November 13, 2012
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This essay is excerpted from a recent version of The Credit Strategist (formerly the HCM Market Letter). To obtain the complete issue, you must subscribe directly to this publication; Please go here. The Credit Strategist is on Twitter - @credstrategist
“The more money becomes the sole centre of interest, the more one discovers that honour and conviction, talent and virtue, beauty and salvation of the soul, are exchanged against money and so the more a mocking and frivolous attitude will develop in relation to these higher values that are for sale for the same kind of value as groceries, and that also command a ‘market price’.”
“The search for mere stimuli in themselves is the consequence of the increasing blasé attitude through which natural excitement increasingly disappears. This search for stimuli originates in the money economy with the fading of all specific values into a mere mediating value. We have here one of those interesting cases in which the disease determines its own form of the cure. A money culture signifies such an enslavement of life in its means, that release from its weariness is also evidently sought in a mere means which conceals its final significance – in the fact of ‘stimulation’ as such.”
George Simmel, The Philosophy of Money (1907)
In 1977, the United States launched two small satellites, Voyager 1 and Voyager 2, to explore the universe. Thirty-four years later, these two man-made miracles are still emitting daily readings of their travels through the universe. Recently, it became apparent that Voyager 1, which is now more than 11.1 billion miles from earth, may be on the verge of exiting our solar system and headed into interstellar space. It takes 16 hours and 38 minutes for data to travel the billions of miles from Voyager 1 to the antenna of NASA’s Deep Space Network on Earth. Astrophysicists parsing this data apply three criteria to determine whether Voyager has left our solar system: the stream of particles coming from the sun should decline, the stream of charged particles coming from the galaxy should increase, and the direction of the magnetic field surrounding the satellite should change. Over the summer, these changes began to be detected. Ed Stone, Voyager project scientist at the California Institute of Technology, explains: “The laws of physics say that someday Voyager will become the first human-made object to enter interstellar space, but we still do not know exactly when that someday will be. The latest data indicate that we are clearly in a new region where things are changing more quickly. It is very exciting. We are approaching the solar system’s frontier.” Those of us whose physical bodies are earthbound and spend our days pondering politics and markets might take a moment to reflect on this incredible achievement. Man is capable of great highs and great lows. Those of us in the worry business, charged with protecting other people’s capital, tend to dwell on the lows. Voyager reminds us not to ignore the highs, and to appreciate the remarkable capabilities of the human minds and souls that built that little spaceship now rocketing into regions of this infinite universe that human consciousness can barely imagine.
Back here on Earth, all eyes are rightfully on November 6, when American voters will face one of the most consequential decisions in their lifetimes. The momentum that had been building toward a crescendo on Election Day appears to have been broken by Hurricane Sandy. Whether the country’s attention, which was already being tested by overexposure of both candidates, can be recaptured remains to be seen. The U.S. Constitution has survived civil wars and world wars, so it will survive Sandy. Our system of government was designed to withstand the forces of war and nature, and to allow change to happen only incrementally. But the choice between Barack Obama and Mitt Romney will have dramatic short-term consequences. Is this the most important election in our lifetimes? It is difficult to say. Had Al Gore defeated George W. Bush in 2000, it is highly unlikely that the U.S. would have invaded Iraq, or that large tax cuts would have been occurred. In retrospect, the outcome of the 2000 election looks just as monumental as today’s.
From an economic standpoint, 2014 will be just as important, if not more important, than 2012. Ben Bernanke’s term as Chairman of the Federal Reserve expires in 2014. While there are reports that Mr. Bernanke is not interested in another term, it would not be easy for him to say no if the then sitting president asked him to stay on. We already know that Mitt Romney will not make such an offer, while Mr. Obama’s thoughts on the matter are unknown. So at the very least, a Romney victory will virtually guarantee the end not only of Mr. Bernanke’s term but of the unprecedented period of central bank activism and monetary accommodation over which the former Princeton economics professor has presided. While markets are likely to greet a Romney victory with a short-term rally, more considered reflection could lead them to conclude that the days of easy money will be coming to an end.1 Moreover, they would end long before mid-2015, the period through which the current Open Market Committee has promised zero interest rates. The prospect of a Federal Reserve Chairman in the “tough love” mode would not bode well for stocks or bonds. Unfortunately, it is precisely what the economy needs in order to recover.
The latest adventures of the Bernanke Fed will likely go down as among the most misguided central bank policies in history. It is one thing to step up with emergency measures during a crisis, as Mr. Bernanke did in 2008, in order to prevent a global financial collapse. Mr. Bernanke acted appropriately then and deserves credit. But it is quite another to extend those policies for years after the crisis has passed and prevent free market functions from resuming. That is particularly true with respect to the housing markets that lay at the heart of the crisis. One would have thought that of all people, the chairman of America’s central bank and a former economics professor from Princeton would have learned the primary lesson from the U.S. housing bust – housing is an unproductive asset that enjoys far too much policy support. Yet housing is precisely the sector that Mr. Bernanke has targeted with his open-ended commitment to purchase $40 billion per month of mortgage paper. Perpetuating abnormally low mortgage rates distorts the free operation of the markets and delays the necessary market clearing that has to occur for the housing markets to return to health. Moreover, by continuing to allocate more capital to the unproductive housing sector, the Federal Reserve is depriving other productive sectors of capital. This is another example of the authorities insuring failure by attempting to eliminate it. It hasn’t worked before and it won’t work now. Paul Volcker understood that in the 1980s. Hopefully there is another Paul Volcker out there and the next president will find him and appoint him to replace Mr. Bernanke in 2014.
On a longer term basis, however, much has to happen to render the outcome of the election truly decisive. The long-term trajectory of federal and state finances is so negative that only radical reform can alter our fate. The candidates can speak until they are blue in the face about various proposals to create jobs and stimulate economic growth, but the U.S. economy will continue to grow slowly as long as it is suffocating beneath trillions of dollars of public and private sector debt. Too much capital is being drained by debt service, even with record low interest rates. When interest rates rise again – and it is a matter of when, not if – it will be game over for any hope of economic growth. We are currently spending no more on interest on the federal debt than we did in 2007 when the debt was only 40% as large as it is today – the result of interest rates on the debt being so much lower today than in 2007. That situation is not going to persist forever. Ben Bernanke is not going to be the Federal Reserve Chairman forever (and that is why if Mitt Romney wins on November 6 this issue may rock markets sooner than many expect). The U.S. has barely been able to eke out 2.0% GDP growth over since 2009; with higher interest rates, growth would quickly sink into negative territory. This is the crisis we are facing and the reason something must be done yesterday to address the problem.
Regardless of who is elected, the federal debt is almost certain to exceed $20 trillion by 2016. There is a chance this figure will be slightly lower if whoever is elected is able to work with Congress to adopt a plan on the order of that proposed by the President Obama’s Deficit Commission headed by Alan Simpson and Erskine Bowles. But even that plan only modestly alters the accumulation of budget deficits rather than eliminates them, recognizing that anything more drastic would send the economy into a tailspin. Anything short of drastic entitlement reform, serious cutbacks in defense spending (I don’t believe for a minute that a President Romney would increase this spending by $2 trillion), and serious tax reform that alters incentives away from speculation in favor of production will leave this country stuck on the dangerous path it is on today.How many more Voyagers will be sending into space if we continue to debauch our economic capabilities here on earth?
1. I recently read a report arguing that a change in the Chairman wouldn’t lead to a radical change in Federal Reserve policy because of the many dovish Federal Reserve Governors. I think this argument underestimates the significant cultural and institutional bias inside the central bank that gives the Chairman the ability to steer the Open Market Committee to his point of view.
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