Good News

Well the good news is that MMT advocate Lael Brainard has been removed from the position of Vice Chair at the Fed, effectively stripping her of any actual power. Oh and inflation came in pretty much as expected.

Honne And Tatemae

There are many financial conditions indexes, but in general terms they represent the cost and availability of credit and equity financing, interpreted as relatively “tighter” or “loose, easy”. Markets were surprised that Powell appeared unconcerned that these indexes showed that financial conditions were more or less unchanged by the Fed’s rate and QT actions. His unconcern was interpreted as conceding that the bulls were right in believing that rates would soon come down.

My interpretation was that he simply didn’t think it was a problem. One of the Fed’s primary concerns is to keep financial markets functioning normally, and the indexes show that they are. However, it is important to remember that the Fed is very well informed. The Japanese have words for this, “honne” and “tatemae”. “Tatemae” is the outward appearance of conformance to society’s norms and rituals, while “Honne” is what is really going on behind the scenes. In this case, the “Tatemae” is the traditional information bureaucracy – the BLS, BEA, and even the Fed itself – and the ritual announcements of  lagged and often politicized estimates of economic data. The “Honne” is that the Fed uses all kinds of information services and is very much in touch with the high-frequency data that is gathered by state governments, industry associations and many other private services. The recent callout of the BLS by the Philly Fed shows that the Fed has little faith in the BLS. Powell knows that the economy is either on the verge of recession or already in one regardless of the NBER’s view. He knows that deflationary collapses are underway in markets like housing and used cars. He probably also expects that taking down inflation, as happened in the GFC, will likely require a severe correction in financial markets, probably worse than the GFC. But I am of the opinion that  he is willing to be wrong about that, so if markets are right to “look through” the recession to a return to low inflation he would be perfectly OK with that. He did warn that no rate reductions should be expected in 2023, nor would he back off prematurely, but this was widely ignored.

Edit: This morning’s employment report demonstrates the useless, erratic nature of the BLS data.

Happy Days Are Here Again

Markets continue to behave as if 2022 never happened, inflation is dead, growth is strong, the Fed is impotent, we’ve had a soft landing and caution can be thrown to the winds. Stock prices have resumed their uptrend and new highs are soon to be seen. After all, the Dow is only down 7.5% from its all-time high close, and the S&P only 15%, dragged down by the big tech stocks, which are recovering fast from irrational selling, thanks to cost reductions from layoffs. VIX, the volatility index, is at levels last seen in early January last year, close to the December 2021 all-time stock market highs (18.06 as I write). Perhaps that is not a coincidence.

To me, this looks like an opportunity. Far be it for me to rain on a parade, but this looks like a bull trap.

Unwarranted

From the minutes of  the Fed’s 12/13-14 meeting:

Participants noted that, because monetary policy worked importantly through financial markets, an unwarranted easing in financial conditions, especially if driven by a misperception by the public of the Committee’s reaction function, would complicate the Committee’s effort to restore price stability.

Per Bloomberg, financial conditions are now back in pre-QT, super low rate – i.e. bubble – territory.

This isn’t going to make Jerome Powell happy, is it? Could 0.50 be back on the table? Just to get the markets’ attention…

What If?

The stock and bond markets are depending on the recession to “force” the Fed to “pivot” back to money printing and ZIRP. The economy is addicted to free money and is slowing rapidly now that it has been withdrawn. The bond market has already priced in disinflation and Fed easing, and the stock market has been buoyed accordingly, proceeding from short squeeze to short squeeze since June of 2022.

But what if Powell has decided that the QE policies that have yielded only $1 of GDP growth for every $10 of fresh debt are toxic and the addiction must be broken, no matter what the symptoms of withdrawal might be? That his legacy will be having returned the economy from dependence on continuous stimulus to sustainable growth? To say nothing of reducing the Fed-induced income inequality that is being exacerbated by inflation? That would certainly earn him a niche in the financial Hall of Fame, perhaps next to Paul Volcker.

Froth

While a little of the massive cash pile that resulted from the Fed’s monetization of Treasury debt has been whittled away, there’s more than enough left to continue to encourage the manic speculation that we’ve seen in recent years. A week ago yesterday, Thursday, January 5, Bed Bath and Beyond (NYSE: BBBY), a past favorite of meme stock traders, told investors that ”there is substantial doubt about the Company’s ability to continue as a going concern.”

The stock closed that day about 30% lower, at $1.69. The following day, Friday, it closed another 23% lower, at $1.30 – fair enough for a company that had just issued a bankruptcy warning. But starting on Monday, the meme stock traders started a bull run and took BBBY along for the ride. On Thursday – yesterday –  the stock touched 5.87, a 350% gain from last Fridays’s close. Today, it closed at 3.66, a 180% gain from its low close and a 52% gain from its pre-news close.

This is not investing. This is the kind of speculative frenzy that is generally called “froth.” As in “frothing at the mouth” or “rabid.” “Froth” is at tops, not bottoms.

Edit: Just noticed that Bitcoin is back over $20K. Despite the continuous drumbeat of frauds, hacks, rug-pulls, SEC lawsuits, defaults, bankruptcies etc. Another sign of speculative fever.

Edit: I guess it is everywhere. “Lotto Madness” is back. Two months after a record-breaking $2 billion jackpot, another winning ticket, sold in Maine, is worth an estimated $1.35 billion. Odds of a jackpot-winning ticket: 1 in 302,575,350.

Money, Money, Money

Money, money, money
Must be funny
In the rich man’s world
Money, money, money
Always sunny
In the rich man’s world
A-ha, ah
All the things I could do
If I had a little money
It’s a rich man’s world

(Abba)

Money today is simply a claim on a bank. In the case of cash, it is a claim on the Federal Reserve Bank (Fed). Otherwise it is a liquid deposit in a commercial bank, S&L, credit union or similar institution which can be converted to cash. By law, any debt, public or private, can be settled with cash.

Banks do not lend depositors’ money. Or anyone else’s money. Nor do they lend their reserves (money banks deposit in the Fed). They create the money that they lend. The proceeds of a loan transaction are deposited in the borrower’s bank account. The money is not transferred from anywhere. The loan is added the asset side of the bank’s balance sheet and a  deposit is added to the liability side. This deposit becomes money because it now meets the definition of money (see above). This is also exactly what the Fed does when it monetizes Federal debt. It buys Treasuries (loans to the government) from a bank or other approved institution, which become Fed assets, and credits the purchase price to the seller’s Fed account. Which, by definition, is money.

If the loan is not fully repaid, eventually the loan is “written off”. In this case, the unpaid amount – loss – is charged to the bank’s equity capital.

Edit: Note that bank reserves are not included in M1, which is not affected by the Fed’s Treasury purchases from banks. Bank reserves are included in the broad money supply, the monetary base (MB).

Labor Pains

The Bureau of Labor Statistics produces a monthly report which is largely based on two telephone surveys, the establishment survey and the household survey. The establishment survey covers businesses and produces an estimate of the number of jobs, which makes the headlines. The household survey produces estimates of the number of employed persons and the unemployment rate. 2022 to date has featured a record and growing discrepancy between the two reports. Of course, a discrepancy is normal as a result of individuals holding multiple jobs, but this year has been exceptional.

However, the Philly Fed produces a quarterly revision of the employment estimates based on the QCEW, the Quarterly Census of Employment and Wages which covers more than 95% of employers. The most recent revisions, for 2Q2022, revealed that headline job growth was 10,500, consistent with the household survey, rather than the 1,047,000 reported by the BLS, The discrepancy between the BLS estimates continues in the rest of the year to date so it is reasonable to assume that the job growth during that period was also a mirage.

Bullish analysts have seized upon this report to justify an early “pivot” by the Fed. This fails to be convincing because the unemployment rate and average hourly wages continue to show a very tight labor market, reported layoffs notwithstanding. What is does show is that Biden’s boast of job creation was BS, just like pretty much everything he boasts about.

What Happens Next

Well 2022 is just about over. I traded badly this year but that is behind me, I hope. Especially annoying since I have been expecting this bubble to burst for a long time. The big question is, where do we go from here. Some thoughts:

• Housing. Sales volumes are falling very rapidly because affordability is poor, but prices are holding as sellers are reluctant to drop their expectations. In the last housing bubble pop, it took a year and a half for this process to work through so that sellers finally acknowledged that prices could actually fall. This means that housing costs, which make up a disproportionate share of CPI, will be sticky.
• Employment. The pandemic significantly reduced the labor pool as many people retired or just dropped out. In China, the pandemic and measures to suppress it have badly damaged the economy and look to continue to do so. It seems likely that the offshoring that reduced labor demand in the US is over, and will be replaced by onshoring and relocation of production. Either way, labor demand is likely to remain relatively strong well after consumption growth falls. Labor looks to reclaim at least part of the loss of its share of economic output, at the expense of capital, i.e. profits.
• Energy. The idiocy of belief that minor reductions in CO2 output will have a material affect on the climate is hampering investment in energy sources. Of course this will throttle growth in energy production and keep prices high, even as a slowing economy will reduce demand for other commodities. I was amused to find that DNA recovered from northern Greenland revealed that during the region’s warm period, when average temperatures were 20 to 34 degrees Fahrenheit (11 to 19 degrees Celsius) higher than today, the area was filled with an unusual array of plant and animal life, including aurochs and mastodons. Then of course there are the (hopefully temporary) supply constraints that have been caused by the sanctions on Russian production.
• Food. The good news is that more CO2 in the atmosphere helps food production. But modern farming depends heavily on diesel fuel for big equipment and natural gas for fertilizer production. Fossil fuel prices directly affect food prices, because even though yields may be good, farmers will not plant crops on which they cannot make a profit. In addition to high prices, shortages of some crops will develop as farmers pivot to crops which require less of these costly inputs.
• Interest Rates. It seems that no-one believes that Fed Chair Powell will actually carry out the attack on inflation that he has outlined. Some argue that a recession will “force” him to abandon his current goals and resume ZIRP and QE, redefining his goals in the process to accept a higher level of inflation on an ongoing basis. Others believe that the recession will cause inflation to fall quickly and make the question moot as his goals, such as positive real rates across all maturities, will be automatically met.It is certainly true that this long-suppressed business cycle is moving fast, but there is a long way to go to normal. My personal view is that his vision for his legacy is an economy that does not depend on massive growth of debt relative to GDP as has been the case in recent years, and he will do “whatever it takes” to get there

In summary, inflation will prove sticky although not runaway, and Powell will accept a recession. But as the recession gains hold, it will accelerate as defaults reduce credit availability regardless of Powell.

Housing Collapse Redux

Take a look at this chart:

That is a collapse in process. An unprecedented collapse in modern times. Perhaps 1346-53 showed something similar. It will take 4-6 months to work its way into the hard data, but it is coming. Recall Stephanie Pomboy’s observation that in July of 2008, inflation was at 5.6%. By July of 2009, it was at -2.1%. There’s a Fed pivot of some kind. Now look at John Hussman’s pivot chart:

Which clearly shows that the real bear market will follow the pivot. Then contemplate another of Hussman’s charts which shows the potential losses from here:

Now look at the international context. China has its own housing bubble collapse going on, to say nothing of choking its economy with a stupid Covid strategy because a dictator like Xi cannot admit error. Europe is seized with political correctness, internal division over immigration from Africa and an energy catastrophe. Oh and there’s a proxy war with Russia going on and another with China waiting in the wings, to say nothing of a demented President. Just don’t choke on that turkey.