Monday, September 15, 2014

Janus Yellen and the Great Transition from Risk-On to Risk-Off

The end of risk-on cannot be prettily managed.

In ancient Roman religion and myth, Janus is the god of transitions--beginnings and endings of conflict, war and peace, journeys, trades and eras. Janus has two faces, as befits a god that looks both to the future and to the past.

In our era of omnipotent central banks worshipped by the Status Quo, we have a goddess of financial transitions--Janus Yellen, the two-faced chair/deity of the Federal Reserve--to usher in the Great Transition from risk-on to risk-off.

What is risk-on? Speculative bets directly enabled by central bank issued free money for financiers--also known by the bland technocrat perception management labels stimulus and quantitative easing (QE).

The primary risk-on policies are:

1. ZIRP--zero interest rate policy. This enables financiers (but not J.Q. Citizen) to borrow money for next to nothing and then use this free money to buy assets that pay dividends or interest.

This is effectively a gift to banks and financiers. The goal is straightforward: transfer great wealth from the peasants who once earned interest on their savings to the banks, who have rebuilt their bad-bet-shattered balance sheets on the backs of tax donkeys and savers.

2. Asset purchases. The Fed has bought almost $4 trillion of Treasury bonds and mortgages from primary dealers (banks) and other financial institutions. This is effectively a transfer of cash directly into the financial system.

Those closest to the Fed money-spigot benefit directly from asset purchases (a.k.a. quantitative easing). Those far from the spigot (the 99.9%) get nothing but slightly lower interest on their crushing debt.

Those with low/no debt have lost hundreds of billions in interest that has been transferred to the banks by ZIRP and QE, which actively suppresses interest rates.

3. Liquidity. This simply means the Fed will create as much money as is needed to meet the borrowing needs of the financial system. This unlimited liquidity is offered not just to U.S. banks, but to the entire global banking system. The Fed doesn't just bail out U.S. speculators--it bails out speculators worldwide.

In other words, the Fed deities are lavishly generous to financiers everywhere.

But all these risk-on policies have created extremes of speculative bets, which have generated corresponding extremes in systemic risk. Those who have skimmed profits from risk-on speculation with borrowed money and leveraged bets need to unwind/exit their bets to book their gains.

This unwinding of speculative excesses is risk-off.

It falls to Janus Yellen to oversee this transition from roughly 20 years of risk-on to risk-off. The trick will be to unwind all the debt and leverage without collapsing the global speculative house of cards.

Janus Yellen's job is to manage the transition such that banking sector profits are maintained.One way to do this is to raise interest rates incrementally.

Ilargi at makes a compelling case for the Fed raising interest rates sooner than most believe possible as the only means left to maintain banking-sector profits: The Fed Has A Big Surprise Waiting For You.

Though we can be confident that Janus Yellen's face looking back in time sees the Fed's unprecedented efforts to prop up a failed, broken financial system as a success, to the rest of us, the past is easily visible: central banks did not fix what is broken in the financial system; they simply papered over the sources of speculative instability with multiple layers of additional bureaucracy, ZIRP, QE and unlimited liquidity. As a result, the threat of speculative instability was only deferred, not eliminated.

The future is much less clear. As Janus Yellen looks ahead, she finds no real historic parallels for the extremes of risk-on debt, leverage and speculation that unprecedented central bank intervention have conjured up.

She also finds no recent precedent for the gargantuan expansion of financial claims on real wealth that dwarf the actual expansion of real wealth since the 2008-09 Global Financial Meltdown: energy extracted, soybeans harvested, industrial equipment manufactured, etc.

Multiplying the financial claims on real wealth by creating money and selling Treasury bonds that are claims on future wealth does not expand real wealth. This is the foundational falsity of risk-on monetary easing and the speculation it fuels: expanding claims on real wealth does not increase real wealth.

The idea that expanding financial claims on wealth is wealth is entirely illusory, and this is why risk-on is a self-liquidating dynamic: as everyone holding a claim tries to cash in their illusory gains, the risk-on trade implodes.

Janus Yellen is trying to engineer an impossible "solution" to this destabilizing dynamic: gently transition risk-on to risk-off so imperceptibly that the market for phantom assets will magically absorb all the selling.

But this assumes there will be buyers ready to bid up the market value of these phantom assets as the smart money distributes/sells. And that is of course the dynamic of bubbles throughout human history: there are ready buyers right up to the point that prices start dropping sharply. Then the bid vanishes as the pool of greater fools has been drained and there are no buyers, only sellers.

Perhaps what Janus Yellen's future-facing eyes see is a future in which central banks are forced to become the buyers of last resort not just of trillions of dollars in home mortgages and sovereign bonds, but every other asset as well: real estate, corporate junk bonds, swampland, the debt of bankrupt cities--everything.

This is nothing but another expansion of financial claims, masked by the apparition of phantom assets on the central bank balance sheets. Buying up phantom assets does not transform them into real wealth. Regardless of how Janus Yellen tries to sell the idea as the miraculous "fix" to the systemic bubble in claims the central banks have inflated, it will fail just as predictably as her plan to defuse the risk-on trade while maintaining the inflated value of the phantom assets the speculative frenzy has created out of nothing.

The end of risk-on cannot be prettily managed. If Janus Yellen had looked far enough back in history, she would already know that.

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