Tag Archives: Fed

Chart of the Week

This, below, is the best chart of the week. It’s like an optical illusion. You have to stare at it for a while. Note that the right scale is inverted. Tweeps were quick to confirm their favorite political theories – George Bush “put the economy in a ditch,” Obama never “created or saved” any jobs. Jeremiah debunks president centered economic theories here.

EmploymentThe point of plotting both these lines is to show that one of them is bogus. The blue line is the one that’s economically relevant. The black line, U3 Unemployment, is a proxy measure for the blue one. What is astonishing is that U3 held up so well for so long. All serious observers have switched to U6, nonfarm payroll, and labor force participation. Even if you’re looking at NFP, you have to crack the report and look at the categories.

No one takes the headline numbers seriously, especially not U3. It’s not technically wrong. It’s just irrelevant, and then CNN serves it up as feel good propaganda. The Fed has kept ZIRP for almost seven years now. They are either trying to destroy capitalism, or they see a weak economy. Jeremiah is not prone to conspiracy theories. We disagree with the Fed’s prescription, but not the diagnosis.

Back before Chairman Yellen, the Fed set a benchmark of 6.5% unemployment before they would raise rates. The reason this is “chart of the week” is that it shows the corresponding figure, 62% on the blue line, that would mark the return of a healthy job market.

See also: New Fed Bashing Hero


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Housing Bubble Redux

The root cause of the financial crisis was the housing bubble, going back to Clinton’s repeal of Glass Steagall and looting at FNMA, but – what was the trigger? Understanding the chain of events helps us to evaluate the policy response, and also suggests what to look for the next time.

The nadir, as everyone knows, was the S&P 500 touching 666 in March 2009, before its rescue by Chairman Bernanke. Lehman Brothers had failed in September 2008, precipitating the crash in October, but the market had peaked a full year earlier.

Crash Chart

The NBER identified December 2007 as the recession’s start, and it’s not surprising that the market peaked a few months ahead. It is generally a leading indicator for the economy. Mortgage lending, with its new ecosystem of boiler rooms and dodgy paper, had been shaking out all year. This is variously attributed to a dip in housing prices, declining demand for mortgage backed securities, and rising mortgage interest rates.

… the Federal Reserve’s pivotal failure to stem the flow of toxic mortgages, which it could have done by setting prudent mortgage-lending standards. The Federal Reserve was the one entity empowered to do so and it did not – FCIC

So, among the proximate causes, which was the trigger? Did the Fed pop the bubble by raising rates? Probably not. Fed funds had ramped steadily throughout the bubble, but had been flat at 5.25% since July 2006. That’s an indication the Fed was trying not to spoil the party.

Housing Bubble

Mortgage rates peaked in July 2006 and so, roughly, did the Case-Shiller home price index. The chart shows rates following the price trend up, and then following it back down.

It’s reasonable to suppose that the recession started and then people couldn’t make their mortgage payments, but the timing doesn’t support that. The recession was not a cause of the bust, nor was it obviously an effect. Delinquent mortgage payments, especially for Miami condos, had been on the rise throughout 2006. This chart is from the Financial Crisis Inquiry Commission.


These were flippers running out of people to flip to, like punters at the end of a chain letter, plus some poor fools actually occupying the homes and trying to make the payments. The trough of the rate trend was around 2003. If you had signed an ARM then, your interest rate had just about doubled by 2006.

  • Delinquencies start to rise in 2006.
  • Home prices peak, June 2006.
  • Mortgage rates peak, July 2006.
  • Mortgage bonds downgraded, July 2007.
  • Stock market peaks, October 2007.
  • Recession starts, December 2007.
  • Stock market crashes, October 2008.

Right up until the crash, this reads like a normal business cycle recession. David Stockman argues that main street banks were never in danger from the housing market, because they had been run out of it by big investment banks. On this reasoning, policies like TARP, ARRA, and QE were a response to Wall Street, not the recession.

If you had been alert, you could have predicted when the housing bubble would burst simply by looking at the timing of the 5-year ARMs. Stanley Druckenmiller knew that risk premiums were too low in 2004, but it took him another a year to identify the housing bubble.

When you have zero money for so long, the marginal benefits you get through consumption greatly diminish, but there’s one thing that doesn’t diminish, which is unintended consequences.

We are in a similar phase now. Everyone knows that six years of ZIRP have planted a bomb somewhere in the economy, but no one knows for sure where it is.

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Stories to Frighten Children

MedalCommentators like to exclaim about how much “market cap was lost” or “wealth was destroyed” by the latest drop in price. In a market crash, however, the drop does not destroy wealth. It merely reveals the true level of wealth. Destruction happens on the way up, as irrational exuberance leads to poor investments.

Watching the numbers on Wall Street, it’s easy to forget that investments ultimately are made in earning assets like shops, labs, and factories. It’s during the bubble phase that wealth is destroyed, by funding investments that never pay off.

The EU has had to deal with two crises … The first was obviously the global financial crisis, caused by major falls in asset values. – Douglas Flint, remarks to House of Lords October 2014

We were reminded of this popular misconception when we read it recently in Douglas Flint’s testimony before the House of Lords. This statement is an oversimplification, to put it politely. “Major falls in asset classes” did not materialize out of nowhere.   Is there anyone in the House of Lords who accepts this account of the crisis? It seems scripted – for children, perhaps, or the CNBC cheerleaders.

Masaaki Shirakawa comes off as rather better informed, but still surprised (!) to discover asset price bubbles. In fairness, the Japanese bust was the first of its kind among developed economies in the postwar era.

We have to start by recognizing this odd reality of bubbles being accompanied by price stability, yet then followed by instability of the financial system, subsequently bringing about low growth and often inflation that is lower than desired. – Masaaki Shirakawa, remarks at BIS conference March 2014

Yes, this odd illusion of stability – like ice over a flowing river. He goes on to describe a central bank misled by consumer prices into “accommodating” an asset bubble, which in turn destabilizes the financial system. The ensuing low growth, we have to say, is the true trend rate.

Our purpose here is not to single out people, like Mr. Flint, who should know better. We are intrigued, however, by the long list of trained professionals who continue to be surprised by this well understood chain of events. This prescient article, subtitled “central banks should pay more attention to rising share and property prices,” is from 1999.

U.S. house prices have risen by nearly 25 percent over the past two years … but these increases, [Bernanke] said, “largely reflect strong economic fundamentals.”

This studied “surprise” is starting to wear thin. Have America’s central bankers purposely inflated bubbles and then lied about it? That seems a little extreme. Maybe there’s another explanation. Here is an iconoclastic way of looking at our American trendline:


Maybe, without the tech bubble and the housing bubble, the S&P 500 would have run flat around 1,200. Raghuram Rajan has said that Western leaders are using credit to compensate for their citizens’ loss of purchasing power. They have a powerful incentive not to admit their economies are in decline. Boom and bust cycles, six or seven years long, are preferable to obvious stagnation – especially on an elections calendar.

If the Fed were not complicit in this deception, politicians would change the Fed. Consider Sen. Schumer’s famous “get to work, Mr. Chairman,” or this one from Sen. Gramm – mere weeks before the NASDAQ crash:

 “Don’t become so frightened by success that you throw wet blankets on a fire that isn’t burning.”

Central bankers aren’t stupid, and they aren’t independent. They know their political masters enjoy a rising stock market, and can easily escape blame for the inevitable crash – especially if the crash is inexplicable, and entirely unforeseen.

See also: America’s structural trap

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An economy cannot experience both inflation and deflation, and yet that is exactly what seems to be happening. The Fed’s exertions have produced some consumer price inflation – though not enough for diehard Keynesians – and quite a bit of asset price inflation, and yet the economy “feels” deflationary. This would not be the first paradoxical price phenomenon. Inflation had been associated only with rapid growth – until stagflation was discovered in the 1970s.

One possibility is that prices are behaving differently in different segments of the market. Wolf Richter writes here about a bifurcated real estate market, with mortgages off but cash deals booming. We have mentioned Tiffany’s before, and this interview with John Mauldin touches on the market for fine art.

We need to characterize the economy’s condition, but we should not get hung up on price based definitions. For example, David Stockman describes the Great Moderation as an inflationary period, due to loose monetary policy, offset by cheap Asian imports. Frances Coppola says it would have been deflationary – except for the credit bubble. It all depends on your perspective.

Consider what deflation looks like, without reference to prices. Sellers struggle because demand is weak. They cut back on supplies, and they lay off staff. People are out of work. They don’t have much to spend, and debts become unsustainable. Sound familiar? This is the vicious cycle which characterized that earlier depression – and the current one. Wages and prices ratchet downward, but this is only a symptom.

Another way to look at price is not the value of goods, but the relative scarcity of money. The people unable to buy a house, get a mortgage, or put food on the table, are living in a deflationary world – they’re broke. The Fed doesn’t help by driving prices up all around them.

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Keynesian Blather

YellenPolitical bloggers were not kind to Chairman Yellen’s keynote speech at Jackson Hole. David Stockman called it “Keynesian blather.” Someone else called it an insult to America’s intelligence.

The Fed Chairman makes an easy target, especially if you don’t understand the technical terms. After all, who cares if you’re unemployed for cyclical reasons or structural ones?

Jeremiah prefers to assume people are generally competent for their jobs. We downloaded the speech here. Remember that this is a keynote speech, kicking off a symposium on the labor market. So, when Yellen refers to the unsolved mysteries of employment, that doesn’t mean she’s confused – she is introducing the topics.

Jeremiah was pleased to see that Yellen does not take the headline unemployment figure at face value. She acknowledged the growth in part time employment and the drop in labor force participation. Here are a few of the topics:

  • Is labor force participation off because people have retired, or are they coming back? If people come back en masse, that will drive wages down.
  • Is there “pent up wage deflation?” If so, wages may jump once it has run its course.
  • Have the midlevel jobs gone, to Asia and automation, never to return?

You can see that these are all relevant to ordinary Americans, and relevant to Fed policy. The Fed needs to know whether there is still slack in the labor market, or if our current wretched economy is the new normal. The dual mandate requires the Fed to keep credit conditions easy as long as there is any chance it will help someone find work. This brings us to the Keynesian part.

Keynes reckoned that inflation could reduce unemployment, and this is why the Fed has a dual mandate instead of simply maintaining price stability. In fact, Keynes’ definition of full employment is the level at which inflation can’t help one more guy find work.

Men are involuntarily unemployed if, in the event of a small rise in [inflation], both the aggregate supply of labor willing to work for the current nominal wage and the aggregate demand for it at that wage would be greater than the existing volume of employment.

Lower wages will put more people to work – basic supply and demand – and the role of inflation is to give everyone a pay cut, by reducing the value of their nominal wage. This is a pretty incompetent way to create jobs, and it’s not even a good definition.

There is no magic formula for full employment, any more than there is a magic diet pill. Keynes didn’t have it and, when the symposium is over, Janet Yellen won’t have it either.

Labor is employed when entrepreneurs have profitable projects, capital to invest, and a stable political environment. As public policy, this means the rule of law and – a predictable tax and regulatory regime. Various surveys, including the Fed’s own Beige Book, have indicated this is what’s holding back the job market.

Keynes wrote a system of equilibrium equations, like the ideal gas law. In such a system, aggregate demand for goods cannot be more or less important, as a policy objective, than the aggregate demand for labor.

When companies are starved for workers, they compete by offering higher wages. You guessed it – full employment causes inflation.

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Mind the Wealth Gap

Bubble MachineStandard & Poor’s, God bless ‘em, have figured out that America’s rising wealth gap is responsible for our boom and bust economy. Obviously, blaming anything on a “rising wealth gap” will have a certain political appeal, but – this is to mistake cause and effect.

What Raghuram Rajan and (separately) Larry Summers have said is that the advanced economies ran out of gas in the late twentieth century, leaving us not only in secular stagnation, but with unsustainable social commitments. Since Chairman Greenspan, Fed policy has been to “jump start” the economy with cheap funds, making available – on credit – a lifestyle we can no longer afford.

Those to whom the system brings windfalls … become ‘profiteers’, who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat.

So, we had an economic boom and the tech bubble in the 1990s, and then a bust. Next, federal policy joined cheap Fed funds to produce the housing bubble, and – now we are on the third bubble in recent memory.

The “rising wealth gap” is responsible for this? Quite the contrary. Our monetary policy is a trillion dollar bubble machine. Whoever is nearest the spigot is going to get rich fast even if – as Keynes observed – he’s not trying. There’s your rising wealth gap. It is an effect, not the cause, of our boom and bust economy.


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Stock Market Manipulation

A new study by the OMFIF discloses that the world’s central banks are buying stocks. So, there you have it. The well known correlation between Federal Reserve easing and stock market highs is now proved to be cause and effect. The references on their home page are illustrative:

  • FT finds irony in central banks’ yield hunt
  • Central banks fueling equity bubble
  • Central banks switch to equities for diversification

One weakness of the OMFIF report is that it lumps sovereign wealth funds in with central banks. The former may buy what they like – they don’t have the authority to print money. Central banks playing in the stock market are quite another thing.

A central bank, like the Fed, is the ultimate deep-pocket manipulator. They have an infinite capacity to bid prices up, and they have insider knowledge when easing will end. It is simply unbelievable that this activity is legal.

The justification, of course, is the good of (some) national economy. We are reminded of Lenin in this connection. Indeed:

Asset managers may face efforts to influence their investments in areas like infrastructure or social security systems. Public investors of all categories may be called upon to take part in global and regional safety nets.

Not content with the stock market bubble, central banks are now encouraged to funnel newly printed funds directly into government programs. That’s moar better.

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