The Bear’s Lair: Jackson Hole 2017 was a barmy ideas factory

The Federal Reserve Bank of Kansas City is a relatively solid, well-run institution and its President Esther George is among the most sensible members of the Federal Open Market Committee when she is permitted to attend it (her next triennial year of service is 2019). It is thus surprising and regrettable that its annual Jackson Hole conference has become a factory for bad ideas second only to the annual Davos Gabfest. This year it surpassed all barminess records, with the usual monetary madness of recent years joined by regulatory madness and fiscal madness. Surely the Kansas City Fed can find better things to do than sponsor this nonsense!

To be fair, on monetary policy Jackson Hole was no barmier than it has been for the past decade. The Fed has moved about three inches in the direction of sensible interest rates and has announced its intention of beginning ever so slowly to wind down the excessive market-distorting portfolio of mortgage bonds and Treasuries it took on in the past decade. Indeed, Fed Chairman Janet Yellen avoided monetary policy altogether in her presentation, probably a wise move. However, European Central Bank President Mario Draghi justified the ECB’s much worse current policy, which he had introduced at Jackson Hole three years ago, with massive market-distorting bond buying and zero interest rates.

In particular, Draghi continued to justify the 2% inflation target which he, Japan’s Haruhiko Kuroda and Yellen have in common (it is an explicit target of the ECB and the Bank of Japan, but not of the Fed.) This rises to new heights of barminess. 2% inflation halves the value of your money every 35 years; it means that anyone who retires today is liable to end up destitute in his or her 90s.

2% is just about acceptable as a maximum level of inflation, above which Volckerite 12% interest rates will be used to drag it back in control. However, 2% inflation makes no sense whatever as a target to aim at, still less as a justification for excessively expansionary monetary policies, with negative real interest rates, simply because inflation is at say 1.3%. Even if Japanese-style deflation were proved to be economically damaging (and there has been no such proof; Japan’s productivity performance since 1990 has been among the best of the advanced economies) 1.3% inflation is not deflation and should not be treated as such.

In gliding over monetary policy, Janet Yellen focused heavily on regulation. She claimed that the morass of regulations installed since 2008 has made the banking system safer. In reality, they have created an orgy of cronyism, in which the largest “banks” notably Goldman Sachs increase their profitability while smaller banks and community banks are strangled by bureaucracy. Before the financial crisis, about 100 new banks opened annually, but Winter Park National Bank, of Florida, was in April 2017 the first new national bank to get preliminary approval from the Comptroller of the Currency since 2009 – and it still doesn’t seem to have managed to open yet.

Presumably the various offices responsible for approving new banks have been fully staffed, with officials drawing substantial financial sector regulatory salaries, throughout this eight-year period. Pretty pointless really; it would have been much cheaper to fire the lot, and keep only a janitor, armed with a pad of red ink and a large rubber stamp saying “NYET” who could return all new bank applications to their filers.

In banking regulation, the Obama/Yellen years have been marked by pure obstructionism towards new entrants of any kind, together with endless new bureaucratic barriers protecting incumbents, especially the largest incumbents with political connections. It is not as if banking regulation has been especially effective, either; the regulators at the Fed and elsewhere have missed the creation of a brand new market for crypto-currencies, entirely outside their control, which has already grown to $166 billion and bids fair to pass the $1 trillion mark within the next year.
The crypto-currency market looks likely to remove private transactions and savings once and for all from the control of national monetary authorities, creating an entirely new money supply completely beyond the reach of regulation. From a libertarian perspective, this is an unalloyed blessing. From the point of view of those wishing to maintain any kind of control over the global economy, and who believe state directed monetary policy is a useful tool in controlling the economic system, it is an unmitigated disaster.

I incline towards the “blessing” formulation, largely because state attempts to control the economy have over the past few decades being a complete failure, creating bubble after bubble and slowing productivity growth almost to zero. Still, there’s no doubt an unfettered crypto-currency world will empower a large number of unspeakable crooks. A proper Gold Standard, with or without a limited 19th Century-style central bank, would work very much better.

In fiscal policy, Jackson Hole germinated an even worse idea, via a paper by Alan Auerbach and Yuriy Gorodnichenko of the University of California, Berkeley (where else?) purporting to prove that governments should borrow to “stimulate” their economy in recessions, even if they already have excessive amounts of debt. To justify this extraordinary claim, the authors used performance in the credit default swap markets and local interest rates.

Thereby they purport to show that even borrowing like madmen and running up a debt of 250% of GDP, as Japan has done since 1990, does not increase costs of borrowing. They even claim that spending like mad in recessions does not increase the country’s overall debt to GDP ratio in the long term, to which I would respond: how do they explain what has happened in Japan in the last 27 years (debt to GDP from 70% to 250%) which is surely “long-term” enough for any mere mortal?

The flaws in this analysis are glaringly obvious. The CDS market is a nest of insider-trading crooks that certainly does not represent credit conditions accurately. The market was developed in the 1990s by people who never got over the problem that there was no sound way to determine the amount and timing of the payoff on default. Running a financial arbitrage operation in the 1980s, I looked at the possibility of CDS, and came to the conclusion that there was no way to create them on a legally and financially sound basis. Nothing that has happened since has convinced me that I was wrong. Just this week, ISDA, the CDS market’s ruling body, has shown itself unable to decide even the simple matter of whether Noble Group is in default or not, let alone what the payout on its CDS should be if it is.

In 2008, Goldman Sachs received an entirely spurious $13 billion courtesy of U.S. taxpayers, based on the bets it had made against the U.S. mortgage bond market through CDS written by AIG. AIG was unable to pay off its CDS casino trading obligations in 2008, which resulted in the bankruptcy of an otherwise solid insurance company. Had Goldman been made to lose its $13 billion in that bankruptcy, two salutary effects would have occurred: the CDS market would have been killed stone dead and Goldman (which would have survived) would have learned not to play ethically disreputable games betting against the securities it had issued.

CDS are a false market that clearly does not represent the true credit position of a borrower. Debt interest rates are equally spurious when the country’s central bank is not only manipulating interest rates but buying government bonds like a madman, as all major rich country central banks have done since 2008. Since both its indicators of health are fatally flawed, the Berkeley paper is completely worthless, driven entirely by the ideological belief of that institution’s academics that ever larger government is the best future for mankind.

In reality, excess borrowing by government does not stimulate, it crowds out more productive activities of the private sector, as it has done in the U.S. since 2008, bringing appalling productivity performance and increasing inequality in its wake. Central banks financing the excess debt may keep interest rates down, but they do not improve the health of the private sector or its productivity. Thank goodness, President Trump appears to understand this, though I remain somewhat unconvinced since his chief economic advisor is a former COO of Goldman Sachs, the croniest of the cronies.

It is inevitable that the faculties of prestige West Coast and East Coast colleges will attempt to project their poisonous Marxist-Keynesian economic beliefs by any means. The Kansas City Fed, however, should have more sense than to abet them in this attempt. President George, your Jackson Hole symposium is an annual forum of error and intellectual destruction. Please abolish it.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)