The Marginal Buyer

No more markets, just interventions?

“The Fed is the greatest hedge fund in history” – Warren Buffett

'Modern Monetary Theory' has nice ring to it and even its own three letter acronym of 'MMT', which seems to be de rigeur for every financial sleight of hand. A better term for MMT however would be 'Magic Money Theory', as it is merely another asymmetric risk carry trade, based on the pretence that it will ever get paid back in either incremental growth or directly from future consumption. Unfortunately, for these proponents of this Keynesian multiplier effect, the evidence from these applications of 'helicopter money' suggest the reverse, with GDP growth actually less than the stimulus applied, notwithstanding that the strategy has indeed delivered on the first part of the plan, in raising asset prices.  What is has failed to do however, is "trickle down" to the plebs and incremental consumption and GDP growth, as originally advertised. 

It is here where ivory tower economic theory has parted company with the human experience; perhaps underestimating markets ability to appreciate when it is being manipulated over a cliff. Over the past decade, investors have been conditioned not to "fight the Fed" and its unlimited capacity to swamp markets with liquidity, but the policy's failure to deliver on its stated aim while actually exacerbating problems of income inequality is hastening the demise of MMT. Like a junkie, central banks are addicted to the asset stimulus and have shown themselves unable to kick the habit voluntarily. At some point however, this lunch will have to be paid for. What remains unresolved, is whether reality and monetary discipline is restored by currency markets, or from political push-back first.  

“The Federal Reserve isn’t just inflating markets but is shifting a massive amount of wealth from the middle class to the rich" - Stanley Druckenmiller - billionaire hedge fund manager

Central Bank Interventions

Junkies rarely admit to their addiction and will go to great lengths to justify that one 'last fix'. 

It certainly didn't take much to flip-flop the US Fed from a tightening, to an easing stance at the back end of 2018. A shift that has been propelling equity markets ever since and which has also encouraged other central banks, such as the ECB, to dispense with even the pretence of fiscal and monetary responsibility, now that a pandemic has provided cover for MOAR!

The key question however, is whether the US has indeed 'fallen off the wagon' or if this apparent volte face is merely a tactical manoeuvre to nurse the US economy through the current COVID-19 induced recession and restore a positive trajectory for economic growth and employment into the new Biden administration and before tax-payers and savers wake up to the realisation of who and when all this is going to have to be paid for.

This of course will also include the $1.9tn of pork that has been dressed up as a 'stimulus' bill by the Democrats. The big question with this though, is whether Yellen will be able to influence her old muckers at the Fed, on behalf of her new paymasters, that the economy and inflationary pressures are so weak as to justify the Fed's continued intervention in monetising this expenditure.  Fiddling to job statistics and pushing for lockdowns to depress economic growth expectations, while opening borders to yet more unemployed is surely not going to fool those at the Fed, which will also be concerned with its key mandate, that of controlling inflation, at a time when Treasury bond yields are pricing in a spike in implied inflation towards 2.5% again.  

As always, with the Fed, this will initially be a political decision, but ultimately a survival issue for the US dollar and those who control and profit from it.  As in the 1970's, rising inflation fears on fiscal irresponsibility can deliver a rude awakening to markets and politicians alike!

Tough for the US maybe, but potentially devastating for the rest who seemed content to keep partying on their central bank's tab.


CB assets as % GDP by region

As the World's reserve currency, QE in the US under Obama provided cover for other central banks/economies with unresolved structural deficits to follow suit. What is perhaps missed by markets however, is the considerably higher proportional exposure by these other major economies, relative to GDP, than for the US. 

In the chart opposite, I have included the positions for Japan (BoJ) and the ECB (Euro) along with that for the US Fed. 

While the Paul Krugman inspired position at the BoJ ought to speak for itself, there are two points of note with regards the ECB's asset exposure.

  1. Firstly, it is over double that of the US Fed relative to the EURO 19 GDP and 

    2. Secondly, the ECB position is not directly covered by recourse to tax payers, because as of yet, it is not actually a country. 

One more reason to hasten the EU state and transfer union! 

Multiplier effect?   LoL

The chart opposite shows the quarter-on-quarter change (in USD millions) in GDP and central bank balance sheet assets for the US, ECB and Japan. 

Even if one were to exclude the exceptional intervention in 2009, what is clear from this data is that 

    1. The Subsequent QoQ growth in aggregated GDP has failed to even match the growth in Central Bank assets.

    2.  Each QoQ contraction in GDP triggers a QE (or equivalent) policy response and intervention from central banks. 

Multiplier effect - cumulative impact

'Exceptional' monetary stimulus? 

Hardly, when the incremental expansion in GDP has been less than the additional 'funny money' pumped into the economy!   

Please let the implications of this settle in, while central banks embark on a second throw of the dice. 

Perhaps the replacement of a command economy to replace the market pricing of assets is not conducive to efficient pricing of capital and therefore investments. Should we therefore be surprised if companies allocate capital to share buybacks and acquisitions rather than organic investment and expansion?

Replace the incentives to save and invest with a spend and borrow model and hey pesto, you get a zombie economy!