Janet Yellen deserves exactly none of the adulation being conferred upon her tenure by the mainstream financial press. In fact, her reign will be judged by history as a spectacular failure that left main street high and dry---even as it finally and completely addicted Wall Street to the toxic monetary heroin that is the specialty of Keynesian central bankers.
Accordingly, it may take a dozen or more episodes like the 12% crash of the last few days to finally purge the "buy the dips" addiction that is rampant in the casinos. Pending that day of deliverance, however, the soon-to-be shaking and shivering cold turkeys of Wall Street will surely come to see that Opioid Janet was not their friend at all, but their very worst nightmare.
The truth is, she was incompetent, clueless and truculently wedded to Keynesian macro-economic models that are so primitive and dethatched from reality as to be downright embarrassing. At the same time, her stubborn obliviousness to the gambling mania that suffuses the financial markets has been just plain pathetic.
Awhile back the venerable monetary seer who publishes Grant's Interest Rate Observer adduced that money and finance had befallen to the the PhD standard. We recall that Jim Grant had Professor Ben Bernanke, PhD from MIT and wrong-head scholar of the Great Depression, in mind. But surely from the perspective of February 2018, it is Janet Yellen who finally brought paint-by-the-numbers economics and rule-by-the-model central banking to their present destructive estate.
That's in considerable part because to our knowledge Janet Yellen never set foot on Wall Street, but more importantly has no clue about the dangerous breed that congregates there. In a word, they are a self-selected sliver of mankind's most ambitious, arrogant, cunning, glandular, greedy and reckless gene pool.
The very worst thing that central bankers can do, therefore, is to impair and eventually destroy the free market's natural mechanisms of self-discipline. Among these checks and balances are short-sellers, carry costs, hedging expense and surprises. These are what keep greed in check and fear of ruin alive and palpable in the trading pits.
In this context, Yellen's cowardly and clueless coddling of Wall Street could not have occurred at a worse time. That is, her tenure as Fed chair encompassed months #54 to #104 of the post-crisis recovery---or middle age by historic standards. That's the interval in the endless cycles of business and finance when the pains from the last crash have faded and when the great central bankers of the past---William McChesney Martin and Paul Volcker are the only ones who come to mind----stood ready to remove the punch bowl before the Wall Street party got out of hand.
In this case, the cycle's middle age also came hard upon Bernanke's utterly misguided attack on a recurrence of the Great Depression that was never in the cards. Yet the resulting "emergency measures" such as the madness of ZIRP and QE remained fully in place for years. By the time of Yellen's ascension to the Fed chair, in fact, the resulting tsunami of liquidity, cheap debt and financial price-keeping operations had completely backfired: It had done nothing at all for the main street economy---even as it replicated the very same Wall Street bubble that had crashed in September 2008.
So early 2014 was the time to nip it in the bud, if there every was one. After all, you just couldn't plausibly argue at that point that the economy was too weak to be weaned from zero-cost money. During the seven quarters after Yellen's appointment, in fact, real GDP growth made a good accounting for itself, rising by an average of just under 3.0% per annum on a year-over-year basis.
Nevertheless, Yellen dithered for the entire period (until December 2015) and the reason was self-evidently a weak backbone, not a weak economy. She and her posse were flat-out petrified of a Wall Street hissy-fit and confected a pile of Keynesian excuses to avoid raising rates. These included insufficient inflation and the timely discovery that the "neutral funds rate" (the financial equivalent of a unicorn that has never been seen) had mysteriously dropped all the way to the zero bound for the first time in modern history.
Accordingly, what was to be the long middle age of the business cycle---after the liquidation of labor and inventories had long ceased and had actually reversed-----got wasted. The imperative need to make up for lost time and to get the Fed's hulking presence out of the casino never even penetrated Yellen's Keynesian befogged beer goggles.
By 2014, in fact, it was especially urgent to get the Fed's big fat foot off the neck of the money market, thereby putting risk back into the carry trades; and to swiftly shrink its Bernanke bloated balance sheet, thereby enabling long-term interest rates to find market clearing levels and the yield curve to be shaped by macroeconomic conditions and prospects, not the bond buying activity of central banks and the trillions wielded by front-running speculators who lunched off their announced bond purchase schedules.
Indeed, had Yellen done the right thing by adopting an aggressive balance sheet shrinkage plan (QT) in the winter-spring of 2014, there never would have been the subsequent $5 trillion mad-cap bond-buying program conducted by Draghi and Kuroda during 2015-2017. Indeed, the second dark blue hump in the chart below is the real villain of the piece---yet Janet Yellen's timidity and Keynesian befuddlement were the proximate cause which enabled it, and which permitted fevered speculation to reach unprecedented intensity and scale.
By contrast, a rapid rise in yields on US treasuries and other dollar bonds would have stopped the global hunt for yield cold in its tracks. And it would also have shutdown Draghi and Kuroda long before they fraudulently printed $5 trillion of fiat credit. In the face of a rapidly hardening dollar, the euro and yen would have otherwise gone into an unsustainable free-fall.
Stated differently, much of the mischief, madness and reckless speculation now implanted in the global financial markets happened during the Yellen-enabled global QE phase of 2014-2018. During that period, for example, corporate debt issuance set all-time records. But as we documented in Part 1, the proceeds went into financial engineering and bidding up the price of existing shares to ludicrous heights, not new growth capital.
Likewise, carry trade speculation by front-runners went to mindless extremes, such as the fact that the Italian 10-year note traded under 1.0% during points in 2016. The facts that Italy's public debt stood at 133% of GDP, that its political system was completely broken and dysfunctional and that its economy was 10% smaller than it had been earlier in this century were irrelevant to the price of its debt; the latter was being set by front-running speculators who were buying on massive repo leverage what the idiot central banker, Mario Draghi, promised them he would be buying, too.
Indeed, as Yellen dithered, deferred, ducked and delayed the urgent imperative of monetary normalization at the Fed, the other lesser central banks were given leave to expand their collective balance sheets at a stupendous $2.2 trillion annual rate during much of 2016-2017. With two massive central bank vaults swinging their doors wide open, it's no wonder that upwards of $15 trillion of sovereign debt traded with a negative yield during the peak of the madness.
And that wasn't the half of it. By killing the yield on sovereigns, Yellen and her convoy of Keynesian central bankers forced money managers into what will soon be evident as crazy-ass risk taking in order to scrape-up a semblance of yield.
Not only did European junk bonds trade inside the UST 10-year yield at one point, but the corporate bond market was literally primed for an explosion of issuance by fund managers desperate for returns. The proceeds, of course, went almost entirely into funding giant, pointless M&A deals, stock buybacks and other forms of debt-financed recapitalization.
And that gets us to our fundamental point about a failed economic recovery that is overwhelmingly the fruit of Yellen style central banking. In part, monetary stimulus didn't work because as we saw in Part 1, households were already at Peak Debt by the eve of the crisis in 2008.
But adding insult to injury, nine years of ZIRP and QE also disabled the C-suites of corporate America, turning them into financial engineering joints and therefore barriers to investment, growth, jobs and wages rather than the agent of their delivery. In effect, corporate America is being strip-mined of cash and investments in order to fuel soaring stock prices and executive stock option windfalls.
However, the fact that Yellen and her posse of money printers have been oblivious to this destructive dynamic is in some part due to the fact that they refuse to recognize just how horrid this s0-called recovery has actually been. Indeed, by focusing obsessively on the noise-ridden version of the "labor market" embedded in the BLS reports and what we call short-run economic weather reports, Yellen has missed the big picture entirely.
Here's the truth and it hasn't changed with the passage of another year (2017). On a peak-to-peak basis over the last decade, real GDP growth measured by final sales (which eliminates short-run inventory fluctuations) has averaged just 1.2% per annum. That is just plain in the sub-basement of historic performance and barely amounts to one-third of the trend rate during the 1980s and 1990s---to say nothing of the 4% rates achieved in the 1960s.
Moreover, the horse is now out of the barn door. The current business cycle is in its final innings---s0 there is no chance whatsoever that even a final blast of Trumpian growth could measurably improve the average.
Worse still, Yellen's Keynesian successors and assigns have been left so far behind the curve by her mindless dithering that they now have no choice but to plow ahead with an unprecedented bond dumping campaign that will soon shock an already shell-shocked bond market with $600 billion per year of twice-baked supply.
The above chart has most surely never been viewed or discussed at a FOMC meeting, but its heavy duty import blows away all of the monthly blather from the Fed about labor market conditions and the puts and takes of short-run macro indicators. Had our Keynesian monetary central planners got their heads out of their DSGE (dynamic stochastic general equilibrium) models even occasionally they would have recognized that the US economy is failing badly and that their bathtub model of the US economy is woefully obsolete and irrelevant.
The fact is, in the present open global economy "full-employment" and domestic "inflation" are conceptually irrelevant and empirically un-measureable. For instance, in a world where (on the margin) wages are set by the China Price for goods, the India Price for services, the Technology price for labor substitution, and where work is ladled out in 15-minute spoonful's by computerized schedulers and gig-based labor procurement practices, the current BLS headcount based metrics are essentially noise.
Accordingly, the Fed's current "soft" target of 4.0% on the U-3 unemployment rate is downright ridiculous, and most especially so when in the ninth year of a business recovery you still have 102 million adults not in the labor force or officially unemployed----of which only half are retired and receiving social security benefits(OASI).
Likewise, the U-3 computational method counts as "employed" anyone who works only a few hour per week---even as the establishment survey designates as a "job" each of the three or four part time gigs that millions of Americans take on in order to make ends meet.
In short, what you get from the BLS reports----which Yellen slavishly studied via 19 separate dashboards----is statistical noise, pure and simple. The U-3 unemployment rate as a proxy for full employment does not even make it as primitive grade school economics.
In fact, the US idle labor supply is huge, tremendously elastic and wholly outside the capacity of the Fed's primitive tools of interest rate manipulation and fiat credit expansion to impact. Thus, there are currently 210 million adult Americans between the ages of 16 and 68---to take a plausible measure of the potential work force.
That amounts to 420 billion potential labor hours, if we accept the convention that all adults are at least theoretically capable of holding a full-time job (2,000 hours/year) and pulling their share of society's need for production and work effort.
By contrast, during 2017 only 250 billion hours were actually supplied to the US economy, according to the BLS estimates. Technically, therefore, there were 170 billion unemployed labor hours, meaning that the real unemployment rate was 40.4%, not 4.1%!
Yes, we have to allow for non-working wives, students, the disabled, early retirees and coupon clippers. We also have drifters, grifters, welfare cheats, bums and people between jobs, enrolled in training programs, on sabbaticals and much else.
But here's the thing. There are dozens of reasons for 170 billion unemployed labor hours, but whether the Fed is monetizing $80 billion of public debt per month or not, and whether the money market interest rate is 100 bps or 135 bps doesn't even make the top 25 reasons for unutilized adult labor. What actually drives our current 40% unutilized labor rate is global economic forces of cheap labor and new productive capacity throughout the EM and dozens of domestic policy and cultural factors that influence the decision to work or not.
Without spooling through all the details, it is equally obvious that the Fed's ability to impact the virtually impossible to measure "inflation rate" to the nearest two digits around 2.00% is also negligible over any meaningful period of time. We now have global monetary inflation and price cycles and undulations that the FOMC could not manage in a month of Sundays.
This much is obvious enough. But Yellen did not simply waste four years pretending to be pursing the willow-wisps of "full employment" and 2.00% inflation. She actually spent the entirety of her tenure at the Fed's helm meddling in financial markets that need no help from the Fed in accomplishing their essential mission of honest price discovery. So doing, she helped bring about the most systematic and relentless falsification of financial asset prices in recorded history.
Needless to say, after the current swoon has exhausted itself, the dip-buying addicts are likely to be back in full force---piling on to the same crowded trades that have levitated the stock averages to truly preposterous levels. Yet it is only a matter of time before the current feeble business cycle succumbs to the next downturn, and the underlying structural weaknesses of the US economy become glaringly evident for all to see.
What the Wall Street speculators and robo-machines will see, of course, is a central bank out of dry powder and impotent in the face of a faltering economy---and just as the massive borrowing requirements of the US treasury hit the bond markets. The resulting conflagration will not be a pretty picture.
So instead of shoveling out free money to the carry traders and obsessing about the U-3 unemployment rate and the PCE deflator minus food, energy and whatever else was inconvenient at the moment, our PhD at the helm might have better spent the time pondering the chart below.
American productivity has truly hit the skids and the reason lies in the handiwork of Janet Yellen and her two immediate predecessors. In turning the money and capital markets into gambling arenas, they thereby also transformed the C-suites of corporate America into financial engineering joints. And that, at the end of the day, is what has driven capitalist enterprise and energy out of the main street economy.