Notes From Underground: Are We Reliving 1930?

Upon taking some time to reflect on the current state of the global macro world it seems that the most relevant are the years between 1928 and 1933. This was when the U.S. Congress was debating the famed Smoot-Hawley tariffs while the Treasury was reining in spending, and the FED was tightening liquidity and credit. While we don’t have a restricted Treasury (quite the opposite, actually), the Fed seems intent on raising rates to curtail the impact from an ill-advised fiscal stimulus at a time of 3.8% unemployment.

A FED that gives credence to a flawed Phillips Curve is prone to err on the side of raising rates at a time of contracting global liquidity and tepid growth. While this BLOG has been in favor of a more aggressive FED since 2013 (and I have the blog posts to prove it), there is a great possibility that the current environment has proven the wrong time for the FOMC to embark on an accelerated pace of tightening. Two weeks ago, I cited the Financial Times piece by Reserve Bank of India Governor Urjit Patel in which he argues that the recent FED moves to raise the FED FUNDS rate along with increased quantitative tightening and rising U.S. DEBT ISSUANCE is proving to be a DRAIN on global dollar liquidity.

Unlike 1930, the world financial system is built upon a DOLLAR STANDARD in which the FED is the key provider of the world’s reserve asset. What is the economic impact of tariffs? The global macro world has been taught that the Smoot/Hawley tariff that began in June 1930 was the economic straw that broke the proverbial back of the global economy. In a recently released book titled Clashing Over Commerce, Professor Douglas Irwin provides a 220 year history of U.S. trade relations and the politics behind much of government policy.

In regards to the Hawley/Smoot tariffs, Professor Irwin challenges well established beliefs by postulating that the world financial system was already in a deflationary environment before the increased tariffs because the FED was raising rates to stem stock market speculation. While credit to support stock prices was increasing, the velocity of money and commodity prices were already on the wane. It was the U.S. Treasury Secretary Andrew Mellon who was purported to express the Treasury’s policy as the following: “Liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate … it will purge the rottenness out of the system.”

This is not to say that the Trump administration is a believer in fiscal austerity (we know it is certainly not), but the question will remain if the FED will be more aggressive in response to the fiscal irresponsibility of the Republican Congress and a weak Treasury Secretary in Steven Mnuchin. The culmination of this appears to be the continued flattening of the U.S. yield curve. (The 2/10 currently at 34.6 basis points.) A critical difference between the world in 1930 versus today is the vast amount of public and private DEBT. The QE programs from the world’s key central banks has led to a debt explosion.

The BIS issued its annual report over the weekend warning about the explosion in global debt ratios. The FED‘s efforts to raise rates to forestall a rise in U.S. inflation becomes a problem for the global financial system as the COST OF DEBT SERVICE outpaces the benefits of fiscal stimulus. Issues to be correlated with the outcome of FED tightening and massive accumulated debt:

1. The yen continues to be a haven for Japanese investors. The problem: While YEN strengthens, the Chinese yuan weakens and this will keep the BOJ in its QQE program for far longer.

2. The yield curve in the U.S. appears to be monitoring the rising short-term interest rates, coupled with fears for massive debt accumulation and its increased servicing costs.

3. Gold will remain weak as long as short-term U.S. REAL YIELDS rise but GOLD will be a buy against other foreign currencies once the fears of central banks banking to forestall the fears of deflation. I don’t know when but will monitor.

4. Will increased fears of global trade friction lead to U.S. corporations cutting capital expenditure in response to slower global trade? There are more questions than answers but that is where knowledge begins. In the global macro world the continued focus on the tariffs results in this: Redundancy is the father of boring analysis. Please, President Trump, end the tweets as they are redundant at best.


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20 Responses to “Notes From Underground: Are We Reliving 1930?”

  1. Chicken Says:

    “Liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate … it will purge the rottenness out of the system.”

    Love it. Bernanke’s easy money accomplished the opposite and created untold “unintended” consequences.

  2. fredhavell Says:

    “GOLD will be a buy against other foreign currencies once the fears of central banks banking to forestall the fears of deflation.” I do not understand?

    • Yra Says:

      Fredhavell—good catch.That is terribly awkward and needed an edit.It should read embarking on efforts to forestall fears of deflation.The initial effort for this was Draghi’s press conference when he provided forward guidance to keep EURIBOR rates in negative territory for another year.The following day the BOJ’S Kuroda kept the BOJ in line with the ECB—the FED is pursuing a lone course but attention will be paid to FED speak about global concerns –including a slowdown from fears of trade “wars”—but rising short-term interest rates are the most dynamic element for the FED

  3. Stefan Jovanovich Says:

    Arguing against Smoot-Hawley’s prime importance is like taking the Stephen Douglas side in the debate over the foundation of Americans’ actual civil rights. They do, in fact, depend entirely on popular sovereignty and not some non-denominational God out of John Locke’s Whig apology. But no law school in America will let you think it. Compared to the effects of Davis-Bacon and the Revenue Act of 1932, the increase in tariffs was minor, as Irwin and others scholars have verified. Tariffs were blamed because they highlighed the unanswerable question: what would ecporters to the U.S. use to pay them now that they had abandoned convertibility to gold? Or, to put it another way, what price would the U.S. accept as full payment in another country’s fiat currency? Hoover’s fantasy was that the answer could be answered by him, not the credit markets.

  4. Rob Syp Says:

    Are the soybeans down a dollar 1/2 a bushel the past month from the trade tussle or something else?

    • Yra Says:

      rob–great weather and farmer hedging for fear of a Chinese drag on purchases .As discussed a few months ago–Ross,Navarro timed this wrong as it was done into the teeth of a massive Brazilian harvest and a depreciating REAL making BRAZILIAN beans very cheap for initial Chinese purchases—-that is my take and while initially the beans held up [I lost money] the recent bout of weather and the crops excellent condition in the midwest broke the back of the demand picture

      • the bigman Says:

        And the CDC reports an incredibly high rate of suicide among farmers(5x the national average) there is a very real and tragic human cost to all these manipulations

  5. Bellino Says:

    Cnbc commentators said that ECB has bought all the available
    Assets in Europe. Did I hear right? If so what does it mean?


    • yraharris Says:

      Bellino—they have bought a great deal but i think you miss heard—they may have bought all of a certain issue but certainly not all —in fact European corporations have begun to issue more corporate bonds which is a change from how they typically borrow—-I am still waiting to see how the Hinckley Point energy project gets funded

  6. rld Says:

    This blog is very informative – thanks,
    Sometimes, even the smartest and most successful people (Trump), miscalculate, and make mistakes…. Could this be a Trump miscalculation ? Time will tell, and while we wait for the outcome, there will be pain. Companies are not able to plan future strategies, and purchases, etc…..UNCERTAINTY = STRESS.

    • Publius Says:

      I know this excellent feed is not to be Twitter-like, but if you believe Trump is really smart… well, …

  7. fredhavell Says:

    Mr. Harris, thanks for the clarification, you’re the best.

  8. Bobby Z Says:

    Trump is initiating a trade war. Trump in his mind feels he is playing the part of the Lone Ranger for the US. He feels that the US is in the driver’s seat. The world needs the US not the other way around. IMHO it will get very ugly. Cover up.

  9. Pierre Chapuis Says:

    This all reminds me of the quote from Frederic Bastiat. “When goods are not allowed to cross borders, soldiers will”

  10. GreenAB Says:

    The Chinese are very smart. Read:

    So they are indirectly threatening a new financial crisis (if stocks continue to fall driven by Trump´s anti trade policy)…

    If there´s a weakness at the Trump administration, it´s the financial markets. As seen by the timing of Navarro or this mornings CFIUS news.

    • yraharris Says:

      Green AB–stealing my thunder as it is the theme of tonight’s efforts.I am just looking at an overlay of the SHCOMP with the YUAN –previous correlation breaking down

  11. Chicken Says:

    4.7% GDP growth ought to help steepen the curve, no?

  12. Arthur Says:

    Will the Chinese risk boycotting Apple when it’s one of the largest employers in China?

  13. traderjohn990 Says:

    Why are we so worried about what the Fed will “do” with Fed Funds target rate ? Does the Fed Funds target rate mostly follow (and lag ) the bill yield, the 2 yr rate ,and the actual ff overnight negotiated rate ? Therefore, is it easy to discern a hike coming ?

    Should we not be more concerned about credit demand vs. credit supply and its effect on interest rates and asset prices?

    Is the int rate the Fed pays on its received deposits and the rate those deps are burning off really the big elephant in the room?

    Have we been sold a bag of goods to believe the economy depends on the Fed, so we can embrace and enable fiscal deficit monetizations as well as large elite corporate bailouts in tough times?

    Are we being fooled into thinking the Fed needs to provide perpetual additional fuel to the economy when $ T’s are already in circulation??
    is the world fooled into fearing high debts when debts are in fact iou’s to mostly western interests ?

    Did the Fed really extinguish bullish credit cycles or did those cycles naturally fan out after animal spirit credit demand, and then as borrowing ceased , lenders cut rates and the fed followed and looked good ?

    Is the fed’s hike forecast perhaps merely a forecast of short term market rates based on history?

    Does the Fed have access to the best data with smart people ?

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