'The Germans don’t want to play ball.'<blockquote>
'The long-held German (and Austrian!) notion of “sound money” fails to resonate in The Age of the PhD Standard. Especially in the U.S., the Great Depression is understood as a consequence of gross dereliction of the Federal Reserve’s responsibility for ensuring sufficient “money” and bank capital. Somehow it is forgotten that the harbinger of devastating economic collapse was the collapse of confidence in Credit and financial assets. Instead of a German-like tenacity for protecting the Creditworthiness and stability of the system’s core, our monetary doctors are instead determined to gamble the bedrock of our financial system on a policymaking course that amounts to little more than unending government debt issuance and monetization (contemporary “money printing”).
Texas governor Perry was lambasted for his verbal attack on “treasonous” Federal Reserve “money printing.” “Presidential” it was not. But do I expect this type of message to resonate? Bet on it! American society is showing the increasing strains of monetary mismanagement. More and more, it seems that only the PhDs and stock market punditry actually believe that Fed policymaking is on the right track. And it really is a fascinating and frightening dynamic where the general populace has this right and policymakers have it dead wrong.
This is a huge monetary experiment run amuck – and the evidence is everywhere (i.e. high unemployment, rising inflation, massive federal deficits, the Fed’s balance sheet, unstable markets, rising wealth inequality, intractable trade deficits, the value of the dollar, the price of gold, waning American power and influence, public anger and distrust…). The American people no longer buy the notion that piling on more debt and “money printing” offers a reasonable solution. They are appreciating that it’s instead the problem, and there will be less tolerance for this “experiment” going forward.
And the PhDs? They stick steadfastly with their doctrine, not for a minute admitting the experimental and theoretical nature of their policy prescriptions. And I see no willingness on their part to question their view that contemporary monetary management is enlightened and superior to the past. There is an element of hubris that gets in the way of objectivity.'</blockquote>
The PhD StandardBy Doug Noland
August 19, 2011
Source (
The Fall of the House of Bernanke, August 15, 2011) (
Michael Pettis: Long-Term Outlook for China, Europe, and the World; 12 Global Predictions, August 22, 2011)
“There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.” John Maynard Keynes
This week, Federal Reserve “money printing” became a focal point of American political discourse. Across the Atlantic, a worsening banking crisis failed to diminish German resolve against backing the issuance of “eurobonds.” Many of us have read and pondered Keynes’s famous quote on debauching the currency so often we’re rather numb to it. But in light of recent developments, it’s worth reminding readers that history is unequivocal: The soundness of money – monetary stability – is fundamental to the well-being of both the economy and society. The myriad consequences of prolonged monetary instability are these days increasingly difficult to disregard.
I have argued that the global financial “system” for decades now has operated in a unique environment. I know of no comparable period in history where there were no restraints on either the quantity or quality of global Credit creation. I have further posited that “Unconstrained Credit is the Bane of Capitalism.” Unfettered finance ensures severe pricing distortions, speculative excess, the misallocation of resources, Bubble dynamics, acute financial and economic fragility - and the “debauching” of currencies across the globe. Again, increasingly difficult to disregard.
I have referred to this anchorless global Credit system as “Global Wildcat Finance.” As a proponent for the return to the Gold Standard, Jim Grant has coined the term “The PhD Standard” to describe the current state of monetary affairs. I hope Mr. Grant doesn’t mind too much if I borrow his brilliant terminology. It’s just too perfect. And as a product of public schools and universities (and a couple decades of diligent independent study of finance and economic history), it’s too tempting to label the unfolding tumult the “Ivy League Crisis.”
My hunch is that unfolding developments will likely catch a lot of very intelligent - and highly degreed – folks completely unprepared. Recent comments from some of this era’s most successful investors suggest they are increasingly out of touch. The talk today is that stocks are so “cheap,” especially in terms of price-to-earnings multiples. And on a historical basis, valuations don’t appear expensive. Yet I would argue that equity multiples should be extraordinarily low today – specifically because system finance is extraordinarily unstable. And proponents for investing in equities and corporate bonds point to the soundness of corporate America’s balance sheet. But again, there is much more here than meets the superficial analytical eye.
Federal debt has increased in the neighborhood of $5.0 TN during the past three years. This unprecedented expansion of government debt fueled spending and inflated corporate cash flows and earnings. This followed a decade of similar effects from an unprecedented expansion of household and financial sector borrowings. In just the past two years, global central bank international reserve holdings expanded over $3.0 TN. The greatest concerted fiscal and monetary stimulus in history (“The Global Government Finance Bubble”) stoked the reflation of global financial and economic systems. Now, the global marketplace has meted out harsh punishment to those investors/speculators caught extrapolating the near-term effects of inflationary policymaking – albeit recent growth trajectories, earnings trends or financial asset valuation metrics.
The debt market experiences of Greece, Ireland, Portugal, Spain and Italy point to “systemic extrapolation risks”. In such an exceptionally unstable Credit environment, most financial assets should trade at discounted valuations. Future earnings and cash flows are highly uncertain – and extraordinary uncertainties dictate that future cash flows should be discounted back at reasonably high discount rates (definitely not Treasury yields). There has been an extremely wide divergence between bull and bear valuation metrics, and the markets have begun to move decisively in the “bear’s” direction.
My thesis remains that the European crisis marks the piercing of the global government debt Bubble. I fully expect unfolding developments to prove a momentous inflection point in financial and economic history. The world is today awash in endless debt, financial claims, and financial contracts – and faith in underpinning debt structures is waning.
At the center of the current storm, the European banking system is increasingly impaired by suspect assets – chiefly the liabilities of hopelessly over-indebted sovereign borrowers. Forced austerity measures and abruptly tightened finance ensure economic disappointment, as the unavoidable downside of a prolonged Credit cycle gathers momentum. As major global derivative players and financiers to the “leveraged speculating community” (especially after the demise of much of their American competition in the ’08 crisis), the stability of the major European financial institutions has become a major global market issue.
The bursting of the Global Government Finance Bubble portends major changes to the derivatives market landscape. First, some of the major derivatives players are increasingly impaired from holdings of sovereign and related debt instruments. Second, an important part of my thesis is that government policymaking, in general, will be increasingly incapacitated in the face of a rapidly changing landscape. The efficacy of fiscal and monetary management is clearly waning, which I believe brings into question key assumptions underpinning much of the derivatives marketplace, including “liquid and continuous markets”. And as confidence in sovereign debt and policymaking deteriorates – and global markets convulse - the capacity for hundreds of Trillions of derivatives to function as advertised will be questioned. An issue that should have been addressed in 2008 (better yet, 1998) was allowed (incentivized) to fester. The PhDs and their quant models are in for another severe test.
European policymaking has become an easy target for market pundits. “They are timid and lack resolve.” “Their incompetence and failure to adopt bold action is at the roots of an unnecessary crisis.” “There is a complete lack of political leadership.” Essentially, the markets want the Germans to back a new eurobond that could be issued in sufficiently enormous quantities to reflate European markets, economies, banking systems and markets. The consensus market view holds that such a policy course offers huge benefits with limited costs. And for markets that have grown accustomed to getting whatever they demand from global policymakers, this is a major shock. The Germans don’t want to play ball.
No society understands the dangers of debauching the currency better than the Germans. And they have principled elder statesmen that understand what’s at stake at this critical juncture in financial history. I wouldn’t count on them backing down. They appreciate that bailouts and debt guarantees commence a slippery slope of Credit and currency debasement. Put a German guarantee on the debt required to bailout profligate borrowers and be prepared for years of German-backed debt certain to impair German and European creditworthiness. The Bundesbank, in particular, must today appreciate that safeguarding their monetary system has become an absolute priority both for the German people and for Europe. Impairing the stable “core” in the name of assisting a failed periphery would be extremely detrimental to Germany and for European integration.
The long-held German (and Austrian!) notion of “sound money” fails to resonate in The Age of the PhD Standard. Especially in the U.S., the Great Depression is understood as a consequence of gross dereliction of the Federal Reserve’s responsibility for ensuring sufficient “money” and bank capital. Somehow it is forgotten that the harbinger of devastating economic collapse was the collapse of confidence in Credit and financial assets. Instead of a German-like tenacity for protecting the Creditworthiness and stability of the system’s core, our monetary doctors are instead determined to gamble the bedrock of our financial system on a policymaking course that amounts to little more than unending government debt issuance and monetization (contemporary “money printing”).
Texas governor Perry was lambasted for his verbal attack on “treasonous” Federal Reserve “money printing.” “Presidential” it was not. But do I expect this type of message to resonate? Bet on it! American society is showing the increasing strains of monetary mismanagement. More and more, it seems that only the PhDs and stock market punditry actually believe that Fed policymaking is on the right track. And it really is a fascinating and frightening dynamic where the general populace has this right and policymakers have it dead wrong.
This is a huge monetary experiment run amuck – and the evidence is everywhere (i.e. high unemployment, rising inflation, massive federal deficits, the Fed’s balance sheet, unstable markets, rising wealth inequality, intractable trade deficits, the value of the dollar, the price of gold, waning American power and influence, public anger and distrust…). The American people no longer buy the notion that piling on more debt and “money printing” offers a reasonable solution. They are appreciating that it’s instead the problem, and there will be less tolerance for this “experiment” going forward.
And the PhDs? They stick steadfastly with their doctrine, not for a minute admitting the experimental and theoretical nature of their policy prescriptions. And I see no willingness on their part to question their view that contemporary monetary management is enlightened and superior to the past. There is an element of hubris that gets in the way of objectivity.
I have for years now referred to this theoretical framework – both from an economic doctrine and policymaking perspective – as little more than a sophisticated version of “inflationism.” And we are increasingly witness to the age-old Scourge of Inflationism. And as we’ve already witnessed recently, the inflationists will warn about the dangers of not being bold – of losing resolve. “Don’t repeat the mistakes of Japan!” As it’s been throughout history, it always seems to be a case of “just one more bout of money printing” and government spending – and then we’ll get monetary religion. Did I really hear and read this week that the remedy for our nation’s problems is to be found with one more economic stimulus package coupled with additional measures ensuring long-term deficit reduction?
Fiscal and monetary policies are rapidly losing credibility. Treasury prices may be inflated, but don’t mistake this for confidence in our system’s “core”. It may exist completely outside of the PhD’s sophisticated framework, but the markets and regular folk are feeling the ill-effects of currency debauchery.