I sat on the porch
Listened to the rain
Smoked a cigarette
And counted to ten
Oh no, here it comes again
That funny feeling
― Camper Van Beethoven, Oh No! (1985)
A quick post-Fed follow-up to “Tell My Horse”, the best-received Epsilon Theory note to date (thank you!). I’ll jump right into what I’ve got to say, without the usual 20 pages of movie quotes and the like. Well, I’ve got one quote above, because I can’t help myself. They’re the lyrics to the best break-up song ever, and they’re what Janet Yellen was singing to the market on Wednesday.
Let’s review, shall we? Last fall, the Fed floated the trial balloon that they were thinking about ways to shrink their balance sheet. All very preliminary, of course, maybe years in the future. Then they started talking about doing this in 2018. Then they started talking about doing this maybe at the end of 2017. Two days ago, Yellen announced exactly how they intended to roll off trillions of dollars from the portfolio, and said that they would be starting “relatively soon”, which the market is taking to be September but could be as early as July.
Now what has happened in the real world to accelerate the Fed’s tightening agenda, and more to the point, a specific form of tightening that impacts markets more directly than any sort of interest rate hike? Did some sort of inflationary or stimulative fiscal policy emerge from the Trump-cleared DC swamp <sarc>? Umm … no. Was the real economy off to the races with sharp increases in CPI, consumer spending, and other measures of inflationary pressures? Umm … no. On the contrary, in fact.
Two things and two things only have changed in the real world since last fall. First, Donald Trump — a man every Fed Governor dislikes and mistrusts — is in the White House. Second, the job market has heated up to the point where it is — Yellen’s words — close to being unstable, and is — Yellen’s words — inevitably going to heat up still further.
What has happened (and apologies for the ten dollar words) is that the Fed’s reaction function has flipped 180 degrees since the Trump election. Today the Fed is looking for excuses to tighten monetary policy, not excuses to weaken. So long as the unemployment rate is on the cusp of “instability”, that’s the only thing that really matters to the Fed (for reasons discussed below). Every other data point, including a market sell-off or a flat yield curve or a bad CPI number — data points that used to be front and center in Fed thinking — is now in the backseat.
I’m not the only one saying this about the Fed’s reaction function. Far more influential Missionaries than me, people like Jeff Gundlach and Mohamed El-Erian, are saying the same thing. If you think that this Fed still has your back, Mr. Investor, the way they had your back in 2009 and 2010 and 2011 and 2012 and 2013 and 2014 and 2015 and 2016 … well, I think you are mistaken. I think Janet Yellen broke up with you this week.
The Fed is tightening, and they’re not going to stop tightening just because the stock market goes down 5% or 10% or (maybe) even 20%. Bigger game than propping up market prices is afoot, namely consolidating a reputation as a prudent central banker before the inevitable Trump purge occurs, and consolidating that reputation means keeping the evilest of all evil genies — wage inflation — firmly stoppered inside its bottle.
Let’s be clear, not all inflation is created equal. Financial asset price inflation? Woo-hoo! Well done, Mr. or Mrs. Central Banker. That’s what we’re talkin’ about! Price inflation in goods and services? Hmm … a mixed bag, really, particularly when input price inflation can’t be passed through and crimps corporate earnings. But we can change the way we measure all this stuff and create a narrative around the remaining inflation being a sign of robust growth and all that. So no real harm done, Mr. or Mrs. Central Banker.
Wage inflation, though … ahem … surely you must be joking, Mr. or Mrs. Central Banker. How does that possibly advance economic efficiency and social utility? I mean, even a first year grad student can prove with mathematical certainty that wage inflation only sparks a wage-price spiral where everyone is worse off. What’s wrong with you, don’t you believe in math? Don’t you believe in science? Hmm, maybe you’re just not as smart as we thought you were. But I’m sure you’ll be very happy as an emeritus professor at a large Midwestern state university. No, Ken Griffin is not interested in taking a meeting.
I know I sound like a raving Marxist to be saying this, that the Federal Reserve system and all its brethren systems were established specifically to serve the interests of Capital in its age-old battle with Labor. But yeah, that’s exactly what I’m saying. Propping up financial markets? That’s a nice-to-have. Preserving Capital as the apex predator in our social ecosystem? There’s your must-have.
Whatever you think full employment might be in the modern age, 4.3% is at the finish line. And 4.1% or 3.9% or wherever the unemployment rate is going over the next few months is well past the finish line. You’re already seeing clear signs of labor shortages, particularly skilled labor shortages, in lots of geographies. Wage inflation is baked in, and modern populist politics make it impossible for corporations to play the usual well-we’re-off-to-Mexico-then card. Not that wages in Mexico or China are really that much better anymore, depending on what you’re doing, and there are inflationary wage pressures there, too.
Bottom line: I think that the Fed is going to do whatever it takes to prevent wage inflation from getting away from them, and shrinking the balance sheet is going to be a vital part of that tightening, maybe the most important part. Why? Because the Fed thinks it will push the yield curve higher as it lets its bonds and mortgage securities roll off, which will help the banks and provide an aura of “growth” and a cover story for the interest rate hikes. Otherwise you’ve got an inverted yield curve and a recession and who knows what other sources of reputational pain.
But here’s the problem, Mr. Investor. Ordinarily if the Fed was determined to take the punchbowl away by tightening monetary policy and raising interest rates, your reaction function was pretty clear. Get out of stocks and get into bonds. Wait out the inevitable bear market and garden-variety business cycle recession, and then get back into stocks. Or just ride your 60/40 vanilla stock/bond allocation through the cycle, which is the whole point of the 60/40 thing (even, though, of course, you’re really running a 95/5 portfolio from a risk perspective). But now you’re going to have both stocks *and* bonds going down together as the Fed hikes rates and sells bonds, in a reversal of both stocks *and* bonds going up together over the past eight years as the Fed cut rates and bought bonds.
Hmmm. ‘Tis a dilemma. What to do when indiscriminate long-the-world doesn’t work? What to do when nothing works? Maybe, with apologies to the old Monty Python line, active management isn’t quite dead yet. And just at the point of maximum capitulation to the idea that it is. Wouldn’t be the first time. In fact, that’s kinda how maximum capitulation works.
Is everything as neat and clean in reality as I’m making it out to be? Of course not. Other central banks are still buying bonds. Maybe global growth pulls everything through. Maybe President Pence/Ryan/whoever-is-fourth-in-line pushes through all the tax cuts and regulatory rollback and infrastructure build programs that your little old capitalist heart desires. Plus, this isn’t some cataclysmic event like “China floats the yuan” or “Italy has a bad election”. It’s a slow burn.
But I think that if your investment mantra is “don’t fight the Fed”, you now must have a short bias to both the U.S. equity and bond markets, not the long bias that you’ve been so well trained and so well rewarded to maintain over the past eight years. This is a sea change in how to navigate a policy-driven market, and it’s a sea change I expect to last for years.
I have found that the best way to give advice to your children is to find out what they want and then advise them to do it. ―Harry Truman (1884 – 1972)
As far as I was concerned, his decision was one of non-interference — basically, a decision not to upset the existing plans. ―Lt. Gen. Leslie Groves (1896 – 1970), commanding officer of the Manhattan Project, discussing Truman’s okay to drop atomic weapons on both Hiroshima and Nagasaki.
“Ah,” she cried, “you look so cool!”
Their eyes met, and they stared together at each other, alone in space. With an effort she glanced down at the table.
“You always look so cool,” she repeated.
She had told him that she loved him, and Tom Buchanan saw.
― F. Scott Fitzgerald, “The Great Gatsby” (1925)
And that was the end of the party. When Tom Buchanan saw.
Create her child of spleen, that it may live
And be a thwart disnatur’d torment to her!
Let it stamp wrinkles in her brow of youth,
With cadent tears fret channels in her cheeks,
Turn all her mother’s pains and benefits
To laughter and contempt, that she may feel
How sharper than a serpent’s tooth it is
To have a thankless child!
― William Shakespeare, “King Lear” Act 1 Scene 4 (1606)
Once-revered central bank failed to foresee the crisis and has struggled in its aftermath, fostering the rise of populism and distrust of institutions.
Theology, sir, is a fortress; no crack in a fortress may be accounted small.
― Arthur Miller, “The Crucible” (1953)
Few of us can easily surrender our belief that society must somehow make sense. The thought that the State has lost its mind and is punishing so many innocent people is intolerable. And so the evidence has to be internally denied.
The structure of a play is always the story of how the birds came home to roost.
That’s a very good question. I don’t know the answer. But can you tell me the name of a classical Greek shoemaker?
― Arthur Miller (1915 – 2005)
That last, one of my all-time favorite quotes, was in response to a shoe manufacturer who asked why Miller’s job should be subsidized while his was not. Miller’s finest accomplishment: when McCarthy and crew forced him to testify in their Communist witch hunt, he refused to name names. Miller was a leftie and a huge ego. And a freedom lover. Imagine that.
Yet each man kills the thing he loves
By each let this be heard
Some do it with a bitter look
Some with a flattering word
The coward does it with a kiss
The brave man with a sword
― Oscar Wilde, “The Ballad of Reading Gaol” (1898)
We’ll get the kiss, not the sword. Don’t know when, but it’s going to kill this market that the Fed loves.
In 1969, Graham Allison published an academic paper about the Cuban Missile Crisis, which he turned into a 1971 book called Essence of Decision. That book made Allison’s career. More than that, the book provided a raison d’être for the Kennedy School of Government at Harvard, which — combined with Allison’s fundraising prowess — transformed a sleepy research institute into the most prominent public policy school in the world.
The central idea of Essence of Decision is this: the dominant academic theory to explain the world’s events is a high-level, rational expectations model based on formal economics, a theory that ignores the impact of bureaucratic imperatives and institutional politics. If you look at the Cuban Missile Crisis through all three lenses, however, you get a much better picture of what actually happened in October 1962. In fact, the more you dig into the Cuban Missile Crisis, the more it seems that the actual people involved (on both sides … Allison wrote a follow-up edition in 1999 when Russian archives opened up post-Gorbachev) made their actual decisions based on where they sat (bureaucracy) and where they stood (internal politics), not on some bloodless economic model. Publicly and after the fact, JFK and RFK and all the others mouthed the right words about geopolitical this and macroeconomic that, but when you look at the transcripts of the meetings (Nixon wasn’t the first to tape Oval Office conversations), it’s a totally different story.
Allison’s conclusion: the economic Rational Actor model is a tautology — meaning it is impossible to disprove — but that’s exactly why it doesn’t do you much good if you want to explain what happened or predict what’s next. It’s not that the formal economic models are wrong. By definition and by design, they can never be wrong! It’s that the models are used principally as ex-post rationalizations for decisions that are actually made under far more human, far more social inputs. Any big policy decision — whether it’s to order a naval blockade or an air strike on Cuba, or whether it’s to drop atomic bombs on Hiroshima AND Nagasaki, or whether it’s to raise interest rates in September or December or not at all — is a combination of all three of these perspectives. But for Allison’s money, we’d do better if we focused more on the bureaucratic and political perspectives, less on the rational expectations perspective.
What follows is my analysis of the Fed’s forthcoming decision on interest rates from a bureaucratic and an internal politics perspective. Seen through these lenses, I think they hike. Maybe I’m wrong. These things are always probabilistic shades of gray, never black and white. But what I’m certain about is that the bureaucratic and internal politics perspectives give a different, higher probability of hiking than the rational expectations/modeling perspective. So heads up.
First the bureaucratic perspective.
What I’m calling the bureaucratic perspective, Allison calls the “Organizational Behavior” perspective. His phrase is better. It’s better because entities like the Federal Reserve are, of course, large bureaucracies, but what we’re trying to analyze here is not the level of do-nothing inertia that we usually associate with the word “bureaucracy”. What we’re trying to analyze is the spirit or culture of the organization in question. What is the institutional memory of the Fed? What do personnel, not just the Fed governors but also the rank-and-file staffers, believe is the proper role of the institution? Most importantly, how do these personnel seek to protect their organization and grow its influence within the jungle of other organizations seeking to grow their influence?
The spirit, culture, and personnel composition of the modern Federal Reserve is almost identical to that of a large research university. That’s not a novel observation on my part, but a 30-year evolution commonly noted by Fed watchers. Why is this important? It’s important because it means that the current marriage between Fed and markets is a marriage of convenience. As an organization, the Fed doesn’t really care whether or not markets go up or down, and as an institution it’s not motivated by making money (or whether or not anyone else makes money). Like all research universities, the Fed at the organizational level is motivated almost entirely by reputation. Not results. Reputation. A choice between “markets up but reputation fraying” and “markets down but reputation preserved” is no choice at all. The Fed will choose the latter 100% of the time. I can’t emphasize this point strongly enough. From a bureaucratic perspective, the Fed absolutely Does. Not. Care. whether or not the market goes up, down, or sideways. When they talk about “risk” associated with their policy choices, they mean risk to their institutional reputation, not risk to financial asset prices. And today, after more than two years of a “tightening bias” and “data dependency”, there’s more reputational risk associated with staying pat than with raising rates in a one-and-done manner.
Why? Because the public Narrative around extraordinary monetary policy and quantitative easing has steadily become more and more negative over the past three years, and the public Narrative around negative rates in particular is now overwhelmingly in opposition. When I did my Narrative analysis of financial press sentiment surrounding Brexit prior to that vote, I always thought that would be the most hated thing I’d ever see. Nope. I’ll append the Quid maps and analysis at the end of this note for those who are interested in digging in, but here’s the skinny: the negative sentiment around negative rates is now greater than the negative sentiment around Brexit. The public Narrative around ever more accommodative monetary policy has completely turned against the Fed. And they know it.
I think that Summers has been emboldened and Hilsenrath has been turned because they’re picking up on the same sea change in public opinion that the Quid analysis is identifying with more precision. For Hilsenrath, here’s the centerpiece of his j’accuse: a long-running Gallup poll asking Americans to rate the relative competence of federal agencies. Yep, that’s right, the Fed — which used to have a better reputation than the FBI and NASA — is now at the absolute bottom of the heap, dragging behind (by a significant margin) even the IRS! It’s one thing to bring up the rear in 2009 polls, what with the immediate aftermath of the deepest recession in 70+ years. But to still be at the bottom in 2014 after a stock market triples (!) and The Longest Expansion In Modern American History™? Incredible. And the most recent poll was in 2014. If anything, the Fed’s reputation is even lower today. I mean … this is really striking, and I can promise you that none of this is lost on the current custodians of the Fed’s prestige and reputation. Or, like Summers, the wannabe custodians. If you’re a professional academic politician like Summers, you can smell the blood in the water.
How Americans Rate Federal Agencies Share of respondents who said each agency was doing either a ‘good’ or ‘excellent’ job, for the eight agencies for which consistent numbers were available.
Source: Gallup telephone polls, most recently 1,020 U.S. adults conducted Nov. 11—12, 2014, with a margin of error of +/-4 percentage points. As reported by the Wall Street Journal.
So what does all this mean for the September FOMC meeting?
Look … does “the market” want more and more supportive policy? Of course it does. We’re addicts. But if the Fed takes a dovish stance now — and anything less than a hike is going to be perceived as a dovish stance — from an organizational perspective the Fed is risking a lot more than a market sell-off from a rate hike. It risks being blamed for anything bad that happens in the economy going forward. This is the risk of being an unpopular political actor. This is the risk of losing your reputation for competence. The Golden Rule of organizational behavior is quite simple: there must ALWAYS be plausible deniability for culpability if something goes wrong. There must ALWAYS be some other political actor to blame. Unless the Fed takes steps now to stem the erosion in their reputation and their position in the public Narrative, they will own this economy and the downturn that everyone (including the Fed) suspects is coming.
By raising rates now, on the other hand, the Fed can declare victory. We achieved our dual mandates of price stability and full employment! Mission accomplished! And unlike George Bush and his infamously premature declaration of same, the Fed has someone to blame when the “mission” unravels (which of course it will) — those dastardly fiscal policymakers who didn’t follow up with structural reforms or pro-growth policies or whatever when they were elected this November. While the consensus view is that the Fed loathes to do anything to rock the market boat before the November election, in truth this meeting is the perfect time to act if your political goal is to declare victory and pass the buck. Hey, we did our part, says the Fed. Prudent stewards of monetary policy and all that. Now, about that consulting gig at Citadel …
That’s the bureaucratic or organizational perspective. Here’s the internal political dynamic as I see it.
An internal politics perspective is similarly driven by questions of reputation, but at the individual level rather than the organizational level. In an academic organization like the modern Fed, your internal reputation is based entirely on how smart you are, as evidenced by the research you do and the papers you write and the talks you give, not on how effective you are in any practical implementation of organizational aims. It’s not that the Fed or major research universities are intentionally ignoring or trying to put down practical implementations like teaching or outreach to commercial bank staffers, but every hour you spend doing that is an hour you’re not spending impressing your colleagues and bosses with how smart you are. It’s just how the internal political game is played, and anyone who has achieved any measure of success in an organization like this knows exactly what I’m talking about.
What this means in practice is that FOMC meetings are driven by a desire to form a consensus with the other smart people around the table, so that each of you is recognized by the other members of the consensus as being smart enough to be a member of the consensus. It’s the precise opposite of the old Groucho Marx joke: “I don’t want to be a member of any club that would have me as a member.” Every FOMC member desperately wants to be a member of the club that would have him or her as a member, because it means that you’ve been recognized as one of the smart kids. The internal political dynamic of academic cultures like the Fed, at least at the highest levels of Governor to Governor interaction, is NOT antagonistic or divisive. On the contrary, it’s cooperative and consensus-forming.
Not sure what I’m talking about? Read this Jon Hilsenrath interview of St. Louis Fed Governor Jim Bullard again (I say again because I published it for other reasons in the last Epsilon Theory note, Magical Thinking), where Bullard describes this consensus building dynamic.
What kind of compromise would it take to get the FOMC to move in September? I mean, so the tradition is there’s some kind of — like you say, some kind of agreement. What would it take to get them there?
Well, I have no idea, so — and it’s really — it’s really the chair’s job to fashion that. But I will say that — I’ll talk historically about the FOMC, the kinds of things that the FOMC would do. You would trade off. You would say, OK, we could hike today, but then we’ll not plan to do anything in the future. That would be one way to — one way to go about a consensus. So that often happens on the FOMC. Or vice versa. If you read the Greenspan-era transcripts, he’ll do things like, OK, we won’t go today, but we’ll kind of hint that we’re pretty sure we’re going to go next time.
And so you get this inter-tempo kind of trade-off, and that often — that often is enough to get people to sign up.
So, hike today and then delay.
Or, no hike today and then no more delay.
Something like that.
Yeah, those kinds of trade-offs are, historically speaking — I’m not saying I know what Janet’s doing, because I don’t. But, historically speaking, those are the kinds of things that the FOMC has done.
I came up with my catchphrase for the — for the month. (Laughter.)
Those are great. That’s worthy of a T-shirt. (Laughs, laughter.) You could have one on the front and one on the back.
What Bullard is describing from a game theoretic perspective is a dual-equilibrium coordination game. Either it’s “Hike today and then delay” (Bullard’s preferred equilibrium outcome) or “No hike today and then no more delay”. Those are the two possible consensus outcomes. Both are stable equilibria, meaning that once you get a consensus at either phrase, there is no incentive for anyone to change his or her mind and leave the consensus. Importantly, both are robust equilibria in their gameplay, meaning that it only takes one or two high-reputation players in the group to commit to one outcome or the other in order to start attracting more and more reputation-seeking players to that same outcome. You can think of individual reputation as a gravitational pull, so that even a proto-consensus of a few will start to draw others into their orbit.
It’s always really tough to predict one equilibrium over another as the outcome in a multi-equilibrium game, because the decision-making dynamic is solely driven by characteristics internal to the group, meaning that there is ZERO predictive value in our evaluations of external characteristics like Taylor Rule inputs in 2016 or US/Soviet nuclear arsenals in 1962. (I wrote about this at length in the context of games of Chicken, like Germany vs. Greece or the Fed vs. the PBOC, in the note Inherent Vice). But my sense — and it’s only a sense — is that the “Hike today and then delay” equilibrium is a more likely outcome of the September meeting than “No hike today and then no more delay”. Why? Because it’s the position both a hawk like Fischer and a dove like Bullard, both of whom are high-reputation members, would clearly prefer. If one of these guys stakes out this position early in the meeting, such that “Hike today and then delay” is the first mover in establishing a “gravitational pull” on other members, I think it sticks. Or at least that’s how I would play the game, if I were Fischer or Bullard.
Okay, Ben, fair enough. If you’re right, though, what do we do about it? How are markets likely to react to the shock of a largely unanticipated rate hike?
In the short term, I don’t think there’s much doubt that it would be a negative shock, because as I write this the implied “market odds” of a rate hike here in September are not even 20%. My analysis suggests that the true odds are about three times that, as I give a slight edge to the “Hike today and then delay” equilibrium over “No hike today and then no more delay”. Do I think it’s a sure thing that they hike next week? Give me a break. Of course I don’t. But if I can be dealt enough hands where the true odds of something occurring are three times the market odds of something occurring …
The medium-to-long term market reaction to whatever the Fed decides next week is going to be driven less by the hike-or-no-hike decision and more by the Fed-directed Narrative that accompanies that rates decision. That is, if they hike next week and start talking about how this is the next step of a “normalization” process where the Fed will try to get rates back up to 3% or 4% in a couple of years … well, that’s a disaster for markets. That’s a repeat of the December rate hike fiasco, and you’ll see a repeat of the January-February horror show, where the dollar is way up, commodities and emerging markets are way down, and everyone starts freaking out over China and systemic risk again. But if they hike next week and start talking about how they’re rethinking the whole idea of normalization, that maybe rates will be super-low on a semi-permanent basis, or at least until productivity magically starts to improve … well, that’s maybe not such a disaster for markets. Ditto if they don’t hike next week. If the jawboning associated with a no-hike in September sets up a yes-hike in December as a foregone conclusion, that’s probably just as bad (if not worse) for markets than a shock today.
Of course, the Fed is well aware of the power of their “communication policy” and the control it exerts over market behavior. Which means that whenever the Fed hikes — whether it’s next week or next month or next meeting or next year — they’re going to sugarcoat the decision for markets. They’re going to fall all over themselves saying that they’re still oh-so supportive of markets. They’re going to proclaim their undying love for markets even as they take actions to distance themselves.
But here’s the thing. The Fed is now revealing its one True Love — its own reputation and its own political standing — and that’s going to be a bombshell revelation to investors who think that the Fed loves them. Investors are like Tom Buchanan in The Great Gatsby. We’re married to this really swell girl, and we get invited to these really great parties, but then we see that Daisy is truly in love with Jay Gatsby, not us. And everything changes. Maybe not on the surface, but deep down, where it really matters. I’m not saying that the Fed abandons the markets. After all, Daisy stays married to Tom. But everything changes in that moment of realization that she truly loves someone else, not you, and that’s what the next Fed hike will mean to markets.
That’s when the party stops.
Appendix: Quid Narrative Analysis
For a recap of how I’m using the Quid tool kit to analyze financial media narrative formation and evolution, please refer to the Epsilon Theory note The Narrative Machine. Below are two slides from Quid providing a quick background on the process.
Here’s the network of all 941 Bloomberg articles over the past year mentioning negative rates, colored by topic cluster:
This is a prototypical focused narrative network, indicative of articles that are truly “about” negative rates, as opposed to articles about something else that provides the clustering characteristics and only mention negative rates in passing. So now let’s look at the same network, but colored by sentiment rather than by topic clustering.
Fully 50% of the articles are negative, 42% neutral, and only 7% are positive in their sentiment.
How does this compare to other Bloomberg networks and other sentiment scores? Horribly. The only subject issue that even comes close is Brexit, with 47% negative, 42% neutral, and 10% positive in the weeks leading up to the vote. Post-vote, the negative sentiment around Brexit drops to the mid-twenties.
To be sure, few topics associated with monetary policy have an overtly positive sentiment distribution, at least in recent years. For example, here’s a chart of the Quid sentiment scores for all Bloomberg articles mentioning Quantitative Easing (QE), by year over the past three years. The Narrative is steadily deteriorating, but we’re still not close to negative articles taking the lead over neutral articles.
Sentiment Scores for Bloomberg Articles Mentioning QE, by Year
9/13 – 9/14
9/14 – 9/15
9/15 – 9/16
One final network observation. Of the positively-oriented Bloomberg articles, they tend to cluster in the topic circled below. That topic? Gold. The articles have a positive sentiment because negative rates are great for gold prices. Of course, that’s a very negative thing from the Fed’s reputational perspective, which means that many of the articles that speak positively about negative rates are actually intimating something negative about central bankers! Bottom line: there is no more hated policy initiative in the world than negative rates.
You may just be a patsy, but you’re an important one. In fact, I don’t think I’ve ever met a bigger crisis actor than you before. … This is for our country!
[Man in Bar shoots Gideon in neck, killing him]
— “Mr. Robot: eps2.0_unm4sk-pt1.tc” (2016)
Why would some poor slob on a farm want to risk his life in a war when the best that he can get out of it is to come back to his farm in one piece? … It is always a simple matter to drag the people along, whether it is a democracy or a fascist dictatorship or a Parliament or a Communist dictatorship.
The people can always be brought to the bidding of the leaders. That is easy. All you have to do is tell them they are being attacked and denounce the pacifists for lack of patriotism and exposing the country to danger. It works the same way in any country.
— Gustave Gilbert, interview recording of Hermann Göring for “Nuremberg Diary” (1947)
Hermann Göring and the Nazis didn’t burn the Reichstag down in 1933. They left that to a simpleton Communist patsy (that’s him in the photo; quite the ur-terrorist, no?). But Göring and the Nazis used the Reichstag fire as their excuse to arrest thousands, establish Hitler as the Führer and unleash a decade-plus of fascist horror on Germany and the world. History is rhyming today, as it always does.
Hynkel, the dictator, ruled the nation with an iron fist. Under the new emblem of the double cross, liberty was banished, free speech was suppressed and only the voice of Hynkel was heard.
― Charlie Chaplin, “The Great Dictator” (1940)
Just need a little hair dye on that Erdogan moustache, and I think we’re good to go.
You’re crazy. I know who I am. You’re trying to frame me. You’re trying to frame me. Cyphre, I know who I am. You murdered them people. I never killed nobody. I didn’t kill Fowler, and … and I didn’t kill Toots, and I didn’t kill Margaret, and I didn’t kill Krusemark, I didn’t kill no one!
I’m afraid you did, Johnny.
My name’s not Johnny!
All killed by your own hand. Guided by me, naturally. Frankly, you were doomed from the moment you slit that young boy in half, Johnny … for twelve years you’ve been living on borrowed time and another man’s memories.
― Alan Parker, “Angel Heart” (1987)
My favorite De Niro role, worth watching just for the fingernails and the way the man eats an egg.
I shouted out,
Who killed the Kennedys?
When after all
It was you and me.
― Jagger and Richards “Sympathy for the Devil” (1968)
Four people died at the 1969 Altamont concert, including a front row murder during the Stones set. It’s fun to strut on stage and sing about this stuff, until the Hells Angels show you what you’re singing about.
When you strike at a king, you must kill him. ― Ralph Waldo Emerson (1803 – 1882)
Omar: Come at the king, you best not miss.
― David Simon, “The Wire” (2002)
Everything I know about politics, I learned from “The Wire”. That and a Ph.D. in Government from Harvard. But mostly “The Wire”.
I hope they don’t hang you, precious, by that sweet neck. Yes, angel, I’m gonna send you over. The chances are you’ll get off with life. That means if you’re a good girl, you’ll be out in 20 years. I’ll be waiting for you. If they hang you, I’ll always remember you.
― John Huston, “The Maltese Falcon” (1941)
I think it’s a guy thing, this willingness to be a patsy for a cause, be it love, or lust, or greed, or religion … or a political party. Don’t be a patsy. Be a Sam Spade. Be an Omar.
A “crisis actor” is a familiar theme in all sorts of conspiracy theories. Basically, the idea is that terrorist attacks and the like are false-flag operations, where nefarious government agencies kill their own citizens, directly or indirectly, in order to instill fear and maintain popular support for the smiley-face authoritarianism of the modern State. Crisis actors are the patsies hired by the agencies to weep and wail for the cameras, creating the initial Narrative of terror and supporting the follow-on Narrative of steely government resolve to track down the supposed bad guys.
As per usual with conspiracy theories, the specifics of their claims about crisis actors are nonsense. It’s not “the same girl” crying at Newtown and Orlando and Nice, as the photos on conspiracy websites claim. CNN isn’t a secret division of the CIA. Neil Armstrong really did walk on the moon.
Hermann Göring and Erdogan are crisis actors, pretending that the Nazis or the Islamists are the only force standing between the Motherland and political traitors within and abroad, pretending that their “emergency policies” are anything less than a permanent seizure of political control.
It’s oh so easy to look at what’s going on in Turkey and shake our heads and tsk-tsk that awful Erdogan and the awful anti-democratic things he’s doing over there. Because it IS awful. What’s happening today in Turkey is absolutely a carbon copy of what happened in Germany in 1933 with the Reichstag Fire, and every Western president and prime minister and chancellor and secretary of state and foreign minister — all of whom are mouthing the same diplo-speak pablum about the Islamist fascists of 2016 that their counterparts mouthed about the Nazi fascists of 1933 — will have the same stain on their souls. Not that I’m sure many of this 2016 crowd have a soul left to stain. As Gertrude Stein famously said about Oakland, and I’m saying about these crisis actors, there’s no there there. Whatever human beings they used to be, it seems they’ve been absorbed by their public cartoons, which is really just … sad.
But look homeward, angel. Look homeward, too.
Paul Krugman and Tom Friedman and Jim Cramer and their media Missionary kin are also crisis actors, pretending that the Brexit vote was a deluded, colossal mistake perpetrated on innocent UK voters by economic traitors within and abroad.
Janet Yellen and Mario Draghi and their central bank Missionary kin are also crisis actors, pretending that their “emergency policies”, now more than seven years old, are anything less than a permanent political shift in the global allocation of money and credit.
I mean, can’t we just stop these charades surrounding “the Horror of Brexit” and “data dependence”? Can’t we just admit that it’s all an exercise in — to use the Fed’s terminology — “communication policy”, where words are chosen for effect rather than to convey true belief or opinion … or what we would call in normal human interaction “lying”?
Of course we can’t. Whether you’re Göring or Erdogan or Yellen or Draghi, once you start weaving that tangled web of deception, you can’t un-weave it. Once you sell your soul to the Narrative Devil you can’t buy it back. Erdogan can’t walk his purge back even if he wanted to. Yellen can’t walk her dot plots and forward guidance back even if she wanted to. Draghi and Kuroda are never going to go on stage and shrug their shoulders and say “oops, sorry ‘bout that.” At least St. Louis Fed Governor Jim Bullard didn’t have to flee to Greece for his “failed dot plot coup”.
And yeah … I understand that I’m tarring central bankers and their fellow travelers with the fascist brush. Because the road to hell is paved with good intentions as well as bad. Because there IS a moral equivalence between the means used by Göring and Erdogan to accomplish their ends and the means used by central bankers to accomplish theirs. Do the differing ends and the better intentions matter? Of course they do. And that’s why Ben Bernanke gets $250,000 per speech and Hermann Göring got a cyanide pill in his prison cell. But the shared means of false Narrative and crisis acting matter, too, because they create a world of profound inauthenticity, where ALL public speech is deemed suspect and self-serving — because it is! — and where ANY public speech, no matter how demagogue-ish or false or borderline insane, is deemed functionally equivalent to any other speech. Because it is. It’s what I call Gresham’s Law of Narrative: inauthentic speech drives authentic speech out of circulation, just like bad money drives good money out of circulation. If the function of public speech is to persuade rather than inform — and that’s precisely the function of forward guidance and every other status quo political statement of the past seven years — then it’s just comical for those same status quo institutions to complain now that their political opponents are “lying”. No, they’re just more effective persuaders. They’re just better liars.
And yeah … I’m saying that the rise of Trump and Farage and Le Pen and their ilk is a direct consequence of the communication policy toolkit and the crisis acting employed by every Western central banker and politician over the past seven years. That’s exactly what I’m saying.
As for us investors … we’re the “poor slobs on a farm” that Hermann Göring talks about in his prison cell interviews during the Nuremberg Trials. We don’t want to go to war, whether it’s a real-life war like Erdogan is waging or an ersatz war like Yellen and Draghi are waging. As Göring said, the best outcome for us is that we get home to our farms alive. Why in the world would we sign up for that?
We sign up for it because we are biologically hard-wired over millions of years and socially soft-wired over tens of thousands of years to respond to Narrative. We are social animals in the scientific, technical sense of the phrase, and we — along with our termite, ant, and bee cousins — are the four most successful multi-cellular animal species on Earth because of it. The hallmark of what biologists call a eusocial species isn’t just that it communicates. It swims in an ocean of communication. It is evolved to be immersed in constant communication. How many waking minutes of every day are you away from some sort of message from other humans? Five? Ten? For me it’s however long my morning shower takes. That’s about it. Probably about the same amount of time that an ant or a termite goes without a message from another ant or termite. That’s the human animal for you … basically a giant termite with fire. As a eusocial species, we can no more ignore a message from Janet Yellen than an ant can ignore a pheromone from its queen. Not only can we not ignore it, but it WILL move us, in some small way, at least.
Thankfully, though, unlike an ant we have self-awareness. Or at least the capacity for self-awareness. We can recognize that this process of Narrative influence is happening to ourselves and to others, and we can resist if we choose to.
Now, we will probably go along with whatever the Narrative is suggesting we do, because that’s usually the smart play. We know that there are millions of other ants hearing the queen’s message, and we know that each of them will be moved by her message. Plus — and this is the big insight from game theory, the engine for all of these Common Knowledge behaviors — we know that all of the other ants are thinking about US in exactly the same way we are thinking about THEM. Knowing that, it is entirely rational for each of us to act AS IF the queen’s message is True with a capital T.
Okay, Ben, all very heroic and heartfelt, but what do we do?
Well… here’s what we don’t do. We don’t “fight the Fed”, and we don’t stick our head in the sand and pretend that the status quo Missionaries can’t construct highly investable rallies. You know, like the rally we’re experiencing right now. But by the same token we don’t allow ourselves to become a patsy for the Fed or the ECB or the DNC or the RNC or the WSJ or the NYT or CNBC or whatever other institutional collection of initials asks you to play the fool. We should never trust the Fed or any other Missionary, because one day we’re going to need to, if not fight them, then at least take ourselves off their battlefield.
I think what we need to DO is identify the potential political and economic catalysts coming down the pike and figure out which of these are potential Humpty Dumpty moments — crack-ups in the current system of global credit allocation that are too large for the central banks to piece back together again with their crisis acting and Narrative creation efforts. Then we need to track that Narrative effort so we can get the timing right on these massive catalysts. Because as any coup-launcher or Fed-fighter or volatility-embracer knows, if you’re wrong on timing … you’re just wrong. Starting with the next Epsilon Theory note — “The Narrative Machine” — I’ll be launching a new chapter in this project by demonstrating a set of tools for tracking Narrative evolution and impact. If you’re not yet on the direct distribution list, you can sign up here. I’m pretty excited about where this is going, and hope you’ll join me.
The only thing that I ask from this group today and the American people is to judge me from this day forward. That’s all I can ask for.
– Alex Rodriguez press conference, February 17, 2009, regarding his steroid use from 2001 – 2003.
I’m ready to put this chapter behind me and play some ball. – Alex Rodriguez “apology” letter, February 17, 2015, regarding his steroid use from 2010 – 2012.
I would never do something that was outside of the rules of play. I would never have someone do something that I thought was outside of the rules.
So you never knowingly played with a football that was under 12.5 pounds?
– Tom Brady press conference, January 22, 2015
Now, we all know that air pressure is a function of the atmospheric conditions. If there is activity in the ball relative to the rubbing process I think that explains why when we gave them to the official and the officials put them at let’s say 12.5 … once the ball reached its equilibrium state it’s probably closer to 11.5. – noted physicist and football coach Bill Belichick, January 24, 2015.
That is an allegation [FOMC quashing their own General Counsel’s investigation of leaks] that I don’t believe has any basis in fact. I’m not going to go into any detail but I don’t know where that piece of information could possibly have come from. – Janet Yellen press conference, March 18, 2015.
The Board’s Inspector General and the Department of Justice are in the midst of an investigation into this matter [FOMC leaks to journalists and market consultants]. We are cooperating fully with them and look forward to the results of their investigation. … I had one meeting with Ms. Regina Schleiger of Medley Global Advisors during the period covered by the staff review. As Vice Chair of the Board, I met with Ms. Schleiger on June 11, 2012, to hear her perspectives on international developments. – Janet Yellen letter to Rep. Jeb Hensarling, May 4, 2015.
Mr. Bernanke said that he was sensitive to the public’s anxieties about the “revolving door” between Wall Street and Washington and chose to go to Citadel, in part, because “it is not regulated by the Federal Reserve and I won’t be doing any lobbying of any sort.” He added that he had been recruited by banks but declined their offers. “I wanted to avoid the appearance of a conflict of interest,” he said. “I ruled out any firm that was regulated by the Federal Reserve.” – New York Times, April 16, 2015.
Fletcher, there’s an old saying to the victors belong the spoils.
There’s another old saying, Senator. Don’t piss down my back and tell me it’s raining.
– “The Outlaw Josey Wales” (1976)
My father was a doctor who spent his entire career in a small hospital built by the Tennessee Coal and Iron company in Fairfield, Alabama. He was an ER doc way before emergency medicine was its own thing, which meant that he saw a wide gamut of cases, from knife fights to car wrecks to heart attacks. But it also meant that he saw a lot of ordinary colds and various infectious diseases, as the emergency clinic then – as now – was the only on-demand medical facility available for people who couldn’t afford or didn’t have access to private physician practices. Now one of my father’s great joys in life was watching sports on our grainy black and white TV, miraculously upgraded to a grainy color TV when I was 12. I’m sure he spent hundreds, if not thousands, of happy hours watching sports. Unless, of course, the hapless TV commentator made the mistake of excusing the absence of, say, Larry Bird from a Celtics game by saying that Bird “had a touch of the flu” and so was too sick to play, which was guaranteed to send my father into a 10-minute tirade.
“A touch of the flu? A touch of the flu? You mean he has contracted the influenza virus? Are you out of your mind? Do you have any idea what it means to have the flu? Do you have any idea how sick you are if you have the flu? People DIE from the flu, you moron! What does that even mean … a touch of the flu? Is Larry Bird in the hospital? Because if he has influenza, you sure better get him to the hospital! I hope you’ve got a saline IV hooked up to Larry Bird’s arm right now! No, he’s not in the hospital. Do you know why? Because he has a COLD. That’s right, you idiot, he has a COLD! Not the flu!”\
Honest to god, this would go on for quite a while. Somehow it never got old to my father to rail at what he perceived as the mendacity – to use a good Tennessee Williams word – of a TV commentator elevating Larry Bird’s status from an ordinary human wrestling with a common cold to a heroic struggle with influenza. Even today, 30 years later, I can’t help but laugh at these memories of my father whenever I read or hear about a player out for the game because of “flu-like symptoms.”
I’ve inherited a lot of my father’s traits, and one of them is his intolerance for this mendacity of language, this intentional failure to call things by their proper names, this linguistic exercise in self-puffery and cover-up. Unfortunately for me and anyone else who shares this peculiar sensitivity, mendacity of language has never been more rampant in all of our social worlds, from sports to politics to markets.
With the advent of always-on mass media that projects the illusion of a one-to-one personal connection with cartoons like “Tom Brady” and “Jim Cramer” – corporate entities that are connected with but distinct from human beings like Tom Brady and Jim Cramer – language intentionally designed to influence rather than inform is now ubiquitous in the business of sports and politics and markets Why? Because it works. It delays sanctions until after you play in the Super Bowl, until after you sign a quarter of a billion dollar contract. It deflects attention until after your term in office is over, until after you cash in with a book deal and hedge fund consultancy.
To use the ponderous, legally parsed language of the NFL’s Wells Report on “deflate-gate”, language which I think wonderfully encapsulates the pinched spirit of our age, here are four things that I believe are “more probable than not”:
Alex Rodriguez has routinely used steroids and PED’s of various stripes since he was a sophomore in high school.
Tom Brady has routinely bribed equipment managers with autographed jerseys and new shoes in order to receive footballs deflated well below what he knew was the legal limit.
Janet Yellen has routinely leaked market-moving information to favored private sector conduits, and has also sought to quash internal investigations of same.
Ben Bernanke is for sale to the highest bidder.
But here’s the thing. I’m not that worked up about ANY of these issues. Yes, A-Rod has been juicing for 25 years, and Tom Terrific breaks the rules he thinks he can get away with breaking. Okay. Them and about 5,000 other professional athletes. Janet Yellen, the prime author of Fed “communication policy” (the intentional use of words to influence market expectations), leaks her viewpoint as part of that communication policy and then tries to kill an internal investigation. Okay. Her and every other senior politician and bureaucrat in the history of human civilization. As for Bernanke … a former President of the United States and the leading candidate to be the next President of the United States have personally received more than $100 million in “donations” from mega-corporations and foreign governments, and I’m supposed to be outraged about Ben Bernanke cashing a big check from Ken Griffin?
What I AM worked up about, though, is the mendacity … the utter lack of character and authenticity … on full display in ALL of these cases. All of these cases and so many, many more.
You want to go work for Citadel? Fine, go work for Citadel. But OWN IT. Don’t insult my … I’m not even going to say intelligence, because it’s not an assault on intelligence we’re talking about here … don’t insult my 50 years of life as a reasonably self-aware human being by claiming that you’re taking the high road here by working for Citadel instead of, say, JP Morgan. I mean, the notion that access to the Fed’s regulatory authority over big banks is somehow the defining characteristic of why Ben Bernanke is a sought-after commodity, or that any public outrage here is clearly misplaced because, after all, he won’t be a – gasp! – bank lobbyist, per se … it’s all just horrifically insulting to anyone with the common sense to know that the sky is blue, that 2 + 2 = 4, and that you don’t meaningfully change the air pressure in footballs by rubbing them vigorously. It’s mendacity and inauthenticity in the first degree.
You want to embark on a conscious policy of manipulating market expectations (yes, manipulating is a strong word, but it’s exactly accurate) by planting a carefully constructed Narrative with journalists like Jon Hilsenrath at the Wall Street Journal and consultants like Regina Schleiger at Medley, journalists and consultants who you know will be influential precisely because they are trumpeting their exclusive access to you? Fine. I totally get it. Once you’ve hit zero on short rates and pushed your balance sheet up over $4 trillion in LSAP’s, jawboning is the only bullet you’ve got left in the gun. But OWN IT. Don’t tell me that you’re meeting with Regina Schleiger at Medley because you want to hear HER perspectives on monetary policy! I’m sure that Ms. Schleiger is a very smart person. I’m sure that she is an insightful observer of the international economic scene. But – and I’m trying to say this in the kindest possible way – there’s not 1 in 100,000 investors who even knows who Ms. Schleiger is, and fewer still who would be willing to pay money or time to hear her personal opinion about the proper course of monetary policy. The exception, we are told, is the Chair of the Federal Reserve, in many respects the most powerful person on the planet … she, of course, is terribly keen to hear Ms. Schleiger’s views on international economics.
And yes, I know that Fed governors have these consultant meetings all the time. I know that their guests do most of the talking. But I also know, because I’ve done it, that professional investors and allocators are willing to pay tens of thousands of dollars to consultants like Medley, solely to glean a scrap of insight as to what the Fed is thinking, solely to be a willing host of the Narrative virus that the Fed is trying to spread. More to the point, Janet Yellen knows it, too, which is why she has these meetings. The act itself is not a horrible thing … not for A-Rod, not for Brady, not for Yellen, and not for Bernanke. It’s not a crime, or at least not a crime that will shame your children or your fan base. Certainly it’s a difficult and unpleasant thing when you’re revealed, because now you’ve got to deal with the Roger Goodell’s and the Bud Selig’s and the Jeb Hensarling’s and the Elizabeth Warren’s of the world – petty tyrants, all – but you knew there was this chance when you made the decision to break the rules, (or the “rules” in Bernanke’s and 2009 A-Rod’s case). But don’t turn a difficult situation into a personal capitulation to mendacity. Far better to own it.
Believe it or not, I’m not just venting my spleen at the outrageous displays of mendacity that assault us at every turn. I think that there’s an enormous political opportunity today (and I mean political in the broadest sense of the word, a sense that clearly includes the Fed, and arguably includes the NFL and MLB) to embrace authenticity, even if you are authentically an unlikable or – to use the insult du jour – a “polarizing” person. Not only am I convinced that we are each more likely to be successful in our chosen field when acting authentically (don’t you think that if Tiger Woods had embraced his authentically heel-ish nature in 2009, grown a goatee and moved to a casino suite in Vegas, that he’d still be winning majors today?), but also specifically within the chosen field of politics I think there is such a hunger for authenticity that ANY display of honest conviction when confronted with adversity, even if the adversity is well-deserved for breaking a rule, quickly becomes an enormous asset. Maybe this will turn out to be a more interesting election in 2016 than we think. Then again, with the vast campaign coffers already accumulated by Clinton™ and Bush™, two profoundly inauthentic corporate entities, maybe not.
Sigh. I know I’m not going to change anything by writing about this stuff, any more than my father was going to change a sports commentator’s patter by yelling at the TV. Like my father, though, I just can’t help myself. It’s never easy to be authentic. It’s never easy to call things by their proper names. It’s never easy to own it. But here in the Golden Age of the Central Banker, it’s never been more important. Or more politically savvy.