“This is exactly what the Ice Age end-game always was”, Albert Edwards writes, in his latest weekly missive.
If Edwards has been “early” over the course of his career, he’s been right on time when it comes to the world’s decisive pivot to overt (as opposed to covert) debt monetization.
Back in February, Edwards said “The Ice Age” (his long-standing thesis describing western markets’ date with deflation) was near its end. We are, he said, on the verge of transitioning to “The Great Melt”, which will be catalyzed by the adoption of helicopter money (or some derivation thereof) across the developed world. The policy response to the pandemic sealed the deal.
I’ve argued that the supposed distinction between helicopter money and debt monetization is meaningless in a world where QE is calibrated almost precisely to the size of the government’s borrowing needs.
At the same time, note that the complete unwind of central bank balance sheets (i.e., “total normalization”) is a distant prospect at best, and impossible at “worst”. Even if, at some point years from now, central banks do allow assets to mature without reinvesting the principal, equities don’t “mature”. That means the BoJ would have to become an active seller in a “full normalization” scenario. That’s actually not “impossible” in a mechanical sense, but it probably is in the sense that it would upend markets. If other central banks follow Japan down the road to buying stocks, the same quandary will present itself in other locales.
In any case, the point is that what you see in the visual is not going to be unwound. Not fully, anyway.
As a quick aside, some folks pointed recently to a decline in the Fed’s balance sheet and attempted to make a connection between that and a fleeting wobble in US equities two Thursdays ago.
I certainly hope most readers are apprised of why that is not a good argument. In the top pane is the bar chart which served as fodder for a couple of misleading Fed takes.
The bottom pane shows you why this is nothing to be “concerned” about (i.e., nothing that should shake anyone’s faith in the notion that the Fed is determined to support risk assets).
The decline was largely due to a drop in swaps, as the dollar liquidity crunch which necessitated the enhancement and expansion of swap lines has now abated. It’s also possible folks were making room for other kinds of cheap funding (e.g., TLTROs across the pond). The point is: The drop in swaps is actually a good thing to the extent it reflects less stress.
Getting back to the matter at hand, SocGen’s Edwards quotes his colleague Kit Juckes who, in a note dated June 16, wrote the following:
As for the Fed, what concerns is me is that of the reasons I can think of for extending QE, only one makes sense now. The original case for QE was that if private sector investors are too cautious, putting their money only in ‘safe’ assets, then the central bank can/should crowd them out of those and into something more useful. That made sense during the financial crisis, but risk aversion isn’t today’s problem. Another argument for QE is that, in tandem with low/negative rates, it can deliver a weaker currency, as it has at times for the ECB and BOJ. But the US economy is less open than either of these. The third argument for QE is that it can spread the cost of the fiscal reaction to the current pandemic over many years. That’s an argument made by BOE Governor Andrew Bailey. But why go through the charade of buying bonds in the market, providing an incentive for companies to issue debt and buy back more equity. And sending share prices to unstable levels? Partnering with government to provide short-term cash to stressed households and companies makes more sense. The current policy will weaken the dollar over time, but that’s not a policy goal, even if it’s important for the FX market!
Regular readers will note that this is, to my mind, one of the most pressing economic questions of our time.
When Juckes asks, “Why go through the charade of buying bonds in the market, providing an incentive for companies to issue debt and buy back more equity…sending share prices to unstable levels?”, the answer from my perspective is “We shouldn’t”. That charade is the proximate cause for many of the undesirable side effects of QE.
Of course, the term “undesirable” depends on who you are in this equation. If you’re capital, that arrangement is just fine, as it makes you richer. If, on the other hand, you’re labor, it means that trillions in digitally-conjured dollars ostensibly meant to bolster your economic prospects instead end up trapped on what amounts to a carousel of inequality creation, with only a fraction trickling down to the real economy.
The idea is simply to cut out the middleman by having the central bank coordinate directly with the government, as opposed to the central bank buying the government’s bonds from a third party. Once you do that, you open the door for money we’re printing anyway to directly fund fiscal forays that would bolster the economic prospects of the lower- and middle-class via generous initiatives, whether it’s something as “radical” as free college or something that has broader appeal and bipartisan support, such as a massive infrastructure program.
Getting back to Edwards, he reiterates a point he’s made on countless occasions — namely that in its current incarnation, the “only effective transmission mechanism for QE to stimulate the economy” is through driving down one’s own currency. In that regard, he suggests that to the extent yield-curve control (YCC) actually ends up entailing less in the way of asset purchases (e.g., the “stealth taper” in Japan), implementing YCC could amount to shooting oneself in the foot.
Regardless, Albert notes that the US, like Australia, is on track to follow the Japanese down the road to YCC. In addition, America is poised to follow in Japan’s footsteps on the path to huge government debt piles that are effectively monetized by a central bank which corners the market, enabling ever more borrowing.
And that brings us neatly to the concluding passage from Edwards’s latest missive.
“I have consistently said that Japan leads the way, not just in their own Ice Age unfolding a full decade before the west, but in terms of policy”, he writes, adding the following:
Hence, I note that the must-read Heisenberg Report picked up on the comments coming out of the BoJ about the need for close cooperation between the monetary and fiscal authorities being essential – very much in line with Kit’s comments above.
The comments he references are these:
We're getting pretty explicit with it now.
BOJ MEMBERS: ACTIVE JGB BUYING DESIRABLE GIVEN GOVT ISSUANCE
ONE BOJ MEMBER: CLOSE FISCAL, MONETARY COOPERATION ESSENTIAL
— Heisenberg Report (@heisenbergrpt) June 19, 2020
And this is exactly what the Ice Age end-game always was. ‘Co-operation’ here is a euphemism for full blown monetization of the government deficit. The end game is in sight as we transition to The Great Melt. The veil is finally being lifted and once again, Japan leads the way.