Thursday, December 31, 2015

A Preliminary Fed Report Card

A grade of F would seem generous.  Aside from the funds rate and the repo rate, for which the Fed has become a perfectly elastic demander and supplier, all other market rates in the American economy are lower today than they were before the "Fed raised rates."

What does "raising rates" mean these days?  Obviously it doesn't mean raising rates determined in the free market, as those rates were now lower since the Fed took its actions two weeks ago.

So, an F would seem generous.  Maybe an I for irrelevant would be more appropriate.

Banking and Free Markets

American financial institutions were once the envy of the world.  Average returns over the past 120 years in American stock markets have exceed 10 percent per annum, meaning that the average person with a diversified buy and hold strategy could have expected to double their money every eight years.  Private commercial banking fueled the enormous economic growth of the United States, despite the Great Depression and the Second World War.  The American middle class thrived and real wages in America soared past others in the developed and undeveloped world.

This is a record of unassailable success.  It was no surprise that the rest of the world began to emulate the American model. The Soviet empire crumbled, mostly because their economy was worthless.  Big government couldn't create a "workers' paradise" after all.

Europe rode the wave of the powerful American economic engine, in spite of its politicians.

Finally, Asian economies began their liftoff in the last two decades of the twentieth century and, as the new millennium approached, it appeared that peace and prosperity were permanent features of the American landscape.

That was then.  In scarcely a decade and a half, all of that promise of economic growth and economic freedom has given way to government overreach and economic stagnation.

Banking is probably the most interesting example of how big government can kill off free enterprise.  Banking once was a private business, but in the 1930s when more than one-third of all US commercial banks failed, the government initiated a deposit guarantee program and ushered in a regulatory regime that, at first, seemed almost benign.  Many banks weren't federally regulated at all, even after the 1930s.  The result: an enormous economic recovery that, by the mid 1960s, made America the economic envy of the world.

Gradually, over time, banking regulations increased, mostly from political motivation.  The Community Reinvestment Act is the poster child of government interference in banking.  This act has been used mainly to extort funds from banks to fund pet projects of politicians.  This seemed to be the signal that banking was no longer considered to be a private sector entity.  The sweeping Dodd-Frank legislation and the regulatory environment initiated by the Obama Administration all but eliminated lending decisions by bankers.  Regulators took over.

In China, the state controls the flow of bank loans.  The same is now true in the US.  Banks are no longer free to lend to who they want to lend.  They lend to who they are told to lend to.

As a result, commercial banking in America is now simply one more arm of a growing and grasping government distributing spoils to its friends and punishing its enemies.

What is replacing this now stagnant and politically polluted American (and European) commercial banking system is the rise of shadow banking -- lenders who aren't told who to lend to and how much to lend.  This started with hedge funds, but is growing to a variety of non-bank lenders who have moved heavily into mortgage lending both residential and commercial and are making major inroads into traditional commercial lending.

In time the market will move to shadow banking as traditional banking is seen as nothing more than an arm of the US government.

The same pattern shows up in investment banking as traditional market making activities  have been largely outlawed by Dodd-Frank, These are the market making activities that accompanied the extraordinary stock market returns of the past 120 years. Regulators could care less if the American stock market performance is now poised to mirror American economic performance -- pitiful at best.

It almost seems as if the Obama Administration was angry at the extraordinarily positive results of American economic growth -- historically 4 percent even after accounting for the 1930s and the 2007-2008 slump.  The Obama Administration now cheers an Obama record of 2 percent economic growth -- a growth rate that implies a declining real income for most Americans. Maybe if the Obama folks can get growth down to zero, they would really have something to celebrate! 

Economic stagnation and government run banking is the new normal in America.  You can hike the minimum wage to whatever level you desire and it will not improve this situation -- in fact, it will make the situation far, far worse (and has already done so).  Taxing the rich won't matter either.  As you transform your economy to the old Soviet and old China models, you will get the same results they got -- economic stagnation and declining living standards.

As for the stock market, forget it.  S&P earnings declined in 2015 as compared to 2014 and look for a similar pattern in the New Year.  S&P earnings ultimately have to fall in line with economic growth.  That does not spell a good future for the American stock market or the American middle class.

Now that both major political parties have given up on free markets and economic growth, the new agenda will increasingly be: how to divide up a dwindling pie.  That means politics will get more divisive and free markets will continue to be under attack from politicians.

That said, let's hope that entrepreneurs find a way around the shackles that now bind the American economy.  Technology and energy forestalled a complete economic stall since 2009. Technology and energy seem to be in trouble now, just as the most deleterious effects of ObamaCare are set to deal another body blow to the American economy.

Forget the Fed. What the US needs is the return of free markets.  Absent that, the future looks dim.





Thursday, December 24, 2015

Why Do Economies Prosper?

You would think that economists would provide a good answer to the question as to why one economy does better than another.  A simple enough question.

Is it really that one country has a better Fed policy than another?

Does monetary policy really matter at all?

Prior to the twentieth century, there wasn't much serious "monetary policy."  Yet, some countries managed very high rates of economic growth while others remained stuck in the mire.  The US, as it surged to world prominence in the latter half of the nineteenth century didn't have a central bank, much less any kind of monetary policy.  Yet, the US grew far faster than Germany and the UK, in spite of no monetary (or fiscal) policy.

So, economies can grow at differing rates, without regard to monetary or fiscal policy -- certainly they did so in time periods when there was no real monetary or fiscal policy to speak of.

The pitiful economic results of the developed world since 2009 are often discussed  in terms of monetary and fiscal policy.  Why?  Could different monetary and fiscal policies have made any real difference?

If it takes three years to get the various levels of approvals to open a new business and get appropriate zoning and licensing accomplished, what difference does it make what the target federal funds rate happens to be? 

If a young ghetto resident in Baltimore wanted to open a "legal" lemonade stand in West Baltimore, how many months would it take to get the appropriate approvals in Baltimore, assuming it could be done at all?  If that same ghetto resident approached a business asking to trade hours of labor for job training, how long before the federal and state officials would put both in jail for violating the minimum wage laws.  Where, in this discussion, does monetary and fiscal policy come into play?

If regulators intervene to prohibit certain transactions because they don't fit their imposed guidelines (think mortgages, consumer credit), then who cares what monetary and fiscal policy is doing.

Economists seem to think that if government prohibits all economic transactions of any kind, that the economy can hum right along anyway so long as monetary and fiscal policy are tuned to the right dials.

In short, according to modern economists, real world conditions of laws, regulations or the lack of the rule of law, just don't make any difference.  If banks are prohibited from lending, somehow commercial loans should expand anyway, so long as the funds rate is set appropriately.  If workers are forbidden by law to take a job that pays less than some politician thinks it should, then who cares as long as the target funds rate is sufficiently low.  If punitive restrictions on certain industries (coal comes to mind) creates massive pockets of unemployment and hardship, what difference does it make so long as the Fed is accomodative.

Why some countries prospered in the 17th, 18th, and 19th century, while others didn't, must be a great unfathomable mystery to the modern economist who lives or dies by monetary and fiscal policy, since monetary and fiscal policy were non-existent way back them.  Nevertheless, in the real world, some countries prospered while others stagnated long before economists invented monetary and fiscal policy.  Not much has changed.

Wednesday, December 23, 2015

So Much for Climate Change

The politics of climate change has been dealt a severe blow by the abundance of fossil-fuel energy that appears not to be going away anytime soon.  If gas and oil are cheap, then people will use more of them...and they are.  The alternative energy businesses have been savaged by the declining prices of fossil-fuel energy.

What kind of cars are people buying?  The big, old gas guzzlers!

By painting climate change as apocalyptic and letting the developing world do whatever it wants, it is very clear that the developed world is not going to make the sacrifices that the Paris agreement wishes for. 

The failure to provide a reasoned, bi-partisan approach to the issue of climate change has made climate change a hot-button partisan shouting match.  Arbitrary actions by the EPA and by the Obama Administration will be reversed by the next Administration, regardless of which party occupies the White House.  The public will not be willing to return to stone age economics while the rest of the world passes it by.

Europe has already abandoned almost all of its green initiatives.  The US will follow suit within 24 months when saner and less partisan folks occupy the White House.

Only then, perhaps, can we have a serious discussion about climate change.  Hysterics and arbitrary decrees won't get anything done. The public must be convinced with reasoned argument and legitimate science that there is a real problem before the political will can be mustered to sacrifice economic growth for what might be nothing more than an academic illusion.

What Fed Rate Hike?

You and I don't borrow federal funds.  Federal funds are cash reserves traded only between commercial banks.  So, does it really matter what the federal funds rate is?

The answer is: normally yes.  But, not now.

Normally, the rate of interest on federal funds is increased by reducing the amount of federal funds in the system so that banks have to scramble to meet their legal cash reserve requirements. That's not what happened ten days ago when the "Fed raised the target federal funds rate."  No, indeed.

There are $ 2.5 trillion in excess cash reserves sloshing around in the commercial banking system, thanks to QE1, QE2, and QE3.  No bank needs to borrow reserves from anyone.  So, the Fed now pays 50 basis points (1/2 of one percent) on commercial bank cash reserves.  Thus, no rational bank would loan its reserves to another bank for less than 50 basis points.  Voila.  The target funds rate is raise by this strategem.

The problem:  no other rates get raised, because there is no "tightness" in the credit markets induced in this artificial manner.  Other than non-market rates, like prime rates, all other rates are lower today than they were before the "Fed raised rates."

This is like me going into a closet and announcing that I am raising the rate that I will charge my children to borrow money from me.  How does this affect the rate my neighbor is going to pay on a car loan or a home mortgage?  Answer: it won't.

The Fed has made itself irrelevant.  That doesn't mean the financial media won't remain obsessed with fed watching as opposed to checking out supply and demand to figure out the future direction of interest rates.  The Fed no longer matters in the real world (except that they have $ 3 trillion in securities hanging over the market).

Sunday, December 20, 2015

Limping Into the New Year

After seven years of an absurdly slow-walked economic recovery, the economy looks ready to slide backward.  In prior recoveries, it took two years to accomplish what this recovery has not yet accomplished in seven years.  And, now it appears to be over.

The Obama Administration, surprisingly, is taking a bow for this pitiful showing and Hillary Clinton changes the subject.  The usual excuse for this poor economic performance is the severity of the 2008 financial collapse.  A better explanation is the incredibly stifling government response to the 2008 crisis that culminated in the passage of the infamous Dodd-Frank legislation. 

Dodd-Frank guaranteed that commercial lending would never be adequate to fund a decent recovery and its passage inspired an out-of-control Justice Department to extort billions of dollars from financial institutions to dish out to Obama-Clinton political allies.  Why, no recovery?  The real surprise is that the American economy was able to show a pulse at all with the hammering given it by the Obama Administration and their allies.

Both Republicans and Democrats alike seem to have given up on the idea of an American economy regaining its footing.  The Paul Ryan spending compromise that recently passed Congress is a concrete example of the capitulation of Republicans to the stifling policies of the Obama crowd.

So, what does 2016 portend?  Consider first that S&P earnings in 2015 were below the level of 2014 and things could get worse in 2016.  The one thing that has gone up (besides the number of people who have given up trying to find a job) is the stock market, which has nearly tripled in value since March of 2009.  But, in 2016, the stock market appears to be a loser -- not a big loser, but a loser nonetheless.

And what has 2 percent growth done for us?  Middle income disposable income has consistently lost ground since 2008.  Corrected for labor force participation rates, the employment market remains moribund.  There is no wage pressure, regardless of what Janet Yellen may think.  Poverty is higher and growing.  2 percent growth hasn't hurt the wealthy (Obama, Clinton, Buffett, Gore, etc.) but it has savaged the rest of the country.

So, what should economic growth be?  Historically, economic growth, leaving out the Johnson-Nixon 1970s, has been north of 4 percent.  But, given the pace of technological change and paradigm shifts (think Uber, AirBnb), there is no reasons that private sector economic growth could not exceed 8 percent on a sustained basis.  But, this cannot happen with Obamacare, Dodd-Frank, Sarbanes-Oxley, the EPA, the Department of Education, higher minimum wage laws, over-regulated economy and a lawless executive branch of government.

The poor, the disenfranchised have no hope in a growthless economy.  There is zero empirical evidence that government programs help poor people when the economy experiences limited or no growth.  The only thing that helps the poor, the disadvantaged, the middle class is robust economic growth, creating opportunities for individual advancement.  Slow growth merely shifts the deck chairs around.

No wonder the rich support slow economic growth policies.  The rich can maintain their position of hegemony over the masses.   This is George Soros' and Warren Buffett's dream -- pretend to help poor people but focus on policies that maintain their own personal economic power.  If Soros and Buffett think the tax system is unfair (as they claim), nothing prevents either of them from paying higher taxes voluntarily.  What conceivable reason, other than personal greed, prevents Soros and Buffett from doing exactly that?  Hypocricy abounds.

Meanwhile, the economy limps into the New Year with little prospect for improvement and a foreboding sense of coming danger.

Friday, December 18, 2015

Fed Raises Target Funds Rate But Little Else

Well, it is finally done.  Federal funds traded yesterday at 0.35 percent, up from 0.11 to 0.13 where it had been prior to this week.   How did this happen?  The Fed now pays 0.50 % on excess reserves deposited (by commercial banks) at the Fed.  It makes you wonder why anyone lends reserves to anyone else at less than 0.50 %.

In the good old days, the textbooks say, the Fed would raise the target on the funds rates by making reserves scarce (open market sales of treasuries were cited as the appropriate mechanism).  Scarcity in the funds market would then spill over into money markets and all rates would rise accordingly.  That was in the good old days.

This week's raise seems to have affected no other rates in the money market arena -- cd rates are unchanged, bill rates, treasury note issues all seem to have lower yields at the end of the week than earlier in the week.  So, besides funds and temporarily repo rates, of what significance is the Fed's raising its target funds rates.  Answer: apparently, zero.

Prime rates all jumped, but the prime rate is not a market determined rate and is often completely unrelated to the actual lending rates paid by prime customers.  This is probably just backdoor gouging by the commercial banks of their smaller customers.  No serious large lender would be impacted by a change, of any kind, in the announced prime rate.

Listening to Janet Yellen explain what the Fed was up to was interesting.  She thinks 2 percent growth is a sign of a good economy.  She did reference, indirectly, the strangling impact of Dodd-Frank on commercial lending.  She sees inflation as a major problem down the road.  Has no plans to reduce Fed's $ 3 trillion balance sheet.

So much for the Fed.  They have made the federal funds rate irrelevant.  Who cares what their target rate is?

Monday, December 14, 2015

The Fed Makes Itself Irrelevant

Apparently, the Fed intends to announce a policy of paying interest on excess reserve balances held at the Fed.  Since any bank thinking of lending its excess reserves to another bank will do so only if it could earn more than what the Fed is paying, then, almost by definition, the Fed can raise its target on the funds rate.  Whew!

But, so what?

Why would any other rates follow suit?  Most likely they won't.

But, what about repos?  Traditionally funds and repos have been joined at the hip, but paying interest on excess reserves may unhinge that relationship (or lead to a massive amount of excess reserves parked at the Fed as commercial banks arbitrage repos against funds).

But, regardless of what happens in funds/repo land, it is questionable whether other money market rates will be much impacted.  After all the banking system is awash in liquidity, even if the junk bond market is imploding for a lack of liquidity.  The over-kill of Dodd-Frank and the accompanying regulatory straight-jackets have all but eliminated the liquidity safety valves of the investment banks, as is all too apparent in the junk market.

Meanwhile, why is this of interest?  Nothing the Fed can do can get the American economy humming again.  Is there anyone out there who believes that it's inflation-fighting season?

Janet Yellen and the Fed are irrelevant and so also will be their activity on the rate front this week.  Other than the completely irrelevant fed funds rate, no other rates are headed higher, no matter how hard the Fed huffs and puffs.

Saturday, December 12, 2015

The Paris Climate Change Pact

The Paris Climate Change Pact brings the curtain down on what will be remembered as the last hurrah for the climate change crowd.  The Pact requires nothing of anyone.  But, the Pact pretends to reduce carbon emissions with a heavy dose of wishful thinking.

None of the signatories can currently afford their own national debt levels and domestic welfare burdens, much less commit themselves to an heroic belt tightening, that would be required to reduce CO2 emissions. In fact, the current lower trajectory of fossil-fuel energy pricing will increase CO2 emissions well beyond anything currently projected.  (But don't be surprised if temperatures fail to rise).

This is mainly a bunch of rich, disconnected and empty-headed politicians who have long since lost any grip on the economics of the real world.  In the real world, overly obtrusive government has shut down all of the major world economies. Only parts of China and Asia are still hopefully looking to the future.

In the US, minimal growth is now the accepted norm.  In Europe, zero growth is the accepted norm.  Frankly, there isn't a lot of difference anymore between the US and Europe -- neither has much of an economic future.

Batten down the hatches, because almost all of the developed nations in Paris will soon be paring back on their promises of retirement security and publicly provided health care.  Not a single developed country in the world can afford their current promises.  There is certainly no room to deal with climate change -- real or imagined.

Actual facts on the ground don't seem to matter to the wealthy activists who tout the climate change agenda.  That the poor would be ground into the dust if they got their way doesn't matter to these activists, who mainly focus on the pose they strike preening in front of the world's adulating press.

So, Al Gore can step back into his fancy jet and continue polluting the atmosphere more in a couple of hours than most people do in a lifetime.  Then, Gore can return to his palatial estate in the US and sit back, Scrooge-like, in his bathtub of billions.  That's the life of the modern day environmental activist.

Saturday, December 5, 2015

Climate Change Politics

Ever since industrialization began more than three centuries ago, there are always those who say:  "Whoa, lets stop all of this."

Invariably those who advocate stopping all of this are already quite wealthy themselves and are perched on top of the economic pile.  As Europe and the US went to Paris as the wealthiest countries in the world, they looked down their noses at China and India as Johnny-come-latelies.  "Lets stop all of this, but let us keep ours," say the US and Europe.

No one knows if the globe is really warming or not.  The globe is always either warming or cooling.  I guess that's why the left has adopted the notion of climate change, since it is nothing more than a truism -- the climate is always changing.  Who can argue with that?

But, what to do?

According to the climate change crowd, nothing will really do the trick unless all carbon emissions are halted permanently.  For China and India, that means mass famine.  For the US, that means major increases in poverty and a dramatic fall in standard of living of average Americans, except for the chosen few (those already wealthy).  This seem like a pretty high price to pay for something that, as yet, is little more than speculation.

If it is that big an issue, why don't those who believe it stop polluting the atmostphere with their personal jets and limousines?  Are they exempt?

Environmental activists tend to be very wealthy as a group.  They tend to be major polluters themselves.  Yet, somehow, environmental activists feel that as long as they say the right things, that the reality of what they are doing is irrelevant.

But, for the rest of us, reality matters.

Read "Green Gone Wrong" to get a true taste of what havoc on the environment is directly caused by environmental activists and the implementation of their policies.  It's pretty clear from author Heather Ross, an environmental activist herself, that thus far, environmental activism has mainly served to damage the environment, no matter high-minded the motives of such activists might be.

As in many other things, activism itself is usually mainly an exercise in egotism, not a cure for what ails the planet.

Friday, December 4, 2015

Draghi and the Economic Mess in the Eurozone

You would think that politicians can conjure up economic growth by waving magic wands.  Look at the Eurozone.

Mario Draghi, the head of the European Central Bank (ECB) announced a further drop in the central bank's lending rate from minus -0.3% to -0.4%.  They now pay banks even more to borrow their money.  But, guess what, no takers.

Commercial lending in the Eurozone remains mired below levels achieved in 2008.  Economic growth in the Eurozone is non-existent and several Eurozone economies are imploding (Greece is not the only one).

Why no growth?  Why no commercial lending?

Read Keynes again.  Keynes spoke of "animal spirits" that animate entrepreneurs to embark on starting new businesses and expanding existing businesses.  For the Eurozone, "animal spirits" are a thing of ancient history.  Most of the GDP in a typical Eurozone country is government or government-satellite businesses.  Such businesses only grow by increased taxpayer funding. 

No one working for government has any incentive whatsoever to improve productivity.  Often, as a recent study of US government employees demonstrated, large numbers of government employees don't even have the incentive to show up for work. 

So where is the economic growth going to come from -- lowering ECB lending rates? 

The bankruptcy of modern macroeconomics is that there is an underlying assumption that the rule of law and the regulatory environment don't matter.  In the US and the Eurozone, a large part of government activity is devoted to shutting down private economic activity. In this endeavor, the government has achieved its greatest success. 

Modern US and Europe no longer have economic growth of any substance.  Government bureaucrats have killed off economic growth.  The Climate Change crowd actually proposes substantial negative economic growth as the cure to, what they say, ails the planet. 

So, don't expect the return of normal, say 4 percent, economic growth any time soon.  The great uplifting effect of economic growth is gone.  Those in poverty will remain there. Those at the top of the stagecoach -- Clintons, the Al Gores, the George Soros's, the Michael Moores --will remain atop the stagecoach cavorting around in their sleek jets and limousines, while loudly decrying the evils of the rich (all, except themselves, of course).

These folks don't need economic growth.  They already have their huge share of the pie and they are not about to put their hegemony at risk by permitting economic growth, so that the poor and middle income can prosper.

It is worth noting that, as a matter of history, government economic policy has never, ever produced any economic growth of substance.  Economic growth in the US was its highest in the period from the end of the civil war to the beginning of World War I -- a period in which the US middle class became the economic envy of the world.  There was no government policy at all during this period of dramatic economic growth and no central bank at all.

Only when government decided it knew how to "fine tune" the economy to produce economic growth did American economic growth rates begin to collapse.  We have now learned to accept little or no economic growth without even asking questions.

So, Draghi and Yellen can do whatever they want.  It won't matter.  As Keynes noted, without "animal spirits," there can be no economic growth.

Wednesday, December 2, 2015

A Toothless Fed

For four years, the Fed has been suggesting a forthcoming rate rise.  Once again, a rate rise is expected in the next two weeks by 70 percent of prognosticators.  Will it happen? Not likely.

The massive excess reserves in the commercial banking system, put in place by the various QE's, makes it unlikely that the Fed can do much of anything but hope and pray that rates, on their own, will drift higher. 

The Fed has been waiting for this to happen for years.  The market is unlikely to accommodate the Fed in the next two weeks, so don't expect a Fed rate rise in December.