China’s Quiet Central Banking Revolution

Since Yi Gang became governor in March 2018, the People’s Bank of China has improved its communications, boosted its transparency, and moved toward a flexible exchange rate. Although the PBOC has plenty of room for further improvement, its progress so far is good news for China and international policymakers alike.

Miao Yanliang




BEIJING – Fifteen years ago, Alan Blinder, a former vice chair of the US Federal Reserve System and a longtime professor of economics at Princeton, wrote a book entitled The Quiet Revolution about changes in central banking. Chief among these was a move by some central banks toward open communication and transparency, and away from their long-held tradition of secrecy and surprise. A central bank “goes modern,” to borrow from the subtitle of Blinder’s book, when it starts talking.

The Fed was slowly heading in this direction by the turn of the century. It finally began announcing its interest-rate decisions in 1994, and started issuing regular press releases in 2000 (though it did not hold regular press conferences until 2011). These changes reflected a new appreciation among central bankers of how changes in short-term policy rates work their way through the economy via expectations and market pricing.

Today, the People’s Bank of China (PBOC) is undergoing its own quiet revolution. Like the Fed before it, China’s central bank is becoming more communicative. But the real revolution in Beijing concerns exchange-rate policy, with the PBOC increasingly allowing market forces to determine the renminbi’s value. Both developments are welcome.

The PBOC’s communication offensive has much to do with its new governor, Yi Gang, who was appointed in March 2018. Last month, the bank hosted its first-ever briefing to explain the latest economic and monetary data. And Yi himself has taken the initiative to explain policy decisions, notably his “three arrows” to support funding for small and medium-size enterprises. The governor also occasionally weighs in about stock-market volatility, even though such interventions may raise eyebrows among central-banking traditionalists.

Another significant move came in January, when the PBOC unveiled a new version of its English-language website. Previously, only about 2% of the Chinese site’s content was available in English, prompting foreign investors to complain about an uneven playing field. But the bank’s new English site covers almost every major aspect of policy, from open-market operations and decisions to the governor’s speeches and activities. For example, it features Yi’s speech last December at Tsinghua University on China’s monetary policy framework, together with an English version of his original PowerPoint slides, which are not available in Chinese on the PBOC’s site.

Although this open communication is certainly important, the PBOC’s increasingly flexible exchange-rate policy is far more transformative. In 2015-2016, the PBOC spent about $1 trillion of China’s foreign-exchange reserves to prop up the depreciating renminbi. These days, the PBOC no longer intervenes regularly in the currency market, and does not have an exchange-rate target.

This flexibility has been increasingly evident since the start of 2018. After peaking at CN¥6.26 against the US dollar in February last year, the renminbi slid all the way to CN¥6.97 by the end of October, a 10% drop. (It has since risen again and currently stands at about CN¥6.70.)

The renminbi’s peak-to-trough swing against the dollar in 2018 was comparable to that of the other Special Drawing Right (SDR) currencies: the euro (10%), yen (9%), and British pound (13%). In a similar vein, the renminbi’s daily volatility last year reached 4.3% – about 70% of the volatility level of the four other SDR currencies (including the US dollar). And for the first time, the Chinese currency was more volatile than the Singapore dollar.

Despite – or because of – swings in bilateral exchange rates, the renminbi remained broadly stable against a mix of currencies. The index of the China Foreign Exchange Trade System (CFETS), a 24-currency basket, started and ended the year at around 95. This happened with little central-bank intervention. Even the US Treasury Department said in an October 2018 report that direct intervention by the PBOC last year had been “limited” and that foreign-exchange sales by state banks had been “modest.”

A flexible exchange rate acts as an automatic stabilizer in two ways. First, it serves as a safety valve that responds to, and relieves pressures from, capital flows and global demand. Indirectly, and more fundamentally, a market-driven exchange rate gives the PBOC more room to use interest rates and other monetary-policy tools, such as the reserve requirement ratio (RRR), to help stabilize the economy. This in turn stabilizes the renminbi.

For evidence of this, look again at 2018. Whereas the Fed raised interest rates four times during the year, the PBOC settled for a mere five-basis-point hike in March, and actually cut the RRR four times as part of a policy of targeted countercyclical easing. Despite these cuts, the renminbi has not gone into free fall, as some might have expected: its current value against the US dollar is similar to that in mid-December 2017, when the PBOC last followed the Fed with a five-basis-point rate increase.

As the renminbi increasingly becomes a two-way floating currency, market expectations are adapting accordingly, and one-way directional bets against it seem far riskier than before. By contrast, a return to routine PBOC intervention in the foreign-exchange market would breed instability. When policymakers do not allow exchange rates to adjust, they risk triggering a destabilizing downward spiral of lower reserves, less confidence, and more panic.

The quiet revolution Blinder described in 2004 is underway in Beijing. True, the PBOC has plenty of room for further improvement in its communication and exchange-rate policies. But its progress so far is good news for China and international policymakers alike.


Miao Yanliang is a member of China Finance 40, a Beijing think tank.


Buttonwood

China’s trading day is starting to influence global markets

The importance of opening time in Shanghái



IN HIS BOOK “The Death of Gentlemanly Capitalism”, Philip Augar described a shift in the culture of London’s financial industry during the 1980s and 1990s. The old City of public-school amateurism, late starts, early finishes and long, boozy lunches disappeared. In its place, a new City emerged under the sway of American investment banks. The morning meeting started two hours earlier. Lunch was a sandwich at your desk. And instead of port and cigars, try mineral water.

It was time to sober up, too, because America’s influence on the London market went well beyond the acquisition by its banks of a few old-school stockbrokers. America was home to much of the world’s capital. As more buying and selling of assets took place across borders and time zones, the New York trading day set the tone for markets everywhere else. A City broker had to be at his desk, and with his wits about him, when the New York market opened just after lunchtime in London.

The global trading day still only truly begins when New York clears its throat. Markets in the rest of the world then take note of what has been said. But listen closely, and you hear the beginnings of a dialogue. China has barely opened its capital markets to foreign investors and the yuan is still a managed currency. Yet its say in how global markets rise and fall is already apparent. And China’s influence will only increase as more foreign capital flows into the financial markets on its mainland.

China’s voice is most audible in currency markets. For a long time, the yuan hugged the dollar closely, taking its cue from America. But since August 2015 it has been allowed to fluctuate more in response to market forces. In theory, its value is set by reference to a basket of currencies. In practice, this means a wider trading range against the dollar—not so weak as to spark capital flight, but not so strong as to hurt exports. Within this range, the yuan exerts a sizeable pull. Other important currencies, notably the euro, have tracked its ups and downs against the dollar.

Stockmarkets are next. China has led this year’s sharp bounce-back in share prices worldwide. True, the change in mood is not only about China. The Federal Reserve no longer seems hellbent on tighter monetary policy. General Electric, one of the largest issuers of corporate bonds, has so far averted a downgrade to junk. Italy’s clash with the European Union over fiscal policy has fizzled. But the anxieties about China that troubled investors in the final months of 2018 have also faded. There is now a real prospect of a truce with America over trade. And a host of tax cuts and other measures are in train to pep up China’s slowing economy.

That is, in part, why buying A-shares (yuan-denominated stocks listed in Shanghai and Shenzhen) is a favoured trade of bulls. After falling hard last year stocks in China had headroom. Although America’s economy looks fairly robust, its stockmarket is expensive. Foreigners looking at China’s stockmarket felt it was awfully cheap by comparison. And it is telling that the way to play renewed optimism is to buy stocks on the mainland. In the past, investors might have turned to Hong Kong-listed shares or proxies for China’s economy, such as the Australian dollar.

There is more to foreign buying of Chinese stocks than a revival in risk appetite. Global investors own just 2-3% of Chinese stocks and bonds, well below the country’s weight in world GDP. For foreigners to buy financial assets on the mainland is far from frictionless, but it has become a lot easier. The compilers of the stock and bond indices, benchmarks for trillions of dollars of investments, have taken note. MSCI is speeding up the inclusion of A-shares in its emerging-market index and will quadruple their weighting this year. Next month Bloomberg Barclays is adding China to its main bond index. Other providers of bond indices are likely to follow suit. Analysts at Morgan Stanley expect a marked acceleration of foreign capital flows into Chinese shares and government bonds this year in response.

It is not too fanciful to imagine a time in the future when the start of the trading day in Shanghai is an important moment for global capital markets. Would London, eight hours west of Shanghai and five east of New York, then regain some of its lost relevance? Maybe not. Perhaps Los Angeles would be a better bridge. An early riser could be up before New York opens and still awake when Shanghai closes. What would the rheumy brokers of the old City make of that?


Beware The Signs Of Recession/Deflation

 
by: Avi Gilburt
 
 
Summary
 
- Markets seem to convince investors that the current trend will continue unabated right at the inflection turning points.

- I believe we are approaching another inflection point which will turn us down to 2600 first, and potentially as deep as 2200SPX.

- Even if we drop down to the 2200SPX region, I still see this bull market taking us higher over the next 3-4 years.

     
    
As I now provide analysis to over 5000 subscribers between my services on Elliottwavetrader, The Market Pinball Wizard, and FATrader, I am the beneficiary of much feedback from various segments of the financial markets. In fact, since we have over 500 money manager clients, I see a lot of what the predominant thinking is on “the street.”
 
Of late, I have been pointing to the potential for the dollar to rise to the region of 99-100DXY and TLT to take us up towards the 131-136 region. And, it seems many on “the street” are on the wrong side of the boat on this one. In fact, when I wrote a recent article on the TLT potentially rallying quite strongly in the coming months, I experienced quite a bit of pushback in the comment section to that article.
 
But, that is what normally happens at inflection points, and I suppose this one will be no different.
 
Moreover, I still see strong potential for the market to drop down to the 2100-2200SPX region in the coming months. And, many will associate the “bad times” of deflationary periods with a rising dollar, a dropping yield, and dropping asset prices. And, that is exactly what my charts suggest we can see over the next several months.
 
Now, I know that many believe that dropping yields suggest a flight to safety and bearish market conditions. This is how the media and pundits “spin” a rising bond market. But, I do have to ask if these people even bothered looking at rates over the last 30+ years, as they dropped alongside the stock market rallying? But, I digress.
 
So, should a dropping yield, rising dollar and dropping asset prices over the coming months concern you?
 
Well, in my humble opinion, I don’t believe it should concern you in the bigger picture. While I do think we have potential for the stock market to drop back down to the 2500-2600SPX region, and even drop as deep as the 2100-2200SPX region in the coming months, I do not think this will end the bull market which began in 2009.
For those that want to understand a bit more about my primary analysis methodology, I view market sentiment as the strongest driver of the larger financial markets. You see, markets do not top when people sell. Rather, a stock market finds a top when buyers run out of money.
 
When there are no more buyers, as everyone has reached a maximum state of bullishness, there is only one direction left for the market to go, and that is down. That is when the selling begins.
 
In other words, when bullish sentiment reaches an extreme, and bearish sentiment reaches the opposite extreme, we often see a top to the stock market.
 
Moreover, I believe that market sentiment follows a specific pattern, unaffected by exogenous factors, and many recent studies have proven this to be the case.
 
Back in the 1930s, an accountant named Ralph Nelson Elliott identified behavioral patterns within the stock market which represented the larger collective behavioral patterns of society en masse. And, in 1940, Elliott publicly tied the movements of human behavior to the natural law represented through Fibonacci mathematics.
 
Elliott understood that financial markets provide us with a representation of the overall mood or psychology of the masses. And, he also understood that markets are fractal in nature. That means they are variably self-similar at different degrees of trend.
 
Most specifically, Elliott theorized that public sentiment and mass psychology move in 5 waves within a primary trend, and 3 waves within a counter-trend. Once a 5 wave move in public sentiment has completed, then it is time for the subconscious sentiment of the public to shift in the opposite direction, which is simply the natural cycle within the human psyche, and not the operative effect of some form of “news.”
 
This mass form of progression and regression seems to be hard wired deep within the psyche of all living creatures, and that is what we have come to know today as the “herding principle,” which gives this theory its ultimate power.
And, over the last 30 years, many social experiments have been conducted throughout the world which have provided scientific support to Elliott’s theories presented almost a century ago.
 
As one example, in a paper entitled “Large Financial Crashes,” published in 1997 in Physica A., a publication of the European Physical Society, the authors, within their conclusions, present a nice summation for the overall herding phenomena within financial markets:
 
Stock markets are fascinating structures with analogies to what is arguably the most complex dynamical system found in natural sciences, i.e., the human mind. Instead of the usual interpretation of the Efficient Market Hypothesis in which traders extract and incorporate consciously (by their action) all information contained in market prices, we propose that the market as a whole can exhibit an “emergent” behavior not shared by any of its constituents. In other words, we have in mind the process of the emergence of intelligent behavior at a macroscopic scale that individuals at the microscopic scales have no idea of. This process has been discussed in biology for instance in the animal populations such as ant colonies or in connection with the emergence of consciousness.
 
As Elliott stated:
The causes of these cyclical changes seem clearly to have their origin in the immutable natural law that governs all things, including the various moods of human behavior. Causes, therefore, tend to become relatively unimportant in the long term progress of the cycle. This fundamental law cannot be subverted or set aside by statutes or restrictions. Current news and political developments are of only incidental importance, soon forgotten; their presumed influence on market trends is not as weighty as is commonly believed. 
- R.N. Elliott on causes of the waves, October 1, 1940
 
In 1997, the Europhysics Letters published a study conducted by Caldarelli, Marsili and Zhang, in which subjects simulated trading currencies, however, there were no exogenous factors that were involved in potentially affecting the trading pattern. Their specific goal was to observe financial market psychology “in the absence of external factors.”
One of the noted findings was that the trading behavior of the participants were “very similar to that observed in the real economy,“ wherein the price distributions were based on Phi.
 
In a different study conducted at the School of Social Sciences at the University of California, they came to the conclusion that “We may suppose that in a human being, there is a special algorithm for working with codes independent of particular objects.” Specifically, when subjects were asked to sort indistinguishable objects into two piles, their decision making within that process divided the objects into a 62/38 ratio. In other words, these individuals exhibited a Fibonacci tendency in their personal decision making.
 
Therefore, the more research that is being done into this issue, the more evidence we are uncovering that behavior and decision making within a herd and on an individual basis displays mathematically driven distributions based on Phi, which do not seem to be affected by exogenous events.
 
This basically means that mass decision making will move forward and move backward based upon mathematical relationships within their movements, and not based upon outside stimuli.
 
This is the same mathematical basis with which nature is governed, as Elliott suggested back in 1940’s.
 
At the end of the day, ALL investors should arm themselves with not just an understanding of the fundamental drivers of the markets, but also an understanding of market psychology. As Bernard Baruch once said:
All economic movements, by their very nature, are motivated by crowd psychology. Without due recognition of crowd-thinking ... our theories of economics leave much to be desired. ... It has always seemed to me that the periodic madness which afflicts mankind must reflect some deeply rooted trait in human nature — a trait akin to the force that motivates the migration of birds or the rush of lemmings to the sea ... It is a force wholly impalpable ... yet, knowledge of it is necessary to right judgments on passing events.
So, I see the market as being within a 5-wave structure rally off the 2009 lows. And, within that structure, I see us as still being within the 4th wave within that 5-wave structure. Moreover, my ideal target for this 4th wave is in the 2100-2200 region.
 
While it is possible that the market already completed this 4th wave in December when it came within 100 points of my target region, the manner in which we drop down to the 2600 region in the coming weeks will give us more indications regarding whether we are still going to target the 2100-2200 region, or whether we will only see a pullback to the 2500-2600SPX before we head to new stock market highs in the coming years.
 
As far as my longer-term target, well, for years we have had a minimum target of 3200SPX before this long-term rally off the 2009 lows completes. However, I am beginning to see signs that it can extend as high as the 4000-4100SPX region by 2022/23. Much will depend upon how the market takes shape over the rest of 2019, which should then provide us a more accurate perspective as to how high this final 5th wave can take us. Stay tuned.

The Similarities Between The 1920s And The 2010s

by: Cashflow Capitalist
Summary
 
- There are some eerie similarities between the 1920s and 2010s.

- Many of the patterns that played out in the 1920s have been playing out in recent years and decades.

- Accommodative monetary policy fueled debt growth and excessive speculation in the 1920s just as they have today.

- The future may not repeat the past, but will it rhyme?

 
History doesn't repeat, but it rhymes.
 
 
This trusty aphorism, often attributed to Mark Twain, strikes just the right balance between perceptiveness and vagueness. Of course, history never repeats. That would be impossible. But rhyming words, though they sound similar, can connote far different concepts.
 
Indeed, periods of history can, on the surface, look new and involve new elements while also sounding eerily reminiscent of earlier periods. Today's world doesn't look or feel like any prior age of history. Technology has advanced. Entertainment has taken on many new forms. Previously unheard of transportation methods and medical procedures are regularly enjoyed by average people.
 
And yet, fundamental aspects of human behavior haven't changed. We are still the same flesh-and-blood creatures with the same motivations, still responding to incentives and disincentives.
 
Every human action spurs a reaction, and on and on, forming cycles, ups and downs. Periods of war and peace. Prosperity and poverty. Innovation and convention.
 
What prior period of history rhymes with the present one when it comes to finance?
 
I humbly submit the 1920s as a period of eerie reminiscence to our current decade, the 2010s.
 
Now, I know many may object to this comparison on the same basis as famed hedge fund manager Ray Dalio, who asserts that we have already reached the end of our long-term debt cycle and are now in the midst of a "beautiful deleveraging." Certainly, from the perspective of interest rates, we have hovered around zero percent on the ultra-short end for about as long as during the Great Depression in the 1930s, but we have not seen the sustained and inescapable deleveraging witnessed during that decade. Nor have we spent the better part of the decade locked in a bitter depression.
In a previous article, I argued that we have not actually reached the end of the road in this long-term debt cycle, but rather that the next downturn will finally get us there. If this is true, then the 2010s are already more like the 1920s than the 1930s. But there are many more similarities that are worth discussing.
 
Let's start with the non-financial realm:
 
 
1. Both decades were periods of intense culture wars between "modernists" and "traditionalists"
 
Today, you might substitute the word "modernist" for "progressive," as well as the word "traditionalist" for "conservative." Still, the basic meanings of the words hold for both today and the 1920s.
 
Interestingly, the debates and conflicts between these camps are based on the same subject matter today as they were in the '20s. Only the specifics are different.
 
Take science for instance. In the 1920s, a fierce debate raged over Darwin's theory of evolution, culminating in the Scopes Trial of 1925. Clarence Darrow, defending the school teacher John Thomas Scopes on trial for the teaching of evolution, represented the modernists. Former Secretary of State William Jennings Bryan represented the traditionalists, who were repulsed by a newfangled theory that did not sit well with a literal reading of the Bible.
 
The "evolution issue" of today is climate change. The modernist/progressives (perhaps represented by Alexandria Ocasio-Cortez) argue with quasi-religious zeal that climate change will inevitably ruin the planet unless dramatic measures are taken immediately. The traditionalist/conservatives (perhaps represented by Donald Trump) are skeptical of the supposed ravages that climate change will bring, if they accept the validity of the theory at all.
 
We haven't had the "Scopes Trial" of climate change yet, though perhaps it is coming.
 
Both decades were also defined by a conflict over mind-altering substances. In the 1920s, it was alcohol, resulting in the Prohibition. In the 2010s, it's marijuana. Though the Prohibitionists had their way in 1920, both production and use of alcohol grew over the course of the decade. Similarly, marijuana prohibitionists had their way throughout most of the country in 2010, but in 2019, it seems inevitable that the plant will be enjoyed legally and recreationally across the country in the foreseeable future.
Both decades struggled with race relations. In the 1920s, the Ku Klux Klan made a resurgence even as the NAACP gained ground and anti-lynching measures were passed. Today, various white nationalist groups seem to be emboldened even as an African American occupied the White House for most of the decade and reparations measures are being endorsed by presidential candidates.
 
Both decades were marked by high immigration, even as the native population bristled at the influx and took measures to cut off the flow. In the 1920s, this led to the passing of the Emergency Immigration Act of 1921 and then the Immigration Act of 1924, which successively restricted immigration inflows. In the present decade, it led to the election of the most anti-immigration president in decades (echoes of "Build that Wall!" resound in the distance).
 
Both decades could be seen as periods of female empowerment. In the 1920s, women were empowered by entering the workforce, consuming countless new items in the home, and enjoying new birth control methods. In the 2010s, women felt empowered by the first female presidential nominee of a major party, pushes for equal pay for equal work, and the 2017-2018 Women's Marches.
 
I might also add that the Russian Revolution of 1917 spurred a worldwide wave of interest in Marxist thinking. Socialism became feared and loathed in capitalist countries in the 1920s, even as its popularity took off with American immigrants and laborers. Similarly, "socialism" was a dirty word in American politics prior to Bernie Sanders' 2016 presidential campaign. Now, it's the hot new movement.
 
2. Both decades began with a major economic downturn
 
We all know about the Great Recession of 2008-2009 (extending into the early years of the 2010s in the experiences of many, though perhaps not in official reckoning). Most people probably do not know that the 1920s also began with a devastating economic downturn, worse than the Great Recession by many standards.
 
In his excellent book, The Forgotten Depression, Jim Grant documents the severity of the downturn.
GNP plummeted from $91.5 billion in 1920 to $69.9 billion in 1921, a 24% nominal decrease.
 
Even adjusting for falling prices shows a 9% decline. Compare this to the Great Recession's 4.3% inflation-adjusted decline in GDP.
 
Industrial production fell by 31.6% from 1920 to 1921 compared to the Great Recession's decline of 16.9%. Unemployment reached 15.3% in 1921 (though other estimates put it as high as 19%) compared to the Great Recession's peak unemployment rate of 10%. In but one area the Great Recession has the recession of 1921 beat: In 1921, the Dow Jones Industrial Average fell 46.6%, while the Great Recession brought about a decline in the DJIA of around 48%. Peak to trough, corporate profits plunged 92% (Grant, 67-69).
 
Wartime deficit spending, accommodated by the Federal Reserve's easy money policy through 1919, created a nasty inflation that needed to be mopped up. And mopped up it was, when the Fed lifted its discount rate from 4% in late 1919 to 7% in 1920 (we'll return to the subject of interest rates shortly).
 
In any case, though much shorter-lived, the recession of 1920-1921 was at least as sharp and painful as the Great Depression or the Great Recession, despite being the last "governmentally unmedicated" (to use Grant's words) recession in American history. This is how the 1920s began, just as it was how our present decade began.
 
3. Both decades were marked by economic growth and prosperity
 
Unemployment averaged 3.3% from 1922 to 1929. But the average doesn't tell the whole story.
 
After peaking at ~15% in 1921, unemployment fell to 6.7% in 1922 and 2.3% in 1923. Compare this to the much more drawn out Great Depression, in which unemployment jumped from 3.2% in 1929 to 8.7% in 1930, continuing to shoot up to 25% by 1933. Compare also to the tepid recovery following the Great Recession, edging downward from 10% unemployment in October 2009 to 9.4% in October 2010 and 8.8% in October 2011 to finally arrive at our current 4%.
 
We all know the story of economic growth in the 2010s: Moderate yet respectable 2%-average annual GDP growth. The longest stock bull market in history. Innovators continuing to find new ways to improve life via the Internet.
The 1920s were also an age of innovation. "In 1920, only 35 percent of homes had electricity; by 1930 the number was 68 percent. Similar increases occurred in the number of households with indoor plumbing, washing machines, and automobiles." (From America: The Essential Learning Edition, Vol. 2, p. 786).
 
From 1924 to 1929, gross national product (GNP) increased annually by 7%. Per capita income grew 30% from 1922 to 1928, and though that increase in national income was not distributed equally, workers were getting better off at a rapid rate. Real earnings for employed wage earners increased 22% from 1922 to 1928.
 
During this same time period, industrial production rose by 70% while the average workweek shrank by 4%. Illiteracy nearly halved during the decade as education spending quadrupled.
 
This as total federal expenditures shrank from $5.1 billion in 1921 to $3.3 billion in 1929.
 
The US increasingly exported its numerous products overseas: movies, vacuum cleaners, radios, toasters, refrigerators, cars, and other gadgets. By the end of the decade, America was producing around 85% of the world's cars (Data from the previous three paragraphs taken from Silent Cal's Almanack, 19).
 
Total wealth nearly doubled during the 1920s, and GDP rose by 70%. And all this corresponded with a booming stock market, which enjoyed 20% average annual gains from 1921 to 1929. See, for instance, the marvelous bull run of the Dow Jones Industrial Average:
 
 
 
4. Both decades had similar interest rate patterns
 
While the Fed operated a little differently under the gold standard, it did have something similar to the "Fed Funds rate," namely the New York Fed discount rate, all short-term loans with the Federal Reserve although not all overnight loans.
 
 
This chart is a bit busy and the writing is small, so you may need to click on the image to enlarge it.
 
Notice that the bold purple line (the NY Fed Discount Rate) stair-stepped up from 4% in 1919 to a staggering 7% in 1920 - an effort by the central bankers to reign in postwar inflation, as previously stated. This ought to remind us of the 4.25% hike in the Fed Funds rate carried out prior to the Great Recession.
 
After the recession of 1921, it pushed the discount rate back down to around 4% or under, where it stayed for the majority of the decade, despite inflation rising a bit above 4% in 1923 and 1925-26:
 
 
Inflation rate from 1914 to 1940. Source: Trading Economics
 
 
In other words, real (inflation-adjusted) interest rates on the shorter end of maturity were, at times, near zero, other times 5 or 6%, and often the same as the nominal rate.
 
Near the end of the decade, just like our own, the Fed crept its main rate back up in order to tame a raging stock market. At the highest, the NY Fed discount rate hit 6%. This proved too much for the economy to bear and pricked the dangerously inflated stock market bubble.
 
Notice one other thing: The orange and red lines in the chart of interest rates above are investment grade (red) and non-investment grade (orange) bond yields. After a slight rise at the beginning of the decade, they fell along with the Fed discount rate for the majority of the decade. Investment grade bonds enjoyed a fall in yields from above 6% to below 5%. Non-investment grade bonds enjoyed a drop from above 8% to below 6%. The same has happened in the present decade, in which corporations are enjoying some of the lowest cost of debt in history.
 
5. Both decades witnessed a rise in installment plan purchases
 
In another previous article, I discussed the way in which low interest rates hurt the poor and middle class. One way they (inadvertently) do this is by inducing lower-earners to forego saving and instead purchase all sorts of durable goods (and even some non-durable products) on installment plans. "Buy now, pay later" seems to be the motto of the decade, whether it be for vehicles, cell phones, TVs, furniture, medical bills, or even small items like bed sheets or concert tickets. Hence the explosion of consumer debt:
 
Source: Wolf Richter
 
 
Funnily enough, the same motto applies to the 1920s, which saw for the first time in American history a rise in installment buying. Prior to this, consumer debt was heavily frowned upon. But through a combination of low interest rates and a burgeoning advertising industry, Americans were swayed to "buy now, pay later."
 
The authors of America: The Essential Learning Edition attest that as "paying with cash and staying out of debt came to be seen as needlessly 'old-fashioned' practices, consumer debt almost tripled during the twenties. By 1929, almost 60 percent of American purchases were made on the installment plan" (p. 786).
 
The country seemed to be engulfed in a new consumerist culture, fueled by targeted radio and print ads. One journalist, who apparently viewed this newfound consumerism unfavorably, penned in 1920:
During the war, we accustomed ourselves to doing without, to buying carefully, to using economically. But with the close of the war came reaction. A veritable orgy of extravagant buying is going on. Reckless spending takes the place of saving, waste replaces conservation (America, 785).
This might seem like excessive exaggeration, but data backs up the idea that the balance of spending and savings became significantly tilted toward spending in the '20s. One study shows that the personal savings rate fell from 12.9% in 1920 to 4.1% in 1930, before shooting back up in the Great Depression to end the decade in 1940 at 12.6%.
 
This should remind us of our own era, in which the personal savings rate has collapsed right along with interest rates:
 
 
 
 
And an increasing amount of this spending during the decade was channeled through installment buying. According to data compiled by the San Francisco State University, in 1925, there was $1.38 billion of consumer credit outstanding. In 1929, there was $3 billion of consumer credit outstanding, and $7 billion worth of consumer goods were purchased on installment plans - this in a year when the US economy produced $105 billion in GDP.
 
By 1927, 15% of all consumer durables were bought on an installment plan. Sixty percent of automobiles were financed, and an astonishing 80% of radios were financed. Around 1,500 installment credit companies sprang up in the 1920s, competing with each other to capture relatively low-interest consumer loans.
Average purchases of major durable goods rose from 3.7% of disposable income between 1898 and 1916 to 7.2% between 1922 and 1929. Accompanying this rise in purchases of durables was a drop in the personal savings rate, from 6.4% of disposable income in the former period to 3.8% in the latter.
 
Meanwhile, on the top end of the income spectrum, just like in our present decade, the wealthy redirected their savings into investments. While 80% of American families had no savings at all in the '20s, the top 0.1% of earners enjoyed 34% of the nation's savings, and the top 2.3% of earners held fully two-thirds of the nation's savings. Income (including dividends and capital gains) for the top 1% of earners increased by 75% from 1920 to 1929.
Steadily falling corporate bond yields (i.e. cost of debt) along with high innovation and productivity growth helped corporate profits soar 62% from 1923 to 1929. This certainly "rhymes" with rising corporate profits during our current decade, although those have come without much innovation or productivity growth.
 
6. In both decades, a large portion of total debt growth was corporate debt
 
Staying on the theme of corporate debt, it's important to note that during the 1920s, corporate debt expanded rapidly over the course of the decade. We can see, for instance, the run-up of private credit in this chart:
Source: Derived from Historical Statistics of the United States, Census Bureau
 
 
By the end of the decade, corporate debt had become the largest share of the total credit market by a wide margin.
 
 
 
 
Second only to corporate debt was mortgage debt, which grew by more than eight times just from 1920 to 1929. Both of these - corporate and mortgage debt - echo our own decade.
 
Mortgage debt quickly bounced back during the recovery after the Great Recession, and corporate debt roared back even more strongly, now cresting 46% of GDP.
 
 
Source: MoneyWeek
 
 
7. In both decades, the Fed's balance sheet shrank late in the decade
 
This may not seem worth noting, given that the Fed's Treasury holdings during the 1920s were a pittance compared to what they are now. Even at the peak of $700 million in 1927, the Fed's Treasury holdings didn't quite reach 1% of GDP. 
 
 
 
In the 2010s, Fed Treasury assets remained well in excess of 10% of GDP. Total assets (including mortgage-backed securities) exceeded 20% of GDP.
 
Some say that rising interest rates late in the decade were a result of high demand for borrowed money, mainly from investors speculating in the stock market. This is only partially true. For the most part, private market rates (including broker lending rates and money markets) followed the course of the Fed's discount rate over the decade. Margin rates only disconnected in 1928 and 1929. This is when the "equity" portions of margin loans compressed down to 10-20%, meaning that speculators would borrow 80-90% of the cost of stocks in order to invest.
 
 
 
 
By the second half of 1928, though, most of the damage had already been done. Credit expansion had already spiraled out of control. Much focus tends to be placed on the astonishing margin debt-to-GDP of 8.14% hit in 1929 - and it deserves astonishment - but such a lofty number isn't reached under normal financial circumstances. Even in our current historically low interest rate environment, margin debt peaked only at 3.37% of GDP (higher than in 2000 or 2007) and, after a brief deleveraging in December, is on its way back up in 2019.
What role did the Fed play in this debt expansion?
 
We find that changes in all three policy instruments [the discount rate, the slightly shorter-maturity acceptance rate, and Treasury holdings] are followed by changes in market interest rates during the following week. Changes in the discount window rate appear to have large effects ... Purchases of Treasury securities seem to have also influenced private rates.
 
Here we return to the Fed's balance sheet. From Q4 of 1927 to Q2 of 1929, the Fed shrank its Treasury holdings from $700 million to under $200 million. This had the duel effect of further lifting interest rates, making borrowing more expensive, and finally (after a long period of easy money) attracting investment capital away from higher-risk assets and back to bonds.
 
Interestingly, in the late 1920s, the Fed found itself in a similar position as it has been in the last few years - shrinking its balance sheet while raising interest rates after a long period of holding interest rates lower than they otherwise would be. Only, in the '20s, the Fed had much smaller holdings of Treasuries and so had to rely more heavily on interest rate hikes, going all the way to 6%.
 
What Does the Future Hold?
 
Now that interest rates appear to have paused and balance sheet reduction will presumably soon pause at the timid hands of Fed officials who don't want to make the same mistakes as in the past, where do we go from here?
 
It's clear from the experiences of the Great Depression and Great Recession that deleveraging does not occur unless serious pain forces it to occur. So the economy and markets will eventually tread down one of two paths. Either monetary policy continues to be accommodative and debt levels remain elevated (or even rising) or it ceases to be accommodative and a very painful deleveraging (mainly concentrated in housing, corporates, and municipalities) unfolds.
 
I think central bankers are too skittish to let the latter scenario play out. That leaves the former. But how long can we tread down the path of ever-rising debt? This line of reasoning persuades me that some sort of jubilee (debt forgiveness) scenario will eventually be implemented by fiscal policymakers or monetary policymakers or both (see my article on the Year Of The American Jubilee).
The future is opaque, but one thing about it is certain: It may not repeat, but it will rhyme.