RICHARD KOO: WHY PONZI FINANCE HAS ALWAYS FAILED
The recent announcement that the Bank of Japan will be buying ETFs and REITs surely has Richard Koo upset. After all, he has shown time and time again that such government intervention does nothing in the long-run. The U.S. government is currently hoping for a similar asset response as they attempt to keep “asset prices higher than they otherwise would be”. The problem, according to Koo, is that this is nothing more than a short-term psychological injection that separates fundamentals from reality. In the end, government buying real assets does nothing to alter free cash flow and always fails. In his Holy Grail of Macroeconomics he writes:
“Investors suffer heavy losses when the bubble collapses. The speculative demand that had been supporting prices falls away, and chastened investors start to rely on upon DCF as a gauge of value. Therefore, investors will not view asset-price increases brought about by the central bank purchases as being sustainable unless they are certain that the future cash flows generated by those assets will also increase.
Many governments have attempted to sustain or boost asset prices after the collapse of asset-price bubbles, but with the exception of the short squeeze orchestrated by the Hong Kong government in 1997, all have failed. The reason is simple: market participants did not believe that these efforts would lift the DCF value of assets. In October 2002, for example, the Bank of Japan launched a much publicized effort to buy shares held by Japanese banks. But this effort not only failed to arrest the decline in Japanese shares, but left the Bank of Japan with large capital losses six months later. Even in the U.S., aggressive easing by the Fed in the wake of the Internet Bubble collapse in 2000 failed to stop the NASDAQ’s decline. It was only after demand for IT products had to pick up-that is, after the DCF of IT firms began to rise-that the NASDAQ shares began to stabilize and recover.”
This gets to the real crux of this sort of government intervention in markets. It does not make people more productive, it does not create jobs, it does not increase output and it does not increase future cash flows. The Fed and BOJ hope to spark an investment and hiring boom. Unfortunately, there is no evidence that this sort of intervention can lower rates, increase borrowing or increase sustained economic activity. The conclusions should be obvious to everyone. A shuffling around of Fed assets does not alter private sector net financial assets. It might alter perceptions in the near-term, but hoping for a sustained recovery generated by the Fed’s balance sheet is sheer fantasy. Herding investors into risk assets that do not show the underlying fundamental improvement to sustain higher prices is nothing more than Ponzi finance. Or what Brian Sack prefers to call ” United States monetary policy”.
I agree with your take but maybe we are missing how very different the US “investor” class is from the Japanese? We seem more apt at taking massive jumps of risk if the perception is that it will work short term (momemtum trading) but this thing has been working for a long time so far, longer than I thought possible. Maybe psychological differences will yield a better result?
I don’t think so but trying to see the other side.
That just makes us dumber and nothing else if it’s in fact true. When stocks rise they should rise because there is a stream of cash flows that support the higher prices. If there is no increasing stream of cash flows the capital gains that are caused by price increases will evaporate. This “wealth effect” is sheer ponzi. If you cause a $1T rise in the stock market without a future confirming increase in cash flows the prices will ultimately adjust. Investors might feel richer in the short-term. They might go out and finance a new car loan or spend some extra money on an ipad, but in the end, if the cash flows don’t catch up the prices declines and then that same consumer is back at square one. Except there’s one problem – HE HAS MORE DEBT. Sound familar? Try the late 90′s and mid 00′s. We’re rehashing dangerously old strategies.
These guys get up in the morning and worry about which tie will go with which suit. Then they worry that they might have put on a few pounds, and once again promise themselves that they will go light on lunch and do more on their treadmills after work. Then they go to the office, where young staffers, who are working for peanuts but intend to make a killing when they jump to Wall Street, have prepared memos for them. Then, they throw a trillion here, a trillion there, thinking it just might work, and, if not, they won’t be blamed by history for failing to try. Then they go home so tired that they don’t have the energy to use their treadmills. But they have just enough energy to go to some Georgetown bistro, where they throw down a few drinks and tell their spouses and friends that they seem to be making progress with the economy.
It amazes me that so shortly after the housing bubble burst, members of the Fed still believe that the wealth effect and keeping “asset prices higher than they otherwise would be” are viable and sustainable ways to drive economic growth. I’m afraid that the bursting of this bubble will be even worse than the bursting of the housing bubble.
TPC,
What’s your take on this piece by John Taylor I saw over Zero Hedge:
“The Fed will be hamstrung, as Ron Paul, a conservative standard-bearer and harsh critic of the Fed, will head the sub-committee overseeing its actions. Liquidity expansion or new programs will probably drop sharply under his watch.”
If Ron Paul takes tthe reigns, this could be a FED Game Changer ya think?
http://www.zerohedge.com/article/john-taylor-november-will-see-flash-point-begins-markets-reversal
That all looks pretty solid. Thanks for passing that along. There are very serious risks here that the market is oblivious towards. Those three (Greece, gridlock and Ron Paul) will all come to the forefront in November when the anticipation of the election and QE2 finally wears off.
If QE 2is nothing more than a short-term psychological injection that separates fundamentals from reality” then what we can expect are the well known “placebo effects”. Sugar coated placebo’s, for some, not insignificant number of recipients, positively influence both expectations and perceptions. The result can be a change in behavior (behavioral economics) consistent with those more favorable expectations.
Oftentimes, the consequences of taking placebos are indistinguishable from those of genuine interventions.
Given that the only alternative (within our contemporary political circumstances would be abstinance (austerity), it may well be the case that artificial stimulation (QE 2) is worth a try. Think 1937!
Ultimately the irony of this whole QE debate is that we all seem to agree that this will NOT end well.
It appears that the only differences of opinion on this blog seem to center around when it will end, the path we will take there and how bad it will be once we finally arrive..
Other than that common thread all our disagreements seem to be just noise.
shuffling around of Fed assets does not alter private sector net financial assets
maybe not, but it sure might help to offload worthless assets onto taxpayers
Can’t we offload the crap to overseas investors? In a way they get them as the US bottom line supports them (thus treasuries) but we missed a huge opportunity.
Snark ON.
The neo-liberals have completely won the policy debate and I suspect it will take another complete cycle for new blood (some creativity) to come in. Look for 2 years of grid lock/QE followed by 4 years of austerity/QE.
Then possible learning from mistakes. (always the optimist)
Or is it possible that they will learn that QE will not work sooner?
I think that we are looking at another few years of stagnation, with more problems emerging. The US will have a second deep real estate collapse, that will expose the banks finances as a sham. With Europe in austerity mode and the US probably likely to so the same, then the world economy might fall back into Depression, or the world economy will decouple with the West in the slow lane. I doubt that those in power have the brains or sense to look at the past and use fiscal measures to get out of this crisis. Monetary policy clearly has its limits yet the IMF and others are still not accepting this reality.
It strikes me that Japan actually **wants** disinflation. They do not want a consumer-led economy with its emphasis on GDP growth as is practiced in the US. Instead, they want to maintain a trade surplus, even if it results in a permanent recession.
Japan has terrible demographics and space constraints. It also has low unemployment, which should create fears that the wage growth that one associates with a consumer-based economy could make their export goods uncompetitive.
Japan’s solution to this is to feed disinflation. With disinflation, wages don’t grow quickly, retiree benefits don’t have to be increased as much, and the savings of their aging population won’t be eroded as quickly.
Japan probably perceives its main threats as being exports from low-wage competitors and a strong yen, both of which make their goods relatively expensive and threaten their export-based GDP. The irony is that the trade surplus supports a strong yen, so they swim against the tide in their largely futile efforts to maintain a weak currency.
The US has different constraints. One of the US’ greatest challenges is political — we have a population that has ever-growing demands for consumption, and that gets agitated whenever prosperity growth comes into question. The government needs to continually placate the voter’s desire for more and more stuff at cheaper prices, which feeds our need for a trade deficit and higher base rates of inflation. Asset inflation policies are more likely to work here than they would in Japan, and we can already see the differences in today’s markets.
The Fed is a corporation owned by the banks. Because the government picks the Fed’s board, we are told bank ownership is a mere formality; the banks have no real say on the Fed’s operations. But because most of the people on the board come from the banking industry, this is wishful thinking. In fact, the Fed exists to suck future tax revenues out of the government and give it to the banks; it has no other purpose. Of course, we are told that the Fed’s role is maintain price stability and to adjust interest rates to keep the economy from contracting or over heating. Well, they had to say something. They can’t just tell us it’s there to steal our money.
The Fed also serves as a lightning rod for criticism. The majority of commenters heap invective on Greenspan and Bernanke, calling them everything under the sun, including all synonyms of stupid which they definitely are not. That’s perfect, because it’s exactly what they were hired for. As long as the world screams and yells about the Fed chairman’s IQ, they aren’t screaming and yelling about the banks stealing. The Fed hasn’t been captured by the banking interests, it IS the banking system’s whipping boy.
This financial crisis has revealed the financial sector to be as fraudulent as it is possible to imagine, completely rotted to the core. That galactic levels illegal activity have put the entire global financial system at risk, just so a few banking nerds and quants could build 50,000 sq ft houses in Aspen. During this, the Fed has acted as though these guys are honorable stewards of our money, that they are systemically essential to our society, and just got in a little trouble. In the name of stability the Fed has rained untold quantities of newly printed money on them, with the idea they would start making more (fraudulent) loans. This has nothing to do with economics, they did this because it’s their job.
That this didn’t work, and can’t work has been a well known part of economics since the depression (Hayek, Minsky, Fisher, Mises and more recently Roubini, Steve Keene, Taleb, Hudson and others). These theories were relegated to the trash heap of economics, simply because if followed they would have revealed the banking system for the corrupt Ponzi scheme that it is. God forbid that we actually run our finances for mutual prosperity.
We are left to conclude that our future is in very bad hands. That the Fed has no conception or inclination to handle this situation for the benefit of anybody except the banks. By the time somebody grabs the reins and turns us in the right direction, vast damage will have been done. We need to reform this system, but that requires huge political consensus, something we’ll never get as long as we’re all apoplectic over nonsense issues like abortion, vouchers, Iraq, Afghanistan, Iran, Chirstine O’Donnell, immigrant workers etc. We’re ALL fiddling while Rome burns.
DDT,
an excellent big picture view!