The boom is unsustainable. Investment and consumption are higher than they would have been in the absence of monetary intervention. As asset bubbles inflate, yields increase, but so do inflation expectations. To dampen inflation expectations, the Fed withdraws stimulus. As soon as asset prices start to fall, yields on heavily leveraged assets are negative. As asset prices decline, increasingly more investors are underwater. Loan defaults rise as mortgage payments adjust up with rising interest rates. When asset bubbles pop, the boom becomes the bust.
The American financial establishment has an incredible ability to celebrate the inconsequential while ignoring the vital. Last week, while the Wall Street Journal pondered how the Fed may set interest rates three to four years in the future (an exercise that David Stockman rightly compared to debating how many angels could dance on the head of a pin), the media almost completely ignored one of the most chilling pieces of financial news that I have ever seen. According to a small story in the Financial Times, some Fed officials would like to require retail owners of bond mutual funds to pay an "exit fee" to liquidate their positions. Come again? That such a policy would even be considered tells us much about the current fragility of our bond market and the collective insanity of layers of unnecessary regulation.
"The responsibility of any central bank is price stability. I was at the helm at that time. Price stability is two percent inflation, which we can’t closely control anyway. They ought to make sure that they are making policies that are convincing to the public and to the markets that they’re not going to tolerate inflation... The responsibility of the government is to have a stable currency. This kind of stuff that you’re being taught at Princeton disturbs me. Your teachers must be telling you that if you’ve got expected inflation, then everybody adjusts and then it’s OK. Is that what they’re telling you? Where did the question come from?"
The FOMC should (and might) accelerate the pace of QE reductions to $15 billion on Wednesday (June 18th). Furthermore, at its meeting on July 30th, the FOMC could – and should -announce a similar-sized reduction for the subsequent two months. Hence, the Fed would not have to wait until its September 17th meeting to announce the final leg. QE would then end two months earlier at the end of August rather than the end of October as markets currently expect. Such a path would generally afford the FOMC more freedoms, particularly at the September17th press conference meeting. There are of plenty of reasons to justify such a move...
The central banks have created moral hazard on a scale which is simply unbelievable and set a stage for a bonfire of the vanities seldom, if ever, seen in history. Professional Investors who have spent a lifetime playing these contrarian opportunities offered by human behavior are being carried out on stretchers as historic market behaviors fail to materialize. "Never in my 30+ year career as a market observer have I seen so many out on a limb which is about to be sawed off." Those who live within the matrix are fully loaded for a recovery which is not and will not appear. But when the leverage fails, the world’s developed economies will be thrust into the next leg of the cleansing process of deleveraging and the destruction of it will be equally bigger. This conclusion is firmly on the horizon; let’s call it the great insanity.
"... the Fed is overpromising and over-reaching on what it can actually deliver. It has always been quite a leap of faith to believe that ever-rising asset prices would create a wealth effect adequate enough to boost consumption, so as to make progress on the Fed’s dual mandates without causing adverse financial markets conditions.... After the 2008 crisis, policymakers have tried to end this mindset by becoming more proactive in trying to prevent financial crises. Though well-intentioned, this new approach has arguably led to Fed policy itself becoming a source of systemic risk... Markets are likely headed for a difficult period as the FOMC tries to gradually wean investors off of its liquidity addiction. It is too late for the FOMC to do much other than to try to limit the damage.... The bottom line could simply be that QE means ‘risk-on’, while ending QE means ‘risk-off’."
Equity markets are not happy about the Fed's Charles Plosser's economic exuberance ("3% growth no matter the weather" which is 20% above consensus of 2.5%) and his 'good-news-bad-news' monetary policy hawkishness ("may need to raise rates sooner rather than later"). But perhaps the most crucial part of his speech this morning was what the headlines notably left out. Plosser admonished his global central bank brethren: "if central banks do not limit their interventionist strategies and focus on returning to more normal policymaking aimed at promoting price stability and long-term growth, then they will simply encourage the financial markets to ignore fundamentals and to focus instead on the next actions of the central bank." Simply put, he warned, "central bankers have become too sensitive and desirous of managing prices in the financial world.."
TedBits - Newsletter
Never in a million years did we think we’d ever use an article by Andrew Ross Sorkin as the basis of a blog post, but here we are. While probably entirely unintentional, his article serves to further solidify as accurate the prevailing notion across America that former head of the New York Federal Reserve and Obama’s first Treasury Secretary, Timothy Geithner, is nothing more than an addled, crony, bureaucratic banker cabin boy. Simply put, "Geithner is so bad, he actually makes Larry Summers look good."
This time is different - check; Moral Hazard - check; Easy Money - check; Overblown growth stories - check; No valuation anchor - check; Conspicuous consumption - check; Ponzi finance - check... and, of course, Irrational exuberance: check!
We believe Fed’s actions would be more appropriately described as permitted cancerous beliefs to spread throughout the financial system, thereby killing Democratic Capitalism which is the basis of the capital markets.
Chief Economist Of Central Banks' Central Bank: "It's Extremely Dangerous... I See Speculative Bubbles Like In 2007"Submitted by Tyler Durden on 04/11/2014 17:05 -0500
Yet again, it seems, once senior political or economic figures leave their 'public service' the story changes from one of "you have to lie, when it's serious" to a more truthful reflection on reality. As Finanz und Wirtschaft reports in this great interview, Bill White - former chief economist of the Bank for International Settlements (who admittedly has been quite vocal in the past) - warns of grave adverse effects of the ultra loose monetary policy everywhere in the world... "It all feels like 2007, with equity markets overvalued and spreads in the bond markets extremely thin... central banks are making it up as they go along." Some very uncomfortable truths in this crucial fact-based interview.