Mad Hawk Disease Strikes Federal Reserve

“A serious writer may be a hawk or a buzzard or even a popinjay, but a solemn writer is always a bloody owl.”

– Ernest Hemingway

Image: Magalle L’Abbe via Flickr


Longtime readers know I am not the Federal Reserve’s #1 fan. I can’t recall ever resting easy, confident that the Fed was ably looking out for our economy and banking system. However, I have experienced varying degrees of skepticism and distrust. I must also acknowledge that we are all still here despite the Fed’s many mistakes.

Once or twice a year the Fed rekindles my frustration and concern with a particularly boneheaded statement or policy change. Last summer, the Fed’s annual Jackson Hole Economic Policy Symposium outraged and saddened me at the same time – which, given my emotional makeup, is quite an accomplishment. I shared my rage with readers in “Monetary Mountain Madness.” Feel free to read it again if you enjoy a good rant. I would have been even more depressed if I had known that one of the academic presenters there, Marvin Goodfriend of Carnegie Mellon University, an unabashed cheerleader for NIRP, would appear on the short list of candidates for Donald Trump’s first two appointments to the Fed.

Goodfriend is nominally a monetarist, but he doesn’t quack or waddle like any monetarist I know. The session that he presented was entitled “Negative Nominal Interest Rates.” In the first paragraph of the first section of his paper, he says that “[M]y current paper makes the case for unencumbering interest rate policy so that negative nominal interest rates can be made freely available and fully effective as a realistic policy option in a future crisis.”

So the first appointment to the Fed that Donald Trump will reportedly make is an unabashed advocate of negative interest rates as a policy option. It doesn’t sound like Trump wants a Fed that is modeled on the far more disciplined principles of a Richard Fisher or a Kevin Warsh.

While my rant last summer was about the Fed’s apparent willingness to embrace negative rates, we now face the opposite risk. Janet Yellen & Co. are asserting that inflation is such a serious threat that they must tighten policy with a two-pronged approach. They are already raising the federal funds rate and will soon begin reducing the massive bond portfolio accumulated in the QE years.

I don’t think these moves will create a crisis on their own. Rather, I think the mentality that they reveal may lead to much bigger mistakes when the next recession arrives.

The mistakes may already be unfolding.

Here’s my key question: Is the Fed really as “data-dependent” as Yellen and others say, or do other factors influence them? I think the latter. You’ll see the other factors in a little bit.

Inflation Fail

That the previously dovish Janet Yellen took the Fed chair when she did is almost comedic. Ben Bernanke had uttered that word taper in 2013, signaling that quantitative easing’s days were numbered. No one knew how the Fed would extricate itself from years of QE and near-zero rates. But, to her credit, Yellen accepted the challenge in late 2013.

Having tapered the Fed’s bond buying down to zero (except for reinvestment of dividends and maturity rollovers) and begun the rate-hike cycle, Yellen has accomplished a few things; but normalizing interest rates under a Democratic president was not one of them.

Another objective Yellen hasn’t been able to achieve is to create enough inflation. Yes, you read that right. It is part of the Federal Reserve’s job to keep inflation at an acceptable level, which it defines as 2%. This mandate is articulated in the Federal Open Market Committee’s “Statement on Longer-Run Goals and Monetary Policy Strategy.” The boldface is mine.

The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee reaffirms its judgment that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve’s statutory mandate.

The Fed itself says monetary policy determines the inflation rate. The Fed determines monetary policy, so inflation (or lack thereof) falls squarely in their laps.

That is actually quite a startling statement, if you think about it. The Fed doesn’t just regulate inflation; the Fed causes inflation, not as a side effect of something else but because they think it is desirable. And they admit doing so, right in their own documents.

 But wait, there’s more.

The Committee would be concerned if inflation were running persistently above or below this objective.

PCE inflation has lagged persistently below 2% for years now. The Committee reminds us at every meeting that it is, in fact, concerned about this. But its concern has not stopped it from plowing ahead with policies that produce everything but inflation.

Personally, I think low inflation is preferable to high. It preserves the purchasing power of our currency. The point here is that, by its own self-imposed goals and definitions, the Fed has failed to accomplish a key part of its mission. It wants 2% inflation. It says its policies can create inflation, but those policies haven’t. This is failure by any definition of the word.

Let me comment on the section that I bolded above: “The inflation rate over the longer run is primarily determined by monetary policy….”

Really? If inflation or deflation is primarily determined by monetary policy, why is there no inflation in Japan today, and why hasn’t there been for 25 years? With the most massive quantitative easing and extraordinarily low interest rates ever seen, Japan has been trying as hard as it can to create inflation; but Japan has been pushing on a string, and I think some of the same conditions (demographic and market) that have foiled Japan are beginning to apply in the US and Europe. And I suspect the Fed’s efforts will be as futile as the Bank of Japan’s have been.

When a person or an organization fails – and of course we all do – the best response is to show some humility, identify the problem, and modify the strategy. The Fed is doing the opposite.

Ignoring the Market

FOMC members customarily enter a “quiet period” before each policy meeting. That means we get a heavy dose of speeches and interviews the week after they meet. Last week was that week, and it kicked off with New York Fed President William Dudley.

Speaking at a Business Roundtable event, Dudley reportedly expressed great confidence in both the economy and the Fed’s policy moves. (I’m relying on press reports here because the NY Fed did not release Dudley’s prepared remarks, if he had any.)

The Financial Times’ account captured it best:

Despite some jitters among investors, Mr Dudley reckons continued progress in the jobs market will push wages higher at a more rapid clip, something that would be expected to boost inflation closer to the Fed’s targets.

The policymaker added that stopping rate increases at this point could be dangerous for the economy. His stance echoes that of other senior central bankers who worry that with the jobless rate near levels seen as natural in a properly functioning economy, there is a rising risk of inflation overshoots.

I see zero indication that Dudley is even slightly concerned about the Fed’s overshooting with its rate hikes. However, he is supremely confident that inflation will overshoot if the Fed doesn’t tighten policy. Perhaps more disturbing, a MarketWatch story says that Dudley remarked that he “is not paying much attention to signals of concern from the bond market.”

Read that again. If someone has his exact quote, I’d love to see it, because this is astonishing. The NY Fed’s president is a permanent FOMC member precisely because he is closest to the bond market and is responsible for executing the Fed’s trades. Yet by his own admission he is ignoring the market’s concerns.

Could that be because Dudley doesn’t like the markets’ message? Futures prices show that traders do not believe the Fed will raise rates as aggressively as the FOMC’s dot plots say it will. That’s kind of an important signal. Dudley’s job is to listen to it. If he’s not listening, why not?

I have a theory.

Great Fed Rotation

All this is happening as the Fed is on the cusp of drastic change.

The Federal Reserve System has a seven-member Board of Governors. Three of those seven seats are currently vacant. President Trump has not nominated anyone yet, although two names have been floated in the press (including NIRP lover Goodfriend). Even if Trump were to nominate them tomorrow, they would still have to go through Senate confirmation, and the Senators have a lot on their plates.

Meanwhile, Janet Yellen’s term in the chair expires on February 8, 2018, and Vice-Chair Stanley Fischer’s term ends in June 2018. Their board terms are separate, so both could theoretically remain governors after their leadership terms expire, but most observers expect them to retire. Their staying would not be without precedent (I think there was one exception), but it certainly would be an eye-opener. So, if things go as expected, Trump will have two more seats to fill.

So, we are potentially one year away from a Board of Governors with at least five of the seven being Trump appointees. And it seems highly likely that Lael Brainard will not stick around much longer after Yellen leaves, and then the only question remaining is whether Jerome Powell steps down. I know nothing of his plans, but it could happen. Is his ideal career move to remain on the FOMC as the odd man out?

The seven Fed governors – when there are that many – all sit on the Federal Open Market Committee, which sets interest rates and makes other monetary policy. Also voting on the FOMC are the New York Fed’s president and a rotating cast of four other regional Fed presidents.

President Trump does not appoint the regional Fed bank presidents. They answer to their own boards, which comprise bankers from their regions. So the FOMC has both political appointees and commercial bank representatives. It was set up that way on purpose. But it’s also no accident that the political appointees constitute a majority – or will when more Trump appointees take their seats.

The FOMC works by consensus. Most of its decisions are unanimous or almost unanimous. Fed chairs strive mightily to get everyone on the same page, which I’m sure is tough, on the level of herding cats or getting Republicans in the House to agree. It’s also important – banks and private businesses want to see stability.

Enter Donald Trump, for whom stability is a lesser priority.

The FOMC members must see what is coming. Their beloved unity is in danger, and I doubt they are pleased. I believe a faction on the FOMC wants to cement its own preferred policies in place and make it difficult or impossible for a new majority to change course in 2018 or thereafter. Yellen, Fischer, and Dudley all seem to be of that mind, and they are now taking a hawkish approach to monetary policy. That’s why they don’t want to do the otherwise sensible thing, which is to wait for more evidence that inflation is a problem before tightening further, especially so late in the recovery cycle.

Note also that Yellen and Fischer can further complicate the situation by staying on the board next year. Yellen won’t be chair unless Trump reappoints her, but her board term runs through 2024. Fischer is likewise on the board until 2020.

Can Trump fire Fed governors, like he did the FBI director? Maybe. The Federal Reserve Act says governors can be “removed for cause by the president.” He could certainly find cause if he wished to do so. But firing Fed governors would send a horrible signal to markets. Far better to give them incentives to resign, which could be done quietly. And frankly, I think those around him would let him know that firing would be a really bad idea. Just not done. Independence of the Fed and all that…

In any case, right now we have a Fed that is arguably letting its own parochial political concerns seep into its policy decisions. By raising rates when inflation is nowhere near problematic, they risk tipping the economy into recession. We’re overdue for a recession anyway, and I get that they want to have room to cut rates if necessary. But that will be cold comfort if their own actions trigger the recession. But it even goes further than that…

Bitter Enemies

Division on the FOMC is a microcosm of a much broader problem: the increasingly bitter division within American society. I know many people blame the split on Donald Trump, but it was already well underway before he ran for office. I think Trump is a symptom, not a cause.

The survey data is stark and horrifying. This is from a June 15 New York Times story titled “How We Became Bitter Political Enemies.”

“If you go back to the days of the Civil War, one can find cases in American political history where there was far more rancor and violence,” said Shanto Iyengar, a Stanford political scientist. “But in the modern era, there are no ‘ifs’ and ‘buts’ – partisan animus is at an all-time high.”

Mr. Iyengar doesn’t mean that the typical Democratic or Republican voter has adopted more extreme ideological views (although it is the case that elected officials in Congress have moved further apart). Rather, Democrats and Republicans truly think worse of each other, a trend that isn’t really about policy preferences. Members of the two parties are more likely today to describe each other unfavorably, as selfish, as threats to the nation, even as unsuitable marriage material.

This isn’t just party loyalty. A sizable majority of Americans of both parties now see the other political party as not just mistaken, but as close-minded, immoral, and dangerous, clueless on policy and the correct way to run the country. Again, that’s on both sides. The animus is also clearly visible in the disdain that party elites feel for the members of their own party – no matter what they say when they’re up at the podium.

The current split is even wider than what we think of as more divisive issues like race or gender identification. Regardless of which side you are on, this ought to be terrifying. How can we ever come to a national consensus on crucial issues when this is the underlying environment? More from the NYT story:

Mr. Iyengar also points out that Americans are willing to impugn members of the other party in ways that aren’t publicly acceptable with other groups, like minorities, women or gays. There simply aren’t strong social norms holding partisans back.

This is a terrible state of affairs, and I see no good way out of it. It’s going to manifest itself in many ways, in every institution and corner of society; and in many cases it already has – including at the Federal Reserve. That means it is affecting the economy.

Let me be clear: I am not trying to convert anyone to my own side of the aisle or assert that my side is morally superior. This is a bipartisan problem with plenty of blame to go around. Pretending it doesn’t exist helps no one. I write this because I must hold out hope that we can somehow restore a civic space where we can have adult conversations and somehow recover our lost national unity.

Like it or not, politics is not separate from our private and business lives. It has real-world consequences that affect everyone’s well-being.

And that brings me back to the Fed and their current actions. The following is speculation on my part and will be vigorously denied by anyone associated with the Fed.

I think there is a mixture of political bias and legacy-building that is driving Federal Reserve policy.

The simple fact of the matter is that the Fed should have been normalizing interest rates starting in 2013. Fifty basis points a year and we would be at 2% now. That is not exactly a torrid rate-hike path. It cannot be seen as putting your foot on the brakes; it’s simply moving to normalize a situation that everybody realizes is abnormal. I think that everyone on the FOMC recognizes that rates do have to be normalized, and they don’t want to leave the Committee with rates sub-1% as their legacy.

But when these governors walk into an FOMC meeting, try as they might, they can’t leave their biases in the anteroom. It’s a simple fact that for four years during a Democratic administration they basically refused to raise rates. They said their actions were data-dependent and that the data was telling them it was too early to tighten. Then Donald Trump gets elected, and all of a sudden the data is telling them it’s time to raise rates.

After they have blown a series of bubbles with their low rates, in housing, stocks, all sorts of debt instruments, the automobile market, markets of all sorts, now somehow the data is different, and we have to raise rates.

No two ways about it: There is no significant difference in the data today from that of four years ago – except that four years ago we didn’t have all the bubbles I ticked off above. And we are already late in the cycle. And – the elephant in the room – we now have a Republican president. Who is not going to reappoint these governors.

Let’s look at the data. Unemployment was low four years ago, and it is lower now. The Fed keeps talking about wage inflation, but there is no evidence of it. Further, the Fed’s models are backward-looking and based on historical economic trends and patterns that no longer exist.

In a future letter I’m going to write in depth about the difference between the service class and the working class. The working class generally makes stuff, working at trades and manufacturing jobs. The service class works in the retail sector, in stores and restaurants, and represeents the bulk of the country’s employees. The skill sets are entirely different. There may be in fact some wage pressure in the working class due to a lack of qualified and trained employees (welders, carpenters, and other craftsmen), but that is not the case for the service class. (There are indeed other classes of workers who are more information-oriented or who are professionals. But that is for another letter.)

When Sears goes bankrupt the next time, up to 160,000 people will be joining the unemployment rolls and looking for other service jobs. Ditto for all the other retail jobs that Amazon is gobbling up. There will be millions of such workers in the service industry looking to find jobs – not exactly the stuff that wage inflation in the service job market is made of.

According to a Merrill Lynch study, auto production is going to drop from the projected 17.9 million for this year to 13.8 million in 2021, due to lease roll-offs and other pressures. That dramatic dip in production is going to make a huge dent in the need for workers in the working class. This is not the stuff of wage-pressure-induced inflation.

Subprime auto loan defaults are rising, as are student loan defaults. There are signs everywhere that we are much closer to the end of this business cycle than we were in 2012. There are so many data points that seem to be rolling over. We are not at the end yet, but we’re a lot closer.

The FOMC members are now coming to the realization that leaving the Committee without normalizing rates is going to be disastrous for their legacy, whatever that is. And so they are embarked on a tightening cycle. And they no longer have to worry about creating a recession during a Democratic administration. How convenient. Although they would aggressively deny that any such thing would be ever part of their decision-making process.

And intellectually, I think they are being totally honest. But our emotional biases are not part of our intellectual makeup: This fact of life is basically behavioral psychology 101. Our biases cause us to look at situations (and economic data) in ways that are not always entirely rational. Overcoming our own personal biases is one of the single most difficult things humans can do. So I am not really criticizing the members of the FOMC; I’m just making some observations and freely admitting that I am chief among sinners when it comes to allowing biases to influence thinking.

As David Rosenberg has pointed out, Fed tightening cycles always end with a US market crash or an emerging-market crash or both (but usually just a US market crash). The Fed keeps tightening until we get an unpleasant event.

You really can’t ignore the fact that the FOMC is telling you they are going to raise rates at least once more this year. I know that the two-year bond doesn’t believe that, but I think you need to take it very, very seriously. And I would bet on a January rate hike, in the last month of Yellen’s chairmanship. Doesn’t quite get us to 2% rates but… close enough for government work.

They are hoping that by raising rates slowly they won’t push the economy into a slowdown before they can abandon ship. Then the next chairman and the Fed can deal with it.

One last thought: I want to reiterate that the potential appointment of Marvin Goodfriend is disturbing to me. I’m sure he’s a good guy and a brilliant economist; but it all boils down to this: If you can wrap your head around negative interest rates, I don’t want you anywhere near the policy steering wheel.

If the Goodfriend choice is part of a trend and Mnuchin or whoever is advising the president on these choices, that suggests to me that the Trump team is not looking to appoint a hawkish, less activist FOMC. That means we are not going to get a Kevin Warsh or a Richard Fisher as chairman. We’re certainly not going to get a Volcker. I truly, deeply, sincerely hope I am wrong. I hope I have to eat those words.

Thinking the unthinkable: Could we see a return to QE before the end of Trump’s first term? It’s way too early to tell, and maybe somebody will get with the president and discuss the dynamics of Federal Reserve policy and the problems of quantitative easing and NIRP or zero boundary rates. A recent Princeton study (pointed out to me by Lyric Hughes Hale) suggests that when rates fall below 2% there is no real stimulative value and, in fact, rates that low hurt the economy.

We need a new mindset at the Fed. If we don’t not change the underlying philosophical posture that 12 people can sit around a table and set the price of the most important item in the world, money, and do that better than the market can, we will continue to flounder. If, after all the new appointments, we still end up with an activist FOMC that believes in its own models, which have been preposterously wrong for 30 years and that will continue to blow a series of bubbles in all markets, which will eventually crash, then we are destined to a wash, rinse, and repeat series of financial crises.

This Fed has already engineered the next crisis, just as Greenspan kept rates too low for too long, ignored his regulatory responsibility, and engineered the housing bubble and subprime crisis. If you can’t see this next crisis coming, you’re not paying the right kind of attention. The Trump Fed is going to have to deal with that crisis, but we still have many questions as to what a Trump Fed will actually look like or do.

But make no mistake, whomever Trump puts on the FOMC, it will be an FOMC that he will have to take full ownership of, no matter what they do. Very few other presidents have ever had the opportunity to reshape the FOMC as completely as Trump will do.

And make no mistake, if we plunge into a recession and the market drops 50%, ardent pleas will issue from all points of the world to give us more quantitative easing. Just give us one more fix, the market will beg. “This time we promise not to get too irrationally exuberant again. Just give us a few more rounds of even more massive QE….”

With each passing quarter, the Great Reset is coming nearer. You need to think hard about how you’re positioned in the markets and in your own personal life and businesses, in order to weather the crisis that’s coming as skillfully as posible.
Getting Married on St. Thomas, Omaha, San Francisco, and Freedom Fest in Las Vegas

Shane and I are leaving today for St. Thomas in the US Virgin Islands and will be married on some beautiful beach on June 26, her birthday. Then I actually intend to relax for a week, enjoying time with my new bride and reading books with no redeeming social value (also known as science fiction/fantasy). I will begin final writing on my new book when I come back. I am finally really ready to attack the topic of what the world will look like in 20 years.

I have a quick trip to Omaha in the middle of June; then I’ll head directly on to San Francisco and Palo Alto for speaking engagements (and have dinner with my good friends Andy Kessler and Rich Karlgaard). I will be speaking the next day, Thursday July 13, in San Francisco at the S&P Dow Jones Indexing Conference at the Omni Hotel from 12 till 4. Here’s a PDF of the agenda. If you are an advisor or broker, you can attend for free. I look forward to meeting you there.

Afterward, I’ll come home to Dallas, recover for a few days, and then fly with Shane to Las Vegas for the Freedom Fest. It has become one of the largest libertarian gatherings in the world, and I have so many good friends who go that it’s really a lot of fun for me. And while I am not much of a gambler (as in I suck at it and hate losing money to people who are much richer than I am), I really do like the shows. And dinners with friends.

That covers July, and August is, of course, the annual Maine fishing trip; but right now the rest of August looks to be pretty wide open. If I can figure it out, I may go somewhere that has a much cooler climate than Texas does in August and relax and write.

It’s time to hit the send button – the driver will be here in a few minutes. I’ve been officially informed that calories do not count on St. Thomas and that if you’re on your honeymoon they are actually negative. I’m going to test that theory. Personally, I think it’s about as reliable as Fed models are; but like the Fed, sometimes you do something just because you have a theory about how the world works and the theory makes you feel good. I think I see a serious diet in July…

(Update: Flights have been delayed, so we will be getting into St. Thomas a day late. Extra time in airports is so much fun. And now they are talking about rain on Monday. But I confidently predict that the sun will come out when we get married.)

Your out of here analyst,

John Mauldin

How did Argentina pull off a 100-year bond sale?

Despite past defaults, the Latin American country has sold debt maturing in a century

by: Benedict Mander and Robin Wigglesworth

Mauricio Macri

Little more than a year since Argentina’s return to the capital markets with a record-breaking $16bn issue, it pushed the boundaries even further on Monday by selling a 100-year bond.

This makes the market-friendly government of Mauricio Macri only the second Latin American sovereign to issue a so-called “century bond”, after Mexico in 2010. But such a long-maturity bond sale from a seemingly perennially troubled country raises a host of questions.

Why were there buyers?

Argentina would probably never have made such a bold move without knowing that some investors were already interested, analysts said. “There has to be some big real money player behind this,” said Alejo Costa, chief strategist at BTG Pactual in Buenos Aires.
Adam Bothamley, head of debt syndicate for HSBC, one of the banks that worked on the deal, said it came in response to “reverse inquiries”, where investors approach the issuer with a proposal that will meet its needs and theirs. This worked well for Argentina last year with its massively oversubscribed sale of local currency debt with long maturities.

Why 100 years?
Mr Costa explained that long-duration bonds are the best way for real money investors to place bets on Argentina, given that they are unable to leverage themselves like a more nimble hedge fund. “If you are an investor with a constructive view on Argentina, what you want is duration,” he said.

Argentina sold $2.75bn of the debt with a coupon of 7.125 per cent, equating to an annual yield of 7.9 per cent, according to a statement from the Argentine finance ministry late on Monday. The bond attracted $9.75bn in orders from investors.

If Argentina fulfils its promises to reduce its deficit, meeting its fiscal targets, there is a good chance that Argentine bond prices will rally significantly over the next couple of years. Given the bond was sold at a yield of almost 8 per cent an investor would recoup their initial investment in around 12 years.

Yields could fall by at least 150 basis points, moving more in line with other major economies in the region such as Brazil — implying capital gains on such bonds in the double digits. “Those are pretty good returns. At a rate of 8 per cent or higher, it’s a buy,” Mr Costa said.

Still sounds a bit risky given Argentina’s history as a defaulter?
Argentina has defaulted on its sovereign debt eight times since independence in 1816, spectacularly so in 2001 on $100bn of bonds — at the time the world’s largest default — and most recently in 2014 after clashing with Elliott Management, an aggressive hedge fund.

But Mr Macri’s government “cured” the latest default in 2016, and times have changed, said Joe Harper, a partner at Explorador Capital Management, an investment fund focused on Latin America.

“The policy pendulum in Argentina has shifted to the centre, and the country’s next 100 years will be very different than the last century.”

Few investors are looking that far into the future; most look little further than the next couple of years. Over that period, few are expecting any major upsets in Argentina. The worst that could happen is that Mr Macri’s government disappoints and fails to win a second term. But even then, few envisage a return — in the next elections, at least — to the kind of populism that has been at the root of most of Argentina’s defaults.

But hasn’t Argentina borrowed a lot over the past year?
Yes, but that was always the plan. There was no way out of the inflationary trap it was stuck in — with the central bank printing money on demand for the Treasury — than for the government to finance itself instead on the international capital markets.

Luckily, foreign debt was low when Mr Macri took power as the previous government had been unable to borrow abroad. Most analysts argue that Argentina’s debt-to-GDP ratio is still very sustainable, provided that the government keeps to its fiscal consolidation targets and the economy grows. This year, Argentina has already borrowed about $9.5bn, and is set to borrow another $5bn or so more. The sooner it can cover its needs for 2017, with midterm elections approaching in October, the better.

What does this say more broadly about emerging market and investor appetite?

International investors have not tired of emerging markets just yet. Billions have flowed into bonds issued by the developing world in 2017, with investors hungry for the higher yields on offer and undeterred by the US central bank’s programme of interest rate increases.

“Appetite for emerging markets is rising in a new era of hard-to-find value,” said Mr Harper. For Latin America in particular, growth would continue to be fuelled by demographic trends found in few other regions in the world.

And while the liquidity and inflows remain, Argentina is one of the few opportunities left, said Mr Costa, who pointed also to Ukraine and perhaps Brazil. “Argentina is one of the few constructive stories,” he added.

Should we be worried that this is a sign of froth?

Emerging markets have enjoyed a tremendous year so far, countering fears that the ascent of Donald Trump would usher in trade wars, geopolitical strife and aggressive monetary tightening in the US — all ill omens for the developing world.

But the strength of the rally, coupled by being driven primarily by inflows into mutual funds and exchange traded funds, has sparked concerns in some quarters about when the tide goes out again, as it invariably does.

Markets are riddled with deals that in retrospect signalled a top, such as Time Warner’s 2000 merger with AOL, or Rwanda’s ebulliently received $400m bond sale just before the Fed began to trim its quantitative easing programme in 2013, which triggered a “taper tantrum” in emerging markets.

Argentina’s prospects may have brightened considerably, but sceptics point out that the country has spent a lot of its post-independence life in default on various debts.

Investors buying a 100-year bond issued by Buenos Aires are making a risky bet that this time things are going to be different.

Firing at Democracy

The Toxic State of America

A Commentary by Christoph Scheuermann in Washington, D.C.

 The site of the shooting in Alexandria, Virginia

The attack on Republican members of Congress in the United States this week is a product of America's increasingly toxic political climate. Democracy is at stake in a country where two, deeply divided sides are no longer capable of reasonable debate.

Once the attacker was dead and the injured cared for, once quiet had returned to Congress and the investigation had begun, a hint of harmony briefly descended over Washington. Democrats said prayers for Republicans, adversaries found warm words for each other and even Donald Trump acted like a statesman. America is strongest, he said, "when we are unified and when we work together for the common good."

This, from Trump -- arguably America's most divisive figure.

It sounded as if he had forgotten recent months -- the tirades and hate-filled speeches. As if there were no gaping rift between the opposing political camps, right and left, long since unbridgeable. For a moment, it seemed the president had swept aside all the rage -- and the nation was thankful.

What happened on Wednesday in Alexandria, a Washington suburb, was not Donald Trump's fault.

The attacker opened fire on Republican members of the House and Senate. It was not an attempted political assassination, but it was an act that was at least partly motivated by politics.

The perpetrator, James Thomas Hodgkinson, was a disturbed Bernie Sanders supporter who considered Trump to be a "traitor." It was an attack on democracy, but above all provided evidence of just how toxic the political environment in the United States has become. And of course, this president, both directly and indirectly, bears his share of the blame for this climate.

A political battle is raging in the United States in which the competing camps are no longer engaging in debate. Instead, each side is denying the other's right to participate in the democratic process. Both sides are raising the specter of treason as a way of justifying violence.

The rage against elites has become impossible to contain, with ring leaders on the right speaking of "war" and those on the left of "resistance." The two sides are united by the thirst for confrontation and by the occasional repudiation of their opponents' humanity. Eric Trump, one of President Trump's sons, recently said that critics of the American leader are "not even people."

Debates have often been shrill in the United States. And violence has reared its head in political life before -- and not just since the assassinations of JFK, Martin Luther King and Malcolm X.

Profiteering from Polarization

But today, a man is sitting in the White House who profits from the polarization and is further fanning the flames. It is not the language of moderation that is spoken in Trump's Washington -- it is one of revolt, revenge, rage and cynicism, and that isn't by chance. Journalists have become "enemies of the state," judges are ridiculed, government prosecutors getting too close to the president are threatened with dismissal and the head of the FBI is fired.

But Trump isn't sowing the seeds of rage on his own. His opponents are also doing a fine job of escalating this rhetorical arms race with talk of street battles, as if guerilla warfare were the solution.

Comedienne Cathy Griffin had herself photographed recently holding Trump's fake decapitated head by the hair. At the point in a debate when the physical well-being of one's opponent is no longer sacred, there are no boundaries left.

The ideological divide between Democrats and Republicans has never been as wide as it is today.

The most dangerous aspect of this development is that the two sides are no longer able to agree on basic facts. One wonders whether Republicans and Democrats could even agree that the sky is blue.

If everything is relative and nothing is certain, when a president lies so openly, then who can you trust? When the language of this government is so corrupt and misguided, what is one to do?

There are few institutions left that both sides accept as being nonpartisan. At the moment, Trump's helpers are busy casting aspersions at independent special counsel Robert Mueller, who has been tasked with investigating Russian influence on the presidential campaign and potential ties between Moscow and the Trump team. Until his appointment, he had been accepted by Republicans and Democrats alike as an independent official with integrity. The campaign against Mueller is destroying any possibility, at least on this question, that one side's version of the truth might ultimately be accepted.

The harmony following the attack in Alexandria didn't last long. The next morning, Trump tweeted he was the victim of a "WITCH HUNT." He was referring, of course, to special counsel Mueller.

Debate is one of the foundations of democracy, but in the U.S. it's hardly possible anymore. And when the people of a country are no longer capable of speaking to each other, when they constantly believe their opponents are involved in a conspiracy, then a country's institutions are also imperiled.

And with them, democracy itself.

The Rise of the Food Barons

Christine Chemnitz

BERLIN – The industrial-agriculture sector has long faced criticism for practices that contribute to climate change, environmental destruction, and rural poverty. And yet the sector has taken virtually no steps to improve quality and sustainability, or to promote social justice.
This is not surprising. Although there are more than 570 million farmers and seven billion consumers worldwide, just a handful of companies control the global industrial-agriculture value chain – from field to shop counter. Given the high profits and vast political power of these companies, changes to the status quo are not in their interest.
Moreover, market concentration in the agriculture sector is on the rise, owing to increased demand for the agricultural raw materials needed in food, animal feed, and energy production.

As the middle class in southern countries has grown, its members’ consumption and nutritional habits have changed, boosting global demand for processed foods – and setting off a scramble for market power among multinational agricultural, chemical, and food corporations.
The biggest players in these sectors have been buying out their smaller competitors for years.

But now they are also buying out one another, often with financing provided by investors from completely different sectors.
Consider the seed and agrochemical sector, where Bayer, the second-largest pesticide producer in the world, is in the process of acquiring Monsanto, the largest seed producer, for €66 billion ($74 billion). If the United States and the European Union approve the deal, as seems likely, just three conglomerates – Bayer-Monsanto, Dow-DuPont and ChemChina-Syngenta – will control over 60% of the global seed and agrochemical market. “Baysanto” alone would be the proprietor of almost every genetically modified plant on the planet.
With other large mergers also being announced, the global agriculture market at the end of 2017 could look very different than it did at the beginning. Each of the three major conglomerates will be closer to its goal of achieving domination of the seed and pesticide markets – at which point they will be able to dictate food products, prices, and quality worldwide.
The agrotechnical sector is experiencing some of the same changes as the seed sector. The five largest corporations account for 65% of the market, with Deere & Company, the owner of the John Deere brand, in the lead. In 2015, Deere & Company reported $29 billion in sales, surpassing the $25 billion that Monsanto and Bayer made selling seeds and pesticides.
The most promising new opportunity for food corporations today lies in the digitization of agriculture. This process is still in its early stages, but it is gathering momentum, and eventually it will cover all areas of production. Soon enough, drones will take over the task of spraying pesticides; livestock will be equipped with sensors to track milk quantities, movement patterns, and feed rations; tractors will be controlled by GPS; and app-controlled sowing machines will assess soil quality to determine the optimal distance between rows and plants.
To maximize the benefits of these new technologies, the companies that already dominate the value chain have begun cooperating with one another. The John Deeres and Monsantos have now joined forces. The confluence of soil and weather “big data,” new agrotechnologies, genetically modified seeds, and new developments in agrochemistry will help these companies save money, protect natural resources, and maximize crop yields worldwide.
But while this possible future bodes well for some of the world’s largest companies, it leaves the environmental and social problems associated with industrialized agriculture unsolved. Most farmers, particularly in the global South, will never be able to afford expensive digital-age machinery. The maxim “grow or go” will be replaced with “digitize or disappear.” The ETC Group, an American non-governmental organization, has already outlined a future scenario in which the major agrotechnology corporations move upstream and absorb the seed and pesticide producers. At that point, just a few companies will determine everything that we eat.
Indeed, the same market-concentration problem applies to other links in the value chain, such as agricultural traders and supermarkets. And even though food processing is not yet consolidated on a global scale, it is still dominated at the regional level by companies such as Unilever, Danone, Mondelez, and Nestlé. These companies make money when fresh or semi-processed food is replaced by highly processed convenience foods such as frozen pizza, canned soup, and ready-made meals.
While lucrative, this business model is closely linked to obesity, diabetes, and other chronic diseases.
Worse, food corporations are also profiting from the proliferation of illnesses for which they are partly responsible, by marketing “healthy” processed foods enriched with protein, vitamins, probiotics, and omega-3 fatty acids.
Meanwhile, corporations are amassing market power at the expense of those at the bottom of the value chain: farmers and workers. International Labor Organization standards guarantee all workers the right to organize, and they prohibit forced and child labor and proscribe race and gender discrimination. But labor-law violations have become the norm, because efforts to enforce ILO rules are often quashed, while trade union members are routinely threatened, fired, and even murdered.
In this hostile climate, minimum-wage, overtime-pay, and workplace-safety standards are openly neglected. And women, in particular, are at a disadvantage, because they are paid less than their male counterparts and often must settle for seasonal or temporary jobs.
Today, half of the world’s 800 million starving people are small farmers and workers connected to the agricultural sector. Their lot will hardly improve if the few companies already dominating that sector become even more powerful.

IMF cuts US growth forecast as prospects for fiscal stimulus fade
The fund delivers sceptical assessment of Trump administration’s growth forecasts

by: Sam Fleming in Washington

Falling forecasts: the IMF delivered a highly sceptical assessment of the US administration’s growth predictions © FT montage; Getty

President Donald Trump’s struggle to deliver a fiscal stimulus this year has prompted the International Monetary Fund to cut back its growth forecasts for the US economy — just months after it boosted its outlook on hopes of a policy overhaul.

Following slow progress by the White House and Capitol Hill on long-mooted tax reforms, the fund on Tuesday lowered its prediction for gross domestic product growth this year to 2.1 per cent, down from an earlier forecast of 2.3 per cent. The fund reduced its growth outlook for 2018 to 2.1 per cent from 2.5 per cent.

It also delivered a highly sceptical assessment of the administration’s growth predictions, pouring cold water on White House claims that its policies would help deliver a sustained 1 percentage point acceleration in annual growth. The fund warned that there were few recorded cases of advanced economies achieving such a leap.

Trump administration officials have vowed to boost growth by getting tax legislation to the floor of Congress in September as well as pushing through an infrastructure spending blitz. But infighting in the party over divisive healthcare reform plans, coupled with a White House distracted by the probe into alleged Russian interference in the US election, has contributed to repeated delays.

In its annual Article IV report on the US, the IMF said lawmakers should throw their weight behind a fundamental tax reform package that would, among other things, simplify the tax system, lower rates and strip away exemptions. But the fund said it had become clear during its discussions with the US authorities that “many details” on plans for tax, public spending and deficit reduction were still unsettled, meaning its forecast now assumes no change to existing policies.

“The consultation revealed differences on a range of policies and left open questions as to whether the administration’s proposed policy strategies are best suited to achieve their intended purpose,” the IMF said.

The fund’s critical assessment comes at a delicate time for its relations with the Trump administration. Christine Lagarde, IMF managing director, has worked hard to build ties with Treasury Secretary Steven Mnuchin and Gary Cohn, the National Economic Council director. But the administration has reacted angrily to previous IMF warnings against US protectionism, with commerce secretary Wilbur Ross dismissing them as “rubbish” in April.

The IMF on Tuesday urged Washington to be “judicious” in its use of import restrictions justified on national security grounds, as the administration considers whether steel imports pose a security threat. The fund warned that a retreat from cross-border integration would represent a “downside risk to trade, sentiment and growth”.

Mr Mnuchin and Mr Cohn unveiled tax ideas in April, but these were widely criticised as lacking in substance and implying a multi-trillion-dollar deficit blowout. The administration has also unveiled a budget plan that aims to balance the books over 10 years, but the IMF declined to build those ideas into its forecasts.

The fund signalled its scepticism about the budget as it described the underlying growth assumptions as “extremely optimistic”. While the administration built in growth projections of 3 per cent by 2021, the IMF sees US growth subsiding to an underlying potential rate of 1.8 per cent by 2020.

“Even with an ideal constellation of pro-growth policies, the potential growth dividend is likely to be less than that projected in the budget and will take longer to materialise,” it said.

While the report advocated targeting a federal primary surplus of 1 per cent of GDP in the medium term, it criticised the Trump budget for advocating swingeing cuts to discretionary spending.

These, it said, would put a “disproportionate share of the adjustment burden on low- and middle-income households”.More than half of the US population have lower inflation-adjusted incomes today than in 2000, prospects for upward mobility are “waning” and, at 13.5 per cent, the poverty rate is among the highest in advanced nations, it said.

As a result, the IMF said it was advocating a host of economic reforms, including tax changes to incentivise higher labour force participation and support for low and middle-income households.The IMF also set out recommendations to the Federal Reserve, which has embarked on a steady progression to more normal interest rates. The IMF said policy rates should continue to rise and that the Fed was right to be preparing an unwinding of its quantitative easing programme.

But the report added that given recent weaknesses in inflation data, the Fed should be ready to accept “some modest, temporary overshooting of its inflation goal” of 2 per cent.

An Empire Self-Destructs

by Jeff Thomas

Empires are built through the creation or acquisition of wealth. The Roman Empire came about through the productivity of its people and its subsequent acquisition of wealth from those that it invaded. The Spanish Empire began with productivity and expanded through the use of its large armada of ships, looting the New World of its gold. The British Empire began through localized productivity and grew through its creation of colonies worldwide—colonies that it exploited, bringing the wealth back to England to make it the wealthiest country in the world.

In the Victorian Age, we Brits were proud to say, “There will always be an England,” and “The sun never sets on the British Empire.” So, where did we go wrong? Why are we no longer the world’s foremost empire? Why have we lost not only the majority of our colonies, but also the majority of our wealth?

Well, first, let’s take a peek back at the other aforementioned empires and see how they fared.

Rome was arguably the greatest empire the world has ever seen. Industrious Romans organized large armies that went to other parts of the world, subjugating them and seizing the wealth that they had built up over generations. And as long as there were further conquerable lands just over the next hill, this approach was very effective. However, once Rome faced diminishing returns on new lands to conquer, it became evident that those lands it had conquered had to be maintained and defended, even though there was little further wealth that could be confiscated.

The conquered lands needed costly militaries and bureaucracies in place to keep them subjugated but were no longer paying for themselves. The “colonies” were running at a loss.

Meanwhile, Rome itself had become very spoiled. Its politicians kept promising more in the way of “bread and circuses” to the voters, in order to maintain their political office. So, the coffers were being drained by both the colonies and at home. Finally, in a bid to keep from losing their power, Roman leaders entered into highly expensive wars. This was the final economic crippler and the empire self-destructed.

Spain was a highly productive nation that attacked its neighbours successfully and built up its wealth, then became far wealthier when it sailed west, raiding the Americas of the silver and gold that they had spent hundreds of years accumulating. The sudden addition of this wealth allowed the Spanish kings to be lavish to the people and, as in Rome, the Spanish became very spoiled indeed. But once the gold and silver that was coming out of the New World was down to a trickle, the funding for maintaining the empire began to dry up. Worse, old enemies from Europe were knocking at the door, hoping to even old scores. In a bid to retain the empire, the king entered into extensive warfare in Europe, rapidly draining the royal purse and, like Rome, the Spanish Empire self-destructed.

In the Victorian era, the British Empire was unmatched in the world. It entered the industrial revolution and was highly productive. In addition, it was pulling wealth from its colonies in the form of mining, farming and industry. But, like other countries in Europe, it dove into World War I quickly and, since warfare always diminishes productivity at home whilst it demands major expense abroad, the British Empire was knocked down to one knee by the end of the war.

Then, in 1939, the game was afoot again and Britain was drawn into a second world war. By the end of the war, it could still be said that there would always be an England, but its wealth had been drained off and, one by one, its colonies jumped ship. The days of empire were gone.

Into the breach stepped the US. At the beginning of World War I, the US took no part in the fighting, but, as it had experienced its own industrial revolution, it supplied goods, food, and armaments to Britain and her allies. Because the pound and other European currencies could not be trusted not to inflate, payment was made in gold and silver. So the US was expanding its productivity into a guaranteed market, selling at top dollar, using the profits to create larger, more efficient factories, and getting paid in gold.

Then, in 1939, it all happened again. Although the US eventually joined both wars, they did so much later than Britain and her allies. At the end of World War II, the US had a lively young workforce, as they had lost fewer men to the war. They also had modern factories, which had been paid for by other nations, that could now be used to produce peacetime goods for themselves and the rest of the world more efficiently than anyone else.

And (and this is a very big “and”) by 1945 they owned or controlled three quarters of the world’s gold, as they’d drained it away from the warring nations in the early days of the war.

This allowed the US to invite the post-war leaders to Bretton Woods to explain that, as the holders of the world’s wealth, they’d dictate what the world’s default currency would be: the dollar.

But this was all threatened by the fact that, when the now-poorer nations of the world sold their goods to the US, they, too, beginning with the French, wished to be paid in gold.

And so, in the subsequent years, the gold in Fort Knox was beginning to travel back to the east, from whence it had come in previous years. In 1971, this flow was shut off, as the US, still the foremost empire, had the power to simply remove all intrinsic value from the dollar and turn it into a fiat currency. Payment in gold ended.

Fast-forward to the post-millennium era and we see that America, like the previous empires, ended its acquisition of gold after World War II, yet its people became spoiled by political leaders who promised ever-increasing bread and circuses. The productivity that led to its initial strength was dying off, and it was spending more than it was bringing in. Finally, it sought to maintain its hegemony through warfare, thereby creating a dramatic drain to its wealth.

Like other empires before it, the US is now on the verge of relinquishing the crown of empire. If there’s any difference this time around, it’s that its collapse will very likely be far more spectacular than that of previous empires. However, just as in previous collapses, those who least understand that the collapse is around the corner are those who are closest to its centre.

Clearly, the majority of Americans are worried about their future yet cannot conceive of their country as a second-rate power. And those who hold the reins of that power tend to be the most deluded, delving ever-deeper into debt at an ever-faster rate, whilst expanding welfare and warfare without any concept of how it might all be paid for.

It’s understandable, therefore, that those of us who are on the outside looking in find it easier to observe objectively from afar and see the coming self-destruction of yet another empire.

As stated in the first line of this essay, “empires are built through the creation or acquisition of wealth.” They tend to end through the gradual elimination of the free-market system, the metamorphosis to a welfare state, and, finally, through the destruction of wealth through costly warfare.

Does this indicate the “end of the world”? Not at all. The world did not end with the fall of Rome, Spain, England, or any one of the many other empires. The productive people simply moved to a different geographical location—one that encourages free-market opportunity. The wealth moved with them, then grew, as the free market allowed productive people to make it grow.

Freedom and opportunity still exist and indeed flourish. All that’s changing is the locations where they are to be found.

The Fed’s Poor Record on Soft Landings

The central bank is trying to hold the economy steady by slowing things down a bit, but history says it will go too far

By Justin Lahart

A man walks by the Marriner S. Eccles Federal Reserve Board Building in Washington, D.C. Photo: Tom Williams/Congressional Quarterly/Newscom/Zuma Press        

There are two things investors should keep in mind about the Federal Reserve: One, it is in a tightening cycle. Two, tightening cycles almost always end badly.

The Fed raised rates for a third time in six months last week, and signaled there are more to come. After all the fits and starts of the past several years, the Fed is finally, unambiguously in a tightening cycle -- a fact underscored by its plans to start reducing the amount of bonds it holds on its balance sheet, a legacy of its efforts to restart the economy after the financial crisis “relatively soon,” according to Chairwoman Janet Yellen.

The Fed’s aim here is to guide the economy to a soft landing. To do that, it foresees continuing to raise rates in order to slow growth, ease the pace of hiring, and nudge the unemployment rate little higher. That way, it reckons it will be able to prevent the job market from overheating while getting the inflation rate to settle at 2%.

But executing a soft landing is notoriously difficult to pull off. The Fed can only guess at what the economy’s just-right levels of growth and employment are, and at what level of interest rates is consistent with hitting those marks. The process of running down its balance sheet introduces new complications, points out J.P. Morgan economist Michael Feroli, as does a likely change in leadership at the Fed.

Moreover, the Fed’s track record with soft landings is incredibly poor. It has had, with the benefit of hindsight, a tendency to overtighten in its efforts to tame inflation and other excesses. Rates suddenly go from looking as if they are too low to too high, and the economy suffers as a result.

By the time it stopped raising rates in 2006, for example, the housing bust that would drag the economy into recession and set off the financial crisis was under way.

The only time the Fed really succeeded in executing a soft landing, according to most economists, was when it raised rates through 1994. In the mid-1960s and mid-1980s it had a couple of qualified successes. Its other tightening cycles over the past 60 years were followed by recessions, though in some cases a recession was necessary to wipe out inflation.

A recession seems far from imminent at the moment. Hiring appears to have slowed, but is still running fast to keep the unemployment rate slipping lower. Inflation has been stubbornly low, allowing the Fed to raise rates slowly, which might prevent the bank from tightening too much.

And while stock valuations are running high, the types of financial market excess that got the economy in trouble during the dot-com and housing bubbles haven’t presented themselves.

Still, with the Fed trying to pull off a maneuver it has had little success with, investors should pay attention. And be a little nervous.