What Donald Trump gets right about the US economy

The president understands monetary policy has done more for the markets than Main Street

Rana Foroohar




It is amazing how adept Donald Trump is at identifying something important in the felt experience of the American public and then exploiting it for his own gain. So it has been with his suggestion that businessman and former presidential aspirant Herman Cain should be on the board of the US Federal Reserve. Just when we thought it couldn’t get any worse than pundit Stephen Moore, Mr Trump presents the Pizza King.

It is easy to dismiss the suggestion as the latest example of the president’s economic cluelessness — as four Republican senators have done this week, making it unlikely that Mr Cain will secure a seat on the Fed board.

But we shouldn’t be dismissive. It is true that Mr Cain has no idea how financial markets work. This is a man who, along with Trump nominee Mr Moore, wanted interest rates to rise right after the 2008 crisis. But the president’s defence of Mr Cain is that he is not a policy wonk, but rather a job creator who understands Main Street. Mr Trump cares only about packing the Fed with political lackeys. However, he has nevertheless hit on an important truth — that monetary policy over the past decade has done much more for the markets than the real economy.

Consider that since the beginning of 2010, real hourly wages in the US have grown by only 6 per cent, while real housing prices have grown by over 20 per cent and inflation-adjusted stock market valuations have doubled. Household incomes have grown quicker than wages, thanks to employment growth. They are up 10 per cent from 2010 to 2017, though they still lag behind asset price growth. Meanwhile, the period 2007 to 2016 saw the largest increase in wealth inequality in the US on record.

This, along with record levels of corporate indebtedness relative to gross domestic product, were unintended consequences of the Fed’s efforts. The central bank could bolster asset prices, but couldn’t remove the principal drags on the economy. These do not stem from a lack of money, but from deeper challenges that monetary policy can’t solve — from a skills and jobs mismatch, through an ageing workforce, declining geographic mobility and greater corporate concentration, to technology-driven labour market disruptions.

You can’t fix those things with low interest rates and quantitative easing alone. You need fiscal policy decided on by elected officials, not technocrats. But polarised governments cannot deliver it. This is a conundrum not only for the US, but also in Europe, where arguments rage about the effectiveness of the European Central Bank’s monetary firepower and the merits of a co-ordinated programme of fiscal easing across the eurozone.

I worry a lot about this overdependence on central bankers. It amazes me that many of the same people who worried about too much easy money causing hyperinflation after the crisis (Messrs Moore and Cain among them) now argue for lower rates — not because they care about ordinary people particularly, but because it suits their political aims. We should call this exactly what it is: buck-passing — the kind that has happened many times before when presidents have wanted to paper over their problems with cheap debt.

It is not only Republicans who want to have it both ways, either. The current popularity on the left of “modern monetary theory,” or MMT, is driven by the idea that it holds out the prospect of a “people’s QE” of the sort proposed in 2015 by Jeremy Corbyn, the leader of Britain’s Labour party. The belief among some Democrats in the US is that they could circumvent contentious political debates over tax and spending by empowering the Fed to use its balance sheet to fund not financial asset inflation but real growth-creating investments in education and infrastructure.

The success of such a scheme would depend on low interest rates, low inflation and relatively sanguine credit markets. Whether or not you believe those conditions will remain, MMT would also politicise the Fed by making it appear that the central bank was being used to accomplish specific policy goals outside the democratic process. This, of course, is exactly what Mr Trump is doing, albeit to very different ends, right now.

The bottom line is that we are exactly where we were in 2008 — with politicians looking to central bankers to do what they can’t. But why would we ever believe that the Fed (or the ECB) could somehow magically change the fact that we have a bifurcated economy and a looming skills gap? Central banks can’t create growth by themselves. They can only funnel money around.

Mr Trump wants to disrupt the Fed for his own gain. But the Fed is already disrupting itself. The US central bank has recently embarked on a major review of its monetary policy framework, including a listening tour in which regional governors will be talking to people outside their ivory tower — business leaders, mortgage borrowers, pensioners, millennials, labourers and entrepreneurs. The idea is to consider the ways in which the real economy has changed over the past several decades, and think about whether monetary policy should evolve too. Perhaps by the time they finish, we’ll also have an administration and a Congress ready and able to play their part.


A Deep Dive Into U.S. Liquidity

by: Trading Places Research

 
Summary
 
- Since the crisis, the real money supply has inflected above the historical trend, the result of Fed actions and the lack of inflation that has typically accompanied money supply growth.

- While the Fed has been successful in inflating the money supply, they have been less successful at juicing nominal GDP growth.

- Historically, the nominal money supply and asset prices are tightly correlated, but this has become unglued in the last 2 years.

- The major risks here are a version of the liquidity trap, and systemic liquidity risk.

- The experience of Japan is instructive: low population growth, low economic growth, low inflation, low interest rates. This is not a recipe for a dynamic economy.
 
 
 
Why I Read The Comments, Against Everyone’s Sage Advice
 
In my recent Q2 Outlook, here’s how I framed recent trends in US equities:

There is a tug-of-war happening right now. The fundamentals are souring everywhere you look at the beginning of 2019, yet equities surged globally in response to increased central bank liquidity, and what people believe that means.  
But as we saw up top, these valuations are not justified by the growth of the economy generally or corporate profits specifically. 
The entire point of increased central bank liquidity is to reduce the cost of capital so that marginal or high risk/reward investments go from thumbs down to thumbs up.  
But that’s not what’s happening. Outside of IP investment, fixed investment growth and productivity growth have been moderate at best. 
So where is all this capital going? First, to the tune of an additional $1.25 trillion in 2018, it is going to fund the federal debt at rates barely above inflation. That should tell you what investors think about other opportunities. Second, at least for the S&P 500 companies, the increased cash flows they are generating from all this liquidity is going back to shareholders. Some companies are even issuing debt to return cash to shareholders, raiding their own balance sheets, because long term rates are so low.  
Again, there doesn’t seem to be much interest in investing in new capacity. Finally, with the increased savings rate, consumers put an extra $300 billion in the bank during December and January compared what they would have at the old rate. 
So right now we are floating on a sea of global central bank liquidity, but soon, like Japan, we may start drowning in it.
A commenter, awesomely named DorkVader, brought up the money supply, which has been a little softer than it had been. I realized that I had left a large part of the story on US liquidity out, which I intend to rectify now. Thanks Vader! (Did I just type that?)
 
Defining What We Mean By Liquidity
 
“Liquidity” is a word that is used to mean different things in different contexts. There is accounting liquidity, and market liquidity, and systemic macro liquidity. But they have one thing in common: cash is king.
 
Take a simple example. You want to buy a new car that costs $30k. If you have $30k cash in your house, you can walk down to the dealer and make a deal right there. If that $30k is in a checking or savings account, you may have to get a bank check before you get your car. If that $30k is in stocks, you will have to sell them first, and you don’t get to choose your price, so you may have to wait, or take less than $30k. Each of these things is progressively more illiquid, because they take longer to turn into cash and subsequently a new car.
 
But what if your money is tied up in your one-of-a-kind collection of potato chips shaped like famous people’s heads, which you value at $30k? Needless to say, the barter possibilities with the auto dealer are doubtful.
 
So you have to hop on eBay (NASDAQ:EBAY) and auction them off, which will take time, and the market for novelty potato chips may not be as, um, liquid, as you thought it was, so you may have to wait a long time, or take less than $30k.
 
The point here is that cash is king and assets can be converted to cash easily at acceptable prices when there is a lot of systemic liquidity - cash in readily available places. The potato chip example is what happens when market liquidity dries up, like it did in 2007-8. The mortgage-backed assets that everyone thought were worth something turned out about as valuable as those potato chips, and no one wanted to exchange cash for them.
 
This brings us to…
 
 
Systemic Liquidity Risk: These Potato Chips Are Worthless!
Suppose you really want that new car, but also don’t want to sell those potato chips, which you believe will only increase in value with time. So you take out a loan to finance the car, thinking if something goes wrong, you can always sell the chips.
 
This is called the wealth effect. You look at what you think the value of your potato chips is, and think you have $30k to consume, when in actuality, you just have some potato chips. So now you are in debt to a bank, and making monthly payments.
 
But then the economy sours, and you are no longer able to make those monthly payments. When you go to sell the chips, you find that people have begun to prefer cash and cash-equivalent government bills to riskier assets and aren’t willing to part with it. The auction goes poorly, and you are forced to default on the loan, losing the car and declaring bankruptcy.
 
The bank gets the car, but its value doesn’t nearly cover the outstanding loan amount. Also, it turns out that there were quite a few people besides you who were goaded into new purchases by the wealth effect, who also just defaulted on their car loans. The bank, which valued these loans as pretty good risks, then packaged them and sold them to buyers, just blew a huge hole in its balance sheet.
 
But it’s not just the bank. All those buyers, many of whom are other banks chasing yield, also had to reprice those assets, and now they have a huge hole in their balance sheets. Credit freezes up - even though there’s plenty of cash in the system - because of some improperly valued potato chips. This is the unusual situation where systemic liquidity does not translate into market liquidity.
 
So having enough liquidity is important for price stability and it keeps credit flowing during normal times. But when everything is headed downhill, the central bank has to step in and use its full suite of tools to restore order. Most notably, this is the Fed Funds rate and federal debt purchased by the Fed, i.e., quantitative easing. In 2009, they also bought a lot of worthless potato chips at inflated prices.

But the trend over the last 20 years, pretty much everywhere, is that even when restoring order, the increased liquidity in the system is not going to investment that improves GDP growth, but into asset-price inflation, while goods and services price inflation remains muted. The old economic “truism” that Savings = Investment no longer holds, unless you count $1.25 trillion in new federal debt in 2018 as an “investment."
 
Fifty years of supply-side thinking have made everyone forget that demand exists. Without demand, the beneficiaries of increased systemic liquidity have no reason to invest in new capacity, and all of a sudden a 5-year Treasury bond 14 bps below Fed Funds sounds pretty good.
 
Liquidity: You’re Soaking In It
 
Who knew Admiral Ackbar knew so much about macroeconomics?
 
 
The thing that I underestimated coming into 2019 is how much the sea of liquidity we have been soaking in over the past decade has affected sentiment. The only news that seems to interest investors these days is central bank liquidity, and how much they can fill up on.
 
As is typical at the end of cycles, sentiment has become divorced from fundamentals. In the past, it has usually been investors chasing growth, like in 1999, or yield, like in 2006. Now everyone chases any signs of liquidity in the system, whether they understand what that means or not. Demand for US Treasuries remains very high despite all-time record supply, because many investors see an interest rate just above inflation as the best use of their capital. No amount of added liquidity is going to change that.
 
The surge in buybacks is clear evidence that companies don’t believe investing in new capacity with all this liquidity is a very good bet. They have generated record amounts of cash, and are returning all of it to investors. Some companies are even taking out debt at historically low rates to do buybacks, essentially raiding their own balance sheets.

In 2018, the S&P 500 companies returned over 99% of GAAP earnings to shareholders. To put this in context, all US companies spent an additional $251 billion in nominal dollars over 2017 on all fixed investment in all of 2018. Instead of adding to that, just the S&P 500 companies chose to return $1.26 trillion to shareholders, a $324 billion increase over 2017, the previous record year. This should tell you everything you need to know about how corporate leadership view organic earnings growth prospects.
 
This is a version of the Liquidity Trap that Keynes originally described. In his telling, when interest rates hit the lower bound, investors prefer cash to bonds and stop buying, driving rates back up when the central bank is trying to keep them low.
 
In this version, let’s call it LT2.0, the system is awash with liquidity, but the growth in the system doesn’t seem as attractive as a 6-month bill at 2.45% yield, or a 3-year bond at 2.26%, or the 10-year Bund at 0.07%, or buying your own shares. So the central bank loses the ability to juice the real economy with cuts to the lower bound, and only inflates asset prices.
 
Just How Awash Are We?
 
Lounging in a sea of liquidity. Itamar Grinberg for the Israeli Ministry of Tourism.
 
 
Pretty awash, but not like we were going under. Yet.
 
There are two primary measurements of liquidity: the M1 and M2. M1 is currency and checking accounts, whereas M2 includes savings accounts, money market funds and small short-timed deposits like short-maturity CDs. We’re only going to be talking about M2, the broader measure.
 
All money supply measurements come from Fed Table H.6 "Money Stock and Debt Measures.”
 
First let’s look how the money supply has grown in nominal dollars
 
As we should expect, the money supply grows exponentially, but we have been well below trend since 2004, with the inflection happening in the early 1980s after a bulge in the late 70s. What we are seeing is the effect of inflation, or the lack thereof, on the nominal money supply and vice-versa.
 
 
 
 
Since the peaks in the 70s, inflation has remained tamed. At first, the policies of the Volker Fed broke the back of inflation and brought it back to more reasonable levels in the 3-5% range. But after the 90s recession, inflation began dropping into its current range of 1.5-2.5% without any significant Fed policy driving it. Since then, inflation has remained historically low, and the Fed has not had big inflationary cues to raise the Fed Funds rate. As investors became convinced that the new low-inflation regime was not going anywhere, long term rates, as represented by the 10-year Treasury, have been dropping steadily over this long period.
 
So let’s get rid of inflation and look at real M2, using a 2012 chained-price deflator.
 
 
So this changes the picture radically. Even subtracting inflation, M2 grows exponentially. But now we see that real M2 has been well above trend since 2011, with the inflection happening at the financial crisis, and the Fed’s dramatic actions in its wake to reflate the economy.

In the past, nominal M2 growth over time has more or less been the same as nominal GDP growth (real GDP growth plus inflation). But since the recession, they have become divorced by Fed actions.
 
 
 
 
The blue line is the annual spread between nominal M2 growth and nominal GDP growth. In the pre-2008 period, the average YoY change was -0.21% (red line), basically zero. But since 2008, the average has been 2.94% (green line). This is the effect of the Fed actions. They have inflated the money supply, but not the economy nearly as much. Both real GDP growth and inflation remain muted.
 
While the low Fed Funds rate had a lot to do with this, there are diminishing returns to rate cuts as you approach the lower bound, so the Fed began quantitative easing, or buying US government debt at scale, as well as worthless mortgage-backed securities at inflated prices.
 
The Fed has always kept some US debt on the balance sheet, both for the same reasons all banks do, but also to fill small holes in Treasury market liquidity as they arise at auction.
 
Leading up to the recession, they held about half a trillion dollars in US debt, which had very little effect on the money supply.
 
But someone had the bright idea that if they bought small amounts of debt to fill small holes in liquidity, if needed, they could buy large amounts of debt to fill large holes in liquidity. So if we look at the M2 and subtract the liquidity the Fed has added with its balance sheet, we can see the huge gap that opened up. We’ll call this new measure M2-FED. To be clear, this is nominal M2 minus the sum of Fed holdings of US Treasuries, federal agency debt and mortgage-backed securities (from Fed Table H.4.1), then deflated with the 2012 chained-price index.
 
 
The red line approximates what would have happened to M2 had the Fed not stepped in and you see it is not pretty. We can clearly see the effects of the sequester (AKA, The Dumbest Bill Ever) on the reduction of M2-FED in 2013-2014, which forced the Fed to step in with more QE to keep M2 growing. Since 2015, the M2-FED has been growing at a very nice clip, but the balance sheet remains, and they will begin backdoor QE4 this fall. In the media, you have likely heard this referred to as “printing money,” or “monetizing the debt.” Both are accurate characterizations.
 
To be clear, monetizing the debt is a good thing in crisis times, but not so much at the end of the cycle.
 
So to sum up:
  • Over time, nominal M2 grows exponentially. Its growth historically has mirrored the growth of nominal GDP.
  • Since the last recession, real M2 has inflected above the historical trend. This is the result of Fed actions, particularly quantitative easing, and the lack of inflation that has typically accompanied increases in the money supply.
  • While the Fed has been successful in inflating the money supply, they have been less successful at juicing nominal GDP growth. On average, there is a 3% per year spread in the growth rates since the crisis.
  • Without Fed actions, the money supply would have been a hugely disastrous situation in the early recovery years.
  • Instead of juicing nominal GDP growth, the Fed-sponsored M2 growth has gone to asset price inflation.

M2 and the S&P: A Love Story

 
Let’s dig a little deeper on asset price inflation. I will be using the S&P 500 as a proxy, but you could use the Case-Shiller home price index, or any other asset price index, and the results are similar. Since the S&P is nominal, we will be using nominal M2.
 
Stats 101 caveat! Correlation does not equal causation. You have been warned.
 
Starting with the historical data going back to 1959, we can see that in this long period, M2 and the S&P are highly linearly correlated.
 
 
But since 1994, in the period of low interest rates and low inflation, the two have become much less correlated, as the relatively low Fed Funds has produced more exogenous factors affecting the S&P.
 
 
 
But to get back to where we started all this, since the crisis the S&P has become even more tightly correlated to the money supply than ever before. As we saw above, much of the growth in the M2 in this period is Fed-sponsored QE, made possible by the US deficit, so all four are correlated.
 
 
 
But since 2017, the promise and then reality of late-cycle stimulus from the federal budget left the two unmoored from each other.
 

I’m not a shrink, but I play one on Seeking Alpha. Seriously, I do spend a lot of time thinking and reading about market psychology, because I believe this is the most underappreciated aspect of analysis.
 
The experience of the post-crisis era (“Staying Together for the Kids”) has created an expectation that asset price growth will be even more closely tied to liquidity growth than ever.
 
Much of this growth in liquidity came courtesy of the federal deficit and the Fed, not nominal GDP growth, but this has not seemed to matter to investors. When this broke in 2017 due to the expectation of late-cycle federal stimulus, it was to the upside and no one spent too much time worrying about it.
 
But then December happened. The 1-year effects of the stimulus were fading, and Fed-sponsored money supply inflation was fading, both via Fed Funds increases and balance sheet “normalization.”
 
Even though M2 continued to rise through December at a fast clip, the Fed saw credit tightening and spreads collapsing - systemic liquidity was not translating to market liquidity.
 
Thus, the double-pivot to radically reshape expectations.
 
But the Fed’s actions and signaling of possible future easing did not have the intended effect on the money supply which was down significantly in January and February (QT continues through the fall), recovering in March, but still below previous growth trajectories.
 
Market participants have begun to anticipate easing from the Fed, and sooner rather than later - sometime around 6 months, if the yield curve is to be believed.
 
 
 
The 6-month bill is flat or inverted all the way to the 7-year bond. The 3- and 5-year maturities have been below Fed Funds for some time now, going as low as 2.16% just a couple of weeks ago. This tells us bond investors are anticipating that rates will start falling in the 6-12 month window, probably closer to 6 months at this point. Maybe in the fall when the Fed starts buying Treasuries again.
So we are back to 2017 again, hoping to return to that post-crisis ultra-tight correlation of liquidity and asset prices. But instead of market participants anticipating added liquidity from federal stimulus, they are anticipating added liquidity from the Fed. Since the Christmas Eve bottom, the relationship between M2 and the S&P has been shattered.
 
 
Small sample size, but it’s all over the map here. Again, so long as it’s to the upside, no one’s going to worry too much.
 
So, to sum up:
  • Historically, nominal money supply and the S&P 500 are tightly linearly correlated.
  • In the period of 1994 to the present, the relationship between the two became strained as permalow interest rates and inflation have added more exogenous factors.
  • But the post-crisis period is characterized by an even tighter relationship between the money supply and the S&P than in the historical data. Much of the money supply growth in this period was sponsored by the federal deficit and the Fed’s balance sheet, not nominal GDP growth, as had previously been the case. The Fed’s actions have been much more successful in inflating the money supply and asset prices than nominal GDP.
  • Since 2017, the money supply and S&P have become divorced from each other, especially recently. End-of-cycle psychology has taken hold, but instead of chasing growth like in 1999, or yield, like in 2007, based on the experience on the last 10 years, investors are chasing liquidity from the federal budget and the Fed.

Why You Should Care

 
There are two possible outcomes from this delicate balance that should worry you. The LT2.0 situation and systemic liquidity risk, both described above. Let’s dig down on these concepts.
 
We are living in a house of cards that has taken decades and three cycles to build. The muting of inflation post-1990 has led the Fed to keep Fed Funds unusually low, and when recessions have come, they have had progressively less and less ammo in their bandoliers to combat it.
 
This is one of the reasons I believe the Fed should switch from inflation targeting to nominal GDP targeting.
 
Year of RecessionPeak Fed Funds of Cycle
19709.20%
197412.92%
198119.10%
19909.84%
20016.51%
20075.25%
Current2.40%

 
 
As we have seen, rate cuts have diminishing returns to the real economy near the lower bound. In 2007, the Fed had 525 bps to zero, and that was obviously not enough. If 240 winds up being the peak of this cycle, there will be little the Fed can do with interest rates and we will need more QE. A lot more.
 
Meanwhile, with a trillion dollar structural deficit that is only growing, there is very little hope for fiscal stimulus to fill a liquidity hole.
 
Japan is the first country where this happened, so let’s look at them and see where this can end up:
 
 
 
At the end of 2018:
  • Overnight rate: 0.30%
  • Real YoY GDP growth: 0.25%, with a 20-year CAGR of 0.8%
  • 10-year government bond: 0.068%
Not pretty. This is all in a period where the overnight rate was close to zero almost the entire time.
 
Let’s look at Germany, where this also seems to be happening:
 
 
 
At the end of 2018:
  • Overnight rate: -0.36% (negative since 2015)
  • Real YoY GDP growth: 0.64% with a 1.4% 20-year CAGR
  • 10-year government bond: 0.19%
This can all be ours if we’re not careful. The US numbers at the end of 2018:
  • Fed Funds: 2.4%
  • Real YoY GDP growth: 2.97% with a 20-year CAGR of 2.14%
  • 10-year Treasury: 2.69%

Much better than the other two countries, but still well below historical norms on all accounts.
 
The most under-appreciated aspect of all this is working-age population growth, which is highly correlated to GDP growth in advanced economies. The 10-year CAGRs:
 
 
 
 
That US number doesn’t look so bad by comparison, until I tell you that the 50-year US CAGR is 1.20%, over double the 10-year. Working age population growth has been decelerating rapidly for a number of demographic reasons, and restricting the immigration of working-age people will not help this.
 
So we are obviously not there yet, but the next recession could easily tip us into LT2.0.
 
But what may tip us into recession? This is where the danger of systemic liquidity risk comes in, and gets us back to market psychology. The experience of the last financial crisis is instructive here.
 
There were large numbers of empty subdivisions all over the country in places no one wanted to live in. Like our novelty potato chip example, these were only worth something so long as people thought they were worth something.
 
The “value” of these houses never changed - they were the same houses in the same places in 2008 as they were before. What was different was that everyone woke up one day and realized that, while the day before they thought they owned shares of a tranche of low-risk paying US mortgages, today they owned some worthless potato chips.
 
We are already in a pretax earnings recession in 2018, and without the growth in durables inventories that no one seems interested in buying, real GDP growth was very weak in H2 2018 - 0.59% annualized. The Atlanta Fed just upped their 2019 Q1 GDPNow estimate to 2.3% from a low of 0.3% at the beginning of March, largely on the back of, gulp, investment in inventories. Good God.

Meanwhile, GDPNow estimates of personal consumption expenditures growth plunged from 1.6% annualized (already well below the 2.8% annual growth of the past 2 years) to 0.7%. No one wants this stuff.
 
So will companies wake up one day and realize these inventories are just so many potato chips?
 
What day is that? I would definitely like to know.
 
But inventories are just but one risk from assets that may be currently vastly overvalued by their owners:
  • Student loans: $1.5 trillion.
  • Credit card debt: $1 trillion.
  • Auto loans: $1.25 trillion.
  • US Equities: The ratio of the Wilshire 5000 to GDP is near the all-time highs of the dot-com bubble. Same for the S&P 500.
  • US Mortgages: Again. The ratio of the Case-Shiller home price index to GDP is approaching the pre-crisis high.
This is just what I could come up with off the top of my head. Ask yourself: how many people were focusing on the systemic risk emanating from the US mortgage market in 2007? Very few.
 
There may be risks hiding in plain sight that we do not even see. The “unknown unknowns” are the most troubling.
 
Summing Up
 
 
  • Over time, nominal M2 grows exponentially. Its growth historically has mirrored the growth of nominal GDP.
  • Since the last recession, real M2 has inflected above the historical trend. This is the result of Fed actions, particularly quantitative easing, and the lack of inflation that has typically accompanied increases in the nominal money supply.
  • While the Fed has been successful in inflating the money supply, they have been less successful at juicing nominal GDP growth. On average, there is a 3% per year spread in the growth rates since the crisis.
  • Without Fed actions, the money supply would have been a disaster in the early recovery years.
  • Instead of juicing nominal GDP growth, the Fed-sponsored M2 growth has gone to asset price inflation.
  • Historically, nominal money supply and asset prices as represented by the S&P 500 are tightly linearly correlated.
  • In the period of 1994 to the present, the relationship between the two became strained as permalow interest rates and inflation have added more exogenous factors.
  • But the post-crisis period is characterized by an even tighter relationship between the money supply and the S&P than in the historical data. Much of the money supply growth in this period was sponsored by the federal deficit and the Fed’s balance sheet, not nominal GDP growth, as had previously been the case. The Fed’s actions have been much more successful in inflating the money supply and asset prices than nominal GDP.
  • Since 2017, the money supply and S&P have become divorced from each other, especially recently. End-of-cycle psychology has taken hold, but instead of chasing growth like in 1999, or yield, like in 2007, investors are chasing liquidity from the federal budget and the Fed.
  • The major risks here are LT2.0 and systemic liquidity risk.
  • With the Fed Funds at 2.4%, the Fed will have very little ammo to combat the next recession.
  • With trillion dollar structural deficits as far the eye can see, the hope for fiscal stimulus to fill liquidity holes is slim.
  • The experience of Japan is instructive: low population growth, low economic growth, low inflation, low interest rates. This is not a recipe for a dynamic economy.
  • There are many asset classes that may be overvalued by their owners.
So where does that leave us? So long as everyone believes that the Fed will continue to provide liquidity absent nominal GDP growth, and that this will inflate asset prices, not nominal GDP, assets will be the thing to own.
 
My portfolio. Evan-Amos
 
 
But one day, everyone may wake up and realize they own a bag of potato chips. Again, I would like to know what day that is.
 
Remember, Wile E. Coyote stays aloft, until he looks down.
 


How to Win Friends and Influence Algorithms

From YouTube to Instagram, what you see in your feeds isn’t really up to you—it’s all chosen by invisible, inscrutable bots. Here’s how to take back at least some control

By David Pierce


The algorithms that power Facebook, Instagram, Twitter and YouTube have a disproportionate control over our lives. And while there are certain controls that allow us to tweak what we see when we’re on these massively popular networks, there’s no real escape. Pierce investigates ways to resist, whether it’s by tweaking settings or changing how you interact. Photo: Photo Illustration by Emil Lendof/The Wall Street Journal; Photos: iStock


The top of my Facebook FB 0.90%▲ feed currently shows a photo of a woman I’m not really friends with—I think we were on a kickball team once?—who recently got married. This photo has topped my feed for the better part of three days, despite the fact that I don’t care. Meanwhile, there’s been a black-hole sighting and a new way to watch Disney movies and a WikiLeaks arrest and presumably lots more. I’ll never know because, according to Facebook, what matters is that wedding photo.

This is life in the age of the inscrutable, opaque algorithmic feed. I may decide whom I friend or follow, but Facebook, Twitter, Instagram, YouTube and the rest decide what I actually see.

This can be annoying, like the ever-present wedding photos. It can also be hugely problematic, like when Facebook surfaces hateful and fake content or a simple YouTube search leads you down a recommendations rabbit hole into the internet’s darkest corners. Often, what you’re seeing and who made it are a total mystery.

Ostensibly, the point of these algorithms is to show you what you care about. The companies frame it like the difference between Netflix and channel-flipping: Wouldn’t you rather see the best stuff whenever you want, instead of only what happens to be on right now? These services claim to have users’ interests at heart, but they also have an interest of their own, to show you whatever good, bad or ugly stuff it takes to keep force-feeding you ads.

These services don’t make it easy, but there are ways to take back a bit of control over your feed. Some offer the ability to turn the algorithms off and see your feeds in more transparent ways. More often, the best you can do is try to influence the algorithm slightly in your direction. (You still might never know if it’s working.) There are handy Chrome extensions and third-party apps that do some of the work for you, too.

Tweaking the System

In general, one word rules the way your feed is sorted and presented to you: engagement. The more you click, like, comment, share and read, the more likely you are to keep checking back in. Your feed is carefully ordered to make sure you never get bored. As my colleague Christopher Mims put it so well: “If it’s outrageous, it’s contagious.”

The invisible sorting systems start with a few obvious things: whom you follow, friend or subscribe to heavily influences what you see in your feeds. If you double-tap to like an Instagram post or comment below it, that’s another positive signal. If you tend to watch a lot of videos, the platforms will show you more videos and fewer photos. If you don’t like a post, but stare at it for a while, you’re still adding a tick to the “show me more!” column. And these bots don’t get sarcasm: Hate-likes are the same as like-likes.

But it’s also possible to tell the algorithms what you don’t like. On Facebook, for instance, you can click the three dots at the top right of any post and choose from options such as “Hide post,” which will both hide that post and show you fewer like it, or “Unfollow [the person who posted],” which removes all of that person’s posts from your feed without unfriending them. Facebook says these are among the strongest indicators you can send to its algorithm. Twitter and YouTube offer similar tools. Clicking the “Not Interested” button on a YouTube thumbnail makes a powerful statement.

You can send the social-media algorithms a strong signal by telling them what you don't like, and why. Unfortunately, that's a lot more work than just liking a post. Photo: David Pierce/The Wall Street Journal


Companies should make it easier. “This is an area we’re investing more in—explicit controls for you to say, ‘I like this thing’ or ‘I don’t,’” said Wally Gurzynski, a product manager at Twitter. Mr. Gurzynski said Twitter’s also working on helping users understand what happens when they click those buttons and how their actions affect the content they see. Facebook recently announced a similar feature, called “Why am I seeing this post?” When (if?) the company rolls it out, you’ll be allowed to take actions to see more or less content like any particular post.

Even then, these controls aren’t enough. “They give you the illusion of control without giving you actual control,” said Matt Kruse, the developer of Social Fixer, a browser extension I like that lets you filter certain users, keywords or topics out of your Facebook feed. When you tell Facebook what you don’t like, all you’re really doing is shouting instructions at the wizard behind the curtain. You should really be able to get back there and tinker yourself.

Everything in its right place

For all its problems with abuse and hate speech, Twitter is at least the most transparent feed: You can click the starry icon at the top and see all your tweets in reverse-chronological order. Keep an eye on it, though, because Twitter will eventually switch you back to the algorithmic feed. It wants to show you all the intoxicating stuff you’ve missed.


You can set Twitter to show you all your tweets in chronological order by tapping the starry icon, but eventually, it’ll switch back to the algorithmic feed. Photo: David Pierce/The Wall Street Journal


The other networks are worse. Facebook offers a version of your news feed sorted by “Most Recent,” which you can access by clicking the three dots to the right of the News Feed icon, but Facebook still filters out lots of content. (You can access the feed on mobile by typing “Most Recent” into the app’s search field.) Eventually, it also switches back to the Top Stories feed.

Facebook-owned Instagram doesn’t even pretend to offer a chronological feed. “Before we were ranking people’s feeds, they were missing over half of their friends’ posts,” said Julian Gutman, a product lead at Instagram. If you want a cleaner, more transparent experience, I recommend Filtergram, a web app that gives you a chronological, filterable feed of all the public accounts you choose. You don’t need an Instagram account to use it.



Instagram offers fewer tools than other platforms, but you can still tap on the three dots above a post and select 'See Fewer Posts Like This' to tell the algorithm what you don’t like. Photo: David Pierce/The Wall Street Journal 


For YouTube users, I recommend the Chrome extension DF Tube. With it enabled, a YouTube page is rendered as minimally as possible. It won’t automatically play recommended videos at the end, show you related videos on the side, or display all the comments below a video. With everything disabled, YouTube’s homepage becomes a search bar and any video page shows nothing but a video.

Extensions like SocialFixer and DF Tube are popular and the developers say they’re not collecting private information, but you should always be careful about what you add to your browser. They’re also powerless on your phone. Nobody can really give you the tools you need there except the social companies themselves.

I’d like more tools, but even now, by giving up as much algorithmic help as possible, I’ve found I use the services less—and that’s a good thing. In general I feel more able to understand what I’m seeing and why, and more in control over the unrelenting stream of content that determines so much of my life.

And if I don’t like what I see on Facebook or YouTube? You better believe I’ll let them know. And I hope they—or at least, the mysterious black boxes they built that control our lives—are listening.


Things That Seem Normal But Definitely Aren’t, Part 1: Soaring Chinese Debt

by John Rubino

The era of fiat currencies and central bank printing presses has desensitized us to massive leverage and its implications. So when it is reported, for instance, that China‘s private sector borrowing has risen to levels that are unprecedented in financial history, this is greeted with a collective yawn.

It shouldn’t be, though, because no society can continue to borrow this kind of money without spinning out of control. Some details:

China issues record new loans in the first quarter of 2019 as Beijing battles slowing economy amid trade war 
China’s efforts to battle its slowing economy amid the trade war with the United States gathered pace at the start of 2019 with banks issuing a record amount of new loans in the first quarter of the year. 
Banks issued 5.81 trillion yuan (US$865 billion) of new loans between January to March, beating last year’s previous high of 4.86 trillion yuan, the People’s Bank of China said on Friday. 
In March alone, banks issued 1.69 trillion yuan (US$251 billion) in loans, which was the second highest behind only March 2009 when China was at the peak of rolling out an all-out stimulus programme which engineered a rebound in China’s economic growth but also left the country with a huge debt hangover. 
Aggregate financing, the broadest measure of credit supply that include bond issuance, initial public offering and off-balance sheet lending, jumped to 2.86 trillion yuan (US$425 billion) last month, while the January-March amount was 8.18 trillion yuan (US$1.2 trillion), up by 2.34 trillion yuan from a year ago, the central bank data showed.

The following chart shows the year-over-year percentage growth in Chinese private sector borrowing.

Assuming (generously, given the trade war and long-in-the-tooth expansion) that Chinese GDP growth will average 6% in coming years, debt growing at twice that rate is just a tad aggressive.

Especially for an economy that more than quadrupled its debt in the previous decade.


source: tradingeconomics.com


Some comments on the subject from Credit Bubble Bulletin’s Doug Noland:

Beijing has become the poster child for Stop and Go stimulus measures. China employed massive stimulus measures a decade ago to counteract the effects of the global crisis. Officials have employed various measures over the years to restrain Credit and speculative excess, while attempting to suppress inflating apartment and real estate Bubbles. When China’s currency and markets faltered in late-2015/early-2016, Beijing backed away from tightening measures and was again compelled to aggressively engage the accelerator. Timid tightening measures were unsuccessful – and the Bubble rages on.  
China now has the largest banking system in the world and by far the greatest Credit expansion. The Fed’s dovish U-turn – along with a more dovish global central bank community – get Credit for resuscitating global markets. Don’t, however, underestimate the impact of booming Chinese Credit on global financial markets. The emerging markets recovery, in particular, is an upshot of the Chinese Credit surge.  
Booming Credit is viewed as ensuring another year of at least 6.0% Chinese GDP expansion, growth that reverberates throughout EM and the global economy more generally. 
The resurgent global Bubble has me pondering Bubble Analysis. I often refer to the late-cycle “Terminal Phase” of excess, and how much damage that can be wrought by rapid growth of increasingly risky Credit. Dangerous asset Bubbles, resource misallocation, economic imbalances, structural maladjustment, inequitable wealth redistribution, etc. In China and globally, we’re deep into uncharted territory.

Why can’t extremely fast credit growth continue forever? Because at any given time there are only so many borrowers capable of paying back big loans, and most of them have already borrowed what they consider wise for their legitimate needs. In order to move the amount of borrowing beyond this natural equilibrium, lenders have to find new, by definition less creditworthy, borrowers.

Let the process continue for a while and an economy ends up with mostly junk credit – that is, loans unlikely to be repaid. Which is a pretty good description of today’s world.

Buttonwood

Reserve managers’ relationship with the dollar is unhealthy

They may try to diversify, but the global currency will drag them back




JAMES M. CAIN’S novel “The Postman Always Rings Twice” portrays a violent love affair between Frank Chambers, a drifter, and Cora Papadakis, a former beauty queen now married to a man she despises. Their romance is doomed from the beginning. Every attempt to find happiness fails. Any attempt at being apart is equally hopeless. “Why did you have to come back?” she hisses after one break-up. “I had to, that’s all,” he replies.

The story comes to mind when contemplating the fate of the managers of the world’s $11trn-worth of foreign-exchange reserves. This is not to say they are obsessives wracked with guilt and paranoia (though a few might be). But rather that, like Frank and Cora, it has probably occurred to them that their dominant relationship, which is with the dollar, may not be entirely good for them.

The latest figures from the IMF show that the share of dollars in global reserves fell to 62% at the end of last year. Reserve managers seem to be for a cooler, less intense affair with the dollar. But eventually, they will find that it is hard to break free. That is not so much because the alternatives to the dollar have flaws (though they do); rather, it is because the pain of a weaker dollar will become too much to bear.

The dollar is the closest thing to a world currency. Commodities that are traded globally are quoted in dollars. So are other currencies. A lot of cross-border trade is invoiced and settled in dollars, too. Dollars are the unit by which the world of finance keeps score. So there is logic to countries keeping stores of them in reserve. It is generally dollars that you need in an emergency.

But money is also a store of value. There is no guarantee that the dollar will hold its value better than other currencies. So like other portfolio managers, reserve-holders seek to diversify.

That means fewer dollars.

There are other reasons for breaking free of the greenback. Its global role gives America the means to impose financial sanctions to great effect. Its use of such powers has steadily grown.

In response, Russia has slashed the share of dollars in its currency reserves. It is not hard to imagine that some other countries have weighed the odds of at some stage being caught in a dispute with America.

Changes in the market value of currencies can mask underlying shifts in the mix of assets within reserves. For instance, if the euro falls sharply against the dollar, its share in reserves would also fall without any change in the stock of assets held. Steven Englander of Standard Chartered, a bank, applies a constant exchange rate to the IMF data to adjust for this valuation effect. What emerges is a clearer long-term trend downwards in dollar holdings and a sharp sell-off last year (see chart). What kept the dollar strong was the strength of private-sector purchases.



Reserve managers appear to be countercyclical investors, selling when others are buying. This is rather cheering. The dollar looks overvalued on many benchmarks. And if anyone can take a long-term view, it ought to be reserve managers. Even so, Mr Englander suspects that some of them are waiting for signs of dollar weakness before selling.

By then it may be too late. Once private-sector demand for dollars wanes, the combination of this downward pressure and selling by reserve managers might mean that the dollar has to fall a long way to balance supply and demand. That would be a big headache for reserve managers. In one regard they are not like other portfolio managers. They are also charged with keeping their own currency at a competitive level to support exports.

Reserve managers who start off wanting to sell dollars often end up buying them back when they see competitiveness is at risk, says Mr Englander. Their attempts to diversify by, say, selling those dollars for euros is doomed to fail. It is hard to induce private-sector investors to buy dollars for euros when they, too, are trying to diversify away from them. The outcome, says Mr Englander, is that both dollar and non-dollar reserves increase, with the dollar share not much changed.

In Cain’s novel, the star-crossed lovers are joined by a dark passion and by complicity in a murder. What tethers reserve managers to the dollar is not quite as sinister. For a while they can achieve a little distance: if they want to get out of dollars, they can do so while everyone else is trying to get into them. But if the dollar falls hard enough, they will be buyers. Ask a reserve manager, then, why he ever went back, and he may tell you: “I had to, that’s all.”