Power & Market

As reported by CNBC last week, the Consumer Price Index (CPI) figure of 6.5% shows how the mainstream media disseminates false economic information for consumption by the masses. Try to spot some of the more concerning parts:

december_2022_cpi_inflation.png

Initially, the chart raises questions such as where this data comes from and who participated in the sampling. Once the data was compiled, how did statisticians determine what constitutes the “average” egg, frankfurter, or new vehicle?

In another article, CNBC tries to explain:

CPI is the most closely watched inflation gauge as it takes into account moves in everything from a gallon of gas to a dozen eggs and the cost of airline tickets.

As discussed on multiple occasions, calculating (price) inflation is the Art of Moving the Goal Posts. Consider the impossibility of comparing gas, eggs, and an airline ticket. Adding them up and dividing by 3 would not produce meaningful results.

However, if weights of relative importance were assigned to every individual item then apples could be compared to oranges, mathematically. Of course, statistical calculation doesn’t equal sound logic. In addition to using highly subjective guess work to arrive at these relative weights, other tactics such as adjusting for seasonality or simply excluding certain items if they’re “too volatile” are employed to massage the CPI.

Consider the two images below, the first being the latest snapshot of the CPI data showing the relative importance:

relative_importance_nov_2022.png

Now compare the relative importance from almost a year ago:

relative_importance_jan_2021.png

According to the charts, since last year, food has become less important while energy has become more important. Unfortunately, we live in a society that values statistical calculation and the ability to draw upon data more than reasoning.

Rather than argue with merits or lack of logic itself, mainstream economists found that the best career move is to not fight for the truth, but embrace the data, flaws included. This leads to Fedspeak like this excerpt from Andrew Hunter, a senior economists at Capital Economics who told CNBC:

The huge amount of inflation we had from rising gas prices has now almost completely reversed.

It’s one thing to say (price) inflation has slowed in recent months, but to claim “almost completely reversed,” simply makes no sense. The average person could only wish that prices have reversed, meaning price decreases, but this is not the case. At best, we can hope for a slowdown in the rate of increase.

He’s not alone in his inflation elation. In the same article, Mark Zandi, chief economist at Moody’s Analytics said:

I don’t think people will be talking about inflation this time next year.

And despite the skyrocketing price of eggs as purported by the abundance of memes on social media, he went so far as to say:

I think it’s already starting to feel better for people.

Naturally, Moody’s top economist is in a much higher income bracket than the average person; so his perspective could be skewed.

Ultimately, the biggest red flag is waved, not by the data itself, or the economists whose job it is to cheerlead the Fed and its support system, but it comes from this:

Inflation closed out 2022 with a 6.5% annual reading, as measured by the consumer price index, the U.S. Bureau of Labor Statistics said Thursday. It was in line with economists’ expectations.

Given the countless data fields and inputs, including relative weights of importance required to arrive at the CPI figure, how is it conceivable that economists’ expectations matched that of the bureau of labor and statistics?

Either these economists are really that good, or this data is really that bad. 

The average price of eggs increased by 49%, butter/margarine by 34% year-over-year, CNBC reported as of November. Yet, with his first speech of the year, Federal Reserve Chair Jerome Powell addressed the issue of the Fed’s independence. Yes, the conference was on Central Bank independence. But how many Americans have any concern, or the slightest care for this?

At a conference in Sweden, Powell made his case using an appeal to democracy:

With independence comes the responsibility to provide the transparency that enables effective oversight by Congress, which, in turn, supports the Fed's democratic legitimacy. 

Strange that one of the country's most opaque (and possibly most unconstitutional) organizations speaks about both transparency and democratic legitimacy; but once the propagandists commit to Orwellian leaps of the absurd, they must never deviate from the narrative.

Normally, talk about Fed independence centers around being independent from Congress. It was Congress who was tasked by the constitution to handle monetary affairs of the country; it was also Congress who essentially outsourced the task to the Fed. However, Powell somewhat deviated from script when speaking about Fed independence in relation to the banking system.

In the area of bank regulation, too, the Fed has a degree of independence, as do the other federal bank regulators. Independence in this area helps ensure that the public can be confident that our supervisory decisions are not influenced by political considerations.

It’s an odd relationship. I frequently express how peculiar it is that the Fed is tasked with regulating the banking system while simultaneously paying an annual dividend to the very banks it regulates. In addition to the payout of very (normally) large profits, the Fed acts as the “lender of last resort,” creating money to buy bonds when it chooses, bails out wall street, pays interest on bank reserves held at the Fed, conducts repo/reverse repo operations, carrying out all sorts of tactics to keep the banking sector afloat.

No other industry is supported like the banking industry. The existence of the Fed allows banks to take on tremendous amounts of risk, knowing the Fed will protect the downside. In other words: privatize profits and socialize losses; one of the many reasons those who long for a free and fair society are against the Fed.

And so, in addition to lack of transparency, the Fed has an independence problem, whether from Congress or the banking sector. If there was something to agree with him yesterday, it would be that the Fed should not use its monetary powers to tackle climate change. Unfortunately, his stance on not being a “climate policymaker” is not without caveats. Powell tells us:

Decisions about policies to directly address climate change should be made by the elected branches of government and thus reflect the public's will as expressed through elections.

… if it wasn’t clear:

But without explicit congressional legislation, it would be inappropriate for us to use our monetary policy or supervisory tools to promote a greener economy or to achieve other climate-based goals.

Was he giving a wink to Congress?

The moment Congress gives the Fed explicit direction to fight climate change is the moment it becomes appropriate to use the Fed’s monetary firepower to fight the war on climate change. As the democratic process affords, this would be okay if the public, via the electoral process, expressed enough interest on the topic.

It all invokes an interesting conclusion which illustrates the myth of Fed independence. It’s Congress (backed by wealthy individuals) who allows the Fed to exist. The Fed can only serve as a tool to protect special interests (i.e. the same wealthy individuals); and the Fed would never end itself anymore than Congress would. It’s a messy affair! But the Fed, Congress and the current banking system are inextricably linked, and by their very nature go against the public’s interest.

Another month has passed, and the Federal Reserve has once again been able to shrink its balance sheet. It’s now 7 months since the official start of Quantitative Tightening (QT). As of last release, on Thursday, their balance sheet stood at $8.507 trillion.

The long-term chart reveals it’s much easier to expand the balance sheet than to shrink it, with stock market crashes and recessions typically following.

fed_balance_sheet.png

The prior month’s article left off on November 30, when the balance sheet was over $75 billion higher. From Nov 30 to Jan 4, the US Treasuries (UST) balance decreased by roughly $58 billion and the Mortgage-Backed Securities (MBS) balance decreased by roughly $17 billion. (The reports come out every Thursday, so the time period is irregular).

Until we reach the inevitable conclusion of this Fed “tightening,” we will undoubtedly witness milestones and data points which we don’t see too often. Ryan McMaken wrote an article on the money supply and its recent move into negative growth. He noted that it is “not in itself an especially meaningful metric;” however, it does speak to the times we’re living in considering the last time this happened was 28 years ago. Look for new milestones to be hit as we continue along the path to a formal recession. Metrics such as how low the yield curve goes, for example, is a good one to watch.

In addition to economic data we must follow the headlines, like this one from CNBC, just at year end, to serve as a sign of things to come:

Stocks slipped on Friday to end a brutal 2022 with a whimper, as Wall Street wrapped up its worst year since 2008 on a sour note.

Of course, the Fed’s Monumental Monetary Tightening tends to have that effect on equities. And while the Fed can always print more money and may never technically become bankrupt, not every institution is as lucky. CNBC reminds us:

Bed Bath & Beyond warned Thursday it’s running out of cash and is considering bankruptcy.

Anyone holding Bed Bath & Beyond’s $1.2 billion in unsecured notes should be worried. To assuage reader’s fears, I checked the Fed’s Secondary Market Corporate Credit Facility (SMCCF) to see which corporate bonds America’s central bank held due to the COVID-19 crisis. The “SMCCF Transaction-specific Disclosures (XLSX)” document reveals the bonds previously held by the Fed:

corporate_bond_holdings.png

(Note: The list above is from the last disclosure XLSX file on October 13, 2021, but on the January 11, 2021 file, the Fed held bonds of 557 different companies; this excludes all bond ETF holdings!).

Luckily Bed Bath and Beyond didn’t make the list. But why the Fed held bonds of Pfizer, Target, or Toyota… or any other multinational organization is knowledge in which we’ll never be privy.

In 2023, expect to see news headlines pile up as more companies inexplicably find that the sure bets they placed when credit was cheap and easy are not so certain anymore, now that credit is more expensive and harder to come by.

As a reminder, the continual problem (and inevitable conclusion) did not start when the Fed decided to tighten in 2022; rather, the foundation for failure was laid in 2020 when they chose to expand the balance sheet (again). It began with the $5 trillion money creation scheme, when the Fed intervened, buying bonds of Target instead of our once beloved, and possibly now defunct Bed Bath & Beyond.

If you follow Indian politics, chances are you expect news of political horse trading every major election cycle. Horse trading is the phenomenon of elected representatives switching their party affiliations, often in exchange for money or roles in government. When there are simultaneous elections in several states, and the time that lapses between elections less, the machinery of all our political parties is devoted to churning out strategies for winning. And this makes the partisan system of our politics the elephant in the room, but an invisible one.

Horse trading has been around for as long as Indian democracy, yet we always view it as something that morally corrupts the ideal realm of politics every other season. In reality, it is a result of the incentives created by the institutional structure of our polity.

Partisanship has come to be seen as a default in contemporary politics, but this was not always the case. Moreover, it is not viewed as a source of our political problems per se, because both political action and analysis obscure the incentives that it gives rise to.

In ancient Athens, eligible adult male citizens could vote on laws and contest to lead (though this criterion wasn't ideal). Throughout medieval India, there existed one form or another of republican government, some of which continued into the modern period at smaller levels. When the United States was being formed, the Founding Fathers too wanted to insulate the spirit of republicanism from the tensions inherent in a democratic setup. James Madison famously argued about the threat factionalism posed to citizens’ rights. s

In a republic, the constitution is supposed to place institutional checks on the government and places power with the individual. In a democracy, it is the people, the majority, from whom flows the power to govern and make laws. A democratic system is supposed to supervene upon a republican framework, not overwhelm it.

But once elected, a democratic government may escape the checks placed on it constitutionally. This issue is magnified in the case of India, whose constitution already tilts more towards a unitary state than a federal one. Even China boasts a greater degree of decentralization (albeit with its own set of drawbacks). But primarily, it is the capacity of this democratic ideology to generate partisan political factions that allows it to upend the power given to voters.

First, it is important to wrest the romance associated with democracy and the election process. The way in which people exercise their votes is itself highly opaque and ethically fraught. Several scholars like Garett Jones, Bryan Caplan and Jason Brennan have studied this in detail.

Once we have a nonromantic view, it can be extended to the contestants of the election process. Unlike voters, those who contest for representation end up competing for votes as well as factions/parties. A win/loss in one space sends out corresponding signals in the other. In fact, this is exactly how a democracy draws out and maintains the voter-legislator distinction, which is normatively absent in a republic. 

Horse trading, a metaphor that originated from the untrustworthy market for horses during the so-called Gilded Age in the US, is indicative of the lack of market mechanisms (profit/loss and pricing) to discipline immoral behavior. It is apt for an institutional environment that creates a ‘market’ for politics, but not where it may be useful.

In other words, it is the voting mechanism that needs to be supplemented with improved knowledge, but it is large, powerful political parties that become the principal buyers and sellers. They shape outcomes and trade the stamp of their identity and partisanship with politicians. Often, politicians are not identified by the policies they espouse but by their party-based identities. This completely misses the fact that governance and representation are services provided to citizens, not just marks of social status.

There are two ways to overcome such partisanship: by creating a single party state, and by creating an altogether nonpartisan state. The former requires a strong, authoritarian, top-down structure, which is incompatible with the essential freedoms of individuals. The latter is the way to go forward. Nonpartisan politics do not entail that we get divided into tiny republics. For Madison too, it was the opposite. To go beyond narrow-minded factionalism, one needed to be politically positioned in a larger national sphere. In our times, the challenge he grappled with is even more critical. Polarization and partisanship still loom large, even if they are not dramatically high. But this is exactly the context in which an institutional intervention becomes vital.

This kind of intervention ought to be Hayekian in a sense, as it would be aimed at shifting the rules of the game to make it more conducive to catallactic action. In his famous essay, “The Use of Knowledge in Society,” Hayek cautioned against the seductive power of the belief that civilizational phenomena are produced and maintained through some sort of conscious ordering.

Thus, recognizing the shortcomings of ideological democracy does not go to suggest that the republic is the best political fix. It is to draw attention (especially in the Indian context) to why we constitutionally call ourselves a ‘republic’: to preserve our ability to have an individual political life within the socioeconomic collective, and continuously check the centralizing institutional orientation of democratic politics.

We ought to bend away the channels for partisan tendencies to get concentrated at the top. It is a matter of urgent political reform to reimagine the service of governance as equivalent to any other essential good or service, not as something that sits outside the economy.

The conventional view that compares opportunistic political transactions to greed-infested, bad-faith ‘markets’ gives us a simplistic description, not an analysis of the causes. It presumes that democratic politics exists in an ideal realm, and its flaws are the imperfections of humanity.

On the other hand, the institutional view underlines how, when certain rules of the game have ossified, general economic behavior can have corrupt outcomes. The economist James Buchanan said this best in his 1986 Nobel Prize lecture:

The relevant difference between markets and politics does not lie in the kinds of values/interests that persons pursue, but in the conditions under which they pursue their various interests.