Betting On An Infinite Bernanke Put? Not So Fast, Says Fed Governor Kevin Warsh
Last week's Op-Ed du semaine was Ben Bernanke's WaPo glowing endorsement of the Fed market put, whose sole purpose was to remind stocks, which ended up drooping on the day QE2 was announced, that Bernanke will stop at nothing to achieve his now primary goal (as loosely interpreted under the Fed's broad, and unsupervisable, mandate) - surging stock prices. This week, however, may likely belong to Fed Board Governor, and former member of the President's working group on capital markets, Kevin Warsh. In an Op-ed just released in the WSJ, Warsh, whose series of accomplishments include being the youngest ever appointee to the Fed BOD at 35, and being married to Jane Lauder of Estee Lauder fame, writes "Lower risk-free rates and higher equity prices—if sustained—could
strengthen household and business balance sheets, and raise confidence
in the strength of the economy. But if the recent weakness in the
dollar, run-up in commodity prices, and other forward-looking indicators
are sustained and passed along into final prices, the Fed's price
stability objective might no longer be a compelling policy rationale. In
such a case—even with the unemployment rate still high—we would have
cause to consider the path of policy. This is truer still if inflation
expectations increase materially." Translation: if gold continues to exhibit a beta > 1 w/r/t ES, then we are screwed, and all Fed policies will have failed. Elsewhere, look for most commodities to open limit up again tomorrow for the nth day in a row as inflation expectations continue to "increase materially" and more and more Fed members understand just what Warsh is saying.
Much more in this surprisingly austere statement by one of the fresher voices at the Fed:
On focusing on the "seller" in the critical economic equation which the Fed now believes is only defined by end consumer demand, a premise that was thoroughly destroyed earlier by Sean Corrigan:
Policy makers should take notice of the critical importance of the
supply side of the economy. The supply side establishes the economy's
productive capacity. Recovery after a recession demands that capital and
labor be reallocated. But the reallocation of these resources to new
sectors and companies has been painfully slow and unnecessarily
interrupted. We are feeling the ill effects.
On austerity: look for Krugman and fluffer DeLong to go apeshit over this:
Fiscal authorities should resist the temptation to increase government
expenditures continually in order to compensate for shortfalls of
private consumption and investment. A strict economic diet of fiscal
austerity has greater appeal, a kind of penance owed for the excesses of
the past. But root-canal economics also does not constitute optimal
On consumer deleveraging:
The deleveraging by our households and businesses is not a pattern to be
arrested, but good prudence to be celebrated. Larger, more liquid
corporate balance sheets and higher personal saving rates are the
reasonable and right responses to massive government dissaving and
unpredictable government policies. The steep correction in housing
markets, while painful, lays the foundation for recovery, far better
than the countless programs that have sought to subsidize and temporize
the inevitable repricing. It is these transitions in our market
economy—and the adoption of pro-growth fiscal, regulatory and trade
policies—that lay the essential groundwork for greater, more sustainable
Stunningly insightful words for a Fed member. They beg the question, however, why was consensual restructuring not on the table when TARP was being proposed? As we have said so many times, the US banks would not have collapsed had their balance sheets been reorganized, even as their operations continued (totally separate from bank liabilities). Now it is too late, which is why a reversion will necessarily require a complete financial reset, and all those who are calling for a methodological process to go back to where we were in the days of late September 2008, when there still was hope, are naive idealists. In this context a return to a gold standard would not make sense at the current price of gold... It would, however make sense, were gold to be priced at around $5,000, or more.
Yet the most stunning tidbit of clarity and lucidity by Warsh is the following:
Last week, my colleagues and I on the Federal Open Market Committee (FOMC) engaged in this debate. The FOMC announced its intent to purchase an additional $75 billion of long-term Treasury securities per month through the second quarter of 2011. The FOMC did not make an unconditional or open-ended commitment. I consider the FOMC's action as necessarily limited, circumscribed and subject to regular review. Policies should be altered if certain objectives are satisfied, purported benefits disappoint, or potential risks threaten to materialize.
Lower risk-free rates and higher equity prices—if sustained—could strengthen household and business balance sheets, and raise confidence in the strength of the economy. But if the recent weakness in the dollar, run-up in commodity prices, and other forward-looking indicators are sustained and passed along into final prices, the Fed's price stability objective might no longer be a compelling policy rationale. In such a case—even with the unemployment rate still high—we would have cause to consider the path of policy. This is truer still if inflation expectations increase materially.
The Fed's increased presence in the market for long-term Treasury securities poses nontrivial risks that bear watching. The prices assigned to Treasury securities—the risk-free rate—are the foundation from which the price of virtually every asset in the world is calculated. As the Fed's balance sheet expands, it becomes more of a price maker than a price taker in the Treasury market. If market participants come to doubt these prices—or their reliance on these prices proves fleeting—risk premiums across asset classes and geographies could move unexpectedly.
The last sentence is the ultimate kicker as it captures precisely what will happen when the realization that things are slipping outside of the Fed's control spill over to Wall Street (and then to MainStreet). As Warsh says: "The Fed can lose its hard-earned credibility—and monetary policy can
lose its considerable sway—if its policies overpromise or under deliver." As the bulk of the world, and the vast majority of the population already have no faith in the Fed, the acknowledgement that this process can capture everyone, including a ponzified Wall Street, whose fortunes are embedded in the proper functioning of the Fed, should be cause for huge alarm. Since if even the Fed realizes that the risk that the world will look beyond the fake price facade created by Bernanke exists, it is only a matter of time before the transition from hypothetical to real is completed.
As Warsh's words resound with more members of the FOMC and Fed BOD, and especially as 3 new hawks join the voting ranks next year, not to mention Ron Paul's new role, all those betting that "EVERYTHING" will go up under QE2/3/4/etc, may want to promptly reevaluate their thesis...