Monday, April 30, 2012

What's Good About the Bad Goldilocks Economy

Like welfare queens at the corner store swiping a government sponsored debit card for a pack of smokes and a forty of malt liquor, many day traders and other short term speculators on Wall Street complain that we have a Bad Goldilocks economy. It's not growing fast enough to reduce unemployment, boost consumer demand, and spur on the bull market. It's also not so sluggish as to induce the Fed to run its monetary printing presses overtime. In other words, there's no easy money to be made, nor is there a government handout to be had. Life stinks, because getting money may require hard work.

And that's the good thing about the Bad Goldilocks economy. There are no shortcuts or bailouts. The private sector will have to make it on its own, the old-fashioned way, by working and taking risk. That's what we need. No economy grows organically from never-ending government support. Repeated infusions of government bailouts promote dependency and capital hoarding, rather than investment and hiring. Many major American corporations are sitting on shiploads of cash, waiting for another gift from Uncle Ben, and not spending because they don't see a sure bet. Nothing could be more detrimental to America's economic future than this kind of cash hoarding. It doesn't finance innovation, create jobs, or produce operating profits.

The Fed's dilemma with the Bad Goldilocks economy isn't just the risk of recession if it doesn't act and the risk of inflation if it prints more money. In the past four years, the Fed has taken the most morally hazardous route in its history. Its repeated interventions have reduced many on Wall Street and in corporate America to Pavlovian passivity, waiting for the next wave of money printing. Such is not the stuff of which prosperity is made.

Bad Goldilocks gives the Fed an opportunity--to cut the money printing umbilical cord it affixed to the economy and the stock market in 2008. The private sector needs to learn that its next profit opportunity won't come from another round of government intervention. It needs to re-learn how pull up on its bootstraps. The best Fed may be a low profile Fed (if that's not an oxymoron). If the economy seems headed for a major belly flop, further intervention may be needed. But Goldilocks is good, giving the Fed a chance to ween the private sector off bailouts and handouts. We're not talking about doing anything radical like raising interest rates or reducing the Fed's Brobdingnagian balance sheet. We're just suggesting a gradual nudging of attitudes away from expecting the central bank to come by every night on a sleigh drawn by reindeer and drop down the chimney with gifts for all.

Thursday, April 19, 2012

Predicting China's Economic Performance From Political Scandal

China's political scandal du jour is the downfall of Bo Xilai, former top government official in the southwestern city of Chongjing. (That's the modern spelling of Chungking, the capital of free China during World War II.) Bo, formerly an upwardly mobile political star, was abruptly removed from power when his wife, Gu Kailai, was arrested on suspicion of murdering a British businessman named Neil Heywood. Heywood reportedly was a close associate of Bo and Gu, but apparently had a falling out and may have been eliminated because he knew too much and might reveal it. Good airport novel stuff, and there no doubt already are at least several commissioned (and numerous uncommissioned) film scripts about the scandal being written in Hollywood.

Bo appears like a throwback to Maoist days, promoting populist programs such as affordable housing for the masses and government directed spending to build infrastructure, thus fostering job creation. He also encouraged the singing of revolutionary songs from the Communist era, ordered students and government employees to work stints in rural areas (shades of the Cultural Revolution) and made the local TV station stop running commercials and broadcast revolutionary programming. Bo wasn't a pure Communist. He encouraged foreign investment and tried to attract manufacturing away from its established bases on China's coastline. But his overall approach revived notions of egalitarianism, and his popularity among average Chinese blossomed.

That made Bo a dangerous man--dangerous to the central government in Beijing, which is in the process of trying to engineer a transfer of power to a new generation of leaders. It's unclear that the differences between Bo and his adversaries are ideological; many of his policies are consonant with Beijing's expressed priorities. One suspects that this fight is over power. Bo is the son of Bo Yibo, one of the most exalted doyens of the Communist Party in its early days, and seemed destined by family legacy to rise to national prominence. As his popularity among the masses increased, his ascendency to top leadership could have become inexorable. Evidently, there were some people in Beijing who didn't cotton to that notion.

One of the oddest things about the Bo Xilai scandal is how it's being publicized by the Chinese government. This is basically a bare-fisted brawl in the smoke-filled rooms and back alleys of China's political power structure. In the past, such struggles were conducted in the utmost secrecy. Even today, the civil war that was the Cultural Revolution remains heavily shrouded in mystery. But the Beijing government has publicly announced Gu Kailai's arrest. And interesting details of the scandal--the kind of information that would likely be known by government investigators--seem to have found their way into the Western press. Why would the Party air its dirty laundry?

Most likely, to sway public opinion in China. Democracy, as the term is understood in the West, doesn't exist in China. But Chinese governments since the times of the earliest dynasties have understood that they need the loyalty of the populace. Emperors who lost the support of the people risked being overthrown by peasant rebellions, which had a tendency to flare up if government officials were corrupt and overbearing, and harvests were bad. In such circumstances, charismatic leaders would rise up, acquire popular followings and inspire uprisings. Often, they would embellish their appeals by harking back to the supposed moral uprightness and economic security of earlier times. The bad harvests, they would pronounce, were a sign that the emperor had lost the mandate of heaven, which justified rebellion.

Today's equivalent of a bad harvest is an economic downturn. And the economy has been slowing in China. Employment levels have fallen as Chinese exports faltered after the 2008 financial crisis. Real estate values are beginning to drop, and price inflation is disquieting. China's rapid shift to capitalism has removed most of the social safety net that existed in Communist days, leaving hundreds of millions who grew up with the security of the Iron Rice Bowl in the uncomfortable of role of fending for themselves in the mystifying harshness of the capitalist system.

Bo Xilai might have become a rallying point for China's discontented. Indeed, the press has reported that many in Chongqing continue to support him, if not for attribution. The Party's public destruction of Bo's political career would appear to be a message to the Chinese people that there ain't gonna be no change in the mandate of heaven, at least not if the power brokers in Beijing have anything to say about it (and they have a lot to say about it).

Why would they feel so threatened by Bo? Very possibly because they know that China's economy is headed for a downturn, one that could destabilize the fragile political compromise that holds China together today. Most Chinese don't care for Communism. But they also aren't ardent about fostering Western style democracy. They just want economic stability and an opportunity for a better life. As long as the government in Beijing delivers good harvests, most Chinese won't rock the boat. But if the economy starts to circle the drain, a charismatic leader like Bo Xilai, particularly if located far from the dour bureaucrats in the capital, could take advantage of the hard times in a gambit to seize power. Beijing's public exploitation of the scandal is, among other things, a pretty good indication that it expects China's economy to weaken. Hedge your bets if you're invested in the Central Kingdom.

Friday, April 13, 2012

The China GDP Head Fake?

Yesterday, April 12, 2012, rumors in the morning about China's first quarter GDP growth coming in around 9%, higher than the expected 8.4%, fueled a stock market rally. (See The Dow Jones Industrial Average bounded up 183 points.

Today, China's first quarter GDP growth was reported at 8.1%, lower than expectations by 0.3%. (See The Dow closed down 136. The rumor was wrong, seriously wrong.

Maybe it was all an innocent mistake. After all, today's Friday the 13th. Maybe someone just misinterpreted something and spread the misinterpretation. But one thing's for sure. Some people made a bunch of money trading the market up yesterday, and then trading it down today. Volatility makes money for Wall Street pros, including market makers, specialists, high speed traders and so on. But some less cynical market participants, who bought and held overnight, probably lost money and quickly.

Volatility can come from exogenous sources. The idiocy underlying the EU's structural problems and its sovereign debt crisis weren't creations of Wall Street. But they sure as pumpernickel have caused a lot of volatility.

There's also home grown volatility, emanating from Wall Street sources that might have a good day at the office if the market is hopping. Spreading truthful and accurate news is generally okay, unless it happens within the context of insider trading. But spreading false information can make regulatory brows furrow.

It's difficult to investigate rumor mongering, especially if the rumor concerns aggregate economic data (as opposed to company-specific or security-specific information). But trading surges triggered by false information undermine investor confidence. Natural investors (i.e., those that buy with the hope of profiting from investing, as opposed to make a quick buck from trading) are the foundation of the financial markets. But, with the 2000 tech cash, the 2008 financial crisis, and the 2010 flash crash, they are leaning, if not running, toward the exits. It really doesn't help when they are jerked around by false rumors.

Thursday, April 5, 2012

The Cost-Benefit Mismatch of Monetary Policy

This past week, the two largest central banks--the Fed and the ECB--signaled that they would not run the monetary printing presses on overtime in the immediate future. The stock market promptly wailed, shrieked and then threw its pacifier across the room, recording its worst week in 2012. Once again, we see ever so clearly that the financial markets are dependent, above all, on government policy.

With political dysfunction in the U.S. and Europe the rule, not the exception, government policy has largely boiled down to central banking monetary policy. And that policy suffers from a mismatch of costs and benefits that makes it seem more attractive than it really may be.

When a central bank loosens things up, financial markets respond at warp speed. All asset classes rise in value. This increased correlation among asset classes, which has often displaced the more traditional inverse relationship between stocks and bonds, and between financial assets and gold, has made investing more a matter of guessing when central banks will run the monetary printing presses than of conducting any research or evaluation of economic fundamentals. But central bankers feel good because they can see tangible results of their policies in seconds, while receiving hardly disinterested applause from bankers and other Wall Streeters.

The full impact of monetary policy on the economy tends to take about 18 months to emerge. If policy is loosened at the risk of triggering inflation, the inflationary effect will manifest itself months and perhaps over a year after the loosening is implemented. The downsides of monetary policy, therefore, appear well after the financial markets deliver their huzzahs.

Enjoy now, pay the price later. Do people like to indulge too much in something that delivers positive feedback now while imposing costs later? Well, does a bear sit in the woods?

Central bankers, being human like the rest of us, are at risk of succumbing to the crack-like euphoria delivered in milliseconds by the order flow of today's high-speed computerized trading systems (which account for about two-thirds of market volume). The cost of cranking out low-cost credit isn't felt until later, much later. Some of the incumbents at central banks today may not even be in office when the downsides pop up.

This mismatch of costs and benefits from monetary policy may skew policy preferences, especially among central bankers predisposed to act rather than wait. Certainly, some central bankers resist the allure of short term positive feedback. It's been well-publicized, if sometimes anonymously sourced, that disagreement exists among members of the Fed's Open Market Committee, and between the Fed and the ECB. But an unmistakable trend in recent years of central banks to deliver stimulus, even at the risk of sparking inflation in the longer term, makes one wonder if the mismatch of costs and benefits of monetary policy might not be working mischief.