Central Banks to Investors: I Know Nothing

Central Banks to Investors: “I Know Nothing!”

“I know nothing! I see nothing! I hear nothing!”

So light was Hogan’s Heroes, one could easily forget the sitcom, which debuted September 17, 1965, was set in a Nazi P.O.W. camp. More than any one character, Sergeant Schultz deserves credit for the show’s laughable levity. His gregarious girth, sincere sympathy and wonderful weakness for tempting treats — let’s just say Shultz had anything but steely resolve, convincing affable audiences that war could be whimsical. For the prisoners of the Luft Stalag 13, Schultz made an ideal witness to their eternal escape endeavors. His robustly repeated response, “I know nothing!” faithfully failed to fulfill his German superiors’ suspicions.

One can only imagine the proliferation of late 1960s era’s pretentious political philosophers chafing at the bemusement beckoned by Schultz’s channeling Socrates. The Socratic paradox, “I know that I know nothing,” back-translated to Katharevousa Greek, was relayed by Plato in Apology.

Apparently, Socrates attributed his wisdom to not imagining that he knows what he does not. At the intersection of Schultz and Socrates, humility and hilarity collide.

It was neither humor nor humbleness, but rather hubris, being highlighted in London on June 27, 2017 when Federal Reserve Chair Janet Yellen managed to make light of a heavy subject in a live televised Q&A with British Academy President Lord Nicholas Stern. Chuckling in response to one query, Yellen offered up the following on our collective financial future:

“Would I say there will never, ever be another financial crisis? You know probably that would be going too far. But I do think we’re much safer and I hope that it will not be in our lifetimes, and I don’t believe it will be.

It was these last few words that ignited the ire of so many central banking detractors. Was she hoping we’d come to see the softer side of central banking?

Clearly, she takes faith in the radiation detection facilities the Fed has installed in the years since the worst of the financial crisis engulfed the global financial system. If not, why would she have also offered up these words of reassurance, that those at the Fed, “are doing a lot more to try to look for financial stability risks that may not be immediately apparent … in order to try to detect threats to financial stability that may be emerging.”

Though this particular quote got much less in the way of play in the media, marrying the two threads of thought helps explain why Yellen, who no doubt means well, was able to strike a jovial tone at the prospect of future financial crises. Blind faith in those who’ve been assigned tasks has long handicapped Fed leadership.

On a deeper level, one has to question the qualifications of the architects who’ve built out the risk monitoring system in recent years. The February 2015 McKinsey report Debt and (Not Much) Deleveraging did not gain the rank of ‘seminal’ without captivating most front-line veterans of the financial crisis.

The study’s findings were startling in their simplicity: Rather than address the underlying over-indebtedness that detonated systemic risk and culminated in a full-blown catastrophe, policy had simply catalyzed further indebtedness.

The numbers, with which we are all familiar, are as follows. From a starting point of the end of 2007 through mid-year 2014, global debt rose by $57 trillion to $199 trillion. As a percentage of global gross domestic product (GDP), global debt had risen to 286 percent from 269 percent.

Though deleveraging had indeed occurred in some corners (referred to in America as defaulted mortgages), the overabundance of liquidity generated by central banks’ machinations had simply found new places to stoke unquantifiable risks. In the case of the seven years through 2014, some usual suspects made their presence known on the leveraging-up-to-their-eyeballs scale such as Greece and Ireland.

But it was China that stood out in the McKinsey study, specifically, “the quadrupling of China’s debt, fueled by real estate and shadow banking, in just seven years.”

McKinsey was also kind enough to offer a bit more historic perspective for those of us rookies who might have thought this type of perverse approach to treat over-indebtedness novel. It all started at the end of 2000, just about the time investors were reeling from Internet bubble implosion portfolio losses. In the seven ensuing years, global debt rose to $142 trillion from $87 trillion. As a percentage of global GDP, debt had grown ‘smartly,’ to 269 percent from 249 percent. (Lest you’ve forgotten the name of that starlet in the annals of dumb debt, it was referred to as the subprime housing bubble).

Conclusion: Do NOT attempt to resolve over-indebtedness by applying more debt to the problem.

Presumably the task force monitoring the global financial system for signs of building dangers was armed with this simple guiding tenet.

It follows that our protectors were blindsided by yet another report released the very same day Yellen made her fate-tempting London remarks about how much safer we are.

The Institute of International Finance (IIF) is a Washington, DC-based global tracker of capital flows with a stellar reputation for sniffing out risks. In its newest report, the IIF warned of the risks posed by global debt levels that had ballooned to $217 trillion. In the event you are about keeping score, the math works out to 327 percent of global GDP.

The good news:  Developed economies continue to delever; in the past year, they’ve offloaded some $2 trillion in debts. The not-so-good news:  Central banks’ manning the printing presses 24/7 necessitate their crisp, fresh product find a home, fungible as global quantitative easing has proven to be. Enter developing countries, where debt has grown by $3 trillion over the past year to a new record of $56 trillion.

Filling in the blank with the main driver is akin to gaming a multiple-choice test for which you’ve not studied. When in doubt, choose ‘C,’ as in China, which accounted for 2/3rds of last year’s debt growth. Chinese debt now stands at $33 trillion. This most recent spurt of growth has been led both by households and companies.

At least Uncle Sam has that in common with his Red Dragon counterpart. Household debt has recaptured its record high levels led by unsecured debt (lovely). And corporate debt stateside is now at record levels, even when compared to earnings and cash flow, which remain strong. (Note to Fed: tightening into a weakening economy when debt burdens are at record highs has yet to end well.)

The IIF shrewdly expressed unease that all of this debt could pose “headwinds for long-term growth and eventually pose risks for financial stability.” Party poopers.

For good measure, the International Monetary Fund and Bank of International Settlements share the IIF’s concerns. But what do they know?

In the event you sense tongue squarely in cheek, hence the cheekiness, you are correct.

Either you laugh and channel Sargent Schultz. “In (currency) wars, I do not take sides! I see nothing! I know nothing! I didn’t even wake up this morning!” You pray God central bankers are making the best of a gravely unstable situation by making light of it to calm the masses. If you present a strong face, the minions will hopefully buy into your outward confidence.

Well played? Consider the alternative.

What’s worse than the monetary myopia that’s blinded central bankers into believing moral suasion can resolve the teensiest $217 trillion problem?

What if they believe what they are saying in the face of irrefutable evidence to the contrary? Socrates’ self-discovery followed a journey wherein he tried to find a wiser man than himself, whether it be politician, poet or craftsman. His findings were as follows: Politicians boast wisdom without knowledge (some things never change). Poets, for their part, touch people with their words, but don’t grasp their meaning. Finally, craftsmen claim knowledge but it is restricted to too narrow a field.

Socrates concluded that there was no such thing as indelible intellect, but rather ingrained ignorance. Recognizing your fallibility was thus the secret to achieving greatness, to know in your very soul, “I know that I know nothing.”

Future generations across the globe would be well served by central bankers of the strongest constitutions, those who are neither politicians, nor poets, nor craftsmen who bow to econometric models that have scant application outside tight academic circles. May they rather live by Socrates’ humble mantra, may they know they know nothing, and nothing more.

The Buford T. Justice Job Market

The Buford T. Justice Job Market, Danielle DiMartino Booth, Money Strong, Fed UpNever in the history of filmmaking has artistic license paid off so handsomely.

Of course, comic legend Jackie Gleason was no schlep in the world of thespians. Odds were high he would deliver a handsome return on stuntman cum director Hal Needham’s investment. And while it’s no secret there would have been no directorial debut for Needham had his close friend Burt Reynolds not agreed to be in the film, it was Gleason’s improvisation that made the Smokey and the Bandit the stuff of legends.

Though Gleason’s character’s name screams ‘surreal,’ the stranger than fiction fact is that Reynolds’ father was the real life Chief of Police in Jupiter, Florida who just so happened to know a Florida patrolman by the name of Buford T. Justice. The treasure trove of quotes from the film’s tenacious Texas Sherriff Buford T. Justice, who so tirelessly pursues the Bandit in heedless abandon over state lines, elicited nothing short of laugh-out-loud elation from anyone and everyone who has ever feasted on the 1977 runaway hit (it was the year’s second-highest grossing film after Star Wars).

Gleason’s most famous ad-lib moment occurs at a roadside choke-n-puke where Justice unwittingly strikes up a conversation with the same Bandit he’s chasing. “Let me have a diablo sandwich, a Dr. Pepper, and make it quick. I’m in a goddamn hurry,” Justice barks at a waitress after which point he explains to an innocent-faced Reynolds that he’s in such a hurry because he’s chasing a ‘maniac.’ As for yours truly’s favorite, there’s simply nothing funnier than Justice’s rant to his witless son: “There’s no way, no way, that you came from my loins. Soon as I get home, first thing I’m gonna do is punch yo mamma in da mouth.”

As much as Justice wants to score one for the good guys — “What we have here is a complete lack of respect for the law” — in the end, the ‘bad guy’ eludes capture. By the time the credits roll, the audience has no choice but to feel a little sorry for Justice and his habit of acting, and speaking, before he thinks, which inevitably leads to his downfall.

Far from 1977, a new sheriff is in town, and a certain White House occupant is in equally hot pursuit of, not a Bandit, but a strong job market to indelibly leave his mark on history. For the moment, it looks like he’s going to get exactly what he’s asking for using brutish Buford T. Justice-style tweets. At least that’s the causality guaranteed to be drawn.

Something is for certain. The job market is not behaving as one would expect in an economic recovery that’s nearing its eight-year anniversary. And it’s not just one aberrant indicator we’re talking about here.

Forget that we’ve just enjoyed one of the mildest winters on record. The 106,000 goods-producing jobs created in February is officially one for ADP’s record books in data that stretches back to 2002. In all, companies added 298,000, the most in nearly three years. This report alone will quickly silence all the whining we’ve heard of late about soft data being stronger than hard data.

As ‘soft’ as the survey data may be, one indicator within the most recent ISM report is plenty hard. Care of one of the buyside’s best and brightest, whose name has to remain outside the public purview, ISM customers’ inventories at a 10-month low necessitate a period of catch-up on companies’ parts.

A quick primer: The ISM report is a composite index of five diffusion indexes – employment, production, inventories, new orders and supplier deliveries – gathered from surveying over 300 manufacturing firms. A reading of greater than 50 signals those at the forefront of a company’s supply chain anticipate accelerating economic activity; a sub-50 reading signals the opposite. A reading of 65 or higher on the most forward-looking ISM new orders index pushes manufacturing into technical ‘bubble’ territory. As for 70, if it’s reached, look out below as the economy will have officially overheated. The most recent two episodes of 70 being hit occurred before most of us can remember, in 1973 and 1983. The pullback in activity that followed was, shall we say, swift and not so neat.

The current 65-reading on the ISM new orders sub-index, coupled with depleted stockpiles, indicate economic activity could well boil over. Companies will try to get ahead of tight supplies by paying up; delivery times should rise alongside this impulsiveness. Surprise, surprise — the sell side will feed the frenzy, which will push purchasing managers to go one step further and pile on supplies in anticipation of future demand.

Inventory builds, you will recall from Econ 101, are GDP-friendly. So set aside the Atlanta Fed’s Debbie Downer first-quarter GDP forecast of a paltry 1.3 percent. The second quarter looks set to stage a raging comeback. And it looks to be widespread. Of the 18 industries surveyed by the ISM last month, 17 reported improving conditions, up from just 12 in January.

But here’s the catch (does there always have to be one?). This from the ISM: “Comments from the panel largely indicate strong sales and demand, and reflect a positive view of business conditions (but) with a watchful eye on commodities and the potential for inflation.”

In other words, firms are a wee bit concerned a margin squeeze is on the horizon. If that’s the case and the job market is gaining momentum, they should add tightening financial conditions to their worry list.

Pop back into that econ class for a moment. The unemployment rate is the most lagging of all indicators. That means Fed officials should be hard-wired to underreact to job market data. What’s more likely is that they will be compelled to play a bit of catch-up of their own, chasing the curve they’re woefully behind with all their might.

Look no further than the follow through in the bond market from the blowout ADP report. At 1.36 percent, the two-year Treasury note yield is near an eight-year high, which has grabbed investors’ attention by the short hairs. Meanwhile, back over at the Bloomberg Terminal, the following headline just crossed: “Jobs Data May Fuel Bets on Four Rate Hikes in 2017.” Three hikes are darn near baked into the cake, as in a one-handle on the fed funds rate by September. Imagine that.

Like it or not, the Fed’s chase is likely to end just as badly as Buford T. Justice’s did.

Crash landings tend to follow the unemployment rate when it overshoots to the downside, which is exactly what households suggest is in the offing. The last time this many folks were predicting the unemployment rate would be lower 12 months hence was the early 1980s. What followed? Not just overheating, but a 10 percent correction in the S&P 500 over those same next 12 months.

What if, just maybe, just sayin….these extreme readings indicate that firms are sticking like glue to their employees out of a sense of panic that they’re irreplaceable in a world bereft of sufficient skill setters? What if the true, underlying job market is not gaining strength.

That would certainly seem to be the case in the message delivered via gauntlet in the Conference Board’s latest online help wanted postings. Before the howls of, “One month never makes for a trend!” begins, bear in mind that new job postings peaked in November 2015 while those of re-postings (new net of old) peaked a month later.

Up until this latest data set from February, the decline in demand for new employees had been steady but orderly. All that changed last month with the record 364,000 decline in new help wanted ads. The only month that was anywhere near as ugly was January 2009 in the thick of the last recession. Not only that, all 50 states saw declines as did all 52 metro areas tracked.

The one-month move was so striking the Conference Board released the following note with its report: “Recently, the HWOL (Help Wanted Online) Data Series has experienced a declining trend in the number of online job ads that may not reflect broader trends in the U.S. labor market. Based on changes in how job postings appear online, The Conference Board is reviewing its HWOL methodology to ensure accuracy and alignment with market trends.”

You gotta give the number crunchers credit where it’s due – at least they admit to their potential fallibility. That’s more than can be said of the arbiters of the inflation data favored by Fed officials.

We will soon enough know if all this inventory building meets a happy ending. If today’s reported demand is still red hot come Labor Day, well then, the labor market’s current signals could bode well for one Donald J. Trump’s first year in office.

If that’s not the case, if this is a massive head fake, well then manufacturers could be warily eyeing bloated stockpiles come August, stockpiles built on hope. Those keeping the nation’s factories up and humming might even be disenchanted enough to strike out against Trump’s attempts to jawbone the U.S. manufacturing sector back to its halcyon days. The exchange that follows could echo the following from Smokey and the Bandit, one that took place between a peeved fellow sheriff and Sheriff Justice, who had crossed uninvited into the other’s jurisdiction:

U.S. Manufacturers: The fact that you are President is not germane to the situation.

DJT (in a tweet): The goddamn Germans got nothin’ to do with it!

Oh, and please pardon the slight artistic license taken with the cast of characters. Think you get the message about what can be lost in translation loud and clear.