Last Friday, Chair Yellen delivered a speech at the Boston Fed’s Conference on Opportunity and Inequality. The present Fed Chair has frequently opined on the social and economic problems of income equality and I have been very critical of her wading into the waters of social and fiscal policy for many of the previous 80 years issues of wealth inequality have been dealt with through fiscal and social action. I don’t have a moral issue with Yellen’s outlook on wage inequality but I do not think it is the purview of the Federal Reserve Board to use its financial authority in placing the issue into the public domain. The FOMC has enough on its list of responsibilities without taking on the role of advocate for workers of America. Yellen’s dinner table and social engagements is a fine arena for her moral views but she dreads into very dangerous waters when using the political power of her office.
In the speech itself she undercuts one of Ben Bernanke’s most powerful policies and one I am sure she voted in favor of: THE PORTFOLIO BALANCE CHANNEL. In noting that the income gap has widened since the onset of Great Recession, much of that gap can be explained by the vast differential of education levels as higher-skilled jobs have not been as impacted by globalization. Yellen notes that even as income differences have widened, “… distribution of wealth is even more unequal than that of income.” In the Survey of Consumer Finances, “… the wealthiest 5 percent of American households held 54 percent of all wealth reported in the reported in the 1989 survey. Their share rose to 61 percent in 2010 and reached 63 percent in 2013. By contrast, the rest of those in the top half of the wealth distribution–families that in 2013 had a net worth between $81,000 and $1.9 million–held 43 percent of wealth in 1989 and only 36 percent in 2013.”
The portfolio balance channel was the term that Ben Bernanke applied to the onset of the second Quantitative Easing by the Fed, or QE2. QE drove up the price of financial assets, creating an even greater wedge between those with stocks and bonds and those who struggle paycheck to paycheck. The continuance of Fed large asset purchases has benefited the top 1 percent. If Yellen wants to limit the large differential in wealth, the FED should stop placing administrative supports under assets of financial elites. The perfect example was the verbal intervention by St.Louis Fed President James Bullard in his efforts to jawbone the equity markets higher last Thursday. My point is that the FED is wading into dangerous waters and needs to read its mission statement.
***In last Tuesday’s Financial Times, Peter Spiegel and Hugh Carnegy wrote an article titled, “Paris Stands Firm Against Fiscal Enforcers.” It notes that French Prime Minister Manuel Valls angrily responded to Brussel Eurocrats that charged France with not doing enough to restructure its budget. Valls pointedly called out Dutch Finance Minister Jeroen Dijsselbloem, saying, “The president of the Eurogroup should not make remarks like these. IT IS WE WHO WILL DECIDE OUR BUDGET. I WILL NOT ACCEPT LESSONS ON GOOD GOVERNMENT,“(emphasis mine). The French economy is stagnating and it is not a cyclical stagnation but a true structural problem.
The French budget is a classic example of too much government spending as the public sector has made up more than 50 percent of GDP for many years. A nation struggling with economic growth is in dire straits as the cost of maintaining its public grows due to increased debt costs. It was rumored that David Einhorn of Greenlight Capital recommended selling FRENCH GOVERNMENT DEBT in a speech today at the Robin Hood Conference.
The spread on German BUNDS to FRENCH OATS is currently 46 basis points–both are 10-year sovereign debt instruments. The low made last week during the drop in equity markets was roughly 35 basis points. It seems that Einhorn now sees what NOTES FROM UNDERGROUND has discussed for the last two years as French bonds were outperforming German bunds as investors were searching for higher yielding instruments. The market fundamentals seemed not to matter as money chased an extra few basis points. Now, David Einhorn believes fundamentals will replace greed or as Keynes would say, “Markets can remain irrational longer than you and I can remain solvent.”
French bonds have been the beneficiary of European domestic banks buying sovereign debt because it carries a zero risk weighting and no reserves are required to hold European sovereigns. Be aware of what happens to higher yielding sovereign debt–compared to German bunds–after the release of the ECB‘s Asset Quality Review (AQR) this coming Sunday. The only economic bright spot for French President Hollande has been the compression of French bond yields relative to German bund yields. Tonight, courtesy of Bloomberg, here’s a three-year chart for the BUND/OAT. The low and high for the spread is duly noted. This is very important to watch for a barometer of European finances and German and French cooperation.