(What’s Left of) Our Economy: Big New Signs of Re-Bubble-Ization

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2016 elections, Allison Schrager, auto loans, balance sheets, Ben Bernanke, Bloomberg, bubbles, bubbles Federal Reserve, credit, credit cards, debt, Financial Crisis, Fox Business Debate, Goldman Sachs, housing, interest rates, leverage, loans, Matt Phillips, mortgages, quantitative easing, Quartz, revolving credit, Tracy Alloway, zero interest rate policy, ZIRP, {What's Left of) Our Economy

One of the more praiseworthy features of the Fox Business Republican debate was the discussion of the last mega-financial crisis and how to prevent a repeat. Although at their debate on CNN the Democratic presidential candidates were quizzed on the bubble and its bursting and possible remedies, the Milwaukee event marked the first time these subjects came up for the Republicans.

Better late than never, but that’s pretty strange given that the last bubbles inflated and the crisis broke out on the GOP’s watch. In fact, it’s downright disturbing. For a new meltdown remains by far the greatest economic threat to America’s future due to the Federal Reserve’s overly easy money policies – despite the latest reassurances from former Fed Chair Ben Bernanke that such warnings are ludicrous. Maybe not so coincidentally, two important new signs of re-bubble-ization have just appeared.

The first was reported by Quartz’s Matt Phillips, who pointed out that the Federal Reserve’s latest figures on Americans’ borrowing behavior showed that consumers in September took out an all-time record $28.9 billion in new loans in September. In the process, they broke a record set 14 years ago, and increased their credit outstanding by the greatest percentage since 1943 – when these records started to be kept. And even if you adjust for inflation, household borrowing is at lofty levels historically.

Many economists view such increases as a bullish economic sign – signaling that Americans are so confident about their future prospects (and repayment potential) that they’re willing to take on more debt. That may be true, but the data on wages and incomes strongly indicate that this confidence is really overconfidence. And if interest rates really are going to be raised by the Federal Reserve, even gradually, this overconfidence may be tomfoolery.

Also not so bullish – the makeup of these new loans. As economist Allison Schrager has sagely pointed out, not all borrowing decisions are created equal, even for individuals with comparable incomes. Some, like student loans, are arguably sensible investments in one’s own human capital and potential (though signs of diminished returns from a college education seem to be popping up everywhere). Others, like mortgages, are arguably sensible investments in an asset that could well appreciate in value (though the inflation and bursting of the housing bubble should have taught everyone that real estate is no longer a sure thing). And still other loans simply finance consumption – which lacks any capacity to increase one’s wealth.

Unfortunately, much of the September surge in consumer borrowing was in auto and credit card debt – which won’t bring any financial benefits.

The second sign of reb-bubble-ization was reported by Bloomberg News’ Tracy Alloway, who covered a Goldman Sachs study showing that leverage levels in Corporate America are at their highest levels in a decade – during the bubble years. In other words, thanks largely to the super-easy monetary policy pursued by the Federal Reserve since the crisis peaked, even though corporate profits have surged to new records, American business has gone on such a frantic shopping spree that its debt load has grown much faster. Indeed, according to Goldman Sachs, these debts are now at twice the levels they hit in the pre-crisis era.

Just as with consumers, rising interest rates could wreak havoc with the balance sheets of U.S. companies. And just as with consumers, relatively little of this borrowing is being devoted to strengthening these firms in what might be called the old-fashioned way – i.e., through the development of new products and services. Instead, much of this new debt has been used to fund mergers and acquisitions, and stock buybacks.

The Fox Business debate, however, does deserve criticism in one sense. It followed an entirely conventional course in focusing on crisis-proofing American finance by improving Wall Street regulation. Certainly such improvement has been warranted. But the financial crisis was rooted in weaknesses in the real economy. Until presidential candidates start presenting realistic plans for fostering more good jobs and the incomes they generate, and for spurring more production and the earnings they generate – which would reduce the need for binge borrowing in the first place – a new financial crisis looks much more like a matter of “when,” not “if.”

(What’s Left of) Our Economy: New Data Showing the Fed Really has Worsened Inequality

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asset prices, Bank of America, Ben Bernanke, bubbles, Federal Reserve, finance, housing, inequality, interest rates, Janet Yellen, QE, quantitative easing, recovery, stocks, Wall Street, zero interest rate policy, ZIRP, {What's Left of) Our Economy

Here’s a shock! A study claiming that the Federal Reserve’s historically unprecedented easy money policies have supercharged Wall Street (and the rich) and left Main Street (and the rest) in the dust! And it comes from Wall Street!

The debate over how the central bank’s zero interest rate policy (ZIRP) and quantitative easing bond-buying program (QE) has impacted inequality in America has been just as heated as the debate over how these decisions have impacted economic growth and the prospects for recreating real national prosperity.

The critics charge that easy money has greatly widened the rich-poor gap, largely by boosting incentives to buy and own stocks, and thereby fueling a long, powerful bull market that has overwhelmingly benefited the wealthy because they dominate stock ownership.

The mainstream Fed position was stated by Chair Janet Yellen at the September press conference following the decision to keep interest rates on hold:

“It is true that interest rates affect asset prices, but they have a complex effect through balance sheets, through liabilities and assets. To me, the main thing that an accommodative monetary policy does is put people back to work. And since income inequality is surely exacerbated by a high—having high unemployment and a weak job market that has the most profound negative effects on the most vulnerable individuals, to me, putting people back to work and seeing a strengthening of the labor market that has a disproportionately favorable effect on vulnerable portions of our population, that’s not something that increases income inequality.”

Her predecessor, Ben Bernanke, has made similar points, albeit with more reservations.

A new study from Bank of America, however, contains some data strongly indicating that the Fed’s critics deserve to win this clash hands down. For example, the B of A researchers examined the fate of various possible uses of $100 since the Fed began massively supporting the U.S. economy after the collapse of Lehman Brothers in the fall of 2008. The main findings? A $100 dollar investment in a standard stock and bond portfolio during this time would have more than doubled in value. But a $100 dollar wage would be worth only 14 percent more.

The same methodology also reveals that the financial system is channeling much more credit to the wealthy than to the rest. Thus for every $100 they raised at the start of 2010, venture capital and private equity funds are now raising $275. But for every $100 of mortgage credit extended in America since then, just $61 is being loaned and accepted today. And prime real estate in the nation has appreciated in value more than ten times as much as all U.S. residential real estate.

These results (and others in the study) hardly end the debate over the Fed and inequality. Bernanke and Yellen still make powerful “counterfactual”-based arguments – i.e., claiming that as bad as the situation is now, it would be even worse had the central bank not acted so decisively. And B of A’s possible motives need to be noted. Generally speaking, the financial sector has been campaigning strongly for a Fed rate hike because rock bottom interest rates have greatly reduced the profitability of lending.  (In that respect, this report may not be such a shock.)

But the B of A study should greatly increase the burden on the Fed to demonstrate that its monetary policies haven’t been little more than a boondoggle for the nation’s upper classes – not to mention a flop in and possibly an obstacle to restoring genuine economic health.

(What’s Left of) Our Economy: Beyond the Fed Tightening Debate

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Ben Bernanke, bubbles, Employment, Federal Reserve, Financial Crisis, inflation, interest rates, Janet Yellen, Jobs, monetary policy, moral hazard, recovery, zero interest rate policy, ZIRP, {What's Left of) Our Economy

The latest “Fed Day” has now come and gone. The Federal Reserve’s decision-making Open Market Committee has issued its latest monthly pronouncement on where it will set the short-term interest rate it directly controls. (It will stay near zero, where it’s been since the end of 2008). In the process, the central bank revealed a lot about how cheap or expensive the cost of borrowing will be in the U.S. economy at least until its next meeting, in mid-December.

And as always, the effects of this Fed Day will surely ripple much wider, as many investors, businessmen, and consumers look to each new central bank monetary policy statement for clues as to the economy’s health and prospects; for indications of how the Fed will act in the foreseeable future; and for a sense of what kind of rate environment financial markets will face – a key determinant of their performance.

The run-up to today’s Fed statement generated somewhat less suspense or anxiety (take your pick) than lately has been the case. After all, the recent slowing of the American and global economies seemed certain to have eliminated the chance of the Fed raising rates from their current levels just above zero. Chair Janet Yellen and other leading Fed lights, at least, have worried that such tightening could choke off too much growth and therefore hiring, while boosting the odds that a dangerous deflationary cycle could take hold and weaken the economy still further. (Employment and price levels are the Fed’s two main official statutory concerns – its “dual mandate.”)

Yet today’s statement is likely to keep raging the fierce debate in the economics, business, finance, and political communities over what the Fed should do – and what its recent unprecedentedly easy money policies have and have not accomplished so far. For the record, I favor beginning to tighten as soon as possible, for two related reasons.

First, I’ve feared that the artificial life support provided by years of Fed stimulus has so effectively masked the economy’s real weakness that the excesses that built up during the previous bubble decade (also largely enabled by the Fed) can’t undergo painful but necessary corrections. Therefore, the hard work of creating a truly durable foundation for American prosperity keeps getting postponed.

Second, even if the Fed’s gargantuan support prevented a 1930s-style depression, the credit flood it continues to supply is now actually encouraging further excesses – for reasons I spelled out in a post last month. So I’m worried that the United States – and by extension, the world, given America’s still outsized role – can’t avoid another financial crisis without tightening (i.e., starting to normalize) monetary and credit conditions; reimposing genuine market disciplines on economic activity; and making sure that risk is accurately priced (and indeed priced at all).

But as far as I’m concerned, my own views on tightening now or later are much less interesting than what this debate reveals about how well the economy’s ills are understood by both supporters and opponents of the Fed’s record these last few years. I’m simplifying a bit here, but I worry that the looser money advocates – include the apparent majority of Fed officials – are too focused on supporting growth (and hiring) literally at all costs, without thinking about the quality and sustainability of that growth. Weirdly, they appear to understand fully just how weak the economy remains, but seem to believe that all that’s possible is to prop up growth and employment indefinitely with monetary steroids.

I’m also, however, concerned about tightening arguments. Its champions seem to understand the intertwined economic and financial dangers of fostering low quality growth. But most of them appear to overestimate the economy’s underlying strength, and seem to believe that raising interest rates (at whatever pace, to whatever heights) will quickly restore genuine economic health.

Unless this paradox is somehow resolved, it’s hard to imagine recipes for solid recovery emerging that are properly targeted and based on realistic expectations of turnaround.

To be fair, neither side in this debate, much less Fed officials themselves, believes that monetary policy alone can fix the economy. Of course, the favored policies vary widely, but everyone I’m familiar with emphasizes the need for the rest of the government to start doing its part. But this observation brings up another concern. Undoubtedly, the forces that have produced and maintained D.C. gridlock are strong, and show few signs of weakening. But arguably, one of these has been the Fed itself – which may be creating a form of moral hazard in American politics.

For just as overly indulgent policies in economics and finance can convince businesses that, however massively they mess up, Uncle Sam will come to the rescue, it’s certainly possible that, at least in the backs of their minds, U.S. politicians are convinced that they can continue grandstanding unproductively because the Fed will keep the economy slogging along acceptably enough to prevent major voter backlash – and thus keep them in office.

In this vein, it’s fascinating – and a little disturbing – that former Fed Chair Ben Bernanke has also just suggested a belief that the Fed can and should back stop dysfunctional governing systems. In an interview last week with the Financial Times, Bernanke stated that “One of the Federal Reserve’s key functions is to act quickly and proactively when the legislative process is too slow.” Although the central bank was structured to be independent of short-term political considerations and pressures from office-holders, I’ve never heard anyone ever aver that the Fed should in any way substitute for elected politicians.

Does Bernanke’s successor, Yellen, agree? She’s scheduled to appear before Congress in early December. Maybe someone could ask?

(What’s Left of) Our Economy: Bernanke Flunks Crisis History 101

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Ben Bernanke, bubble decade, bubbles, Federal Reserve, finance, Financial Crisis, Great Recession, Lehman Brothers, monetary policy, recovery, regulation, Wall Street, zero interest rate policy, ZIRP, {What's Left of) Our Economy

Because America is unlikely to avoid a rerun of the last financial crisis and recession without recognizing why they broke out in the first place, it can’t be good news that former Fed Chair Ben Bernanke still apparently hasn’t learned the main lesson of this near-catastrophe (and its still punishing aftermath): The crisis was rooted ultimately not in failures of the American financial system, but in weaknesses in the real economy that remain largely neglected.

I say “apparently” because this judgment is based on interviews Bernanke has granted to tout his new memoir on the crisis, and I haven’t read the volume. But it must be significant that both Bernanke and the leading financial journalists who questioned him have concentrated exclusively on the role played by Wall Street’s behavior and structures on the one hand, and lax regulation on the other, in nearly destroying the global economy. No attention whatever has been paid to the deteriorating ability of the Main Street economy to generate adequate levels of real wealth and income; to decisions made going back to the early 2000s to mask these deficiencies with crackpot credit-creation practices; or to the reckless lending and investment patterns to which this artificial credit glut led.

Not that Bernanke is the last word in crisis-ology. Yes, he spearheaded Washington’s efforts to contain the meltdown and spark recovery. But since his tenure at the central bank began in 2002, just about when the bubbles began inflating, and his Chairmanship began in 2006, just before they started bursting, he clearly was as much part of the problem as he’s been part of what’s so far passed for a solution. So his memoir is obviously an opportunity for reputation-burnishing. But finance has so completely dominated America’s views of the crisis and its origins that Bernanke’s perspective can’t simply be dismissed as self-serving.

Here’s a typical Bernanke comment presenting his view that the crisis was rooted in a panic in the unregulated, uninsured non-bank portion of the financial system that had grown so large that it became capable of endangering an otherwise healthy non-financial economy:

“The previous six months [before Lehman Brothers failed], the economy had been growing, house prices had fallen moderately. After Lehman, the economy just went into a death spiral. The fourth quarter of 2008 and the first quarter of 2009 was among the sharpest declines in the economy in U.S. history. Once the crisis went into a new gear, house prices started falling more quickly, and that had a feedback mechanism. Absent the broad-based panic that froze credit markets, caused asset prices to drop sharply and punctured confidence, we wouldn’t have had nearly so bad a recession.”

Bernanke has even appeared to deny that the economy during the previous decade was bubble-ized by overly easy Fed monetary policy. Asked whether the central bank had kept interest rates too low for too long – in fact long after the shallow recession of 2001 had ended – Bernanke responded:

“The first part of a response is to ask whether monetary policy was, in fact, a major contributor to the housing bubble and all that happened. Serious studies that look at it don’t find that to be the case. People such as Bob Shiller [a Nobel laureate currently serving as a Sterling professor of economics at Yale University], who has a lot of credibility on this topic, says that: it wasn’t monetary policy at all; it came from a mania, a psychological phenomenon, that took off from the tech boom and moved into housing.”

Here’s the immensely big picture that Bernanke is missing. The 2001 to 2007 economy was indeed growing, but the growth was energetically propped up by artificial – and, as it turned out, completely unsustainable – government stimulus. In fact, as shown in this (admittedly complicated) chart I made up while that previous recovery was proceeding, the federal funds rate – the short-term rate directly controlled by the Fed – had been plunged to multi-decade lows during that period, whether in inflation-adjusted or current dollar terms. At the same time, within a few short years, George W. Bush’s administration and the Congresses it worked with drove the federal budget from its biggest surplus in decades as a share of the total economy into deep deficit.

But did this unprecedented peacetime stimulus result in unprecedented peacetime growth? As the chart shows, anything but. And the discrepancy between Washington’s herculean efforts and the the economy’s mediocre results could not have made clearer that the nation’s engines of real (not financial) wealth creation, and thus real prosperity, had broken down.

As I’ve written repeatedly, American leaders could have responded with programs to strengthen that real economy, and therefore the real spending power of American workers. Instead, they tried to create the illusion of prosperity by enabling consumer spending that was not remotely justified by consumer incomes.

Fast forward to 2015, and despite the literally trillions of dollars of stimulus poured into the economy by the Fed under Bernanke and his successor, Janet Yellen, U.S. incomes continue to lag and the current recovery has seen even weaker growth than that of the bubble decade. It’s true, as Bernanke and others have argued, that expansion today is being slowed by a significant reduction in federal deficits. But it’s even more important to recognize that the economy will never truly heal unless the private sector leads. And let’s not forget that, thanks to the zero interest rate policy put in effect by Bernanke’s Fed in December, 2008, credit in America has never been cheaper.

Bernanke by no means deserves all or even most of the blame for the nation’s recent economic malaise. The last time I checked, the president and Members of Congress have been cashing paychecks all this time as well. But since leaving the Fed last year, Bernanke has been outspoken enough to make clear his ambition to remain a major economic voice. Judging from his take on why the financial crisis broke out, however, he doesn’t have much of value to teach.

Making News: Podcast of New BBC Interview on China and Global Markets

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BBC, China, China stock markets, currency, currency wars, devaluation, emerging markets, export-led growth, Federal Reserve, finance, interest rates, investing, Making News, monetary policy, recovery, Trade, Wall Street, yuan, ZIRP

I’m pleased to announce that I was interviewed on the BBC this morning on China’s economic and financial turmoil, and how it’s been shaking the world’s economy and financial markets.  Click on this link for the podcast.  My segment is titled “Global Markets React to China’s ‘Black Friday'” and yours truly comes in at about the 7 minute-50-seconds mark.

Moreover, even as we speak, I’m working on a more detailed analysis that I hope to post shortly.  Stay tuned!

(What’s Left of) Our Economy: Why China’s Devaluation is a Huge, and Very Dangerous, Deal

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2016 elections, Bernie Sanders, bubbles, China, Congress, currency, currency manipulation, debt, Democrats, devaluation, Donald Trump, exchange rates, export-led growth, exports, Federal Reserve, Financial Crisis, Global Imbalances, Hillary Clinton, Janet Yellen, Obama, protectionism, QE, quantitative easing, Republicans, TPP, Trade, Trans-Pacific Partnership, yuan, ZIRP, {What's Left of) Our Economy

China’s de facto currency devaluation last night has sent a vitally important message to the President Obama and his trade policy advisers, to a Congress that has just endorsed his strategy for handling currency issues in the proposed Pacific Rim trade deal, and to presidential contenders in both major parties. Their reactions will go far toward determining whether China’s renewed exchange-rate protectionism will further slow the already sluggish American and global economic recoveries, or worse, generate more central bank stimulus that further addicts the nation and world to unhealthy, credit-fueled growth. Indeed, downplaying and coddling a weaker yuan – which could well be cheapened further – may further widen the kinds of international economic and financial imbalances that set the stage for the last global financial crisis.

Constructively dealing with Beijing’s gambit will require correctly understanding its origins and likely effects. This latest example of currency manipulation is not mainly a Chinese attempt to regain competitiveness following the yuan’s rising exchange rate versus export-oriented Asian rivals. Taiwan, Korea, Japan, and others are also seeing their exports fall due to weakening growth in their major final-consumption markets – which are outside Asia. Indeed, China’s trade surplus year-to-date is up more than 200 percent over 2014’s absolute record level. And China’s move into higher value manufacturing – including production of previously imported components of advanced consumer electronics products it once mainly assembled – is proceeding apace.

Instead, China’s decision greatly to widen the yuan’s trading band reflects a determination to boost its economy by increasing its market share even in a world where growth has stagnated or shifted into reverse. As such it’s a quintessential example of beggar-thy-neighbor trade predation. China’s intentions should also be obvious from the devaluation’s timing – two days after the release of trade figures showing a much worse-than-expected year-on-year drop in July exports. And if Beijing really considered the global economy a win-win proposition, it would have sought to juice its own expansion by stimulating domestic demand yet again, which could have helped both foreign-based producers as well as China-based producers. Devaluation, by contrast, bolsters the latter at the former’s expense.

As a result, contrary to many optimistic interpretations, the sluggish global macro picture does not limit the devaluation’s potential to inflict damage on the United States or the rest of the world. In fact, China’s devaluation decision – which is by no means sure to stop with this initial step – arguably could destabilize global finances more dangerously than during the bubble decade. Then, the lopsided financial flows resulting from China’s massive trade surpluses with the United States provided the critical mass of cheap credit that supercharged the intertwined American housing and consumer sectors – and eventually pushed the entire world to the brink. But then, too, U.S. and global growth were stronger. And the Fed and other central banks hadn’t yet created previously undreamed of floods of credit to stave off disaster.

Yet containing the effect of China’s mercantilism this time, without yet more massive – and even reckless – U.S. debt creation, will require the kind of push-back emphatically rejected so far by President Obama and by most Congressional Republicans. Clearly influenced by multinational company interests whose China production benefits from an artificially cheap yuan and other Chinese export subsidies, America’s Democratic and Republican leaders have opposed both sanctioning currency manipulation either unilaterally or through Mr. Obama’s proposed Trans-Pacific Partnership trade agreement (TPP). But they’ve also received cover from no less than Federal Reserve Chair Janet Yellen. She has endorsed the claim that combating currency manipulation could expose the United States to international retaliation because central bank easing – like the Fed’s quantitative easing (QE) and zero interest rate (ZIRP) policies – puts downward pressure on currencies.

The aforementioned timing of China’s action, however, makes this case much harder to make. So does the now greater likelihood that an American failure to respond on either front could well flash a bright devaluation green light before other trading powers – including present and future TPP countries – thinking of continuing (as in the case of Japan) or embarking on this course. Consequently, expect greater pressure on Congress to reject any TPP emerging from ongoing negotiations that lacks strong, enforceable currency manipulation curbs.

One almost certain source of this pressure – this year’s crop of presidential candidates.

As a long-time trade policy critic, Vermont Senator Bernie Sanders seems sure to weigh in quickly on China’s decision and the TPP, and will find a receptive audience among his Capitol Hill Democratic colleagues. He and other Democrats are also bound to turn up the heat on rival White House hopeful Hillary Clinton, whose trade policy and TPP positions have been more ambiguous. After weeks of refusing to comment on the TPP – whose development she must have shaped as President Obama’s first Secretary of State – Clinton declared that a final deal must “address” currency manipulation “either directly or indirectly.” But although this statement left the presumptive Democratic nominee with lots of wiggle room, it also left this flank highly exposed.

At the same time, Congressional Democrats need to remember that currency manipulation is hardly the only protectionist policy pursued by China at the expense of domestic U.S. businesses and their employees, and that even tough currency measures in the TPP text hardly ensures solving the problem. After all, many current and prospective members (like Japan and China, respectively) have vital interests in ensuring that this option remains available. As a result, whatever the merits, they’ll be highly likely to block American currency actions in the treaty’s dispute resolution mechanism. Legislative currency sanctions supporters on both sides of the aisle, therefore, will need to press just as hard for unilateral U.S. currency responses, too.

The politics on the Republican side are clearer. Front-runner Donald Trump has blasted U.S. trade policy with China as a disaster, and has just gotten a huge supply of fresh ammunition. His GOP White House rivals have all supported these China policies with varying degrees of enthusiasm. Will they start backing off? Will they continuing ignoring the subject, even though China’s trade predation inflicts nearly all of its damage on a private sector they claim to prize? Much will depend on whether conservative talk radio and Fox News decide to give this issue any coverage – and of course on whether Trump can keep focused on this subject and stay out of personal feuds.  If he can, he could display more seriousness on critical China issues than most of the rest of the American political establishment – low bar though that is.