Turkey’s Interior Minister Suleyman Soylu (of Erdogan’s Justice and Development Party/AKP) on Friday charged that the United States is meddling in the country’s elections, set to take place Sunday. The national election is shaping up to be the biggest challenge to President Erdogan’s grip on power in years.

“The United States is meddling in these elections… Everyone in this country already knows this, US President [Joe Biden] himself declares this. The attack on [presidential candidate of Turkiye and leader of the Memleket party] Muharrem Ince… it is clear where it came from, it is clear where it was coordinated. This is America. In recent days, Biden has stepped up his people in Turkiye,” Soylu said in an interview, as translated in regional media.

He further charged that Washington’s efforts of trying to subjugate Ankara have failed. “Turkey has a clear position in its foreign policy. The US says ‘Come and obey me.’ We obey the Turkish interests,” Soylu said.

“I am among the most exposed to attacks and insults, and a big part of them comes from foreign accounts,” he explained, while also saying the government is taking extra precautions to defend against cyberattacks. 

Soylu’s reference is to Muharrem Ince, whose pullout is being widely seen as a huge boost to Erdogan’s main challenger, the CHP’s Kemal Kilicdaroglu. The Associated Press reported Thursday:

The candidate who pulled out, Muharrem Ince, is the leader of the center-left Homeland Party. He was one of four contenders running in Sunday’s presidential election. Turkey holds a parliamentary election the same day.

Ince had faced criticism for potentially ciphering support from the six-party Nation Alliance, which has united behind the candidacy of opposition leader Kemal Kilicdaroglu, and thereby forcing the presidential contest into a second-round.

“I am withdrawing from the race,” Ince told reporters in front of his party’s headquarters, following weeks of resisting calls to step down. “I am doing this for my country.”

Ince’s announcement came a mere three days before the May 14 election, and while his polling reportedly slid down to 2%. He didn’t throw his support behind any other candidate, given he was popular among voters dissatisfied with either of the two main contenders. His dropping from the race hurts Erdogan, given Ince was seen as siphoning off crucial votes from Kilicdaroglu.

“While polling indicates that a majority of Ince’s voters are likely to flip to Kilicdaroglu, it’s unclear if there will be enough voters to give him an outright victory in the first round,” regional analyst Hamish Kinnear told AP.

Meanwhile, it’s not only the US being accused of election ‘interference’ – but naturally some are taking to opportunity to allege Russian meddling too. Kilicdaroglu is now seizing on Erdogan’s close relations with Vladimir Putin, and is charging Russia with fabricating deep fake videos meant to harm his candidacy.

In tweets posted in Turkish and Russian, Kilicdaroglu wrote, “Dear Russian friends, you are behind the fabrications, conspiracies, deepfake content and tapes that were exposed in this country yesterday. If you want the continuation of our friendship after May 15, take your hands off the Turkish state. We are still in favor of cooperation and friendship.”

The charge was also in relation to Ince’s pullout, including the following bizarre episode: 

In a televised presser earlier Thursday, Ince announced he was withdrawing from the four-candidate presidential race following a fabricated sex tape that circulated on the web, allegedly implicating him. Ince said he has been the target of a character assassination plot through a series of smear campaigns, including the release of the sex video, which he said was fabricated from an “Israeli porn site.”

A CHP party official separately told Turkish media, “We think that some covert moves are underway aimed at the campaign. We don’t want these. We want our centuries-old relationship to continue like this.”

While incumbent Erdogan is certainly favored to secure another term as president, if it the vote count comes close these growing allegations of ‘foreign interference’ will likely explode into the headlines. Erdogan and his AKP officials have in recent years charged that the US was behind the July 2016 Turkish coup d’état attempt which briefly grabbed the world’s attention.

By Julianne Geiger of Oilprice.com,

Low demand for natural gas has sent Europe’s benchmark gas prices towards a sixth consecutive weekly loss—the longest run of weekly losses since 2020.

The front-month futures at the TTF hub, the benchmark for Europe’s gas trading, fell by 3.7% to $36.80 (33.80 euros) per megawatt-hour (MWh) as of 12:27 p.m. GMT on Friday.   
Lower power demand amid mild spring weather in most of Europe is depressing gas prices, while comfortable inventories of gas have not yet led to any rush for filling storage sites ahead of the next winter.

As of May 10, storage sites across the EU were 62.48% full, according to data from Gas Infrastructure Europe.

Lower gas prices have started to lead to increased coal-to-gas switching, but demand is nevertheless muted with low household consumption.

Europe’s benchmark gas prices have halved since the beginning of the year and are now just one-tenth of the record of over $326 (300 euros) per MWh from August 2022.

Spot LNG prices for delivery to North Asia in June have also plunged in recent weeks and were down for a third consecutive week on Friday, amid weak demand and high inventories in key Asian importers. Prices in Asia, at $10.50 per million British thermal units (MMBtu) this week, plunged by 4.5% from the previous week, according to estimates from industry sources cited by Reuters. The spot LNG prices in Asia are now at the lowest they have been since the end of May 2021.

Despite the current lull in natural gas demand and prices in Europe and Asia, governments and industry warn that Europe should not be complacent and that the energy crisis is not over yet.

The energy crisis is not over yet, and the situation with energy supply in Europe could deteriorate later this year, one of Germany’s top utility firms, E.On, said this week.

Congress left the Capitol this week with no deal on averting a catastrophic debt ceiling default that may be as close as three weeks away.

According to NBC News, a meeting scheduled for Friday between President Joe Biden and House Speaker Kevin McCarthy (R-CA) was postponed until next week while top aides hash continue to negotiate in the hopes of making more headway before the principal negotiators are brought in.

For weeks, the negotiations have boiled down to Democrats insisting that Republicans agree to a ‘clean’ (blank check) debt ceiling increase with no conditions, while Republicans demand that Democrats make spending compromises which would pair a debt limit increase with a budget agreement.

With the debt limit having been raised, avoiding economic catastrophe, the GOP could claim Democrats backed down from the no-negotiations posture and Democrats could claim some wins in the budget talks and focus on those.

A potential bipartisan deal would “take the budget negotiations and kind of blend it in with the raising of the debt ceiling,” said Sen. Lindsey Graham, R-S.C., a member of the Budget Committee tasked with selecting topline spending figures for the government annually and of the Appropriations Committee, which doles out that funding. “We’ve eventually got to fund the government” in September, he noted. –NBC News

“Maybe they can agree on some top lines that would show some fiscal restraint and raise the debt ceiling, but we’ll get there,” said Graham.

Rep. Garret Graves (R-LA) outlined four policy areas where Republicans and Democrats may be able to strike a deal;

• Recapturing unspent Covid relief funds
• Overhauling the permitting process for infrastructure and energy projects
• Establishing spending caps for upcoming government funding bills
• Expanding work requirements for those receiving federal aid

“I think there’s a pretty good opportunity there,” said Graves, a top ally of McCarthy.

Rep. Dusty Johnson (R-SC) thinks the four areas are the “lowest hanging fruit” that could see bipartisan consensus.

“The White House has said that all of these Republican asks are nonstarters. They will say they won’t accept anything. We know they will,” said Johnson, who chairs the GOP Main Street Caucus.

“I’ll take it anywhere I can get it. We’re working to get it,” said Sen. Joe Manchin (D-WV). “This should be a bipartisan permitting reform bill.”

Democrats have seized on Wednesday night comments made by former President Trump, who told CNN‘s Kaitlan Collins during a town hall: “I say to the Republicans out there – congressmen, senators – if they don’t give you massive cuts, you’re going to have to do a default.”

According to Trump, while he doesn’t think a default is likely, “it’s better than what we’re doing right now because we’re spending money like drunken sailors,” adding that the effects of a default might not be as disastrous as everyone expects, suggesting “it’s really psychological more than anything else,” and adding “maybe it’s, you have a bad week or a bad day.”

“We might as well do it now” — Trump endorses a US debt default pic.twitter.com/l81cW3bwH9

— Aaron Rupar (@atrupar) May 11, 2023

“It was dangerous and irresponsible that former President Trump last night said, casually, ‘Eh, just go ahead and default.’” said Sen. Chris Coons (D-DE) in a statement to NBC News.

Pressed about Trump’s comments encouraging default, McCarthy quickly pivoted Thursday to attacking Biden and repeatedly made the case that House Republicans are the only ones in Washington who have passed legislation to raise the debt ceiling. The McCarthy package would raise the federal borrowing limit by $1.5 trillion or through March, whichever comes first, but it would roll back key pieces of Biden’s agenda. -NBC News

“I’ve watched President Biden not want a deal and want default,” McCarthy told reporters on Thursday – attacking Democrats over the impasse, saying that House Republicans are “the only ones who’ve raised the debt limit.”

According to the Treasury Department, the country will default on its debt as soon as June 1 unless the borrowing limit is raised.

Authored by Lance Roberts via RealInvestmentAdvice.com

What if I told you that future market returns could approach zero? This seems hard to believe, considering young investors piling back into the markets since the beginning of the year. As I discussed previously, this behavior follows the clubbing many received in 2022.

A recent Wall Street Journal article discussed how retail traders that made millions during the pandemic trading the market are now mostly wiped out.

A quick search of headlines from the end of 2022 confirms that much of the retail spirit was broken:

• “Retail Traders Throw in the Towel,” September 2022

• “The Era of the Meme Trade Is Over,” October 2022

• “Are Retail Investors Done? Biggest Liquidation Since 2020 as Retail Is Now ‘Selling the Rally,’” October 2022

• “Retail Traders Lose $350 Billion in Brutal Year, December 2022

At the end of 2022, it seemed fairly clear that retail investors were done as they ‘hit the bid” to liquidate stocks at a record pace.

However, that was 2022. Since January, retail investors returned with a vengeance to chase stocks in 2023, pouring $1.5 billion daily into U.S. markets, the highest ever recorded.

This chase for equity risk since the beginning of the year was built on the premise of a Federal Reserve “pivot” and a “no recession” scenario. In this scenario, economic growth continues as inflation falls and the Federal Reserve returns to a rate-cutting cycle. However, as discussed in “No Landing Scenario at Odds With Fed,” that view has a fatal flaw.

What would cause the Fed to cut rates?

If the market advance continues and the economy avoids recession, the Fed does not need to reduce rates.

More important, there is also no reason for the Fed to stop reducing liquidity (quantitative tightening) via its balance sheet.

Also, a “no-landing” scenario gives Congress no reason to provide fiscal support, providing no boost to the money supply.

In other words, if the hope of zero interest rates and a return to quantitative easing is whetting retail investor appetites, then the “no landing” scenario is problematic.

This also is why future returns may approach zero.

Why Future Returns May Approach Zero

The speculation of outsized returns by retail investors is unsurprising, given that most have never seen an actual bear market. Many retail investors today didn’t make their first investments until after the financial crisis of 2008–09 and, since then, have only seen liquidity-fueled markets supported by zero interest rates. As discussed in “Long-Term Returns Are Unsustainable:”

“The chart below shows the average annual inflation-adjusted total returns (dividends included) since 1928. I used the total return data from Aswath Damodaran, a Stern School of Business professor at New York University. The chart shows that from 1928 to 2021, the market returned 8.48 percent after inflation. However, notice that after the financial crisis in 2008, returns jumped by an average of four percentage points for the various periods.

“After more than a decade, many investors have become complacent in expecting elevated rates of return from the financial markets. However, can those expectations continue to get met in the future?”

(Source: Federal Reserve Bank of St. Louis / RealInvestmentAdvice.com chart)

Of course, those excess returns were driven by the massive floods of liquidity from the federal government and the Federal Reserve, including trillions in corporate share buybacks and zero interest rates. Since 2009, there has been more than $43 trillion in various liquidity supports. To put that into perspective, the inputs exceed underlying economic growth by more than 10-fold.

(Source: Federal Reserve Bank of St. Louis / RealInvestmentAdvice.com chart)

However, after a decade, many investors became complacent in expecting elevated rates of return from the financial markets. In other words, the abnormally high returns created by massive doses of liquidity became seemingly ordinary. As such, it is unsurprising that investors developed many rationalizations to justify overpaying for assets.

Commitment to Growth

The problem is that replicating those returns becomes highly improbable unless the Federal Reserve and government commit to ongoing fiscal and monetary interventions. The chart below of annualized growth of stocks, GDP, and earnings show the outsized anomaly of 2021.

(Source: Federal Reserve Bank of St. Louis / RealInvestmentAdvice.com chart)

Since 1947, earnings per share have grown at 7.72 percent, while the economy has expanded by 6.35 percent annually. That close relationship in growth rates is logical, given the significant role that consumer spending has in the GDP equation.

The market disconnect from underlying economic activity over the last decade was due almost solely to successive monetary interventions leading investors to believe “this time is different.” The chart below shows the cumulative total of those interventions that provided the illusion of organic economic growth.

(Source: Federal Reserve Bank of St. Louis / RealInvestmentAdvice.com chart)

Over the next decade, the ability to replicate $10 of interventions for each $1 of economic seems much less probable. Of course, one must also consider the drag on future returns from the excessive debt accumulated since the financial crisis.

(Source: Federal Reserve Bank of St. Louis / RealInvestmentAdvice.com chart)

That debt’s sustainability depends on low-interest rates, which can only exist in a low-growth, low-inflation environment. Low inflation and a slow-growth economy do not support excess return rates.

It is hard to fathom how forward return rates will not be disappointing compared to the last decade. However, those excess returns were the result of a monetary illusion. The consequence of dispelling that illusion will be challenging for investors.

Does this mean that investors will not make any money over the decade? No. It just means that returns will likely be substantially lower than investors have witnessed over the last decade.

But then again, getting average returns may “feel” very disappointing to many.

At 4 Percent, Cash Is King

Another problem weighing against potential future returns is the return on holding cash. For the first time since 2009, the alternative to taking risks in the stock market is just “saving money.” Obviously, “safety” comes at the cost of the return, but at 4 percent or more, savers now have an alternative to investing. However, this works against the Fed’s goal of increasing the wealth effect in the financial markets.

Following the financial crisis, then-Fed chair Ben Bernanke dropped the federal funds rate to zero and flooded the system with liquidity through quantitative easing. As he noted in 2010, those actions would boost asset prices, thereby lifting consumer confidence and creating economic growth. By dropping rates to zero, “risk-free” rates also dropped toward zero, leaving investors little choice to obtain a return on their cash.

Today, that narrative has changed, with current risk-free yields above 4 percent. In other words, it is possible to save your way to retirement. The chart below shows the savings rate on short-term deposits versus the equity-risk premium of the market.

(Source: Federal Reserve Bank of St. Louis / RealInvestmentAdvice.com chart)

One of the problems with the cash hoard in 2023 is that there is no incentive to reverse savings into risk assets unless the Fed drops rates and reintroduces quantitative easing.

However, as discussed in “Banking Crisis Is How It Starts,” if the Fed reverses to accommodative policies, it will be because something “broke.”

Then it won’t be the time to take on more risk, but less.

When you start considering the implications of a market plagued by high valuations, slow growth, and the potential for less liquidity, it is easy to make a case for lower future returns.

While that does not mean returns will be zero every year, we may, by the end of the decade, look back and ask what was the point of investing to begin with?

After last month’s massive jump in 12-month inflation expectations, analysts are hoping the this morning’s preliminary May data from UMich’s consumer sentiment survey shows some pullback in that fear. While inflation expectations for the next year dipped very modestly, expectations for the next 5-10 years jumped to +3.2% – it hasn’t been higher since 2008 (tied for its highest since 2011)…

Source: Bloomberg

A necessary component of returning inflation to the Fed’s 2% target is keeping long-term inflation expectations anchored at a low level. While the pickup is concerning, Hsu noted that there were few signs consumers were buying in advance to avoid future price increases.

That suggests “the rise in long-run inflation expectations did not reflect the growing influence of inflationary psychology or increased risk of a wage-price spiral,” Hsu said.

Back to the headline sentiment data, that was very ugly with the recent bounce having eroded significantly with the consumer sentiment index slid to 57.7, the lowest since November and weaker than all forecasts, from 63.5 last month. The university’s overall measure of expectations fell to a 10-month low of 53.4. The current conditions gauge also decreased.

Source: Bloomberg

Buying conditions for durable goods declined to a five-month low in early May, with about 42% of respondents blaming high prices for eroding their living standards.

“While current incoming macroeconomic data show no sign of recession, consumers’ worries about the economy escalated in May alongside the proliferation of negative news about the economy, including the debt crisis standoff,” Joanne Hsu, director of the survey, said in a statement.

Throughout the current inflationary episode, consumers have shown resilience under strong labor markets, but their anticipation of a recession will lead them to pull back when signs of weakness emerge.

If policymakers fail to resolve the debt ceiling crisis, these dismal views over the economy will exacerbate the dire economic consequences of default.

Consumer confidence also dropped sharply during the 2011 debt-ceiling crisis but snapped back after its resolution.

By Bas van Geffen, Senior Macro Strategist at Rabobank

Treasury Secretary Yellen notified Congress on May 1 that the government may exhaust its ability to honor all of its obligations by early June already, and potentially as early as June 1. Yellen’s warning about the so-called X-date piled a lot more time pressure on the negotiations between the Democrats and the Republicans to agree on a deal to either suspend or raise the debt limit.

The debt ceiling negotiations were always expected to last until the eleventh hour, with both sides of the aisle playing a game of chicken. Yet, few had expected the clock to be moved that much forward. When the debt ceiling came into sight earlier this year, 1-month T-bills started trading rich on the belief that the timing of any potential default would only be after the maturity dates of this very short-term paper. That premium has evaporated since the start of the month, and even turned into a discount over the past week.

Adding an extra time constraint to the mix, President Biden is due to fly to Japan next week for the annual G7 summit – although he indicated that he might cancel his travel plans if the debt limit discussions drag on. Lawmakers, meanwhile, have ramped up their negotiations. President Biden and House Speaker McCarthy met on Tuesday, although the hour-long talks resulted in little more than the commitment to daily discussions between their staff, and a new meeting being scheduled for today. But the pressure may not be high enough yet to force either side to give in. Indeed, CNBC reports that this follow-up meeting has been pushed back to ‘early next week’, according to a source.

That raises the risk of an accidental default, if the Treasury runs out of cash and fiscal creativity sooner than Ms. Yellen expects. Yet, even if such a default is ultimately averted –as has been the case in all of the previous debt ceiling stand-offs– the sheer uncertainty around the debt limit may already be sufficient to damage the economy.

This comes on top of the regional banking crisis that continues to drag on, so it’s easy to explain why the Fed has opened the door to pausing –or potentially ending– the hiking cycle next month. The US CPI data earlier this week did little to change that outlook.

As we noted last week, that could put the US central bank on a different course than its European peers. The ECB acknowledged last week that they weren’t quite ready to consider a pause in their hiking cycle, and the central bank’s hawks have been busy talking up the odds of a hike in September – which would take the policy rate to 4%.

While we certainly can envision such a scenario, isn’t it a bit early for policymakers to discuss the situation three meetings ahead? Especially if we consider that the ECB has repeated ad nauseam that it will set policy on a meeting-by-meeting basis. This suggests that a) there may have been a bit more compromise last week than some of the hawks preferred, and/or b) that there is a group of policymakers that still very much fears the inflation outlook and markets potentially pricing in an earlier ECB pivot which would reduce the efficacy of policy tightening to date.

Such fears are arguably justified, considering that the ECB’s Consumer Expectations Survey saw inflation expectations increase “significantly”, particularly over the medium-term. After declining somewhat in recent months, the median inflation expectation for the three years ahead jumped back to 2.9%. Consumer expectations are notoriously linked to recent inflation developments, and thus this revival in inflation expectations could be related to the increase in news items about e.g. ‘greedflation’. The reversal of the downward trend is a warning sign that expectations could still de-anchor from the ECB’s 2% aim.

The Bank of England joined the ECB yesterday in flagging that inflation risks remain significantly skewed to the upside. The Bank raised its CPI forecast for 2024 from 1.0% to 3.4%. That’s not a modest tweak to the forecast, and a strong signal that rate cuts will not be coming as fast as some market participants are expecting. It also increases the odds that the Bank of England may have to tack on more hikes than the final +25bp we have currently pencilled in for June.

Indeed, Europe may still be in a very different spot when it comes to bending the current inflation back to target. The continent remains ill-positioned for the evolving geo-economic scenario of global fragmentation. It lacks many of the elements required for strategic autonomy, from commodities and resources to domestic production capacity and military firepower. And rebuilding those, while fully possible, is certainly not free.

In a Financial Times op-ed, French President Macron campaigns for a European re-industrialisation strategy, and an increased effort to regain Europe’s economic sovereignty. Macron’s proposed five-pillar approach is a mix of greater competitiveness, subsidies, and protectionism. “’Made in Europe’ should be our motto,” he stresses. Who knew Trump spoke French?

The timing of this op-ed is at least a bit curious. It coincides with a Chinese delegation led by the vice president touring Europe, visiting several countries in an attempt to rekindle some of the diplomatic ties. Germany still appears to be the continent’s soft spot. On Wednesday, the German foreign minister said they want to work in partnership with China “everywhere it’s possible”, without ignoring the risks of overreliance. The realisation that Europe must stop being dependent on other countries is Germany taking one step into the right direction. But surely Macron will want to point out to his German colleagues e.g. the lack of reciprocity when it comes to trade with China.

Still reeling off the news yesterday that Elon Musk had found a CEO for Twitter, Tesla shares were green in the Friday morning pre-market session on news that it has once again raised prices and strengthened its cooperation with Shanghai.

Tesla hiked the prices of most of its vehicles, adding as much as $1000 to the company’s most costly models, according to Bloomberg. The Model S now posts a starting price of $88,490 and the Model X starts at $98,490. 

These compare to prices of $104,990 and $120,990, respectively, at the beginning of the year. 

John Zeng, managing director of consultancy LMC Automotive in Shanghai, says the price hikes are to try and stop the margin bleeding, which was a major concern during Tesla’s last earnings report. He told Bloomberg: “Tesla is attempting to increase its margin as it has faced a sharp decrease in profits from several rounds of earlier price cuts.”

Tesla also recently just re-raised the price of its Model 3 and Model Y in both the U.S. and China. 

Just as was the case with the recent Model S and Model X hikes, the price increases were small compared to the cuts the company has put in place since the beginning of the year. We had just noted days ago that, due to aggressive price cuts, the Model Y was cheaper than the average new vehicle in the U.S. by $759. That’ll likely still be the case, despite the $250 hike. 

It was also reported Friday morning that Shanghai would not only “boosting its ties” with Tesla, according to Bloomberg, but also that it would “strengthen cooperations and promote autonomous driving in the city”. The article cited Shanghai Economic and Information Commission deputy head Chen Kele as its source. 

Recall, just hours ago Elon Musk announced he had found a new CEO for Twitter, helping put a charge into Tesla shares. 

Warehouses operated by Adidas AG are stuffed with a market value of more than $1 billion of unsold Yeezy products. Top executives have been mulling over what to do with all those Yeezy shoes since it terminated its contract with Kanye West last October. 

Adidas’ new CEO Bjorn Gulden offered new insight Thursday at an annual shareholder meeting of what he plans to do with the shoes. 

“Burning is not the solution,” Gulden said. He said over time, the German sportswear maker will “try to sell parts of the product” and donate the profit to charities of people who “were hurt” by West’s antisemitic comments last year.  

Adidas previously warned that if it were to dispose of the remaining inventory of Yeezy shoes — it would suffer an operating loss of as much as €700 million ($765 million) in 2023. This would mark the company’s first loss in three decades. 

Gulden did not specify potential buyers for the Yeezy shoes or identify the charitable organizations that would benefit from the sales proceeds. He added decision over what to do with the unsold product is “unbelievably complicated.” 

West has caused great pain for Adidas since his shoe brand contributed an estimated $1.8 billion in annual revenue for the company or about 7% of total revenue. And why Addidas execs decide to bet a large chunk of revenue on Yeezy is beyond our understanding. 

Shares of Adidas trading in Germany have plunged in recent years. 

Earlier this week, a top Adidas shareholder demanded the company release an internal investigation over West’s inappropriate behavior. A class action lawsuit was recently filed against the company, alleging execs knew about the potential harm of Ye’s reckless “personal behavior” but failed to warn investors. 

Authored by Jesse Felder via TheFelderReport.com,

It’s no secret that for the past decade and a half the Federal Reserve has made it its mission to create a “wealth effect” in the economy by boosting asset prices.

Back in 2010, Ben Bernanke explained,

“…higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”

And so he began a process of printing money with the explicit purpose of inflating asset prices, a policy that has been continued by each of his successors.

[ZH: we know this is neither Ben Bernanke nor a subsequent Fed head but to be rank, any excuse to show Mnuchin’s wife in this pic seems appropriate when discussing ‘wealth effects’]

Over this time, quantitative easing, as the policy is called, has been inordinately successful in boosting asset prices while not so effective in boosting the economy. The most straightforward evidence of this is the fact that household net worth relative to the economy has soared to record highs during the QE era. If it had worked the way Bernanke intended then, after a brief surge in the ratio, it would have flattened out as growth in the economy caught up to growth in asset prices.

Clearly, that didn’t happen.

It does appear, however, as if the central bank did at least accomplish the first half of Bernanke’s mission (boosting wealth) even if it didn’t quite accomplish the second half (kickstarting a virtuous circle of economic growth). But when you look at household net worth relative to the growth in the money supply, it’s clear that the rise in the former was nothing more than an illusion.

Net worth has actually declined relative to M2 since 2008 and is now back to levels not seen in the 20 years prior to that time. The truth is that there has been no “real” wealth created at all when measured this way.

And when you deflate GDP by the growth in the money supply, the picture is even more damning. Since quantitative easing began in 2008, the trajectory of the economy in relation to the growth of M2 has been far more deeply negative than that in household net worth. The truth is that there has been no “real” growth in the economy since 2008 when it is measured in this way; in fact, the economy has been in protracted decline relative to the money supply for decades, a phenomenon that has only worsened during the QE era.

As this week’s CPI report reminds us, that after decades of disinflation the most recent round of money printing has lead to the return of inflation. At the end of the day, it may not be the economy or household net worth but inflation that the central bank’s great monetary experiment has been most effective in stoking. Of course, history could have told us that would be the likely outcome long before Bernanke ever began firing up the printing press.

And it’s failure to heed the warnings of history may help to explain why confidence in the Fed is now at an all-time low, a trend that may only exacerbate the inflation problem over time.

This will not go down well with the climate alarmists and ESG grifters…

No lesser mortal than Fed Governor Christopher Waller has dared to proclaim that climate change does not pose such “significantly unique or material” financial stability risks that the Federal Reserve should treat it separately in its supervision of the financial system.

“Climate change is real, but I do not believe it poses a serious risk to the safety and soundness of large banks or the financial stability of the United States,” Waller said in remarks prepared for delivery to an economic conference in Spain.

“Risks are risks … My job is to make sure that the financial system is resilient to a range of risks. And I believe risks posed by climate change are not sufficiently unique or material to merit special treatment.”

His comments echo Chair Powell’s more conservative attitude towards The Fed’s responsibility for climate issues than its counterparts in Europe, who previously said that the U.S. central bank was not a climate policymaker and would not steer capital or investment away from the fossil fuel industry, for example.

So presumably this means The Fed does not believe the world will end within a decade in a devastating flood and fireball?

Read Waller’s full (carefully and diplomatically worded) statement below: (emphasis ours)

Climate change is real, but I do not believe it poses a serious risk to the safety and soundness of large banks or the financial stability of the United States. Risks are risks. There is no need for us to focus on one set of risks in a way that crowds out our focus on others. My job is to make sure that the financial system is resilient to a range of risks. And I believe risks posed by climate change are not sufficiently unique or material to merit special treatment relative to others. Nevertheless, I think it’s important to continue doing high-quality academic research regarding the role that climate plays in economic outcomes, such as the work presented at today’s conference.

In what follows, I want to be careful not to conflate my views on climate change itself with my views on how we should deal with financial risks associated with climate change. I believe the scientific community has rigorously established that our climate is changing. But my role is not to be a climate policymaker. Consistent with the Fed’s mandates, I must focus on financial risks, and the questions I’m exploring today are about whether the financial risks associated with climate change are different enough from other financial stability risks to merit special treatment. But before getting to those questions, I’d like to briefly explain how we think about financial stability at the Federal Reserve.

Financial stability is at the core of the Federal Reserve and our mission. The Federal Reserve was created in 1913, following the Banking Panic of 1907, with the goal of promoting financial stability and avoiding banking panics. Responsibilities have evolved over the years. In the aftermath of the 2007-09 financial crisis, Congress assigned the Fed additional responsibilities related to promoting financial stability, and the Board of Governors significantly increased the resources dedicated to that purpose. Events in recent years, including the pandemic, emerging geopolitical risks, and recent stress in the banking sector have only highlighted the important role central banks have in understanding and addressing financial stability risks. The Federal Reserve’s goal in financial stability is to help ensure that financial institutions and financial markets remain able to provide critical services to households and businesses so that they can continue to support a well-functioning economy through the business cycle.

Much of how we think about and monitor financial stability at the Federal Reserve is informed by our understanding of how shocks can propagate across financial markets and affect the economy. Economists have studied the role of debt in the macroeconomy dating all the way back to Irving Fisher in the 1930s, and in the past 40 years it has been well established that financial disruptions can reduce the efficiency of credit allocation and have real effects on the broader economy. When borrowers’ financial conditions deteriorate, lenders tend to charge higher rates on loans. That, in turn, can lead to less overall lending and negatively affect the broader economy. And in the wake of the 2007-09 financial crisis, we’ve learned more about the important roles credit growth and asset price growth play in “boom-bust” cycles.

Fundamentally, financial stress emerges when someone is owed something and doesn’t get paid back or becomes worried they won’t be paid back. If I take out a loan from you and can’t repay it, you take a loss. Similarly, if I take out a mortgage from a bank and I can’t repay it, the bank could take a loss. And if the bank hasn’t built sufficient ability to absorb those losses, it may not be able to pay its depositors back. These dynamics can have knock-on effects on asset prices. For example, when people default on their home mortgage loans, banks foreclose and seek to sell the homes, often at steep discounts. Those foreclosure sales can have contagion effects on nearby house prices. When a lot of households and businesses take such losses around the same time, it can have real effects on the economy as consumption and investment spending take a hit and overall trust in financial institutions wanes. The same process works when market participants fear they won’t be paid back or be able to sell their assets. Those fears themselves can drive instability.

The implication is that risks to financial stability have a couple of features. First, the risks must have relatively near-term effects, such that the risk manifesting could result in outstanding contracts being breached. Second, the risks must be material enough to create losses large enough to affect the real economy.

These insights about vulnerabilities across the financial system inform how we think about monitoring financial stability at the Federal Reserve. We identify risks and prioritize resources around those that are most threatening to the U.S. financial system. We distinguish between shocks, which are inherently difficult to predict, and vulnerabilities of the financial system, which can be monitored through the ebb and flow of the economic cycle. If you think about it, there is a huge set of shocks that could hit at any given time. Some of those shocks do hit, but most do not. Our approach promotes general resiliency, recognizing that we can’t predict, prioritize, and tailor specific policy around each and every shock that could occur.

Instead, we focus on monitoring broad groups of vulnerabilities, such as overvalued assets, liquidity risk in the financial system, and the amount of debt held by households and businesses, including banks. This approach implies that we are somewhat agnostic to the particular sources of shocks that may hit the economy at any point in time. Risks are risks, and from a policymaking perspective, the source of a particular shock isn’t as important as building a financial system that is resilient to the range of risks we face. For example, it is plausible that shocks could stem from things ranging from increasing dependence on computer systems and digital technologies to a shrinking labor force to geopolitical risk. Our focus on fundamental vulnerabilities like asset overvaluation, excessive leverage, and liquidity risk in part reflects our humility about our ability to identify the probabilities of each and every potential shock to our system in real time.

Let me provide a tangible example from our capital stress test for the largest banks. We use that stress test to ensure banks have sufficient capital to withstand the types of severe credit-driven recessions we’ve experienced in the United States since World War II. We use a design framework for the hypothetical scenarios that results in sharp declines in asset prices coupled with a steep rise in the unemployment rate, but we don’t detail the specific shocks that cause the recession because it isn’t necessary. What is important is that banks have enough capital to absorb losses associated with those highly adverse conditions. And the losses implied by a scenario like that are huge: last year’s scenario resulted in hypothetical losses of more than $600 billion for the largest banks. This resulted in a decline in their aggregate common equity capital ratio from 12.4 percent to 9.7 percent, which is still more than double the minimum requirement.

That brings us back to my original question: Are the financial risks stemming from climate change somehow different or more material such that we should give them special treatment? Or should our focus remain on monitoring and mitigating general financial system vulnerabilities, which can be affected by climate change over the long-term just like any number of other sources of risk? Before I answer, let me offer some definitions to make sure we’re all talking about the same things.

Climate-related financial risks are generally separated into two groups: physical risks and transition risks. Physical risks include the potential higher frequency and severity of acute events, such as fires, heatwaves, and hurricanes, as well as slower moving events like rising sea levels. Transition risks refer to those risks associated with an economy and society in transition to one that produces less greenhouse gases. These can owe to government policy changes, changes in consumer preferences, and technology transitions. The question is not whether these risks could result in losses for individuals or companies. The question is whether these risks are unique enough to merit special treatment in our financial stability framework.

Let’s start with physical risks. Unfortunately, like every year, it is possible we will experience forest fires, hurricanes, and other natural disasters in the coming months. These events, of course, are devastating to local communities. But they are not material enough to pose an outsized risk to the overall U.S. economy.

Broadly speaking, physical risks could affect the financial system through two related channels. First, physical risks can have a direct impact on property values. Hurricanes, fires, and rising sea levels can all drive down the values of properties. That in turn could put stress on financial institutions that lend against those properties, which could lead them to curb their lending, and suppress economic growth. The losses that individual property owners can realize might be devastating, but evidence I’ve seen so far suggests that these sorts of events don’t have much of an effect on bank performance. That may be in part attributable to banks and other investors effectively pricing physical risks from climate change into loan contracts. For example, recently researchers have found that heat stress—a climate physical risk that is likely to affect the economy—has been priced into bond spreads and stock returns since around 2013. In addition, while it is difficult to isolate the effects of weather events on the broader economy, there is evidence to suggest severe weather events like hurricanes do not likely have an outsized effect on growth rates in countries like the United States.

Over time, it is possible some of these physical risks could contribute to an exodus of people from certain cities or regions. For example, some worry that rising sea levels could significantly change coastal regions. While the cause may be different, the experience of broad property value declines is not a new one. We have had entire American cities that have experienced significant declines in population and property values over time. Take, for example, Detroit. In 1950, Detroit was the fifth largest city in the United States, but now it isn’t even in the top 20, after losing two-thirds of its population. I’m thrilled to see that Detroit has made a comeback in recent years, but the relocation of the automobile industry took a serious toll on the city and its people. Yet the decline in Detroit’s population, and commensurate decline in property values, did not pose a financial stability risk to the United States. What makes the potential future risk of a population decline in coastal cities different?

Second, and a more compelling concern, is the notion that property value declines could occur more-or-less instantaneously and on a large scale when, say, property insurers leave a region en masse. That sort of rapid decline in property values, which serve as collateral on loans, could certainly result in losses for banks and other financial intermediaries. But there is a growing body of literature that suggests economic agents are already adjusting behavior to account for risks associated with climate change. That should mitigate the risk of these potential “Minsky moments.” For the sake of argument though, suppose a great repricing does occur; would those losses be big enough to spill over into the broader financial system? Just as a point of comparison, let’s turn back to the stress tests I mentioned earlier. Each year the Federal Reserve stresses the largest banks against a hypothetical severe macroeconomic scenario. The stress tests don’t cover all risks, of course, but that scenario typically assumes broad real estate price declines of more than 25 percent across the United States. In last year’s stress test, the largest banks were able to absorb nearly $100 billion in losses on loans collateralized by real estate, in addition to another half a trillion dollars of losses on other positions.

What about transition risks? Transition risks are generally neither near-term nor likely to be material given their slow-moving nature and the ability of economic agents to price transition costs into contracts. There seems to be a consensus that orderly transitions will not pose a risk to financial stability. In that case, changes would be gradual and predictable. Households and businesses are generally well prepared to adjust to slow-moving and predicable changes. As are banks. For example, if banks know that certain industries will gradually become less profitable or assets pledged as collateral will become stranded, they will account for that in their loan pricing, loan duration, and risk assessments. And, because assets held by banks in the United States reprice in less than five years on average, there is ample time to adjust to all but the most abrupt of transitions.

But what if the transition is disorderly? One argument is that uncertainty associated with a disorderly transition will make it difficult for households and businesses to plan. It is certainly plausible that there could be swings in policy, and those swings could lead to changes in earnings expectations for companies, property values, and the value of commodities. But policy development is often disorderly and subject to the uncertainty of changing economic realities. In the United States, we have a long history of sweeping policy changes ranging from revisions to the tax code to things like changes in healthcare coverage and environmental policies. While these policy changes can certainly affect the composition of industries, the connection to broader financial stability is far less clear. And when policies are found to have large and damaging consequences, policymakers always have, and frequently make use of, the option to adjust course to limit those disruptions.

There are also concerns that technology development associated with climate change will be disorderly. Much technology development is disorderly. That is why innovators are often referred to as “disruptors.” So, what makes climate-related innovations more disruptive or less predictable than other innovations? Like the innovations of the automobile and the cell phone, I’d expect those stemming from the development of cleaner fuels and more efficient machines to be welfare-increasing on net.

So where does that leave us? I don’t see a need for special treatment for climate-related risks in our financial stability monitoring and policies. As policymakers, we must balance the broad set of risks we face, and we have a responsibility to prioritize using evidence and analysis. Based on what I’ve seen so far, I believe that placing an outsized focus on climate-related risks is not needed, and the Federal Reserve should focus on more near-term and material risks in keeping with our mandate.

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And cue the outrage mob…