A crisis-period experiment in QE came with profound repercussions. The Fed’s 2011 “exit strategy” was supplanted the following year by Draghi’s “whatever it takes” – and there’s been no turning back. The prospect of Whatever and Whenever It Takes QE as essential to the global central banker toolkit has Changed Everything.
The Fed has not only abandoned “normalization,” it has deserted its primary responsibility for safeguarding financial stability.
This is where the analysis turns absolutely fascinating – and becomes as important as it is chilling. The PBOC is at increasing risk of confronting the same predicament that other emerging central banks faced when their Bubbles succumbed: in the event of a mounting crisis of confidence in the stability of the financial system and the local currency, large central bank injections work to fan market fears while generating additional liquidity available to flow out of the system. “Everyone has a plan until they get punched in the mouth.”
Healthy markets would adjust and correct to reflect heightened uncertainties and deteriorating prospects. Speculative markets instead promote excess and the ongoing accumulation of imbalances, maladjustment and impairment. There’s no operable release valve. Pressure builds and builds – risks accumulate in all the wrong places – Then Panic.
At this point, markets have become quite enamored with the notion of Quadruple Puts – the Fed, Trump, Xi/Beijing and corporate buybacks. When historians look back at this period, they will surely be baffled by the markets’ capacity for disregarding major risks and negative developments. We’re at the stage of a historic – and especially protracted – cycle where it has repeatedly paid to ignore risk. Over time, the successful risk ignorers and dip buyers have ascended to the top. Risk-takers systematically rewarded; the cautious banished.
In my 30 years of studying Bubbles, a few things have become clear – I would argue indisputable: They always burst.
Beijing has had ample time to research Bubbles, yet they still have limited actual experience with Credit booms and busts. China has no experience with mortgage finance and housing Bubbles. They have never before managed an economy with a massively leveraged corporate sector – with much of the borrowings via marketable debt issuance. They have no experience with a multi-trillion (US$) money-market complex – and minimal with derivatives. Beijing has zero experience with a banking system that has inflated to about $40 TN – financing a wildly imbalanced and structurally impaired economy (not to mention fraud and malfeasance of epic proportions).
The fact that Fed President chose the Fed’s 1998 response to talk about is chilling. And why mention Autumn of 2020 as the length of time to keep “inflation” running high… what inflation is he talking about? Is he saying “Mr. President, we will keep the stock market bubble inflating until the election”? Absolutely. Why? So the Fed can stay “independent”.
As we are witnessing again in early-2019, when “risk on” is inciting leveraged speculation markets create their own self-reinforcing liquidity. It is when “risk off” de-risking/deleveraging takes hold that illiquidity quickly reemerges as a serious issue. And I would argue that it is the inescapable predicament of speculative Bubbles that they create ever-increasing vulnerability to downside reversals, illiquidity, dislocation and panic.