2016/09/23 Commentary: Infuriatingly Academic (late)
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COMMENTARY: Friday, September 23, 2016
Infuriatingly Academic
This is a very pointed ‘macro’ follow up to our extensive post-Jackson Hole reviews of why the FOMC was NOT going to hike Wednesday afternoon. Please see Tuesday evening’s Commentary: FOMC Won’t Hike post and all previous recent posts for our extended reasoning on the US and global weakness that is rightfully restraining the Fed. This remains disconcerting in the wake of all the hawkish rhetoric since before and after last December. The picture of Chair Yellen is not from Wednesday afternoon’s press conference, but rather her February 24th congressional testimony. It makes plain just how hawkish the Fed remained after last December’s first hike in almost a decade.
And of course, not all areas are infuriated. In fact, equities are rightfully rather elated on the seeming return of a full ‘Goldilocks’ psychology on the FOMC ‘no action’. Govvies are also very firm on the absence of any upward pressure on short-term yields, as only the disappointed asset is the US dollar that had been hoping for the FOMC hike. While the weakness of the latter has been relatively limited against developed economy currencies, the more rate sensitive emerging currencies have extended the rallies which started recently on the evolving expectation that the FOMC would not indeed hike Wednesday.
So what is so upsetting about what the Fed is or, more appropriately, is not doing? Certainly the full FOMC statement (our mildly marked-up version) and projections provide good reasons for the Fed’s continued circumspection in spite of upbeat economic rhetoric. And Chair Yellen certainly provided a credible, in-depth and nuanced explanation of how various factors have combined to encourage a bit more caution (more on that below.)
Yet there was also another seemingly minor yet overall very telling indication on “other policymakers” becoming involved. This leads to a very pointed question we will revisit below on why the Fed isn’t doing more to encourage actions necessary to improve the US (and global) economy that would solve the low growth and low inflation problems.
Yet first to illustrate it is not necessary to be a politico-economic or finance expert to understand the real problem, note this recent shift in US public opinion…
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NOTE: Back on the evening of December 8th we posted our major Extended Perspective Commentary. That reviews a broad array of factors to consider Will 2016 be 2007 Redux? For many who believe that the US economy is really strengthening and can once again lead the rest of the world to more extensive recoveries, this may seem a bit odd.
Yet there are combined factors from many areas we have been focused on since the early part of last year which are less than constructive for the global economy and equity markets. We suggest a read if you have not done so already.
We pointed out in December in the face of another likely Santa Claus Rally this was not an actionable view during the year-end equities rally. Yet it was (and remains) important background to utilize into 2016. This is much like our major late 2006 perspective on Smooth Rebalancing? …or… The Crash of ‘07? In that instance the economic factors built up, but the actual crash was deferred into 2008. It is starting to feel this one may be deferred as well.
▪ …which is also good food for thought as we head into the first of three US Presidential debates on Monday evening (20:00 CDT, 25:00 GMT.) Especially note that one of the already announced select topics will be “Achieving Prosperity.” The recent Gallup poll (ironically also published on Wednesday) shows that more Americans want political compromise to finally accomplish something in Washington DC. Undoubtedly this means some attention to the economy and business, which have been plagued by a lack of any action on a blatant need for corporate tax and regulatory reform.
While the Republican Congress seems great at griping about the use of various means to deter corporate ‘tax inversions’ (change to non-US domicile to lower corporate tax bills), that still does not encourage any domestic US business investment. And as noted again in a couple of recent posts, structural reform that encourages business investment is likely the only thing that matters. Compromise that delivers meaningful tax reform is the only constructive path to more aggressive hiring, and essential productivity and wage growth.
More Important Than Rate Changes
It is far more important than either any new fiscal stimulus or the next 25 basis point change in official interest rates. This is already evident from all of the excitement that has attended previous central bank rate moves, even into negative territory. Yet those have elicited almost no economic strength or hiring and wage improvement.
While we have already shared it recently, the far greater importance of structural reforms was expressed by Waste Management CEO David Steiner guest hosting CNBC Squawk Box two weeks ago. As the head of a firm who needs to deal with his firm’s tax situation and environmental regulations all of the time, and also has solid real economy views on investment and hiring his comments are worth viewing.
Reasons for Constructive Sentiment Change
As the Gallup poll notes, “Americans continue to want their leaders in Washington to find a way to compromise and get things done rather than hold out for what they believe at the cost of inaction.” It also notes, “The current 21% of Americans who prefer that their leaders stick to their principles is the lowest Gallup has recorded; 28% in 2011 was the highest.” And after noting that Democratic and Democratic-leaning respondents were actually less flexible than in 2014, it goes on, “Republicans increased interest in compromise could reflect House Speaker Paul Ryan’s apparent interest in passing legislation rather than holding out for specific provisions at all costs.”
For any of our readers who might not be aware of the US political context, Paul Ryan was the 2012 Republican Vice-Presidential candidate, and is generally considered one of the most highly informed government finance policy experts. If anyone would know how to fix the budget while providing constructive structural reforms, it is Ryan. This public opinion shift to allowing for more incremental compromise also likely signals the weakening of the rigid Tea Party (including the Senator Ted Cruz’ shenanigans) hold on the Right generally and the Republican Party.
Central Bank Kryptonite
As we have noted for a very long time (since our January 19th and 24th of 2015 It’s Lack of Reform, Stupid posts), without structural reform the massive easing and Brobdingnagian Quantitative Easing programs of the central banks alone would not restore robust growth. Beginning last year even the ECB’s Draghi has consistently warned the political class that all of the central bank effort only reinforced seasonal recoveries. Without structural reforms there would logically be no transition into sustained structural growth.
We believe part of the problem is that central bankers are still happy to maintain their title initially assumed by the rightful and effective Federal Reserve rescue of the US and global economy in 2008-2009: Superman! What the central banks and political class have failed to acknowledge along the way is that there is a major difference between economic triage in a crisis and whether the same rate accommodation and extended QE can restore the sort of strong economic growth from prior to the Crisis.
It would seem that Federal Reserve Superman (along with other now over-extended central banks) has stumbled on its form of Kryptonite: that lack of interest by the political class in pursuing the necessary yet painful structural reforms necessary to reinforce the central bank programs. The highly partisan political classes in most countries are content to alternatively damn the central bankers for extremely low interest rates that stress banks and punish savers, yet back off when central bankers (especially Mario Draghi) point out the real problem is lack of growth due to deficient government policies.
Confirmation Central Banks Off Track
While it has been somewhat frustrating realizing that structural reform would be necessary since early 2015 and not hearing anything from the key financial operatives, the broader perception has been increasingly shifting toward that view. As noted repeatedly since last fall, the ECB’s Draghi has been very consistent in his pointed focus on the necessity of structural reform.
And just last week, in fact on the day before the FOMC ‘no action’, there was a very impressive Letter to the Editor of the Financial Times. That was from the estimable John Eatwell and John B. Taylor. For the uninitiated they are respectively the President of Cambridge’s Queens College and the Stanford professor who was also a member of the President’s Council of Economic Advisors under Ford, Carter and George W. Bush as well as Under Secretary of the Treasury under the latter. He is generally considered a very well-informed expert on central banks and their policies.
The Monetarist tools have failed to lift economies letter (our marked-up version) points out that there has not only been no effective address of the economic weakness from the extended extreme central bank actions, but also the potential for “…collateral damage to central bankers’ reputation.” Of course, we already believe that has occurred (see the Fed has No CRED!! link near the top of the sidebar.)
More telling and pointed is their insight, “A balanced approach… would secure improved performance of the real economy and permit the return of a rational monetary policy.” And then the coup de gras, “…central banks (have been) pushed into being multipurpose institutions beyond their range of effective operation.” While it has been a long time coming, it is encouraging to hear this assessment from such well-respected observers. Yet the mystery is why a Fed that is likely aware of this hasn’t done more to spur action from the so far totally lame political class?
Fed is Well Aware of the Problem
And it is not like Janet Yellen does not appreciate that the most troubling aspects of the weakness in the economy (labor market slack and low wages) are something the political class needs to address beyond anything the Fed can do. There was specific discussion of this at Janet Yellen’s February Congressional testimony and Q&A. While she should have been aware long before that time,
As noted in our April 10th Broken Promise post, “the most financially enlightened members of Congress came to Janet Yellen’s defense at her February Congressional testimony and Q&A. While there was criticism of the Fed for the lack of greater economic strength and higher wages, some of the more economically savvy politicians allowed that they are in good measure to blame for the lackluster nature of the current US economic situation. It is not surprising especially in the Senate that folks like Robert Corker (also a very successful businessman), Patrick Toomey (successful currency trader prior to his political career) and Robert Menendez (a Democrat who has stood up to Barack Obama’s more outlandish positions) all shared their views that the Congress was responsible to create conditions of greater productivity and higher wages, and not the Fed.”
Current Lack of Desire to Enlist Help
This finally gets to our key question for the Federal Reserve in general, and especially Chair Yellen: Why aren’t the Chair and other highly regarded Fed minions pressing the political class for more constructive structural reform? It is becoming increasingly apparent that the global central banks have reached the end of their (very distended) radical accommodation and massive QE efforts without the desired economic response.
And it is clear in what might have been a minor aspect, yet with major implications, that the Fed understands the benefit of ‘other policymakers’ involvement if there is another crisis. That will be necessary due to monetary policy already being so distended toward the extremes beyond which it would not likely be effective. And the irony is that the Fed is the least challenged in that regard. What are the ECB and especially the BoJ that have already instituted negative interest rates (see the Eatwell-Taylor FT letter on that) supposed to do if another crisis should develop?
The Pointed Question
Referring back to page 13 of Chair Yellen’s Wednesday press conference transcript, she was very clear that it “…would be worthwhile for other policymakers to think about what role they could play in addressing negative shocks…”!!?? (our punctuation) Really?! That gets back to our very pointed question mentioned in the opening section for the Fed and especially the very well-regarded Chair:
Well in that case, why aren’t those ‘other policymakers’ being engaged aggressively (which is to say criticism as well as any constructive suggestions) to take the steps necessary to restore more robust growth rather than just question what they would do in a crisis?
Infuriatingly Academic
Is the Fed afraid that the politicians might react badly, and possibly diminish the Fed’s essential independence? Well, based on the lack of satisfaction with economic results of the Fed’s actions to date, that may happen anyway if economic weakness continues.
With the more enlightened folks in the political class already aware that the lack of productivity and wage growth is their failure (see above), it seems the Fed doesn’t have much to lose in challenging the political class to do its part. Whatever the reasons, the net effect of the Fed (and most other central banks’) penchant for positing theories that are endlessly referred to as the likely solution even when the problems persist seems…
…infuriatingly academic. With the exception of the ECB there seems to be little desire to drop down from the ivory tower and get into the muck with the political class to press them on the need for the constructive structural reforms that so many informed observers now allow is the only way to return to a robust economy… and rational monetary policy.
[The Evolutionary Trend View market indications remain the same as the Market Observations updated in Tuesday evening’s post on Wednesday morning.]
Thanks for your interest.
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