Danielle DiMartino Booth, Central Bankers, Money Strong LLC, Federal Reserve, Debt, Trojan Horse, Fed Up,

Beware of Central Bankers Bearing Gifts

Ulysses’s reputation preceded him.

   ‘O unhappy citizens, what madness?

Do you think the enemy’s sailed away? Or do you think

any Greek gift’s free of treachery? Is that Ulysses’s reputation?

Either there are Greeks in hiding, concealed by the wood,

or it’s been built as a machine to use against our walls,

or spy on our homes, or fall on the city from above,

or it hides some other trick: Trojans, don’t trust this horse.

Whatever it is, I’m afraid of Greeks even those bearing gifts.’

Virgil, The Aeneid Book II

So warned Laocoön to no avail, and that was with Cassandra’s corroboration. As reward for his prescient prudence, the Trojan priest and his twin sons were crushed to death by two sea serpents. It would seem the Greeks had no intention of relinquishing hold of ancient Anatolia, a critical continental crossroad where Europe and Asia’s borders meet, a natural target for conquering civilizations.

Thankfully, history has made history of menacing machinations crafted with the aim of undermining the opposition. If only… History is rife with exceptions starting with most politicians on Planet Earth and more recently, central bankers.

In what can only be characterized as Mission Creep raised to the power of infinity, the Federal Reserve’s last Federal Open Market Committee Minutes warned that “equity prices are quite high relative to standard valuation measures.”

Let’s see. Where does the stock market fit into Congress’ statutory requirements that the Fed’s objectives be: “maximum employment, stable prices and moderate long-term interest rates”? You neither, huh?

The Minutes also indicated that, “equity price indexes increased over the intermeeting period.” Is it the slightest bit alarming that monetary policymakers are nodding to a phenomena that’s been in place since March 2009 as having just occurred to them? Are we pondering pure coincidence or is this exactly what it appears to be — political pandering?

This from CNBC:  FOMC Minutes have unleashed the word “valuation’ as it pertains to equities six times since Alan Greenspan, a self-described obsessive observer of the stock market, first uttered the words, “irrational exuberance.” In every instance, stocks were hit over the next 12 months.

Could it be that Janet Yellen, who in 2008 said the Minutes should be used, “to provide quantitative information on our expectations” knew exactly what she was doing, that she planted the word ‘valuation’ to send the President a pointed message with nothing less than perfect precision?

You may be thinking our new leader has more than enough on his agenda to be worried about a threat to the stock market from the likes of academics he not so long ago publicly derided. If Trump cares about staying in the good graces of those who put him in office, he will fight the temptation to pivot on the Fed. He’s been in office long enough to have made a move to begin filling the three open seats on the Federal Reserve Board.

More to the point, in the event Trump hasn’t been apprised, the Fed has the economy by the short hairs. And, yes, it was, is, and will be about the economy, at least among those who voted him into office, many of whom remain angry and anxious, but not stupid.

They are still waiting for an advocate who sees through the average data right through to the galling truth that absent executive pay, incomes remain in decline. They pine for a leader who can like debt all he wants to get deals done, but doesn’t force it down the economy’s throat to generate economic growth of the most fleeting nature. They may not be able to identify the enemy within by name but they have every right to expect their President does, that he has the gumption to stand up to the Fed and deliver his People from the shackles of indentured servitude.

It might even be a good thing, for working Americans who’ve long sensed the economy has abandoned them, that Trump has a beef with the media and two savvy guys from Goldman Sachs helping steer the economy. Together they should be able to glean the facts from the data the Fed insists are so much “good news.”

Consider, if you will, a fresh report on the state of consumer finance released by the New York Fed. At $12.73 trillion, household debt sits at a record high. We’re told to look the other way, that it’s a nominal figure and more importantly that debt as a percentage of gross domestic product (GDP) is nowhere near where it was back in the bad old days of 2007.

‘Tis true that household debt is no longer 95 percent of GDP which was the case when it peaked in the fourth quarter of 2007. Before resuming its climb to its current 80-percent level, it got as low as 78 percent of GDP.  But let’s hold off on the austerity bubbly for the moment. Since record keeping began in 1952, when the record low of 23 percent was recorded, debt-to-GDP has averaged 56 percent.

As for the red herring that households have tightened their belts, while that is the case for a minority, the bulk of deleveraging that’s taken place has been the result of the past decade’s 10 million and counting foreclosures. (For those of you still keeping count, some 91,000 individuals had ‘foreclosure’ added to their credit reports in the first three months of this year, an uptick from 2016’s fourth quarter.)

The deleveraging, by the way, ended years ago. Aggregate household debt is 14 percent above the low it hit in the second quarter of 2013. And we’re not talking about mortgages here.

Drawing hard conclusions is a bit of a stretch as it really depends on your perspective. You make the call. How secured by anything of value is the type of debt households have taken on since mortgage lending standards tightened like a vise on would-be homebuyers? Credit card debt is an easy enough call. But what about that car loan? Checked your trade-in value lately? (Not recommended if you’ve had a bad day.) As for that festering $1.3 trillion mountain of student debt? Did someone say ‘perspective’?

The bottom line is we still have too much debt and precious little to show for it.

In return, we get this from the NY Fed’s President Bill Dudley: “Homeownership represents an important means of wealth accumulation, with housing equity being the principal form of wealth for most households.” (Isn’t that a good thing?)

He goes on to observe that, “Changes in the way we finance higher education, with an increased reliance on student debt, may have important implications for the housing market and the distribution of wealth.” (You think?)

And finally, out of the other side of his mouth, he has this gem of a recommendation to kick start the economy: “Whatever the timing, a return to a reasonable pattern of home equity extraction would be a positive development for retailers and would provide a boost to economic growth.” (Wait, wasn’t all that home equity borrowing what pushed debt up to its record highs and drove the economy into the Great Financial Crisis?)

It’s critical to note that Corporate America is also drowning in record levels of debt – nonfinancial corporate debt within a hair of $6 trillion. And though it was nary mentioned in the campaign by either party, at $20 trillion, Uncle Sam himself is up to his eyeballs in hock.

Hopefully you can see Trump’s once in a century chance to reshape the warped thinking inside the Fed. He has the tremendous power to redirect the meme by draining the debt swamp that makes our government beholden to foreign lenders, our corporations less competitive on the global stage and our households seething at their inhibited upward mobility. Talk about Making America Great Again, for ALL Americans.

Without a doubt, this will be one of Trump’s toughest tests, and yes, the Fed can easily take down the stock market in retaliation; they could even follow through on threats to shrink the balance sheet. It would be as if someone flipped a switch and we veered from Quantitative Pleasing to Quantitative Plaguing.

And what politician in their right mind wants plague visited upon their economy on their watch? Ask any of Trump’s predecessors and they’ll shoot you straight. Passing legislation with ultra-easy monetary policy and fluffy stock prices on your side sure as heck beats the alternative.

But in the end, it just buys time, not Greatness.

Artificially low interest rates might be as alluring as that Trojan Horse was to the people of Troy. But let’s put their experience to better use and not dismiss Laocoön’s words as the tragic Trojans did. Let us all Beware of Central Bankers Bearing Gifts.

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Give Me Liberty or Give Me Debt!

In the event you’ve already binge-watched House of Cards Season Four, don’t be so quick to tune Netflix out. Instead, restore your faith in mankind and search for Brothers in War, a gripping National Geographic Vietnam War documentary that recounts the journey of Charlie Company. Though two-thirds of those who served in combat in Vietnam were volunteers, the draftees featured in Brothers were one of the last groups to go through basic training and sent to the front lines together, in this case to the unforgiving Mekong Delta. Some 50 years later in the making of this film, they reunite and marvel at their lasting bond. But most of all, these boys, now seniors, ask what gift of fate allowed them to return home at all, unlike so many of their comrades who made the ultimate sacrifice.

Among the unalienable rights generations of U.S. soldiers have fought to preserve is that of liberty, both ours and that of those in foreign lands. Little could many of those who served in the Vietnam era have known how terribly that very freedom for them as individuals would be impinged upon in their lifetimes. Among workers who are roughly the age of Vietnam veterans, 65 and older, those who work because they have to now exceed those working by choice by a factor of 2 to 1.

Several culprits contributing to their delayed retirements are easily identifiable, chiefly being a lack of savings and income. But these are merely symptoms and don’t get at the root cause of the disease. At its contaminated core is a fundamental change in our culture which has for many, blocked the pathway to achieving the American Dream. That change is an acceptance of debt, rather than investment, to power economic growth.

Evidence of this transformation has shoved its way onto front pages in recent months. Fresh data out of the New York Federal Reserve show that debt among older Americans more than doubled in the 12 years ending 2015. Specifically, the average 65-year old has 47 percent more mortgage debt and 29 percent more auto debt than 65-year olds did in 2003. Over that same period, their labor force participation rate increased to over 19 percent from 13 percent, while that of the entire labor force went in the opposite direction.

As an aside, in the event the allure of a demographic explanation appeals, seniors’ increased debt loads are not directly attributable to longer life expectancy, though that argument would be convenient. The fact is, it’s difficult to retire when your savings have been ravaged and you’re shouldering more debt.

The shame of it is, it didn’t have to be this way. The economy could have been growing organically for the past 30 years in the same vein some of the world’s most successful companies have, from the inside out, by way of reinvestment. Granted, economic growth that stems from the disciplined redeployment of earnings is not as easy to maintain. But by the same token, it leads to far less violence in the business cycle.

Austrian economists refer to the serial boom and bust cycles spawned by prolonged periods of artificially low interest rates as malinvestment. How has this scourge manifested itself since the late 1980s, as today’s Wall Street came of age, with the birth of the Greenspan put? Without getting into the nitty gritty of each iteration, a whole heck of a lot of financialization took place, for lack of a more accepted existing term.

Financial institutions and capital markets worldwide came to dominate the economic landscape by lending into every nook and cranny regulators would knowingly or inadvertently allow credit to seep. Think of the numerous emerging market debt crises, Long Term Capital Management, the dotcom revolution, the commodities supercycle, the housing bubble and finally today’s mammoth credit bubble in its various forms.

In the case of the U.S. economy, the most damning conviction of malinvestment is productivity growth that’s threatening to flat line; it ended last year up 0.5 percent over the last three months of 2014. For comparative purposes, the 30-year average is 1.9 percent.

My former colleagues at The Liscio Report, Philippa Dunne and Doug Henwood, have done extensive work on the origins of declining productivity. They found the most obvious cause to be a lack of investment on companies’ part noting that at 6.0 percent of gross domestic product (GDP), equipment and software spending is below the 1950-2015 average. “The series seems to have topped out for this cycle at levels comparable to earlier recession lows,” they remarked.

Is it that companies are simply low on cash? Not hardly, they’re just directing that cash to share buybacks and buying each other out. “That may make some people happy for a while, but it doesn’t have the feel of a long-term strategy about it,” Dunne and Henwood observed. Indeed.

But there’s something much more subtle at work according to two recently published papers, both of which are footnoted at the bottom of this piece. The first paper links shifts in the composition of the workforce to credit booms and the financial crises that inevitably follow based on 21 episodes in advanced economies since 1969.

Not only does the temporary misallocation of investment do damage during the boom period – think of all those construction jobs that were created during the boom-boom days of the housing mania. The protracted, as opposed to plain vanilla, recessions that follow credit crises also act as a drag on underlying productivity. Income levels take appreciably longer to bounce back limiting both the ability to rebuild savings and splurge on that extra something without incurring even more debt.

The second paper examines the effects of startups, or a lack thereof, on productivity growth. The break in startup activity, such as that which accompanied the 2009 financial crisis, has left a lasting impact on GDP and productivity growth. While startup activity has recovered from its 2009 lows, it remains at the average level that prevailed prior to the crisis, from 1976-2007.

Looking back, Census Bureau data leave little doubt as to how much damage has been exacted as debt has unseated investment as the main driver of the U.S. economy. Newly formed firms represented as much as 16 percent of the total in the late 1970s; that share had declined to eight percent by 2011.

As for the prognosis for future start-up activity, stabilization at a low level may be as good as it gets for the current cycle. In the fourth quarter, venture capital financing fell by 30 percent in dollar terms while the number of transactions declined by 13 percent over the prior three months.

The startups that are lucky enough to survive their first year are otherwise known as small businesses. In February, their reported optimism on the outlook fell to a two-year low according to the National Federation of Independent Businesses. Plans to hire and increase capital spending fell in concert with the number of those reporting they expected improvement in the economy holding stubbornly steady at the lowest level since November 2013.

“The small business sector is not headed up with any strength,” said Bill Dunkelberg who heads up the NFIB. “(it’s) just treading water waiting for a good reason to invest in the future.” That certainly doesn’t portend for a strong rebound in productivity.

One dot that has yet to be connected to complete this picture is how this decline in productivity has impacted households. As pointed out in the Financial Times last week, after adjusting for inflation, median U.S. household income in 2014 was $53,657, about where it was in 1996. Though it will be interesting to see the 2015 numbers once they’re released, the latest data through February show no signs of a pick-up.

That could have to do with the types of jobs that have been created over roughly the same period. Dunne and Henwood were kind enough to run the numbers. What they found: Since 1994, the ‘eat, drink and get sick’ sectors of the workforce, as they like to call them, have seen their share of the labor force pie grow by about a third. Since then, the long decline in manufacturing has continued, with its share nearly halved, while that of trade, transportation, warehousing and utilities has shrunk by a third.

It stands to reason that the industries most supported by flat incomes are those that require the least in the way of disposable incomes. As for the ‘get sick’ sector’s job growth, it’s simply a reflection of the aging and growing of the population. And so, Americans take what little they’ve got left after covering the roof over their head, the cost of which has relentlessly marched upwards thanks to cheap debt financing, and spend the remainder on doctors’ bills and a night out at their eatery of choice.

The irony is working Americans have never been so well educated. They could be doing so much more. But that’s what a lost generation of corporate investment gets an economy – plenty of degree holders but not enough high paying jobs to go around. If only this too hadn’t been financed by debt. The latest figures show government-owned student loans as a percentage of consumer debt now exceed 27 percent.

There is however a silver lining: while the average 30-year old is shouldered with three times as much student debt as in 2003, these borrowers carry so much less in the way of mortgage, credit card and car loan balances that their overall debt loads are lighter than they were 12 years ago.

Granted, this isn’t all by choice; access to mortgage debt has been restricted. Nevertheless, the glass is half full interpretation suggests the beginnings of a tide shift in our culture. What if Millennials prove to be the first generation to reject debt as a way of life and tell central bankers what they can do with their overreaching influence?

That would be a welcome first step and a fitting salute to past generations who have fought and sometimes paid the ultimate price to uphold the principles of our founding fathers. If only it wasn’t the case that so many of the survivors of our country’s hard fought battles today find themselves with so little financial freedom.

Life, liberty and the pursuit of happiness might not come so easy to the current generation’s more fiscally prudent pioneers. But their brand of prosperity, which harkens to a bygone era that should never have gone by, might just stand the test of time and be that much more rewarding in the end.

 

Bank for International Settlements Working Paper No. 534: Labour reallocation and productivity dynamics; financial causes, real consequences by Claudio Borio, Enisse Kharroubi, Christian Upper and Fabrizio Zampolli, December 2015.

The Federal Reserve Bank of Chicago: Firm Entry and Macroeconomic Dynamics: A State-level Analysis by François Gourio, Todd Messer, and Michael Siemer, January 2016.