Welcome to Finance and Fury, The Furious Friday edition

I often wonder – Why the Fed/Central banks continue with polices that create a massive misallocation or resources and are hurting the economy more than helping – well – what If they cant stop or a collapse might follow

Central bank policies cannot be unwound without creating a market collapse

Central banks are focusing on inflation – but money printing has resulted in inflation of asset prices – not in consumer economy – no real business growth (despite markets going up) – limited wage growth and affordability issues – a bit of a mess

Situation, where the policy response is to lower interest rates to try to boost CPI through increased ability to spend more and businesses, can increase how much they sell for – i.e. basket of goods goes up – but doesn’t work as the printed money never ends up in the equation, as velocity of spending is needed-  if the money is in the financial system through sinking money into investments – then velocity of that under current model and measurement system – velocity is non-existent on those funds

This episode focuses more on the Federal Reserve

– they directly, and the USA being the economic powerhouse, and indirectly as well – control the economy now

  1. The irony of the modern economy – the “free market” in the USA is more centrally planned than the USSR could ever dream of
  2. Slowly becoming common knowledge that every single market is distorted beyond comprehension due to Fed policies
    1. Also – continued central bank intervention will only make the ensuing final crash that much greater, but nobody has any idea how to detach the Fed from capital markets not that they are so heavily invested
    2. Since 2008 – a lot of the market’s performance was due to the Fed – their “emergency” measures implemented post GFC are still being continued – Why? Have we recovered from the GFC or not?
    3. A decade and more has passed since the financial crisis, and crisis-era policies are not only still with us – they have been expanded. The $60 billion per month that the Fed is now purchasing for its balance sheet is a new record rate of asset accumulation
      1. Not to mention the other central banks conducting the same operations – like Japan and ECB
  3. Starting to look like we are now living through the third consecutive asset bubble in a row – this one “the central bankers’ bubble” which followed the dot com and housing bubbles om 2000 and 2008
  4. This bubble is fuelled by QE – This offers a conundrum – growth fostered by rising leverage can never be sustainable – you can massively increase your lifestyle – called a credit card – people do then boost lifestyle/consumptions on debt – but is it sustainable? After a little while, not so much –
    1. Gov/central banks aren’t the same as you and I – have much deeper pockets – i.e. all of ours – taxes, Gov Debt per person – as long as the population uses money – Central banks are owed that in repayment – as long as the governments can borrow – the population owes by extension owes money to the Government
    2. Why continue continuous printing – unsustainable monetary policy continues for one simple reason – to end it means a massive collapse –
    3. These monetary policies (like QE) – set up likely with intended consequences in mind – to provide confidence and boost asset prices through injection of cash (liquidity) into financial markets –
    4. But the unintended consequences undermining the sustainability of the current asset price regime are the real concern – it is a complex system – i.e. non-linear –
    5. Depending on where you stand – this was either another blunder by bankers to stumble into another trap – or the unintended consequences were intended as well
    6. Doesn’t matter – the same situation regardless – why better for those with power to have less ability to use it – best intentions don’t mean much when they end up in everyone else but you suffering – saying the road to hell is paved with good intentions 

 

Take a step back – before central banks got heavily involved

  1. When an individual worked – they received their paycheck – they consumed some of it and any surplus (savings) were deposited into a bank – this is then added to their pool of “loanable funds” which would then be auctioned out to a willing “bidder,” say a bank, a mutual fund, or a rental income opportunity – they then make an interest rate on this based around the market price of cash – which wasn’t set by Central banks – then in the 70s this system ceased
  2. But when the 2008 crisis hit, market-clearing levels for loanable funds rose massively –
    1. Created a situation where credit was priced out of reach for all but the most pristine (prudent) borrowers, asset prices were in free fall, and a financial system that had built an excess of leverage was at risk of implosion.
  3. Response by Fed – initiated a suite of policies that included QE. Technocratic justifications aside, QE enabled the “printing” of new loanable funds. Unlike the worker who had to provide something of value in exchange for receipt of his loanable funds, the Fed simply conjured new funds from the electronic ether, thereby massively diluting the existing private sector pool of loanable funds. Predictably, bank deposit rates tanked, credit spreads tightened and cap rates were yanked downwards.
  4. Of course, an asset price inflation spurred on by an expansion of credit is exactly what followed – That all changed with the 2013 “taper tantrum” and was reinforced by the 2018 abortive attempt by the Powell Fed to “normalise” rates and balance sheet so slowly that it was supposed to be like watching “paint dry.” Policies implemented as a response to crisis now can’t be exited without provoking the next crisis.

 

Monetary policies have become more of a problem than a solution 

  1. In basic economic – the supply side of any economy had the tendency through most observable times in history – to invariably configure itself to meet its demand-side – why having free-market supply is important – there will always be demand as long as people exist – supply makes it happen and through the growth of business (supply) – you get growth in demand’s capacity to demand (higher incomes)
    1. But when money is free – and you have the deepest pockets – you can monopolise, buy everything out – and create an oligopoly, where there is a state of limited competition and there are only a few companies that control the free market –
    2. Issue for these zombie companies – merger/buying activities spurred by artificially cheap credit will disappear once that credit is repriced. 
    3. Raising rates and normalizing the Fed’s balance sheet would now be tantamount to pulling the pegs out from the bottom of the Jenga tower.
      1. Fundamentally – the economy is reliant on central banking injections into the financial world – to remove this wouldn’t be possible without forcing changes -would force the supply side to adjust in response to demand and a likely recession would result –
      2. To look further at the corporate health of companies – Fed Policies Have Lifted P/E Multiples, Yet Aggregate Profits Have Stagnated

Central banks used to be viewed as the lender of last resort

– the bank of commercial banks where if one was suffering liquidity issues – CB would lend to commercial banks –

  1. Today – involvement is almost absolute – but the faith in the power of monetary tools to manipulate economic growth is severely misplaced – no different from communist/central planned economies
  2. The economic problem – finite resources with unlimited wants – economics core principle is the management of scarcity
  3. But economists in the CB don’t know what scarcity is – thus the focus has been on demand side policies which require an increase in the supply of credit
  4. How scarcity works in the real world – Beachfront properties in highly populated areas – Sydney Harbour, Hamptoms
    1. The supply and demand laws here market forces that balance the number of people who can buy oceanfront real estate to match the scarcity of oceanfront homes – not many people have $10s of millions – the supply is essentially capped – so prices are mostly reliant on demand and its constraints
      1. i.e. – How much people can demand through their wallets – high mortgage rates, boom times in home price, or loan underwriting standards
    2. Now let’s say the prices were dropping – fed would decrease the interest rate – or remove a few homes – to increase the price if it is below what they deem is reasonable – called to “stimulate” activity
    3. But now say prices got too high – they (if they could) – put up hundreds of houses –
  5. Economics without scarcity can be dangerous long term – but has its own theories
  6. Keynesian – point to the cause of rising real estate prices is “obviously” stimulative because higher prices spur such activities as home improvement adding revenue to the construction trades, one has to wonder: an instructive critique of this way of thinking can be found in the entertaining 19th-century treatise by Bastiat on the fallacy of the “broken window.” Wherever you might come down on the argument, the basic point is that trying to fool Mr. Market works about as well as trying to fool Mother Nature.
    1. If monetary policy were the key to earthly prosperity, surely all nations would have bootstrapped themselves by the simple artifice of helicopter money – high-income nations with a lot of taxpayers and legal system have – use the population as collateral on loans
  7. The unintended consequence – rather than igniting an economic boom – cheap and abundant credit has simply increased the asset prices relative to fundamentals – which haven’t changed by as much as the prices have – getting into the bubble territory
    1. I.e. profits for corporate America have gone more or less nowhere for five years –
      1. Through a combination of share repurchases, creating higher EPS increasing share prices, along with massive flows into indexes to increase demand on the lower number of shares – prices have gone up – but not based on the company performances
    2. Another flow-on consequence – covenant-lite loans have enabled private equity to purchase businesses at high multiples has been unprecedented – Cov-lite is financial jargon for loan agreements that do not contain the usual protective covenants for the benefit of the lending party – Covenant lite loans are typically used for leveraged buyouts and other large, sophisticated loan transactions – i.e. borrowing to conduct buybacks
      1. Cov-lite loans as a percentage of all newly issued institutional loans is about 85% in 2019 – been increasing every year since the major rounds of QE kicked off in 2011 – was almost 0% in 2004 – rose to under 10% in 2006 – jumped to 30% in 2007 just before the crash – then back to 5% post-2008 – bounced a little until 2011 when jumped back to 25% – then climbed all the way to 85% now
    3. Created situation where liability side of the company’s balance sheet can be profoundly altered by central bank policy – making it look more profitable – but long-term growth is a function of businesses operating and providing a good and service than reducing shareholder equity on the right-hand side of the balance sheet –
      1. Operational improvements work best when the incentives to do so are market-based – not when credit is artificially cheap – for instance – borrowing to increase assets and long term profits based around market demand –
  8. Continue to look at the health of the companies and markets next week –
  9. Next part – looking at market values that are there thanks to corporate debt – borrowing for buybacks
  10. And why Central Banks removing their credit or making it more expensive would result in market corrections 

Thank you for listening to today’s episode. If you want to get in contact you can do so here: http://financeandfury.com.au/contact/

 

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