated with Credit and speculative excess.

My interest was piqued when informed Glassman was to be interviewed Monday in commemoration of the Dow’s ascent to 36,000. After publishing a hyper-bullish book at a major market Bubble peak, would he convey a more cautious approach in today’s manic market backdrop? Definitely not. In a sign of these manic times, Glassman has become only more confident in equities and the buy and hold mantra.

I am fascinated by Glassman’s dismissiveness of Policy Mistakes. “We make policy mistakes all the time. But markets react, businesses react, and we do really well.” Glassman believes it’s a mistake to worry about Fed policy. He admits being surprised by zero rates. Curiously, no mention of QE. Federal Reserve Assets were $669 billion when “Dow 36,000” was published. Holdings have reached $8.575 TN, having ballooned almost 12-fold (1,200%). I wouldn’t extrapolate.

They aren’t and won’t, but investors should be keenly focused on Policy Mistakes. Granted, open-ended QE to this point has ensured that every Mistake is followed by greater Mistakes – only more aggressive monetary stimulus ensuring a Fed balance sheet that will approach $9 TN over the coming months. With the Federal Reserve as vanguard, global central bankers are in the throes of a monumental Policy Mistake.

As expected, the Fed Wednesday announced details of its taper strategy, which is essentially starting with a $15 billion reduction. They will take a flexible approach with tapering, while penciling in this pace monthly. Meanwhile, Powell and the FOMC believe it’s much too early to discuss raising rates from zero.

It was the Fed’s big, much anticipated week. And it was overshadowed by a bigger story. A Bloomberg host asked guests why U.S. yields were more impacted by Thursday’s Bank of England (BOE) policy announcement than by the Fed. He didn’t get a satisfactory answer.

Ten-year UK yields sank 19 bps this week to 0.85%, with yields dropping a notable 35 bps in 12 sessions (from October 21st highs). Australian yields sank 28 bps this week to 1.81%. German yields dropped 17 bps (negative 0.28%), with French yields down 21 bps (0.06%), Spain 21 bps (0.40%), and Portugal 21 bps (0.31%). Italian yields sank 29 bps (0.88%) and Greek yields fell 24 bps (1.07%). Ten-year Treasury yields dropped 10 bps this week to 1.46%, with a two-week drop of 18 bps. Two-year and five-year Treasury yields fell 10 bps (0.40%) and 13 bps (1.06%).

It was a huge week for the major global central banks. Clearly not ready to take a backseat following last week’s ECB meeting, Christine Lagarde “doubled down” in a speech ahead of the Fed announcement, saying the ECB was “very unlikely” to raise rates next year – a 2022 hike being “off the charts.” “Despite the current inflation surge, the outlook for inflation over the medium term remains subdued, and thus these three conditions are very unlikely to be satisfied next year.” Calling her “Madam Inflation,” “Germany’s best-selling tabloid Bild scathingly criticised European Central Bank (ECB) President Christine Lagarde…, accusing her of destroying the earnings and savings of ordinary people…” (from Reuters). Little wonder Jens Weidmann threw in the towel.

Tuesday had the Reserve Bank of Australia (RBA) also downplaying inflation risk, shelving yield curve control measures, but sticking with its monthly QE program. RBA Governor Philip Lowe: “The latest data and forecasts do not warrant an increase in the cash rate in 2022. The Board is prepared to be patient.”

Following Thursday’s Bank of England meeting, Bloomberg went with the headline, “BOE Shocks Markets by Keeping Rates on Hold.” Recent hawkish comments from BOE officials had markets anticipating an imminent shift in rate policy. Why did Treasury and global yields notably respond to the BOE? Because the Bank of England caving on inflation risks signaled a unified central bank front in pushing back against market expectations for rising rates and higher market yields.

November 4 – Financial Times (Chris Giles and Delphine Strauss): “Bank of England governor Andrew Bailey had a Herculean three-card trick to pull off on Thursday when presenting the central bank’s new inflation forecast and decision to hold back on immediately raising interest rates. Bailey, who fuelled expectations of a rate rise last month by saying the BoE ‘will have to act’ to tackle surging inflation, wanted those listening to accept three different messages — which to many in the audience may have appeared contradictory. First, that the BoE Monetary Policy Committee is much more concerned about inflation than it was previously and interest rates really are going to rise ‘over coming months’. Second, that it was good to wait and see before taking action because the outlook for economic growth had darkened and the overall picture was terribly uncertain. And third that people should continue to heed his words even though he acknowledged that his comments last month about taming inflation had been ‘truisms’ and therefore empty of meaning.”

A plethora of rationalization and justification from the global central bank community – much stretching credulity. And it’s difficult not to see this week’s developments as important confirmation of a concerted strategy from key global central banks. They’re in this mess together; created it together; and are now trapped together. As a group, they will dismiss rapidly mounting inflationary risks, choosing to remain locked in ultra-stimulative monetary policies. And together they will disregard manic markets and precarious financial imbalances.

It’s not difficult to discern why they would adopt such an approach. Global fragilities have turned acute. China’s Bubble is faltering, with contagion spreading to key EM markets. And last week, we observed acute instability afflict developed bond markets, including the UK, Australia, New Zealand, Canada and even U.S. Treasuries. They’re petrified of bursting Bubbles.

It’s like the stock market. If you’re going to be wrong, much better to be wrong with the group. And I could only chuckle. It’s virtually become a ritual. In analysis prior to Wednesday’s release of the Fed’s policy statement, commentators on Bloomberg Television again recalled the infamous Policy Mistake committed by the ECB when they raised the deposit rate 25 bps to 3.25% on July 3, 2008. According to Wall Street, they perpetrated the cardinal sin of contemporary central banking: they parted company with a dovish Fed (that commenced rate cuts in Sept. ‘07) and tightened policy only weeks before the start of the “great financial crisis.” Listening to the pundits, one is left with the impression that the ECB’s hike actually contributed to the mayhem.

For starters, it’s silly to assert that a small 25 bps rate increase is such a big deal. If it causes significant market reaction, odds are that rates were held too low for too long. And indeed, that is the story of the mortgage finance Bubble period. Despite double-digit mortgage Credit growth, Fed funds ended 2002 at 1.25%. After averaging $268 billion annually during the nineties, mortgage Credit expanded an unprecedented $1.001 TN in 2003. The Fed funds rate was reduced 25 bps in 2003 to end the year at 1.00%. Mortgage Credit was up to $1.466 TN in 2005, yet rates had only been increased to 4.25%. 2006 saw growth of another $1.4 TN, along with $1 TN of subprime derivatives. Financial conditions remained ultra-loose until the subprime eruption in the summer of 2007.

The Fed’s failure to tighten policy and rein in mortgage-related excess was a monumental Policy Mistake – one that led directly to the post-Bubble introduction of QE. And then the Fed stuck with zero rates until the end of 2015. Rather than “exiting” its bloated post-crisis balance sheet, the Fed had doubled holdings again by 2014 to $4.5 TN. And despite booming markets and a recharged economic expansion, Fed funds didn’t return to 1% until mid-2017. By September 2019, with record stock prices and multi-decade low unemployment, the Fed reinstituted QE. The epitome of a Policy Mistake begetting only greater Policy Mistakes.

It’s easy to brush off this week. Contemporary central bankers simply partaking in contemporary central banking. No harm, no foul. But I see it much differently, with central bankers out this week with the huge backhoe digging a hole so deep we’ll never find our way out. I was reminded of Bernanke back in 2013 “pushing back against a tightening of financial conditions” – signaling to markets that the Federal Reserve would not tolerate weakness or corrections.

The big central banks this week signaled they will push back again rising rate expectations and market yields – essentially intervening in the markets to quash market adjustment to surging inflation risk. I have major issues with this. For one, market discipline is today all we have between reckless fiscal and monetary policies and any hope for a future without financial and economic chaos. Financial conditions must tighten, or inflation will run wild. Secondly, today’s artificially low rates and manipulated market yields are fueling precarious Bubbles and market manias. There is no justification for continuing with zero rates and huge monthly QE liquidity injections.

It’s tiring to hear chair Powell repeatedly fall back on the Fed’s “dual mandate of stable prices and full employment”. Give us a break.

“In 1977, Congress amended the Federal Reserve Act, directing the Board of Governors of the Federal Reserve System and the Federal Open Market Committee to ‘maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.’”

In no way did this amendment grant the Fed carte blanch to print Trillions. The crafters of this legislation had in mind the Fed restraining money and Credit growth to ensure monetary and price stability. And for the Fed to use its full-employment mandate these days as justification for zero rates and QE is also making a mockery out of that mandate.

The economy created 843,000 new jobs over the past two months. October’s 4.6% Unemployment Rate is down from June’s 5.9% and the year ago 6.9%. Average hourly earnings were up 4.9% y-o-y. The September trade deficit surged to a record $80.9 billion. And for a services-dominated U.S. economic structure, this week’s ISM data confirmed an overheated economy. Exceeding estimates by almost five points, the ISM Services Index surged to an all-time high 66.7 (data back to 1997). New Orders and Business Activity components also jumped to record highs. Backlogs and Export Orders jumped. Prices Paid rose to the high since 2005. “Demand shows no signs of slowing.”

Powell: “We have not focused on whether we need to [discuss the] liftoff test, because we don’t meet the liftoff test now because we’re not at maximum employment. What I’m saying is, when – given where inflation is and where it’s projected to be, let’s say we do meet the maximum employment test, then the question for the committee at that time will be “has the inflation test been met”, and I don’t want to get ahead of the committee on that.

Bloomberg’s Matthew Boesler: “So, when you’re looking at this question of assessing whether or not the U.S. economy is at maximum employment, do you have a framework for making that judgment that is independent of what inflation is doing? And if not, does it complicate that assessment given all of the uncertainty about inflation right now and the inclination to believe that the high inflation we’re seeing is not related to capacity utilization in the labor market?

Powell: “So, we don’t actually define maximum employment in terms of inflation. Of course, there’s a connection there. Maximum employment has to be a level that is consistent with stable prices. But that’s not really how we think about it. We think about maximum employment as looking at a broad range of things. You can’t just look at, unlike inflation where you can have a number, but with maximum employment you could be in a situation hypothetically where the unemployment rate is low, but there are many people who are out of the labor force and will come back in. And so, you wouldn’t really be at maximum employment because there’s this group that isn’t counted as unemployed. So, we look at a range of things, and by many measures we are at a very tight labor market.”

I’m not sure why Powell used “hypothetically.” The Fed today disregards its stable prices mandate in favor of some nebulous full employment concept, specifically focused on the unusually large number of workers who left the workforce during the pandemic. Powell: “They’re holding themselves out of the labor market because of caretaking needs or because of fear of COVID or for whatever reason.” That’s an issue, of course. And how many millions are enjoying working from home at their new careers as online traders of meme stocks, ETFs, options and cryptocurrencies? How many have retired early after seeing their investment and trading accounts inflate spectacularly? It is a grievous Policy Mistake to disregard inflation while focusing on labor market holdouts.

I was again this week reminded of Adam Fergusson’s masterpiece, “When Money Dies: The Nightmare of Deficit Spending, Devaluation, and Hyperinflation in Weimar Germany.” On my initial reading, I was struck by how Reichsbank officials held to the belief that they were responding to outside forces and were not responsible for surging prices. The Fed blames COVID, global supply shocks and other factors beyond its control for temporarily elevated inflation. Do they honestly believe they can print $4.8 TN in 112 weeks without unleashing powerful inflationary dynamics?

Matthew Boesler: “And if I could just follow-up briefly… You talked a little bit about this possibility that the two goals might be in tension and how you would have to balance those two things. Could you talk a little bit about what the Fed’s process for balancing those two goals would be in an event that, say come next year you decide there’s a serious risk of persistent inflationary pressures…?

Powell: “It’s a risk management thing. I can’t reduce it to an equation. But, ultimately, it’s about risk management. So, you want to be in a position to act to cover the full range of plausible outcomes, not just the base case. And in this case, the risk is skewed for now; it appears to be skewed toward higher inflation. So, we need to be in a position to act in case it becomes necessary to do so or appropriate to do so. And we think we will be. So that’s how we’re thinking about it, and I think through that, judgmentally too, it’s appropriately to be patient. It’s appropriate for us to see what the labor market and what the economy look like when they heal further.”

Euro zone CPI hit 4.1% (y-o-y) back in July 2008, boosted by crude that had skyrocketed to $140. The ECB in July 2008 couldn’t anticipate that Lehman and crude would soon commence epic collapses. They adopted a risk management approach, moving incrementally to tighten policy – to push back against elevated inflation – and then reversed course with rates down to 2.0% by December. The profound impact monetary stability has on all aspects of financial, economic, social and political wellbeing demands conservative central banking doctrine and cautious policymaking. Do no harm. Above all, no big Mistakes.

The Fed and the global central banking community today inflict great harm as they proceed on the greatest monetary policy blunder the world has ever experienced.

The Wall Street Journal’s Michael Derby: “I wonder if the Fed has given any thought yet to the end game for the balance sheet, in terms of once you get the taper process complete. Will you hold the balance sheet steady or will you allow it to start passively winding down? And then in a related question, do you have any greater insight into what Fed bond buying actually does for the economy in terms of its economic impact?”

Powell: “So in terms of the balance sheet, those questions that you mentioned. We haven’t gone back to them… In terms of the effect of asset purchases on the economy, so there’s a tremendous amount of research and scholarship on this and… you can find different people coming out with different views. But I would say the most mainstream view would be that you’re at the effective lower bound, so how do you affect longer-term rates. There are two ways, one – so… let’s say you can’t lower rates any further hypothetically. So, you can give forward guidance, you can say we’re going to keep rates low for a period of time… The other thing you can do is just go buy those securities, buy longer-term securities. That will drive down longer-term rates and hold them lower, and rates right across the rates spectrum matter for borrowers. So lower rates encourage more borrowing, encourage more economic activity…”

It’s readily apparent what Trillions of monetary inflation do for securities, crypto, and asset prices – for speculation and feeding a mania. The euphoria of a record equities market run and Dow 36,000. It’s easy. Buy and hold. Never get shaken out. Don’t worry about Mistakes. Don’t worry about anything. And by the end of the week, market pundits celebrated how adeptly Powell had orchestrated a taper without even a whiff of tantrum. As the arbiter of Fed policies, markets exclaimed, “no Mistake here!”

I would worry about the dynamics fueling this market Bubble. Below the surface, it’s turning messy. Another big short squeeze melt-up in equities, along with another painful bond market squeeze. Scores of levered trades and strategies in mayhem. Dangerous market dysfunction. And there’ll be a huge price to pay for ongoing aggressive Fed support for manic markets. Perhaps even a larger cost to a bond market that cannot adjust to surging inflation because central banks believe it’s within their mandate to manipulate markets. This week’s market action only solidifies my view that when markets eventually do adjust, it’s bound to be violent.

November 5 – Financial Times (Laurence Fletcher, Tommy Stubbington and Kate Duguid): “The era of unlimited central bank largesse is drawing to a close, injecting intense volatility in to government bonds and inflicting heavy damage on a clutch of high-profile hedge funds. Superstars of the industry have been left nursing billions of dollars in losses after an abrupt rethink on how and when central banks will reverse the huge wave of support they provided to markets when the pandemic hit last year. Initially, central banks said that process would be very slow, despite soaring inflation, and hedge funds believed them. But markets began to fret last month that the US Federal Reserve and other central banks would have to raise interest rates more quickly, wrongfooting high-profile traders including Chris Rokos and Crispin Odey. An intense sell-off in short-term government debt upended some of these funds’ biggest bets…”

Original Post 6 November 2021


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