Reviewing Piketty (again)

Michael Roberts Blog

I have just submitted a 6000 word review of Thomas Piketty’s book, Capital in the 21st century, to Historical Materialism journal.  Under HM rules,I cannot publish this anywhere else (unless they reject it) and so it may not see the light of day for a while.  It may not be the most perceptive of the now hundreds of reviews that have been published, but it is certainly vying to be the longest!

Anyway, here is a flavour of what is in the review from the abstract submitted.

Thomas Piketty’s magnum opus on the accumulation and distribution of wealth over the last 200 years has been greeted by the biggest noise from the great and good inmainstream economics (and by the heterodox ) of any economics book, possibly ever. Piketty shows compellingly that inequality of wealth and income is inherent in capitalism and it is getting worse. Most important, he…

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America and Nazi Germany’s Revived Zombies

A Mind Infinite

America and Nazi Germany’s Revived Zombies

By Aaron Peterson | 4/27/2014


Sparks of a United States foreign policy out of control. The train is off the tracks and it’s heading in no actual direction. The chances of collision are only growing higher. In Ukraine, the promoted attitude by the United States government through it’s foreign policy, was one of usurpation of a democratically elected government in Ukraine. Perpetuated by Western backed opposition groups through a campaign of violence, including those predominately farther right of the political compass.

An unholy alliance of the forces of NATO with technocrats, oligarchs and violent extremist Neo-Nazi paramilitaries and political parties, namely Svoboda (Formerly the Social Nationalist Party of Ukraine) and it’s Neo-Nazi paramilitary Right Sector.  Both of which proclaim to carry out the work and legacy of Stepan Bandera, a former collaborator with Nazi Germany. Bandera who himself was responsible for helping Nazi Germany…

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School «reform» is about class, not classrooms

Sam Smith's Essays


Unanswered in all the noise about «education reform» is why, over the past decade, America’s establishment has become so obsessed with controlling public education, a complete reversal of two centuries of American faith in locally controlled schools.

There are answers that the op-eds will give you, such as the need to compete in the global marketplace, but this is pretty weak stuff and not the raw material for major presidential policy under two administrations.

There are answers that can be found in the general shift in government towards data as a worthy substitute, or delaying tactic, for action. As long as you’re assessing something you don’t actually have to do anything about it.

Then there’s the milking of the cash cow of testing. For example, the Washington Post now gets the bulk of its profits from the Kaplan education division, profits bolstered by the paper’s constant editorial…

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The politics of depression: Mark Fisher on mental health and class confidence



Writer and critic Mark Fisher caused a stir recently with his article Good For Nothing in Occupied Times, where he wrote searingly about the experience of depression in our neoliberal capitalist age. Anindya Bhattacharyya spoke to him about the politics of mental health, magical voluntarism and how to struggle against this.

I remember a few years ago turning on the television and watching Deal or No Deal for the first time. It took me a little while to work out what was going on – my sanity somehow putting up resistance to the grim realisation that this was a game of pure luck decked out in all manner of supernatural garbage. I was unsurprised to later hear about the Cosmic ordering wish cult that the show’s host Noel Edmonds peddles.

Deal or No Deal throws randomly selected amounts of money at randomly selected people. Yet the entire message the show insists…

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The Story of Hope and Faith the Government Doesn’t Want You to Hear

Saturday, 26 April 2014 09:19 By Rivera Sun, Truthout | Op-Ed

2014 0426sun(Photo Illustration: Jared Rodriguez / t r u t h o u t)

A sea of candles, a street of soft-lit faces, the swell of a thousand voices singing, the unstoppable surge of tears, an ache of yearning in the heart, the possibility of change, and the sense that as all falls into darkness, the people will rise.

This is the story of nonviolent struggle . . . a story that has changed the world time and again . . . the story the government doesn’t want you to hear.

The government and mass media do their best to suppress this story. The cameras swing to the angry kid dressed in black and the provocations he launches at the police. The images flash scenes of chaos during the crackdown. The news does not report the countless hours of quiet boycotts, uneventful sit-ins, or midnight sign-painting sessions in preparation for tomorrow’s picket lines. The sudden grace of students taking wing from tyranny, walking out on classes and injustice is rarely mediatized.

Few television stations air footage of tedious city council meetings, where people witness the birth of change.

The suspicion of agent provocateurs, the cynical snort that so-and-so is a paid troll, the sighs about infuriating individuals, the teeth-gritting over long-winded speakers, complaints about self-serving power grabbers, the frustration when one person’s anger holds the whole room hostage; these are also truths in the world of nonviolent struggle.

But equally true are the quiet thoughts and subtle emotions that remain locked inside the rib cage. There are the moments when Spirit steps inside the room, and the presence of every person’s faith is palpable. There are times when the lineage of nonviolent struggle comes close enough to touch: Rosa Parks, Cesar Chavez, Dr. King, Gandhi, Aung San Suu Kyi and many countless more.

There is the tired laughter of longtime activists who have run the gauntlet of these experiences. There is the organizer’s stare that pins people as they scramble for excuses to avoid a meeting. There are the head-shaking recollections of victories, losses and uncomfortable defeats. There are the silent, shadowed looks of those who raced in to save the day, but lost the battle. There is the pain that never leaves the heart when an endeavor fails, and the guilty feeling when one’s eyes sweep over a map and sees a community that lies abandoned.

There are the midnight decompression rants after hot-tempered meetings. There are those moments when the jaw drops in disbelief at court injustices, police brutality and politicians’ machinations. There is the cynical snort of the young activist who has seen it all – and the subtle disdain of the old-timer who knows the kid has not. There are the green recruits being punched in the guts for their faith in equality and justice. There are the watery old eyes of grandmothers who refuse to lie down and die.

The world of nonviolent struggle holds libraries of experience: good times, full of laughter, song, community and purpose; tough times when the thrill of rebellion gives way to the fear of repression. There are times when one narrowly avoids the pitfalls of righteousness, other times when one topples blindly in. A moment arrives when you have never felt so alive; then comes another when you wish for death. Your heart breaks. It heals. Hope rises, then falls. It feels as though nothing can stop the movement; then everything does.

Meanwhile, the neighbors are watching television.

Don’t they understand? Life and death are at stake. Extinction looms! There is no epic greater than this. Homer defers to the story of our times. The Ramayana, with its demons and demigods, the Greek epics, Shakespeare’s work – not one can compete. Soap operas have nothing on reality.

But the kids stare glassy-eyed at the screens. Teenagers eat popcorn and watch thrillers. Parents flick through the reruns. Life passes them by.

Loneliness and sadness touch the hearts of all people. Fear of the unknown mingles with the uncertainty of change. There is nothing glossy about nonviolent struggle. No movie music plays in the background. There are no commercial breaks to the intensity of reality. The fallen heroes do not stand up and take bows.

Nonviolent struggle is gritty. It’s real. It is a world the 6 o’clock news fails to adequately report. The neighbors next door frown at the screen, watching the ten-second clip of the angry protester flash again and again. Why do they do it? the wife complains to the husband. He yells at the kid on the screen to get a job.

The kid has a job, you want to tell him. He has a job, and he’s doing it. The black-clad stereotype provoking the cops is keeping his neighbors from changing the world. He’s fueling the propaganda machine. The government may even pay him to do it. He may be sincere. Regardless, he still plays his role. The people keep watching the screen.

Over and over his story repeats. His message of anger and violence drowns out the other . . . the one that entrenched power doesn’t want you to hear.

There is a sea of candles. There is a street of soft-lit faces. There are a thousand voices singing. There are tears in your eyes and a stranger’s hand in your own. The impossible looms, but you refuse to give up. This is the world of nonviolent struggle.

Copyright, Truthout. May not be reprinted without permission.


What is Capitalism? By Peter Staudenmaier


In ancient myths of paradise, people lived in boundless plenty without work or want. The fruits of the earth were freely available to all and no labor was necessary. If life under capitalism is a far cry from paradise, it is nonetheless beholden to its own myths of work, prosperity, and progress. Understanding what the world was like before the rise of capitalism, and envisioning a different world beyond the capitalist reality we live in today, calls for an examination of its myths and the structures on which those myths are built.

Capitalism usually presents itself as an economic system, a way of organizing the production and distribution of goods and services, of wealth and welfare, of material gain and loss. But capitalism is more than an economic system, it is a form of society: A form of society in which the economic has taken precedence over the social. Under capitalism, economic necessities become more important than basic social relationships – finding a job and keeping it can be more pressing than creating a fulfilling life together with friends and companions and loved ones; figuring out how to pay the rent or maintain the mortgage or make sure there’s food on the table wins out over exploring what we have in common; worrying about who’ll take care of us when we’re too old to work gets in the way of taking care of each other here and now. What is best for me individually becomes more vital than what is best for the communities I am part of, than what is best for all of us.

When we find ourselves thinking this way, it is not because we are inherently selfish beings. That notion of natural self-interest and acquisitiveness is one of the major myths of modern capitalism. Human societies have evolved myriad ways of arranging their economic interactions, many of them based squarely on communal rather than individual standards of wellbeing. They aren’t always liberatory, of course, but they do indicate that capitalism’s peculiar preoccupation with concern for oneself over others is not built in to human nature. And most people don’t get all that far under capitalism, economically speaking, no matter how much we focus on our own needs and wants. Though the free market continually holds out the promise of a better life for all, the promise generally becomes reality for only a few.

Viewed in this context, capitalism is by no means historically inevitable. It isn’t part of the fabric of the universe and it isn’t a consequence of the laws of physics. It is not an innate attribute of human existence. It is not, as it pretends to be, the natural state of economic affairs. Capitalism is a social artifact, something created and maintained by people, by our actions and inactions, whether deliberate or inadvertent, whether malevolent or well-meaning. It arose in particular places at specific times under distinctive conditions. It has a history, though admirers of capitalism sometimes like to portray it as timeless. Like everything historical, it has both beginnings and an end. If we made it, we can unmake it.

That means understanding how it functions. To do this we can draw on both theory and practice, incorporating the lessons learned from critical analyses of the basic structures of capitalism as well as the legacies of organized opposition to those structures. We can make use of the insights generated by radical social movements throughout the long history of emancipatory struggles against capitalism. Many of these struggles were led by workers in class-based movements resisting the growing power of capital. Others were made up of peasants or artisans, and some were community-based movements defending popular institutions from encroachment by an advancing capitalist system. The participants in these struggles disagreed about how to make sense of the seemingly senseless society formed by the development of capitalism, but we can distill a series of key concepts from their experiences.

From the perspective of these oppositional movements and their assessment of a world transformed according to capitalist imperatives, the core features of capitalism as an economic system and as a society can be characterized as follows:

Commodity production and exchange. Commodities are the fundamental unit of capitalist societies, as the cell is the fundamental unit of the body. Under full-fledged capitalism a commodity can be just about anything – something useful and necessary, something harmful and pointless, something rare or common, something intangible and ephemeral. What makes an item or an idea or an action a commodity is not some intrinsic quality of the thing itself, but its status as an object of exchange. In its simplest form, a commodity is a good or a service that is produced in order to be exchanged. It is valuable not primarily for what it is but for what price it can fetch when bought or sold, what can be gained by exchanging it for other commodities.

Markets. The mechanism through which commodities are exchanged is the market, a forum in which buyers and sellers compete for advantage. Historically markets were subject to social constraints: typically located in circumscribed areas, limited to certain times of the day or week or year, tempered by ethical stipulations. Many human societies assigned markets a deliberately subordinate position in communal life and delineated clear boundaries within which markets were allowed to operate. This changed with the ascendance of capitalism. In an ideal capitalist world, markets and their competitive dynamic no longer heed social limitations but are ubiquitous and unfettered; they are everywhere all the time. Though championed for their supposed efficiency, markets are frequently models of extraordinary waste and inefficiency. In their capitalist form markets have a tendency to permeate all relationships and all dimensions of social life, extending far beyond the immediate economic realm and turning neighbors into rivals, colleagues into competitors, allies into adversaries.

Property as private investment. Through the processes of commodity production and market exchange, more and more aspects of human life and the natural world are reduced to assets that can and must be owned. Wealth comes from the earth and its creatures and from the work of human hands and minds, and there are countless forms in which it can be created, discovered, and shared. Capitalism imposes one form as paramount: private ownership of resources. In contemporary industrial capitalist societies this type of private property can take the shape of entrepreneurs who own a business, shareholders or investors who own a corporation, landlords who own real estate, speculators who own stock or trade debt and credit and abstract commodities existing only in notional form. The driving force behind this kind of ownership is profit.

Wage labor. Most people in capitalist contexts don’t own assets that earn profit, and have to sell their time and effort to others in order to make a living. Selling your ability to work in exchange for a paycheck is known as wage labor, the component of capitalism with which most of us are intimately familiar. A division of labor between groups of people doing different tasks is not peculiar to capitalism, but in combination with commodity production, the predominance of the market, and private ownership of economic resources, wage labor means that the people who actually produce the goods and services that keep the system running have little say in how the things they produce are made and distributed. Those decisions are normally the prerogative of owners, executives, and managers, whose directives are supposed to be carried out by workers. When the system works the way it is designed, products end up in the hands of consumers divorced from any connection with or knowledge of the producers or their conditions of work, from mass manufacturing to the provision of services.

On the basis of these intertwined core features, capitalism has achieved remarkable levels of economic innovation and equally remarkable levels of ecological and social destructiveness. What drives both its accomplishments and its devastation is a constant requirement for accumulation, for increasing returns on investment, for profits that can be put back into circulation in order to yield even greater profit. Ever-expanding material reward is the carrot that entices capitalist ambitions, accompanied by the stick of potential economic ruin. While its operations are baroquely complex and often inscrutable, its underlying principles are starkly straightforward. This accounts for capitalism’s conspicuous flexibility, the capacity to accommodate itself to widely different social and cultural contexts. It also accounts for the profoundly alienated relationships at the heart of capitalist society.

Because capitalism is built around recurrent crises, economic and otherwise, it has always sparked dissatisfaction and resistance. From anarchists to marxists, from cooperative movements to anti-colonial struggles, diverse groups and individuals have contested the regime of capital for generations. For those of us fundamentally opposed to capitalism, it is crucial to keep in mind the political ambivalence of discontent with capitalist norms. History is littered with false alternatives to an inhumane and unsustainable system. Stalinism, to choose one all too recognizable example, is not a compelling replacement for free market nostrums. Many populists and fascists also oppose capitalism, based often enough on the alluring but deceptive paradigm of hardworking producers versus parasitic financiers. There are numerous authoritarian and right-wing versions of anti-capitalist sentiment. We need to remember this if we don’t want to end up in a future that is even worse than the capitalist present. The challenge is to come up with a comprehensive critical analysis of what is wrong with capitalism and a plausible array of alternative social institutions that could supplant it.

A helpful step toward that goal is to ask questions without easy answers. What is it about capitalism that we oppose? Its outsize impact on our lives, our character, our bodies, our planet? Its privileging of multinational corporations and millionaires? Its cosmopolitanism and its corrosive effect on traditional mores? Or is it alienation and exploitation that we reject? And what are we working toward? A more smoothly functioning liberal state that will provide for all? Local self-sufficiency and regional autarky? Planning bureaucracies and legislated equality? Environmental enterprise and reduced consumption? Neighborhood markets and family farms and mom and pop stores? Or do we want a genuinely anti-capitalist alternative, structurally antagonistic to hierarchy and domination, to profit and property, whatever their scale or scope?

Beyond decisive questions like these, there are many other problems to be thought through and worked out. Capitalism is not as all-encompassing as it appears; non-capitalist relationships exist within and alongside the dominant economy and society. And as central as production is to economic endeavors, reproduction and care are what make our lives possible, while the pleasure of personal and collective creation for its own sake, regardless of utility, can make our lives worth living. Indeed the very notion of «the economy» as a separate sphere of social life is itself a legacy of the historical emergence of capitalism. Today’s shifting affiliations linking capitalism to white supremacy, to patriarchy, to racial and gender and other hierarchies are not an implacable constant but always in flux, with oppressive as well as subversive potentials. The crushing weight of capital distorts any image of a life after capitalism, but the possibilities of transcending its bitter strictures are entirely real. They are ours to explore, ours to construct, and ours to share.


The Cost of Code Red By John Mauldin


April 26, 2014

Speculative Bubbles

(It is especially important to read the opening quotes this week. They set up the theme in the proper context.)

“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

– Ludwig von Mises

“No very deep knowledge of economics is usually needed for grasping the immediate effects of a measure; but the task of economics is to foretell the remoter effects, and so to allow us to avoid such acts as attempt to remedy a present ill by sowing the seeds of a much greater ill for the future.”

– Ludwig von Mises

“[Central banks are at] serious risk of exhausting the policy room for manoeuver over time.”

– Jaime Caruana, General Manager of the Bank for International Settlements

“The gap between the models in the world of monetary policymaking is now wider than at any time since the 1930s.”

– Benjamin Friedman, William Joseph Maier Professor of Political Economy, Harvard

To listen to most of the heads of the world’s central banks, things are going along swimmingly. The dogmatic majority exude a great deal of confidence in their ability to manage their economies through whatever crisis may present itself. (Raghuram Rajan, the sober-minded head of the Reserve Bank of India, is a notable exception.)

However, there is reason to believe that there have been major policy mistakes made by central banks – and will be more of them – that will lead to dislocations in the markets – all types of markets. And it’s not just the usual anti-central bank curmudgeon types (among whose number I have been counted, quite justifiably) who are worried. Sources within the central bank community are worried, too, which should give thoughtful observers of the market cause for concern.

Too often we as investors (and economists) are like the generals who are always fighting the last war. We look at bank balance sheets (except those of Europe and China), corporate balance sheets, sovereign bond spreads and yields, and say it isn’t likely that we will repeat this mistakes which led to 2008. And I smile and say, “You are absolutely right; we are not going to repeat those mistakes. We learned our lessons. Now we are going to make entirely new mistakes.” And while the root cause of the problems, then and now, may be the same – central bank policy – the outcome will be somewhat different. But a crisis by any other name will still be uncomfortable.

If you look at some of the recent statements from the Bank for International Settlements, you should come away with a view much more cautious than the optimistic one that is bandied about in the media today. In fact, to listen to the former chief economist of the BIS, we should all be quite worried.

I am of course referring to Bill White, who is one of my personal intellectual heroes. I hope to get to meet him someday. We have discussed some of his other papers, written in conjunction with the Dallas Federal Reserve, in past letters. He was clearly warning about imbalances and potential bubbles in 2007 and has generally been one of the most prescient observers of the global economy. The prestigious Swiss business newspaper Finanz und Wirtschaft did a far-reaching interview with him a few weeks ago, and I’ve taken the liberty to excerpt pieces that I think are very important. The excerpts run a few pages, but this is really essential reading. (The article is by Mehr zum Thema, and you can read the full piecehere.)

Speculative Bubbles

The headline for the interview is “I see speculative bubbles like in 2007.” As the interviewer rolls out the key questions, White warns of grave adverse effects of ultra-loose monetary policy:

William White is worried. The former chief economist of the Bank for International Settlements is highly skeptical of the ultra-loose monetary policy that most central banks are still pursuing. “It all feels like 2007, with equity markets overvalued and spreads in the bond markets extremely thin,” he warns.

Mr. White, all the major central banks have been running expansive monetary policies for more than five years now. Have you ever experienced anything like this?

The honest truth is no one has ever seen anything like this. Not even during the Great Depression in the Thirties has monetary policy been this loose. And if you look at the details of what these central banks are doing, it’s all very experimental. They are making it up as they go along. I am very worried about any kind of policies that have that nature.

But didn’t the extreme circumstances after the collapse of Lehman Brothers warrant these extreme measures?

Yes, absolutely. After Lehman, many markets just seized up. Central bankers rightly tried to maintain the basic functioning of the system. That was good crisis management. But in my career I have always distinguished between crisis prevention, crisis management, and crisis resolution. Today, the Fed still acts as if it was in crisis management. But we’re six years past that. They are essentially doing more than what they did right in the beginning. There is something fundamentally wrong with that. Plus, the Fed has moved to a completely different motivation. From the attempt to get the markets going again, they suddenly and explicitly started to inflate asset prices again. The aim is to make people feel richer, make them spend more, and have it all trickle down to get the economy going again. Frankly, I don’t think it works, and I think this is extremely dangerous.

So, the first quantitative easing in November 2008 was warranted?


But they should have stopped these kinds of policies long ago?

Yes. But here’s the problem. When you talk about crisis resolution, it’s about attacking the fundamental problems that got you into the trouble in the first place. And the fundamental problem we are still facing is excessive debt. Not excessive public debt, mind you, but excessive debt in the private and public sectors. To resolve that, you need restructurings and write-offs. That’s government policy, not central bank policy. Central banks can’t rescue insolvent institutions. All around the western world, and I include Japan, governments have resolutely failed to see that they bear the responsibility to deal with the underlying problems. With the ultraloose monetary policy, governments have no incentive to act. But if we don’t deal with this now, we will be in worse shape than before.

But wouldn’t large-scale debt write-offs hurt the banking sector again?

Absolutely. But you see, we have a lot of zombie companies and banks out there. That’s a particular worry in Europe, where the banking sector is just a continuous story of denial, denial and denial. With interest rates so low, banks just keep ever-greening everything, pretending all the money is still there. But the more you do that, the more you keep the zombies alive, they pull down the healthy parts of the economy. When you have made bad investments, and the money is gone, it’s much better to write it off and get fifty percent than to pretend it’s still there and end up getting nothing. So yes, we need more debt reduction and more recapitalization of the banking system. This is called facing up to reality.

Where do you see the most acute negative effects of this monetary policy?

The first thing I would worry about are asset prices. Every asset price you could think of is in very odd territory. Equity prices are extremely high if you at valuation measures such as Tobin’s Q or a Shiller-type normalized P/E. Risk-free bond rates are at enormously low levels, spreads are very low, you have all these funny things like covenant-lite loans again. It all looks and feels like 2007. And frankly, I think it’s worse than 2007, because then it was a problem of the developed economies. But in the past five years, all the emerging economies have imported our ultra-low policy rates and have seen their debt levels rise. The emerging economies have morphed from being a part of the solution to being a part of the problem.

Do you see outright bubbles in financial markets?

Yes, I do. Investors try to attribute the rising stock markets to good fundamentals. But I don’t buy that. People are caught up in the momentum of all the liquidity that is provided by the central banks. This is a liquidity-driven thing, not based on fundamentals.

So are we mostly seeing what the Fed has been doing since 1987 – provide liquidity and pump markets up again?

Absolutely. We just saw the last chapter of that long history. This is the last of a whole series of bubbles that have been blown. In the past, monetary policy has always succeeded in pulling up the economy. But each time, the Fed had to act more vigorously to achieve its results. So, logically, at a certain point, it won’t work anymore. Then we’ll be in big trouble. And we will have wasted many years in which we could have been following better policies that would have maintained growth in much more sustainable ways. Now, to make you feel better, I said the same in 1998, and I was way too early.

What about the moral hazard of all this?

The fact of the matter is that if you have had 25 years of central bank and government bailout whenever there was a problem, and the bankers come to appreciate that fact, then we are back in a world where the banks get all the profits, while the government socializes all the losses. Then it just gets worse and worse. So, in terms of curbing the financial system, my own sense is that all of the stuff that has been done until now, while very useful, Basel III and all that, is not going to be sufficient to deal with the moral hazard problem. I would have liked to see a return to limited banking, a return to private ownership, a return to people going to prison when they do bad things. Moral hazard is a real issue.

Do you have any indication that the Yellen Fed will be different than the Greenspan and Bernanke Fed?

Not really. The one person in the FOMC that was kicking up a real fuss about asset bubbles was Governor Jeremy Stein. Unfortunately, he has gone back to Harvard.

The markets seem to assume that the tapering will run very smoothly, though. Volatility, as measured by the Vix index, is low.

Don’t forget that the Vix was at [a] record low in 2007. All that liquidity raises the asset prices and lowers the cost of insurance. I see at least three possible scenarios how this will all work out. One is: Maybe all this monetary stuff will work perfectly. I don’t think this is likely, but I could be wrong. I have been wrong so many times before. So if it works, the long bond rates can go up slowly and smoothly, and the financial system will adapt nicely. But even against the backdrop of strengthening growth, we could still see a disorderly reaction in financial markets, which would then feed back to destroy the economic recovery.


We are such a long way away from normal long-term interest rates. Normal would be perhaps around four percent. Markets have a tendency to rush to the end point immediately. They overshoot. Keynes said in late Thirties that the long bond market could fluctuate at the wrong levels for decades. If fears of inflation suddenly re-appear, this can move interest rates quickly. Plus, there are other possible accidents. What about the fact that maybe most of the collateral you need for normal trading is all tied up now? What about the fact that the big investment dealers have got inventories that are 20 percent of what they were in 2007? When things start to move, the inventory for the market makers might not be there. That’s a particular worry in fields like corporate bonds, which can be quite illiquid to begin with. I’ve met so many people who are in the markets, thinking they are absolutely brilliantly smart, thinking they can get out in the right time. The problem is, they all think that. And when everyone races for the exit at the same time, we will have big problems. I’m not saying all of this will happen, but reasonable people should think about what could go wrong, even against a backdrop of faster growth.

And what is the third scenario?

The strengthening growth might be a mirage. And if it does not materialize, all those elevated prices will be way out of line of fundamentals.

Which of the major central banks runs the highest risk of something going seriously wrong?

At the moment what I am most worried about is Japan. I know there is an expression that the Japanese bond market is called the widowmaker. People have bet against it and lost money. The reason I worry now is that they are much further down the line even than the Americans. What is Abenomics really? As far as I see it, they print the money and tell people that there will be high inflation. But I don’t think it will work. The Japanese consumer will say prices are going up, but my wages won’t. Because they haven’t for years. So I am confronted with a real wage loss, and I have to hunker down. At the same time, financial markets might suddenly not want to hold Japanese Government Bonds anymore with a perspective of 2 percent inflation. This will end up being a double whammy, and Japan will just drop back into deflation. And now happens what Professor Peter Bernholz wrote in his latest book. Now we have a stagnating Japanese economy, tax revenues dropping like a stone, the deficit already at eight percent of GDP, debt at more than 200 percent and counting. I have no difficulty in seeing this thing tipping overnight into hyperinflation. If you go back into history, a lot of hyperinflations started with deflation.

Many people have warned of inflation in the past five years, but nothing has materialized. Isn’t the fear of inflation simply overblown?

One reason we don’t see inflation is because monetary policy is not working. The signals are not getting through. Consumers and corporates are not responding to the signals. We still have a disinflationary gap. There has been a huge increase in base money, but it has not translated into an increase in broader aggregates. And in Europe, the money supply is still shrinking. My worry is that at some point, people will look at this situation and lose confidence that stability will be maintained. If they do and they do start to fear inflation, that change in expectations can have very rapid effects.

More from the BIS

The Bank for International Settlements is known as the “central bankers’ central bank.” It hosts a meeting once a month for all the major central bankers to get together for an extravagant dinner and candid conversation. Surprisingly, there is been no tell-all book about these meetings by some retiring central banker. They take the code of “omertà” (embed) seriously.

Jaime Caruana, the General Manager of the BIS, recently stated that monetary institutions (central banks) are at “serious risk of exhausting the policy room for manoeuver over time.” He followed that statement with a very serious speech at the Harvard Kennedy School two weeks ago. Here is the abstract of the speech (emphasis mine):

This speech contrasts two explanatory views of what he characterizes as “the sluggish and uneven recovery from the global financial crisis of 2008-09.” One view points to a persistent shortfall of demand and the other to the specificities of a financial cycle-induced recession – the “shortfall of demand” vs. the “balance sheet” view. The speech summarizes each diagnosis [and]… then reviews evidence bearing on the two views and contrasts the policy prescriptions to be inferred from each view. The speech concludes that the balance sheet view provides a better overarching explanation of events. In terms of policy, the implication is that there has been too much emphasis since the crisis on stimulating demand and not enough on balance sheet repair and structural reforms to boost productivity. Looking forward, policy frameworks need to ensure that policies are more symmetrical over the financial cycle, so as to avoid the risks of entrenching instability and eventually running out of policy ammunition.

Coming from the head of the BIS, the statement I have highlighted is quite remarkable. He is basically saying (along with his predecessor, William White) that quantitative easing as it is currently practiced is highly problematical. We wasted the past five years by avoiding balance sheet repair and trying to stimulate demand. His analysis perfectly mirrors the one Jonathan Tepper and I laid out in our bookCode Red.

How Does the Economy Adjust to Asset Purchases?

In 2011 the Bank of England gave us a paper outlining what they expected to be the consequences of quantitative easing. Note that in the chart below they predict exactly what we have seen. Real (inflation-adjusted) asset prices rise in the initial phase. Nominal demand rises slowly, and there is a lagging effect on real GDP. But note what happens when a central bank begins to flatten out its asset purchases or what is called “broad money” in the graph: real asset prices begin to fall rather precipitously, and consumer price levels rise. I must confess that I look at the graph and scratch my head and go, “I can understand why you might want the first phase, but what in the name of the wide, wide world of sports are you going to do for policy adjustment in the second phase?” Clearly the central bankers thought this QE thing was a good idea, but from my seat in the back of the plane it seems like they are expecting a rather bumpy ride at some point in the future.

Let’s go to the quote in the BoE paper that explains this graph (emphasis mine):

The overall effect of asset purchases on the macroeconomy can be broken down into two stages: an initial ‘impact’ phase and an ‘adjustment’ phase, during which the stimulus from asset purchases works through the economy, as illustrated in Chart 1. As discussed above, in the impact phase, asset purchases change the composition of the portfolios held by the private sector, increasing holdings of broad money and decreasing those of medium and long-term gilts. But because gilts [gilts is the English term for bonds] and money are imperfect substitutes, this creates an initial imbalance. As asset portfolios are rebalanced, asset prices are bid up until equilibrium in money and asset markets is restored. This is reinforced by the signalling channel and the other effects of asset purchases already discussed, which may also act to raise asset prices. Through lower borrowing costs and higher wealth, asset prices then raise demand, which acts to push up the consumer price level.

[Quick note: I think Lacy Hunt thoroughly devastated the notion that there is a wealth effect and that rising asset prices affect demand in last week’s Outside the Box. Lacy gives us the results of numerous studies which show the theory to be wrong. Nevertheless, many economists and central bankers cling to the wealth effect like a shipwrecked sailor to a piece of wood on a stormy sea. Now back to the BoE.]In the adjustment phase, rising consumer and asset prices raise the demand for money balances and the supply of long-term assets. So the initial imbalance in money and asset markets shrinks, and real asset prices begin to fall back. The boost to demand therefore diminishes and the price level continues to increase but by smaller amounts. The whole process continues until the price level has risen sufficiently to restore real money balances, real asset prices and real output to their equilibrium levels. Thus, from a position of deficient demand, asset purchases should accelerate the return of the economy to equilibrium.

This is the theory under which central banks of the world are operating. Look at this rather cool chart prepared by my team (and specifically Worth Wray). The Fed (with a few notable exceptions on the FOMC) has been openly concerned about deflationary trends. They are purposely trying to induce a higher target inflation. The problem is, the inflation is only showing up in stock prices – and not just in large-cap equity markets but in all assets around the world that price off of the supposedly “risk-free” rate of return.

code red

I hope you get the main idea, because understanding this dynamic is absolutely critical for navigating what the Chairman of the South African Reserve Bank, Gill Marcus, is calling the next phase of the global financial crisis. Every asset price (yes, even and especially in emerging markets) that has been driven higher by unnaturally low interest rates, quantitative easing, and forward guidance must eventually fall back to earth as real interest rates eventually normalize.

Trickle-Down Monetary Policy

For all intents and purposes we have adopted a trickle-down monetary policy, one which manifestly does not work and has served only to enrich financial institutions and the already wealthy. Now I admit that I benefit from that, but it’s a false type of enrichment, since it has come at the expense of the general economy, which is where true wealth is created. I would rather have my business and investments based on something more stably productive, thank you very much.

Monetary policies implemented by central banks around the world are beginning to diverge in a major way. And don’t look now, but that sort of divergence almost always spells disaster for all or part of the global economy. Which is why Indian Central Bank Governor Rajan is pounding the table for more coordinated policies. He can see what is going to happen to cross-border capital flows and doesn’t appreciate being caught in the middle of the field of fire with hardly more than a small pistol to defend himself. And the central banks even smaller than his are bringing only a knife to the gunfight.

The Fed & BoE Are Heading for the Exits…

In the United States, Federal Reserve Chairwoman Janet Yellen is clearly signaling her interest – if not outright intent – to turn the Fed’s steady $10 billion “tapering” of its $55 billion/month quantitative easing program into a more formal exit strategy. The Fed is still actively expanding its balance sheet, but by a smaller amount after every FOMC meeting (so far)… and global markets are already nervously anticipating any move to sell QE-era assets or explicitly raise rates. Just like China’s slowdown (which we have written about extensively), the Fed’s eventual exit will be a global event with major implications for the rest of the world. And US rate normalization could drastically disrupt cross-border real interest rate differentials and trigger the strongest wave of emerging-market balance of payments crises since the 1930s.

In the United Kingdom, Bank of England Governor Mark Carney is carefully broadcasting his intent to hike rates before selling QE-era assets. According to his view, financial markets tend to respond rather mechanically to rate hikes, but unwinding the BoE’s bloated balance sheet could trigger a series of unintended and potentially destructive consequences. Delaying those asset sales indefinitely and leaning on rate targeting once more allows him to guide the BoE toward tightening without giving up the ability to rapidly reverse course if financial markets freeze. Then again, Carney may be making a massive, credibility-cracking mistake.

While the BoJ & ECB Are Just Getting Started

In Japan, Bank of Japan Governor Haruhiko Kuroda is resisting the equity market’s call for additional asset purchases as the Abe administration implements its national sales tax increase – precisely the same mistake that triggered Japan’s 1997 recession. As I have written repeatedly, Japan is the most leveraged government in the world, with a government debt-to-GDP ratio of more than 240%. Against the backdrop of a roughly $6 trillion economy, Japan needs to inflate away something like 150% to 200% of its current debt-to-GDP… that’s roughly $9 trillion to $12 trillion in today’s dollars.

Think about that for a moment. At some point I need to do a whole letter on this, but I seriously believe the Bank of Japan will print something on the order of $8 trillion (give or take) over the next six to ten years. In relative terms, this is the equivalent of the US Federal Reserve printing $32 trillion. To think this will have no impact on the world is simply to ignore how capital flows work. Japan is a seriously large economy with a seriously powerful central bank. This is not Greece or Argentina. This is going to do some damage.

I have no idea whether Japan’s BANG! moment is just around the corner or still several years off, but rest assured that Governor Kuroda and his colleagues at the Bank of Japan will respond to economic weakness with more… and more… and more easing over the coming years.

In the euro area, European Central Bank Chairman Mario Draghi – with unexpected support from his two voting colleagues from the German Bundesbank – is finally signaling that more quantitative easing may be on the way to lower painfully high exchange rates that constrain competitiveness and to raise worryingly low inflation rates that can precipitate a debt crisis by steepening debt-growth trajectories. This QE will be disguised under the rubric of fighting inflation, and all sorts of other euphemisms will be applied to it, but at the end of the day, Europe will have joined in an outright global currency war.

I don’t expect the Japanese and Europeans to engage in modest quantitative easing. Both central banks are getting ready to hit the panic button in response to too-low inflation, steepening debt trajectories, and inconveniently strong exchange rates.

While the Federal Reserve, European Central Bank, Swiss National Bank, Bank of England, and Bank of Japan have collectively grown their balance sheets to roughly $9 trillion today, the next wave of asset purchases could more than double that balance in relatively quick order.

This is what I mean by Code Red: frantic pounding on the central bank panic button that invites tit-for-tat retaliation around the world and especially by emerging-market central banks, leading to a DOUBLING of the assets shown in the chart below and a race to the bottom, as the “guardians” of the world’s primary currencies become their executioners.

The opportunity for a significant policy mistake from a major central bank is higher today than ever. I share Bill White’s concern about Japan. I worry about China and seriously hope they can keep their deleveraging and rebalancing under control, although I doubt that many parts of the world are ready for a China that only grows at 3 to 4% for the next five years. That will cause a serious adjustment in many business and government models.

It is time to hit the send button, but let me close with the point that was made graphically in the Bank of England’s chart back in the middle of the letter. Once central bank asset purchases cease, the BoE expects real asset prices to fall… a lot. You will notice that there is no scale on the vertical axis and no timeline along the bottom of the chart. No one really knows the timing. My friend Doug Kass has aninterview (subscribers only) in Barron’s this week, talking about how to handle what he sees as a bubble.

“Sell in May and go away” might be a very good adage to remember.

Amsterdam, Brussels, Geneva, San Diego, Rome, and Tuscany

I leave Tuesday night for Amsterdam to speak on Thursday afternoon for VBA Beleggingsprofessionals. There will be a debate-style format around the theme of “Are there any safe havens left in this volatile world?” I plan to write my letter from Amsterdam on Friday and then play tourist on Saturday in that delightful city full of wonderful museums. Then, if all goes well, I will rent a car and take a leisurely drive to Brussels through the countryside, something I have always wanted to do. I may try to get lost, at least for a few hours. Who knows what you might stumble on?

I will be speaking Monday night in Brussels for my good friend Geert Wellens of Econopolis Wealth Management before we fly to Geneva for another speech with his firm, and of course there will be the usual meetings with clients and friends. I find Geneva the most irrationally expensive city I travel to, and the current exchange rates don’t suggest I will find anything different this time.

I come back for a few days before heading to San Diego and my Strategic Investment Conference, cosponsored with Altegris. I have spent time with each of the speakers over the last few weeks, going over their topics, and I have to tell you, I am like a kid in a candy store, about as excited as I can get. This is going to be one incredible conference. You really want to make an effort to get there, but if you can’t, be sure to listen to the audio CDs.  You can get a discounted rate by purchasing prior to the conference.

The Dallas weather may be an analogy for the current economic environment. To look out my window is to see nothing but blue sky with puffy little clouds, and the temperature is perfect. My good friend and business partner Darrell Cain will be arriving in a little bit for a late lunch. We’ll go somewhere and sit outside and then move on to an early Dallas Mavericks game against the San Antonio Spurs. Contrary to expectations, the Mavs actually trounced the Spurs down in San Antonio last week. Of course the local fans would like to see that trend continue, but I would not encourage my readers to place any bets on the Mavericks’ winning the current playoff series.

I live only a few blocks from American Airlines Center, and so normally on such a beautiful day we would leisurely walk to the game. But the local weather aficionados are warning us that while we are at the game tornadoes and hail may appear, along with the attendant severe thunderstorms. That kind of thing can happen in Texas. Then again, it could all blow south of here. That sort of thing also happens.

So when I warn people of an impending potential central bank policy mistake, which would be the economic equivalent of tornadoes and hail storms, I also have to acknowledge that the whole thing could blow away and miss us entirely. I think someone once said that the role of economists is to make weathermen look good. Recently, 67 out of 67 economists said they expect interest rates to rise this year. We’ll review that prediction at the end of the year.

I’ve been interrupted while trying to finish this letter by daughter Tiffani, who is frantically trying to figure out how to buy tickets to get us to Italy (Tuscany) for the first part of June for a little vacation (along with a few friends who will be visiting). I am going to take advantage of being in Rome at the end of that trip, in order to spend a few days with my friend Christian Menegatti, the managing director of research for Roubini Global Economics. We will spend June 16-17  visiting with local businessmen, economists, central bankers, and politicians. Or that’s the plan. If you’d like to be part of that visit, drop me a note.

Finally I should note that my Canadian partners, Nicola Wealth Management, are opening a new office in Toronto. They will be having a special event there on May 8. If you’re in the area, you may want to check it out.

Have a great week, and make sure you take a little time to enjoy life. Avoid tornadoes.

Your hoping for a major upset analyst,

John Mauldin