Bannonomics, Not Trumponomics Will Crush the Economy

This article was first published by me on Talkmarkets:

Steve Bannon threw major confusion into the markets with an interview at Hollywood Reporter where he said:
"I’m the guy pushing a trillion-dollar infrastructure plan," said Bannon in the interview. "With negative interest rates throughout the world, it’s the greatest opportunity to rebuild everything. Ship yards, iron works, get them all jacked up. We’re just going to throw it up against the wall and see if it sticks."
This is essentially a call for the New Normal on steroids. The problem with this is that it is the opposite of the euphoria pushing the markets up, a strong dollar and higher interest rates! It is the opposite of the Trumponomics analysis given by Wilbur Ross. But Bannon would have to allow the recession that is expected as we are at the end of the business cycle, in order for stimulus to work in its aftermath, because there may not be enough slack in the economy. And Bannon would likely have to turn it into a major depression!

The Republicans actually made a mistake as to timing, and probably should have allowed Obama a bigger stimulus package when there was slack in the economy in 2009. But they were selfish and determined to destroy Obama from the start, wanting him to be a one term president. An additional stimulus, at the beginning of Obama's second term, still prior to the end of the business cycle would have been more effective than now.

So now, at the end of the business cycle, where there is little slack, that fiscal stimulus could be a big mistake. Steve Bannon appears to understand this in a diabolical way. But for his plan to work the dollar would have to crater and rates would have to plunge and the stimulus would have to be delayed! Millions of people could lose their jobs and a credit crisis of epic proportions would be the result. This would be Bannonomics, not Trumponomics.

The question is, are Bannon and Trump on the same page as to the timing of the stimulus?  Would Donald Trump sanction a massive economic depression? 

Don Irvine Photo Flickr
Prior to becoming a founding contributor to Talkmarkets, Tyler Durden presented a fascinating article about the bond market. I will try to tie it in with other views about bond activity in the new normal and with Bannonomics and Trumponomics.

The argument made is that when stress happens in the financial system, collateral demand rises. The number that is stated for times of stress, is 11.2 Trillion dollars of collateral. While some markets allow collateral to be stocks, and high risk assets, UST's are the collateral of choice. As Tyler Durden points out, the UST collateral is valued more highly than gold. I have called it the new gold many times.

The obvious possibility of a shortage is made worse by collateral simply being tied up. Rehypothecation has stringent rules, but is certainly a large factor in collateral for loans. Clients of lending institutions get a better rate if they allow their collateral to be pledged by the lender to some other transaction.Then there are derivatives, margin stock buying, huge markets that require collateral and more of it in times of stress.

Tyler takes a dim view of netting. And of course, netting didn't work so well when things crashed with Lehman. Now times have changed, some, since the 2013 article, with QE ending.

But the concept of new normal is still with us, and bond demand, despite the Trump tantrum, is still strong. Durden is worried that there is little collateral in the shadow banking system. Here is a definition of the shadow banking system: 
Shadow banking is a blanket term to describe financial activities that take place among nonbank financial institutions outside the scope of federal regulators. These include investment banks, mortgage lenders, money market funds, insurance companies, hedge funds, private equity funds and payday lenders, all of which are a significant and growing source of credit in the economy.
Contrast the Durden article with a recent Durden article on Talkmarkets that quotes a Bloomberg article. The gentleman being quoted makes an astonishing statement:
“If we sell a bond to the market and try and buy it back, the cost will be higher and we’re not sure we can get hold of it again,” said Yann Couellan, Paris-based head of trade execution for fixed income at AXA Investment Managers, which oversees 679 billion euros ($755 billion) of assets. “It makes sense for us to keep the bond internally.”
So, the Durden argument is that this problem is exacerbated by the Fed not providing enough liquidity and if it did prices would decline and yields would go up. However, these companies and counterparties must have it in the back of their heads that they must buy more and more collateral and upgrade their collateral to protect their positions in time of stress. They may think of that 11. 2 trillion dollar number and realize that they are sorely lacking in sufficient quality collateral if the day of reckoning comes.

An  LSE Study shows that there could be shortages of collateral due to rehypothecation now. Think of how things could be and the panic that would set in in times of stress! No wonder institutions hoard UST's.

So we can look at how bond demand will affect both Trumponomics and Bannonomics:

In Bannonomics, all this hoarding of bonds may prove to not be sufficient. Collateral shortages could become the norm. Trades and loans would be curtailed and lending would crater.

In Trumponomics, Dr. Edward Lambert says:
The dividing line about Trumponomics falls on whether ones sees that it will cause output growth or not. I think the output growth will be disappointing because we are at full employment. Greenspan seems to see the same.
The other issue is whether Trumponomics will create inflation. I do not believe so, since after-tax corporate profits are expected to rise and the dollar is getting strong. Both of these are strong headwinds to inflation. However if labor share can rise at full employment, that would help inflation. But I am becoming pessimistic about a rise in labor share. I need to see some data that hasn't been released yet.
At the moment I do not foresee inflation or growth, just higher interest rates which will end the business cycle as most always happen. [Emphasis mine]
This, of course, is also the Duy and Trujillo view. The opposite view is that inflation will run hot and rising rates will follow, necessitating a quick response from the Fed. This is the view of Janet Yellen. Raising rates on the short end could go very bad if bond demand is so strong and labor share of profits remains dismal, even though we really need to get above the zero lower bound.

Jamie Dimon, as I wrote in a previous article, wants slightly higher rates but not an explosion of rates. It is difficult to see rates exploding, as long as the specter of 11+ trillion dollar collateral needs in a downturn still exists. People must upgrade collateral in situations of stress. That means, they will need sovereign bonds, and nothing else will take their place.

So, clearly, financial institutions are hoarding bonds within their own systems. Since these institutions are not like bond funds in that they will likely hold bonds to maturity, they will get their full price back on the bonds. If rates rise, they will still get par. If rates lower, they will get a capital gain. Hoarding appears here to stay.

If Steve Bannon gets his way, the Trump administration would want a Fed chairman that would likely lower rates, and tighten the money supply, and they would wait for the business cycle end, which is likely soon. The Fed chairman could then go negative and Bannon's fiscal plan would be huge as a response.

But with a credit crisis on top of massive unemployment, it becomes a monetary problem and not just a fiscal problem. As we can see, Steve Bannon has thrown massive confusion into the markets if he is serious about his plan for negative rates.


  1. Correction, the article refers to Trujillo, and of course the author meant to say Tarullo. My apologies.


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