Yellen at Stocks to go Up

Big moves happened overnight. In fact, if you go by betting website Paddy Power’s numbers, the moves were so big they had to shut down the entire market.

We’re not talking about stocks or bonds. Well, not directly anyway. It’s all about politics once more. Only this time, the politics actually matter to you…a lot.

Federal Reserve Chairman Ben Bernanke is set to retire soon. Overnight, the leading contender for the throne…er Federal Reserve Chair…took a bow and ran for the hills. Being vetted by a bunch of politicians was just too much to stomach for Larry Summers:

I have reluctantly concluded that any possible confirmation process for me would be acrimonious and would not serve the interests of the Federal Reserve, the Administration, or ultimately, the interests of the nation’s ongoing recovery.

Shortly after the announcement, Paddy Power took down the betting market on who would replace Bernanke. Until recently Larry was a shoe in. Then he gave himself the boot.

So what was Larry worried about? Well, he has plenty of skeletons in his closet. Bill Bonner laid out some of the ‘facts’ that might pop up during his job interview at the US Senate. They include losing a billion dollars for the Harvard endowment fund on interest rate speculation, and telling people the financial crisis wasn’t about to happen in 2007. Then there was his controversial role in dealing with the crisis that wouldn’t happen. So you might think that avoiding Summers is good news. You’re wrong.

As always, the politicians have made a terrible mistake. By voicing their hostility towards Summers before he even got to apply for the job, they’ve awarded the prize to the ‘other pig’. That’s economist Mike Munger’s academic term for this sort of mistake. His story goes as follows: Imagine you’re a judge in a pig judging contest. There are two entrants. The first one is ugly, so you award the prize to the second pig without even bothering to take a look. The thing is, the second pig might be even worse than Larry Summers.

Enter Janet Yellen. She was actually the onetime leading contender until Summers threw his weight around behind the scenes a few months ago. With Summers out of the way, Yellen is considered the most likely once more.

What’s interesting about this development is that Summers expressed scepticism over the effects of QE, whereas Yellen is a big proponent of money printing. If we remember correctly, she advocates higher inflation to get the economy going again. Only a central banker could think raising GDP by increasing prices instead of production is a good idea. We suppose it makes them look good if GDP goes up – whether it improves living standards or not is a secondary concern.

The stock market certainly played its part for Yellen. It surged on Summers’ pre-emptive resignation. More money printing means higher stock prices. The ASX will be rallying like mad by the time you read this. The Aussie dollar popped a cent too. The good old days are back!

Bonds are a little more complex than currencies and shares. On the one hand, the Fed increases the money supply by buying bonds with brand new cash. That bids up prices. On the other hand, this causes price inflation, which is bad for bonds because they pay out a fixed amount of cash in the future.

For now, everyone is bullish on bonds because of the Federal Reserve’s buying power. Pimco’s Bill Gross Tweeted that ‘Summers’s exit makes Monday a huge day for curve/risk on trades. Treasury 5/30 curve may steepen by 10. Stocks should do very well.’ In other words, short term government bonds will rally alongside stocks while long term government bonds, which tend to worry about inflation, won’t rally as much.

The position of Federal Chairmain is also important for the real economy (as opposed to financial markets). It controls the price of borrowing, and everyone will tell you debt is needed for an economy to grow. Finance blog Zerohedge put together the recent success story of this thinking:

‘…we are taking a quick look at how the world’s developed (G7) nations have fared since 2008, and just what the cost to restore “stability” has been. In a nutshell: the G7 have added around $18tn of consolidated debt to a record $140 trillion, relative to only $1tn of nominal GDP activity and nearly $5tn of G7 central bank balance sheet expansion (Fed+BoJ+BoE+ECB). In other words, over the past five years in the developed world,  it took $18 dollars of debt (of which 28% was provided by central banks) to generate $1 of growth.’

That is a truly horrifying take on things. If central bankers can’t engineer growth by encouraging more debt, what are we going to do? Everyone, panic! (Vern Gowdie has a better solution here.)

What’s worse is that GDP has to be repeated each year…it’s a financial flow.  Debt on the other hand is there either way…it’s a financial stock. So if the flow of GDP falls or stalls, the debt stock burden, relative to GDP, grows. Of course, it takes the flow of GDP to service and pay off debt, which is why developed countries find themselves in a pickle – they’re not paying down debt with GDP. Instead, the debt-to-GDP ratio continues to grow for most nations as they increase their stock of debt to try and produce GDP growth. And yes, that does include Australia, which features very high private debt levels.

As Zerohedgementioned, the amount of debt the developed world is stuck with after the last burst of borrowing is enormous. ‘This looks like to me like 2007 all over again, but even worse’ says the Bank of International Settlements former chief economist William White. The BIS did some decent research on the potential for a crisis before 2007, by the way.

So once again, we have an epic battle on our hands. On the one side we have the pressure of too much debt and not enough GDP. On the other side we have the money printers of the world, who want more debt to create more GDP…and if that doesn’t work, they want inflation.

It’s a lose-lose scenario. What could possibly go wrong?

Meanwhile our very own Bill Bonner, founder of the Markets and Money, is making his own bid for the top job at the Fed. He would likely use the same management style for the economy as his publishing company: Dynamic Indifference. If the boss pretends not to care or be competent, everyone else has to pick up the slack and figure things out for themselves. Pretty quickly you end up with a bunch of competent responsible people who don’t wait to be told what to do. Now that’s a sound economy.


Nick Hubble+
for The Daily Reckoning Australia


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From the Archives…

Did a Bear Raid Hit the Gold Market?
13-09-2013 – Greg Canavan

The Market Recovery That Never Was
12-09-2013 – Bill Bonner

Bernard von NotHaus: The ‘Domestic Terrorist’ You Can Call a Hero
11-09-2013 – Jeffrey Tucker

Why the US is Really Chasing War With Syria
10-09-2013 – Greg Canavan

American Empire of Debt
09-09-2013 – Bill Bonner

Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like.

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