Guest Post: The Wolf In Sheep's Clothing
Submitted by Nicholas Bucheleres of NJBDeflator blog,
Let's call the collection of investors and traders that have been ceaselessly squabbling over the Fed's policy decisions, card players, and let's call Bernanke, the dealer. Throughout this summer and fall, investors have been playing cards against a guarded Bernanke, until September 14's FOMC meeting wherein Uncle Ben slated the Fed to purchase an additional $40billion in agency mortgage-backed securities (MBS) per month (increasing total monthly agency MBS purchases to $85billion). Despite all counter-arguments and despite the fact that central banking is going even beyond unchartered waters, it is now clear that the dealer is being forced to show his hand.
These days every pundit and his barber are suddenly central banking gurus and monetary transmission mechanism experts, but while some of them may have an educated guess as to the reality of the matters at hand, none can envisage that which the Fed is able to. What is almost never considered by most wanna-bees is that no one in the world has access to as many economic and financial data sets, metrics, and indicators, and the synthesis thereof, as the United States Federal Reserve. Ben may make mistakes, but he is no fool. When he acts, he either sees present reason to do so, or he is bracing for a future shock.
A famous guy named Socrates from the 400s (BC, that is) once said,
"As for me, all I know is that I know nothing."
Although already agreed upon by the Fed, claims against the pursuance of further monetary action are numerous, and the argument that it fails to ignite the real economy has been proven correct in recent history. The Dallas Federal Reserve President Richard Fisher, who is a non-voting member of the FOMC, has been one of the most reputable and vocal dissenters of further Fed balance sheet expansion:
- The United States currently faces no immediate threat of deflation, which was the implicit prospectus of the post-Great Depression US central banking system. Inflation is slightly below where Bernanke wants it, and, in fact, longer-term inflation expectations have been rising. Oh yeah, and this summer's drought inflated corn and soybean prices by ~50% and ~35% respectively. Inflation will undoubtedly rear its head sooner or later; deflation is far less likely.
- Mortgage rates must be holding people back from purchasing new homes, right? Not quite. Mortgages are currently at their lowest rates ever. Will a couple fewer basis points really matter?
- "Well, I'd start a small business if..." Sorry, pal, that's still not an excuse to live with your mom and her 12 cats. Labor and business survey data empirically show that 9-out-of-10 small and medium sized businesses are not interested in borrowing, or have credit readily available to them.
- US equity indices are setting 4+ year highs and are just shy of clearing all-time highs and US corporations are flushed with cash.
There is an obvious dissonance between the above metrics and the Fed's decision to further prop up the economy but, let's get back to the card game:
That the Fed has enacted another round of easing, even though many of the economic indicators it aims to improve are either robust or have clearly not been effected by recent rounds of liquidity, should be troubling. It means that the Fed foresees imminent headwinds that would be disastrous to our economy in its current state. Maybe Richard Fisher can put it more eloquently than I can. Take it away, Dick.
Nobody on the committee, nor on our staffs at the Board of Governors and the 12 [Federal Reserve] banks, really knows what is holding back the economy. Nobody really knows what will work to get the economy back on course.
Sobering words from Richard Fisher; Bernanke has recently been speaking to the notion of helplessness, also.
If we want our questions about the economy answered, we should look Bernanke's recent move to intuit an idea of the cards he is playing with. There are disconnects between what is considered the common knowledge of investors, and the behavior of the Fed. This move gave Bernanke's hand away, and it is becoming clear that negative developments around the world (some yet to come to fruition) are cornering Bernanke and forcing him to come to terms with his inability to provide the panacea again. The god-like powers of central banking are being questioned, and maybe Bernanke's 2008 silver-bullet should have been a one-off.
Has the writing on the walls faded since 2008? Have we not figured out that whenever the Fed acts, things are either really bad, or are on the way there? Further than that, have we not figured out that the Fed cannot carry the entire economy on its balance-sheet? Do I even need to sarcastically say, "This time it's different!"? Bernanke is not a chump--he is well aware of the short-comings of recent Fed activity and their limited effects going forward. It is quite clear at this point that Ben is pulling his nose out of the textbook and is beginning to act out of last resort. This last resort scenario is confirmed by his preemptive strike and implies that Ben, who has it from the best data in the world, thinks that this economy needs to return to "trend" as quickly as possible in order to weather near-term storms.
An important (and I believe severely under-appreciated) tenant of Bernanke's FOMC stance was his response to a question by a journalist after his speech. His response gave coy indication of his implicit goal to elevate the United States economy to a level of momentum which would allow it to overcome future (unspecified) headwinds. Which headwinds might those be?
- A ballooning $1trillion student-debt load in the United States
- The proverbial "Fiscal Cliff"
- Cracks in the euro zone deepening
- Middle-East turmoil disrupting trade routes, specifically oil
- A sudden deterioration in an already crumbling Chinese economy
...and the list goes on. Bernanke is king-of-the-data-hill and it is more than likely that he is privy to negative developments in one or more of the risks facing the US economy that even the most savvy bank economists cannot or may not see.
Despite entropy from within its own entity, the Federal Reserve is at it once again. This time, we have recent history to act as reference, which is not very encouraging. For many reasons, some aforementioned, the United States economy is clearly not amenable to Fed balance-sheet expansion anymore, yet, despite dissent and all, the members of the Federal Reserve's Federal Open Markets agreed on September 14th to increase their monthly purchases.
This last resort scenario is not just isolated to the United States and the Federal Reserve. The ECB, the Bank of Japan, and the Bank of England are of the most notable "easers" of the last couple weeks. The cases for and against their monetary accommodation are beyond the scope of this article, but the takeaway is the same: central bankers around the world are grasping at straws.
It is a matter of time before markets lose complete faith in the recklessness of central planning Ponzi artists, and this reality is self-evident through the late-summer/early-fall hope-rally.
S&P500 (white) & Dow Jones Transportation sub-sector (blue) over two years.
One of the withstanding pillars of Dow Theory is the notion that market extremes are determined by comparing extremes in the Dow Jones Transportation sub-sector and extremes in the broader equity market. As is clear above, the S&P is a nudge below all-time highs while the Dow Transportation sector continues to set lows of longer time horizons. According to the century old Dow Theory, and among a plethora of other reasons, it might be time to reconsider the beta of your portfolio.