The government is playing a dangerous game. In our society, power rests on belief. In the most basic sense, you vote for the people you want representing you in government. The ones who make laws and rule on your behalf. You vote for them presumably because they represent an alignment with your interests; you "believe" that they will move the country in a direction you think is beneficial and important.
What happens when that belief starts to crumble? What happens when government of, by, and for the people slides into...something else? When the people see institutions of authority as a system rigged against them? The BLM protests last summer (and ongoing) come from that place. So, too, do the election protests. And the lockdown protests that are spreading across Europe and Australia (and coming to the US?).
People, understandably, feel a need to take action. To regain some semblance of control. Our largest collective identity - as a nation, under the same institutions of authority - breaks down and identity becomes more fractured; an "us" vs "them" mentality that fractures across any number of ideological fault lines. The more the belief that those in power have the collective good in mind breaks down, the more fractured those identity groups become until, at the extreme, you end up with anarchy.
Now, governments everywhere and always tend to play fast and loose with credibility. In our own country, you can easily point to entry into the Vietnam War, Weapons of Mass Destruction in Iraq, or domestic surveillance as examples of blatant government lies. But it feels somehow different when you see it play out in front of you. Day in, day out in realtime.
For example, Gavin Newsome is in a bit of hot water again. After his earlier French Laundry gaffe last year (unmasked, non-socially-distanced, indoor $400+ per-person-tasting-menu dining for a lobbyist's birthday that flaunted his own state-mandated COVID restrictions), he's now answering questions about why his kids are at an unmasked indoor summer camp (which he had to sign a waiver for) when he just mandated masks for all "youth gatherings". There's clearly nothing nefarious there, but the optics are terrible. It's a small example of the "I can do whatever I want but you have to obey these onerous rules I just made" sentiment that leads to erosion of belief in government.
A more concerning credibility issue is the CDC's most recent flip-flop on masking. Here's the Director of the CDC earlier this week: "Today, we have new science related to the Delta variant that requires us to update the guidance regarding what you can do when you are fully vaccinated."
"New science". New science? Seriously?? You're the Director of the CD-freaking-C. Did you camp out in front of the Science store overnight to be the first one to get your hands on the newest version of Science? Did you go down with James Cameron and find a heretofore unknown species of Science at the bottom of the ocean? Are you suggesting that germ theory has gone the way of miasma and humoral theories in the progression of scientific thought about disease?
No. The word she was looking for was "data". They have new "data" related to the Delta variant. The problem with "data" is that it's subject to interpretation, whereas "science" has become unquestionable dogma. As in "Science is real". So the CDC Director says "new science" as a means of passing off a data interpretation as unquestionable fact.
(As an aside, the problem with this is that it leads to denigration of actual scientific conclusions as each side politicizes their preferred data under the banner of "science". And then you end up with the Speaker of the House saying - and this is a direct quote, not a Jan Brady adaptation - "Science, science, science, and science. To almost every subject that you can name, science is the answer. Whether it's the climate crisis, whether it's the health crisis, whether it's our preeminence in the world and...technology, science, science, science, science."
Fun fact: research (aka "science") from the National Institute of Health has shown that concept formation, abstraction, and mental flexibility decline with age, especially after age 70. And, apropos of nothing: Pelosi is 81, McConnell is 79, Biden is 78, Trump is 75.)
But this is not a COVID newsletter, other than to tongue-in-cheekily point out that the "masks are useless; maybe mask; definitely mask; double mask; no mask; mask" evolution over the last year-and-a-half coupled with the "vaccines-are-super-effective-but-still-wear-a-mask" tightrope the CDC is trying to walk requires more superpositioning than Schrodinger's Cat. And one does get the feeling that the credibility of public health officials globally is starting to erode rather quickly.
Rather, this newsletter is mostly about another institution of authority that is stumbling its way into a credibility crisis: the Federal Reserve.
The big market news this week is mostly the expanded Chinese regulatory crackdown, which sent emerging markets tumbling below their 200-day moving average (and the first time in about a year any of the major indices have broken that line). To recap, late last year China cancelled the IPO of Jack Ma's (of Alibaba fame) Ant Group, which was set to be easily the largest IPO ever. Then, earlier this summer, China launched an investigation into Didi (Chinese Uber) a couple days after it IPO'd in the US. The most recent crackdown hit the education sector, as China ordered the for-profit education sector to become non-profit and banned them from raising public capital.
Here's what an index of Chinese tech companies has done since February:
Ouch. If it's not clear in the chart, that's a drop of about 45%. It's always a bit hard to ascribe intent to the things that come out of China, but if we had to guess, we would suggest that it has less to do with any "punishing" or "retaliation" against private companies that choose to do business with the "West" and more to do with Xi Jinping actually being serious about trying to limit the inequality that comes via speculative excess and leverage in the markets.
We've pointed out before how the Fed's zero interest rates and QE-forever policies exacerbate the wealth gap and financial inequality in this country. It's honestly a bit of a refreshing signal out of China then, at least compared with our own Fed that seems intent on blowing the biggest speculative bubble possible at the expense of retirees, savers, and those without many assets. On the other hand, it's also fairly shocking when you are confronted with market potentialities when the punchbowl gets taken away.
Elsewhere in non-Fed central bank land, the Bank of Russia hiked interest rates by a full percent to try and combat "persistent factors" to inflation that they see, such as: "growing prices", "a decline in the propensity to save", "disruptions in production and supply chains", "structural changes in the labor market from the pandemic", and "price movements in global commodities".
Does any of that strike you as something that isn't happening? Other than the spike in lumber earlier this year, we kind of doubt that many of you are following global commodity prices too closely, so here's a refresher chart. This goes back to mid-2016:
Yep, they're going up. This is Russia's fourth hike this year, and they're up to an interest rate of 6.5% (!). In June, their inflation rate came in at 6.5%, so that means their real interest rate (nominal rate minus inflation) is still zero. But at least money in the bank over there is keeping up with inflation.
Contrast that with the Fed's downplaying of inflation as "transitory, transitory, transitory", even as inflation has started showing up in the data, on earnings calls, and on the shelves of grocery stores (pay attention to those package sizes: apparently, Doritos is now selling 9.25-oz bags of chips, down from 9.75-oz; Wheat Thins have started coming in 14-oz boxes instead of 16-oz; General Mills cereal "family boxes" are down to 18.1 ounces from 19.3; and toilet paper and paper towels are slowly decreasing the number of sheets per roll.)
On this side of the pond, our June inflation (CPI) came in at 5.4% year over year. Which, sure, is slightly misleading because June 2020 was still in the thick of Covid lockdowns. But so far in 2021, inflation is up 3.6%. If that pace continues, that looks like over 7% inflation for the year. So on an apples to apples basis, the real rate in Russia is 0%, and over here it's… -5.4%. Yes, negative 5.4%. Because our fed funds rate is 0%, and inflation is 5.4%, so 0 - 5.4 = -5.4%.
To perhaps overstate the obvious, money in a bank over here is losing about 5% a year.
In order to have the same 0% real interest rate over here in the US, we would have to hike rates to somewhere around 5%. Remember that little market dip last month when the Fed forecast a *gasp* possible rate hike in maybe 2022? 5% is the equivalent of 20 of those rate hikes. Right now.
Pop quiz time! What do you think that would do to markets? It would blow them up. Like, Archegos communications blowup or Chinese tech regulation blowup...but across everything.
The Fed knows this, and further knows that it is completely undoable. So they say (and pray) that inflation is transitory. Well, inflation had damn well better be transitory, because the Fed has painted themselves into a corner. And if it's not (as most corporate CEOs and certain other central banks seem to think), then their credibility is completely shot and we are currently in the middle of the worst Fed mistake in history.
At the zero bound of interest rates, the only tools left in the Fed's toolkit are "forward guidance," aka "words". (See Mario Draghi's "Whatever it takes" comment or belief in the "Fed Put". If credibility goes, then words become nothing more than hot air.
And now to close with something completely different, in the style of Sir Bedevere the Wise:
What does hot air do?
Goooood! And what else causes things to go up?
Exactly! So, logically….
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