Tonight, we at Notes From Underground will clean up some unfinished business. We will discuss a couple of important speeches and articles from the past two weeks.
Then I will answer the questions Mike Temple made on the previous blog post. In responding to some of Mike’s points I come back to the idea of INFRASTRUCTURE, which I addressed in a few other blog posts. The reason I foresee aggressive fiscal stimulus put forth by the G-20 is precisely because of some of the fears that Mike raises about the damage coming to the investment grade corporate bond market while the FED’s shrinks its balance sheet and raise interest rates. It may be having a greater impact than the FOMC wants to acknowledge.
If the outcome from the FED‘s recent and continued policy causes the DOLLAR to appreciate, the effects will be somewhat deflationary. Emerging market debt will be spooked as the cost of dollar-denominated corporate debt will become onerous. The debt servicing costs for U.S. investment grade debt will rise because of the vast amount of debt piled on during the QE policy during the Bernanke regime. U.S. government debt servicing costs are also rising as borrowing costs are pushed higher in response to Fed policy of rate hikes coupled with tightening reserves. Plus, the uncertainty over the impact of the ECB’s ending QE with an impending Italian banking and budget crisis adds to the uncertainty challenging the global economy.
As an aside, this weekend THE WASHINGTON POST ran a story by Josh Dawsey and Damian Paletta titled, “Trump Wants to Cut Deficit but Still Demands Pricey Spending.” The idea that President Trump is concerned about deficits is from the theater of the absurd. This president has made the policy error of raising defense spending, which will prevent any effort to constrict federal spending. As long as the monster of the military-industrial complex gets fed, all other government programs will be supported for that is the give-get that drives the budget process in Washington. Trump’s concern over deficit cuts is political chicanery at its best. Pay no attention to the man behind the curtain.
Now that the 2020 election cycle has begun, Trump wants an infrastructure program in an effort to stimulate the economy. In addition, the recent equity market weakness necessitates the need for fiscal stimulus. Trump will blame the stock market weakness on the “LOCO FED” so that lifts FISCAL STIMULUS into the position of being “THE ONLY GAME IN TOWN.”
1. CNBC interviewed Fed Vice Chairman Richard Clarida and he raised some important issues for the FED to consider. Clarida raised the issue of the slowing global economy several times. He said:
“It’s important for your viewers to understand that although our mandate is full employment and price to building in the U.S., to achieve that we have to understand and factor in the global economy. And there is some evidence of global slowing. Certainly speaking for myself, that’s something that is going to be relevant as I think about the outlook for the U.S. economy. You know, because it impacts big parts of the economy through trade and through capital markets and the like.”
It is refreshing to hear from an influential voice at the FOMC table that there are concerns about the global economy. The role of the U.S. dollar as the world’s reserve currency ought to give the FED a triple mandate: Dollar strength can cause havoc for a world swimming in a pool of dollar-denominated debt.
2. There was a Wall Street Journal story on November 16 by Joseph C. Sternberg titled, “Why Central Bankers Missed the Crisis.” Sternberg cites the views of Claudio Bario, which are important because he heads up the economic research department for the Bank for International Settlements (BIS). In addition to the significant historical perspective, Sternberg notes that Bario questions the efficacy of the Phillips curve for failing to account for the structural forces of globalization.
“The big structural force Mr.Bario identifies is GLOBALIZATION [ed note: emphasis mine], under which international competition puts sustained downward pressure on inflation.”
If the FED and others fail to understand the dynamic nature of the global financial structure then monetary policy outcomes will struggle to be appropriate.
In a paper the BIS published this year there is a warning we all need to heed: “On one hand, globalization and other [often benign] factors make it harder for central banks to gin up inflation. On the other hand, by slashing rates in pursuit of that hard-to-attain inflation target, they create IMBALANCES IN THE FINANCIAL SYSTEM THAT LEAD TO CRISES LIKE THE ONE IN 2008,” (emphasis mine). This is the dilemma that the global financial system faces and should lead to questioning the false certainty of central banks dependent on academic theories. It is this questioning that makes the Sternberg article so important.
3. On November 20, Bundesbank President Jens Weidmann delivered a speech to the insurance association of Europe titled, “Securing Stability–Challenges From the Low Interest Rate Environment.” The speech provides much perspective on the Great Financial Crisis, which is important. What’s of greater interest is Weidmann’s view about the NATURAL RATE of interest. It is quite possible that Herr Weidmann will be the next President of the ECB so we should pay attention. Weidmann cites the 80-year old study of American economist John H. Williams:
“The natural rate is an abstraction; like faith, it is seen by its works. One can only say that if bank policy succeeds in stabilizing prices, the bank rate must have been brought in line with the natural rate, but if it does not, it must not have been.”
Further, Weidmann raises a very significant point for all investors: “But the concept of the natural rate refers to characteristics of the real economy, so it would be appropriate to apply a risk-bearing return on capital.”
As the markets begin to concentrate on the vast amount of debt plaguing the global economy it is time to get back to work and focus on how the servicing of global debt is going to impact monetary flows around the world. If you thought this was easy you have chosen the wrong vocation. Investing in the global macro world is not a hobby. Now, back to work and rid your mind and body of the impact of TRYPTOPHAN.