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Taking The Monetary Policy Ride Into The Theater Of The Absurd

Submitted by Jeffrey Snider via Alhambra Investment Partners,

There are any number of colloquialisms for monetary repression, “reach for yield” and serial asset bubbles being a few. In the vernacular of monetary policy itself, such color is disdained in favor of technocratic banality – “portfolio effects.” The idea is simple, which is to say that by repressing the returns on “safe” investments financial agents will be forced, not of their own volition, into “riskier” assets and asset classes. The prices of those risky assets rise, and that is supposed to contribute to economy-wide good feelings which loosen purse strings, in the equally prosaic terminology of the “wealth effect.”

There is, yet again, an unearned sense of precision about the task and the linkages to actual economic function that belies the chaos and mess of a real economic foundation. Removing organic profitability as a mechanism for resource distribution also obliterates constraints on methodical behavior. We may not think of such discipline as useful during periods of economic malaise, where “risk” seems to be lacking, but true discipline leads to the very processes which create sustainable economic advance. The allure of monetary-driven “risk” is an illusion of artificial bursts of at best short-term activity.

It seems we have come to a sort of crossroads state whereby past attempts at fostering economic advance through “reach for yield”, portfolio effects, directly interfere with current commanding efforts. Without admitting guilt, central banks and political regulators have combined to “make banks safer” largely through more complex banking regulation conspicuously free of free thought and common sense; especially Basel III. One component, which was “learned” of the Panic of 2008, was that banks “need” a liquidity buffer to withstand “market” funding withdrawal. There are, of course, formulas that determine these.

Banks especially in Europe were found wanting of such a buffer and have been “encouraged” to build their own around sovereign debt – which is believed, still, to be the most highly negotiable of all asset classes despite relatively close experience. That last problem was “dealt with” via Mario Draghi and the ECB’s implicit promises to “do whatever it takes.” That apparently includes undertaking QE.

The problem of QE is that it removes those same bonds in question from circulation, sequestered securely within the confines of the central bank (regardless of whether that central bank has made provisions for addressing the direct short-comings of just such an effort). The trade-off is one of bonds for “cash”, but more of modern liquidity concepts than cash, that will on balance lead to “portfolio effects.”

In one sense, the ECB in particular is saying that banks have become “too safe” and the European economy needs “more risk.” It intends not just to force just such an outcome but also to finance it. Banks, for their part, are not quite ready to “comply”:

Weeks before the European Central Bank begins a program to buy about 1 trillion euros ofeuro zone government bonds, banks, pension funds and insurers across the continent are hoarding them for regulatory or accounting reasons.

 

That may complicate implementation of the quantitative easing program, aimed at reviving growth and inflation in the euro zone. The ECB might have to pay way above market prices, or take additional measures to encourage investors to sell.

 

“We prefer to hold on to them,” said Antoine Lissowski, deputy CEO at French insurer CNP Assurances. “The ECB’s policy … is reaching its limits now.”

I especially like the phrase “take additional measures to encourage investors to sell”, as you can almost envision some Hollywood Mafioso-type threatening a poor, expensively-suited bank executive not over blood money but on behalf of “monetary” authorities to take their cash. There is an element of comedy here that is un-writable as fiction; nobody could dream just such a scene.

In that respect, perhaps monetary depredations have reached their inevitable logical limitations. The banks “must” be made safe because of the last panic, but banks must be made risky because of the economy.

Of course, the central bankers under this paradigm don’t think in such broad terms, as they see no incompatibility at all. Again, they think there is some precision or mathematics of regressions that can “find” harmony between two largely and seemingly contrary or even irreconcilable forces – as if banks can be made “just safe enough” while also “just risky enough.” That is because an actual economy does so, where organic profit governs that relationship – why can’t central banks simply do it instead by dual-mandate? This is the reason for the facileness and technocracy of jargon, as this is all supposedly objective mathematics rather than anything emotionally explosive like bubbles.

While there are any number of reasons commandment of this kind will fail, it really comes down to the market itself, namely that such forces of “safety” and “risk” are not really homogenous and harmonized unto themselves. It takes all sorts of agents and actions to produce stability from chaos, whereby many people “take the other side.” The relative movement of prices, free from directive interference, acts as ultimate arbiter of what constitutes “risk”; safety results from that. Central banks take no sides at all and simply decree based upon poorly constructed mathematics that are stale by the time they are implemented.

And with such opposing policy intentions, is it any wonder how bubbles are formed? Which “side” wins out in the end? The amount of repression taken by monetary authorities will overwhelm any sense of propriety about even mathematically-drawn “prudence.” That is the case in every bubble, but in this one instance, especially in Europe, the tug-of-war is in the very instrument of both policies – government bonds. The ECB is demanding, reduced to constituent cases, that banks buy government bonds for every government bond they sell to the ECB. Banks are rightfully balking as “why bother?” It’s not just the naked convolution to the whole scheme, it is entirely emblematic and demonstrative as to why bank “capital” is so relatively expensive under monetary repression.

Since, however, the “risk” side always wins in these things, the ECB mafia will show up with the heaviest repression possible.

And yet, somehow, monetary policy is still believed neutral in the long run and that bubbles are market events. Central banks have shown why they cannot command economic performance, but that doesn’t mean they can’t give one hell of a comedic performance. We have taken a monetary ride now into the theater of the absurd.