Bullard Acknowledges Asset Bubble, Yet Fed Policy Will Remain Unchanged As Change Would Destroy Banks
In a groundbreaking presentation to be delivered on January 11 in Shanghai, "The First Phase of US Recovery and Beyond" St. Louis Fed president and monetary policy decision-maker James Bullard has come the closest to openly refuting Ben Bernanke's claim that no asset bubbles have been created via the Fed's monetary intervention policy during the post-Lehman period. Yet, Bullard notes, there is nothing that the Fed's "blunt instrument" approach can do to pop such bubbles proactively, as "financial institutions would need to be capable of withstanding large shocks to asset prices, as well as other shocks." Of course, the implication is that the day of reckoning for "financial institutions" is merely delayed to the point where further extend and pretend policy action is impossible and the Lehman collapse reaches a systemic contagion phase. In other words, the Fed admits the current course of action it itself has set the country on, is one of self-destruction, courtesy of the fiat banking system's ultimate death spiral. Alas, the disproof of Keynes' dogma will be a Pyrrhic victory as there will be nothing left of the American financial system in its wake.
Bullard provides interesting observations on the duality of interest rate versus quantitative easing policy intervention:
"The market’s focus on interest rates is disappointing, given
quantitative easing. Markets are still thinking of monetary
policy strictly as changes in interest rates—even though the Fed has
been conducting successful policy this past year through quantitative
easing. Markets should be focusing on quantitative monetary policy
rather than interest rate policy.
The main challenge for monetary policy going forward will be how to
adjust the asset purchase program without generating inflation and
still providing support to the economy while interest rates are near
But wasn't QE supposed to end in March? Not by a long shot. First, consider the facts of QE as highlighted in Bullard's prepared presentation:
- The Committee announced an intention to buy up to $1.725 trillion in assets by 2010 Q1.
- Considered successful as quantitative easing.
- Causing a large and persistent increase in the monetary base ...
- ... and a medium-term inflation risk.
- The FOMC asset purchase program does not have a state-contingent character.
- Main issue: How to adjust the asset purchase program going forward and not generate inflation?
Bingo: the bolded statement is all you need to know about the presumed March end date of the MBS purchase program. Absent a spike in the CPI, PPI, 10 year rates and whatever other doctored and manipulated metrics the Fed evaluates, QE will be with us for a long, long time. This is further observed by the following chart:
Ah, the fabled "extended period" clause. Well, thanks to Bullard's clarification, we now know that this determination defines not an interest rate duration ambiguity, but rather one of the Q.E. program itself. The latter, in turn, is inextricably linked to the $1.1 trillion in excess reserves. So long as that massive overhang exists, and continues growing, any hopes for an end to Q.E., let alone rate increases, are a deluded myth. And all that posturing about extracting excess liquidity and adjusting the liability side of the Fed's balance sheet, well, we'll believe it when we see it. Until then, we, and judging by the dollar's response to this speech, the broader market as well, fully expect another several hundred billion in tack-on MBS and, who knows, maybe even Treasury purchases by the Fed. The dollar carry trade is back, just as it seemed that Japan may regain the dubious distinction of being the supreme annihilator of one's own currency. Sorry Japan, Ben is the man.
But back to asset price bubbles:
Asset price bubbles are a very serious issue for monetary policy,” he
said, adding that this issue has been debated extensively over the past
15 years, and this debate will intensify. “This may mean that monetary
policy should put more weight on asset prices going forward. We need
better analysis of policy issues with respect to bubbles.
He said the question of “whether ‘easy’ money fuels speculative
investment—causing large and sharp increases and decreases in asset
prices, and ultimately, large costs on an economy—raises two questions
for monetary policy.” “Can the Fed identify incipient bubbles in real time? When are policy
judgments better than market judgments?” he asked. “If yes, what should
the Fed do?”
More on the asset bubble mea culpa from the Bullard:
- Monetary policy necessarily affects asset prices and interest rates.
- Historically, this did not appear to create prolonged run-ups in asset prices.
- But changes in the recovery of employment in the past two recessions led the Fed to keep interest rates low for a long time.
- Both periods featured prolonged increases in certain asset prices: for technology in the 1990s, and for housing in the 2000s.
- The drag on the economy from the housing decline since 2006 has been especially severe.
Amusingly, to Bullard the expiation of blowing bubbles is validated by the lack of inflation:
- Inflation has been low and stable through this period.
- If policy was too low for too long in the 1990s and in the 2000s, why didn’t we see more inflation?
- Yet, without an increase in inflation, asset price misalignments seem to have caused significant problems for the macroeconomy.
- This may mean that monetary policy should put more weight on asset prices going forward.
Seriously? Here's a hint Mr. Bullard: as to why we have not seen massive inflation in the past decade - look around you, where are you? Yes, Shanghai, China - the country that gladly funded US purchasing by buying hundreds of billions of US bonds at ever lower rates, and made US consumer cost of capital virtually nil, thereby keeping inflation low, HELOCs generous and the price of Chinese gadgets negligible. As we pointed out earlier, however, the tide is turning, and both China and the US realize the the exporting of inflation across the Pacific will become increasingly impossible. Where would inflation be if the Fed will not have purchased $1.75 trillion in securities by March, Mr. Bullard? That is a rhetorical question.
So Bullard's naive conclusion:
- Asset price "bubbles" are a very serious issue for monetary policy.
- This issue has been debated extensively over the past 15 years, but the debate will now intensify.
- The main problem: It is hard to see what was “wrong” with previous policy, given conventional ideas about what policy is trying to accomplish.
"Hard to see what was wrong?" Well, there you have it in big bold letters - the reason why America is on a path for a hyperdeflationary stagflation followed by unparalleled hyperinflation. And if we are wrong on either count, it is still a path that marks the beginning of the end of the Federal Reserve, whose primary mechanism of enacting monetary policy, the Federal Reserve Note, will soon find its shallow grave, weather by means of a deflationary death spiral, or hyperinflation.
And to add insult to injury, when asked what the Fed's response should be if, on that rare occasion that the Fed does capture a bubble in progress, Bullard says:
“Given the Fed mandates of maximum
sustainable employment and stable prices, plus ensuring financial
stability, monetary policy would be a blunt instrument when responding
to bubbles because monetary policy actions impact the macroeconomy and
cannot be targeted exclusively at a particular sector.”
He added, “If the asset prices contain reliable information about
future inflation and output, then the Fed might respond to the bubble
using monetary policy, but the focus would not be on responding to the
bubble per se. Another alternative would be to use regulatory,
supervisory and lender of last resort powers for financial stability,
but financial institutions would need to be capable of withstanding
large shocks to asset prices, as well as other shocks.”
Yup - the Mutual Assured Destruction which would result from any favorable and dollar-positive intervention, is alive and well, and coming from, you guessed it, Wall Street. Because the implication is that even if we are in a bubble, Wall Street, which is in no way shape or form capable of "withstanding large shocks to asset prices, as well as other shocks" will prevent the Fed from acting appropriately to curtail its interventionist monterey policy.
Lastly, as to the unmistakable bubble in China - well, that is none of the Fed's concern:
“U.S. policymakers are unlikely to react to departures of prices from
fundamental values in other countries,” he said. “It is the authorities
in other countries who must decide how to respond to their individual
country’s departure from fundamentals.”
After all, the last thing we want is to spook China into believing that their schizophrenic monetary policy is something we care about: please just keep on buying our bonds, making our kindles, and sewing our Lululemon sweatpants. If, in the process, the Fed can package its $8+ trillion of implicitly and explicitly guaranteed MBS (here's looking at you FRE and FNM) into a REIT and IPO them in Hong Kong, well, that would be just really swell.
Our prediction: Q.E., ZIRP, and all other disastrous and bubble-friendly policies by the Fed will remain in place until such time as Wall Street has transferred enough wealth from the middle class at current conditions, at which point debtloads will be inflated through a period of hyperinflationary annihilation of the middle class, or, because we have no certainty the Fed can even print enough FRNs quickly enough without screwing something up, will collapse under their own weight in a deflationary implosion. Either way, the end is now in sight.