Think back a moment to September 16 2008. Newly released transcripts analysed by the Wall Street Journal and Financial Times reveal for the first time what was really going on that day at the world’s most important central bank.
Lehman Bros, one of Wall Street’s largest investment banks, had just gone bust. Merrill Lynch, another giant, had had to be rescued. But the chairman of the US Federal Reserve, Ben Bernanke, opened the Fed’s monthly meeting that morning with the following comment:
“I think that our policy is looking actually pretty good. Overall I believe that our current funds rate setting is appropriate, and I don’t really see any reason to change”
Janet Yellen, now Fed Chairman, was worried about minor issues such as reservations at high-end restaurants:
“My contacts report that cutbacks in spending are widespread, especially for discretionary items . . . East Bay plastic surgeons and dentists note that patients are deferring elective procedures. Reservations are no longer necessary at many high-end restaurants. And the Silicon Valley Country Club, with a $250,000 entrance fee and seven-to-eight-year waiting list, has seen the number of would-be new members shrink to a mere 13.”
These reactions would be breath-taking, if one had not already become resigned to the fact that modern central bankers are completely out of touch with the real world:
- Some, like Bernanke and Yellen, are academics who believe that the economy operates according to the principles of mathematical models. For them, there is always constant growth if the right policies are followed
- Others, like Mark Carney (then Bank of Canada; now Bank of England) and Mario Draghi (European Central Bank), are ex-Goldman Sachs deal-makers. Reality for them is closing the deal and outsmarting the other guy
As the Fed’s transcripts confirm, none of the Fed Governors had any understanding of the crisis that was developing, even as late as September 16 2008. Yet as then US Treasury Secretary Hank Paulson told the BBC’s Robert Preston last week “we were quite close to having a collapse of the financial system that was catastrophic.”
As senior editor Gretchen Morgenson of the New York Times wrote yesterday:
“My initial takeaway from these voluminous transcripts is that they paint a disturbing picture of a central bank that was in the dark about each looming disaster throughout 2008. That meant that the nation’s top bank regulators were unprepared to deal with the consequences of each new event.”
Equally worrying is that anyone with an ounce of common sense could see that a disaster was unfolding. Thus the blog wrote on September 15 2008, before the Fed meeting (after having warned consistently of this risk since 2006):
LEHMAN GOES BUST, MERRILL RESCUED
“The blog has never liked disaster movies, but it was quite a weekend for those who do. First, there was the hurricane hitting Houston and Texas.
“Then, the financial hurricane arrived in New York. By Sunday night, Lehman, the 4th largest investment bank in the US was preparing for bankruptcy. And the world’s largest brokerage firm, Merrill Lynch, had been rescued by Bank of America. Ken Lewis, head of BofA, was quoted last October as saying that ‘I’ve had all the fun I can stand in investment banking’. Many more people will be echoing that thought this morning.
“The scale of the US banking crisis is now starting to become clear to the world. The US government last week had to nationalise the two largest mortgage lenders, Fannie and Freddie. Both Bear Stearns and Merrill Lynch have had to be rescued by other banks. And now Lehman has been let go, whilst 10 of the world’s largest banks have had to establish a $70bn fund to try and mitigate the fallout from its collapse.
“Slowly but surely, what began a year ago as a sub-prime collapse, is becoming a financial disaster of epic proportions. As the Wall Street Journal, the house magazine of Wall Street, writes this morning, ‘The American financial system was shaken to its core on Sunday’. These are strong words from a publication not given to exaggeration. And more problems are round the corner, with insurance giant AIG now seeking a $40bn lifeline from the Federal Reserve.
“Company CEO’s need to start preparing contingency plans for surviving a major economic downturn. After the events of the last 48 hours, the chances of this occurring are becoming uncomfortably high. “
Yet the Fed’s senior Governors were still living in the dream-world of their mathematical models, and seemingly failed to realise even at their 16 September meeting that AIG was about to go bust that evening.
The blog makes these points for just one reason. We are now living in even more dangerous times than in September 2008. Since then, global central banks have believed they could reflate the economy via wave after wave of stimulus. They have spent $16tn of our money in this fruitless endeavour so far. They have even ignored the recent public apology to the American people from the man who ran their stimulus programme:
“We went on a bond-buying spree that was supposed to help Main Street. Instead, it was a feast for Wall Street”
But now, the blog fears, payback time is coming near. And once again, the central bankers will be the last to realise what is happening.
What happens next could therefore be very scary indeed as the new Chinese leadership tackles the 3rd wave of the crisis that began with subprime in 2008, and was followed by the Eurozone crisis in 2011.
China’s new leadership have woken up to the risk of an “economic crash“, and have started to put their foot hard on their brakes. The outside world thinks they are bluffing, and are busy positioning themselves for another stimulus package perhaps as early as Q2.
The blog doubts that they will. It believes they understand they cannot risk ‘kicking the can down the road’ again. That is why premier Li described their new policy as “cutting one’s own wrist” in order to save the rest of the body.
We have already seen the first impact of this new policy hit an arc of countries from Argentina through S Africa, Indonesia, India and Turkey. And this is only the start of the process. Nobody can possibly know what the final impact will be, as China continues to remove its $10tn stimulus (nearly 15% of global GDP). Nobody knows, because nobody has ever had to attempt this before.
But what the history of September 2008 teaches us, is that the world’s central banks will only become aware of the impact after it has happened. We simply cannot rely on them to be the wise and far-sighted experts who can guide us safely through difficult times.
Benchmark product markets continue to show accelerating weakness in the Chinese market, with ICIS pricing comments and overall changes since January 2013 below:
PTA China, down 21%. “Weak downstream demand, coupled with an oversupplied condition in the key China markets exerted a downward pressure”
Brent crude oil, down 1%
Benzene, Europe, flat. “Players in Asia expect more March volume to be fixed for export to the US by the end of February, as it is the only outlet for sellers left due to limited demand from the Chinese market”
Naphtha Europe, down 2%. “Europe is structurally long on naphtha, and sellers need to export to the US gasoline and Asian petrochemical sectors to keep stocks in balance”
HDPE US export, up 16%. “China’s prices fell amid bearish market sentiment, based on high inventories among domestic producers and market talk that a large quantity of Iranian cargos are set to arrive at Chinese ports at the end of the month”
US$: yen, up 16%
S&P 500 stock market index, up 25%