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The Fatal Fallacy Of Faith In The Fed's Assumed Powers

Tyler Durden's picture




 

Submitted by Jeffrey Snider via Alhambra Investment Partners,

There is always some chicken and egg to any financial irregularity; as in does a crisis cause a panic or is it the panic that causes the crisis? Though the evidence of the past eight years is decidedly on the side of the irregularity, central banks continue to press as if that were not so. In no uncertain terms, central bankers persist in expressing their own confidence and, if you read or listen closely enough, great disdain for free markets they deem unworthy as if nothing more than unchained emotion. In the context of 2008, as the current FOMC tells it, the markets got all worked up over nothing much and should have instead simply enjoyed the blind faith in the Fed to have fixed it all without the fuss and bother.

As offensive as that sounds, that is exactly what is being preached. Janet Yellen in April 2014:

Fundamental to modern thinking on central banking is the idea that monetary policy is more effective when the public better understands and anticipates how the central bank will respond to evolving economic conditions. Specifically, it is important for the central bank to make clear how it will adjust its policy stance in response to unforeseen economic developments in a manner that reduces or blunts potentially harmful consequences. If the public understands and expects policymakers to behave in this systematically stabilizing manner, it will tend to respond less to such developments.

There is a fatal fallacy at the heart of this philosophy, one in which has blinded these economists as they marvel at their own assumed powers. Yellen suggests that markets should stop worrying so much about liquidity and other perhaps tangential, but no less meaningful, factors and instead only ignore them in the comfort that Yellen has those all under control. It is no less destructive conceit, one which was revealed to all amply this past decade – starting with the housing bubble itself.

In reality, investors and market agents have good reason to concern about both markets and central banks. Yellen says that they are in perfect position to handle whatever may come, but that clearly hasn’t been the case. Instead, central banks all over the world have been forced into one ad hoc program after another, which by itself refutes Yellen’s assertiveness. Rather than instill great confidence to do as the Fed Chair demands, central banks have only proved themselves far too in love with themselves. In order for this end of the Yellen Doctrine to work, central bankers need to stop thinking that everything they do is magic and saying so.

We can see that problem in ways both great and small, as “managing” Bear Stearns’ collapse in March 2008 didn’t round out the bottom but rather only instilled unearned confidence in the Fed that, again, their efforts would work. Bear was a great warning to be prepared about truly dire consequences, but somehow the FOMC was wholly unprepared for Lehman, AIG and the rest (including the GSE’s), leaving them scrambling and again pulling together various spontaneous programs from nowhere – and to no avail. Bernanke says that central banks can mitigate recession, so how come the Great Recession? This scenario was repeated (repeatedly) in 2011 and in smaller ways since.

I believe, in large part, that August 2015 represents just the latest in that gap between how markets do and should work and the ideal utopian scenario central banks plan for. The PBOC, far more so than the Fed, has enjoyed a reputation for control and management that seems to closely align with Yellen’s doctrine (totalitarian envy, the true financial law of central planning hard and soft). The events of August showed once again that there is no true control, only the illusion. The PBOC had clearly “engineered” a RMB/US$ cross without any volatility or variation whatsoever. Rather than view that as Yellen wishes, it was another ad hoc attempt to control and manage a far greater force – a force that none of the central banks wish to appreciate.

ABOOK ChinaYuan CNY

In order to contain yuan trading meant any number of growing intrusiveness, none of which we will ever likely know for sure. We can infer from various market components and then make reasonable judgments and extrapolations, but what is hidden and opaque will remain so until revealed by time. The PBOC and Chinese government have, in the past, used that to their advantage, cultivating the legend of near-omniscience for the PBOC, but since August what seemed to be beneficial in screening the true nature of market conditions might now turn in the other direction.

The narrative about China’s “dollar” efforts has been entirely focused on “selling UST’s” when that is only the gloss. As I noted a few weeks ago, the record of US t-bills more than suggests a deeper financial invective against “dollar” irregularity. It would be preposterous to think that the PBOC would be limiting itself to such an unsuitable arrangement; that the Chinese central bank would not be undertaking much deeper and intentionally muddy measures to at least run down and transform the immediate problem.

That would mean “reserve” mobilization would have been much more comprehensive and far deeper and multi-dimensional than simply “selling UST” of whatever class. In other words, if the PBOC was altering its bill strategy and engaging outright selling of UST securities, it was surely engaging repos and likely swaps of all flavors. After all, collateral in any of the derivative “reserve” activities is usually UST’s anyway.

 

It would also suggest transactions in forward contracts, a type of instrument the PBOC is intimately familiar with through its yuan management methodology. Thus, looking at the China’s “dollar” problem through the lens of wholesale finance opens up greater possibilities as far as what China has done (and is doing) about it.

To this point, it has worked on two fronts. Liquidity volatility has been somewhat improved (though, it has to be pointed out, the boot of PBOC yuan measures remains on SHIBOR which while providing immediate cover only increases the cost down the road) and, more importantly from the Yellen Doctrine standpoint, the “capital” flow numbers for September fooled any number of economists and commentators into issuing their verdict of an end to the emergency. That, of course, was nonsense as any deeper, wholesale appreciation for the PBOC’s tools and likelihoods suggests the opposite; namely that China has indeed followed Brazil. This was no end to the problem, but merely the end of Chapter 1 (if you wish to start the ordinal order at August rather than related prior “dollar” issues).

ABOOK ChinaYuan SHIBOR

As Brazil, the PBOC is proving far against any omniscience, instead it, too, is Fed-like mortal in being forced to inefficient and belatedly improvised emergency stirring. The use of forwards as a liquidity tool against a “dollar” run is as dangerous as the run itself because it moves the strain only in maturity (from immediate to more intermediate) but with a geometrically progressing “cost” and potential disorder for doing so.

Which brings us all back to the question about what, exactly, is an “outflow.” If a flood of PBOC-generated swaps and forwards sets up only a maturity transformation moving the “dollar” pressure from August or September to October and November, then being effective means being able to either deliver “dollars” then (instead of September) without an October disruption, or going deeper into maturity transformations (a form of, as noted above, high cost future indebtedness) in order to continue fooling “markets” into thinking there is nothing going on at all by maintaining this same outward appearance of resumed stability. That latter is surely the motivation behind O/N SHIBOR’s sudden meaninglessness.

 

In my view, and this is speculative on my part but I don’t think unreasonably so, the October 15 reserve mandate seems to be a hedge on the PBOC’s “dollar” intentions as far as taking the first option so as to keep the process to as much of a minimum as possible. The second option, which is what Brazil opted for (as does every other central bank when forced by sustained “dollar” turmoil), is too asymmetric – you gain more maturity transformation, kicking the can further, but the cost to do so increases more geometrically than linear.

The Brazil case is not exactly analogous given its unique financial connection to the eurodollar system and how its central bank attempts to manage it, but the situations are in general terms identical. Brazil found itself in “dollar” trouble in the middle of 2013, instituted swaps and forwards and “bought” only a few months peace and the appearance of calm. Once the maturity transformation took its place, starting September 2014, the real has been obliterated an order of magnitude worse than imaginable at the start of the program in 2013.

ABOOK Sept 2015 Brazil Toast Swaps

In my analysis, Brazil had no plausible escape from the “dollar” and thus the central bank’s efforts only amplified greatly the inevitable. From what I have seen of China, especially the first crack at the “dollar” run through July and August, I can’t fathom why they would find themselves any different. That point is bolstered by the belated recognition, in the mainstream no less, the wholesale inner workings that have, to this point, masked the continued difficulties:

The People’s Bank of China and local lenders increased their holdings in onshore forwards to $67.9 billion in August, positions that would boost China’s currency against the dollar. The amount is five times more than the average in the first seven months, PBOC data show. The positions are part of a three-stage process to support the currency without immediately draining reserves, according to China Merchants Bank Co. and Goldman Sachs Group Inc.

 

Standard central-bank intervention to support a currency generally involves selling dollars and buying the home tender. In this case, China’s large state banks borrowed dollars in the swap market, sold the U.S. currency in the cash spot market and used forward contracts with the central bank to hedge those positions.

In the parlance of what I have used to describe for Brazil, the PBOC like Banco do Brasil enticed Chinese banks already short (synthetically) the “dollar” to become more so – all because they are coaxed into believing, as Yellen, that the central bank will have it covered on the other end. The PBOC’s motivation is only immediate, just hoping that the unwind into the future can be more manageable. What Brazilian banks found was quite the opposite, and Brazil is now suffering greatly for it.

That last is the central issue here, namely that doing as Yellen and her counterparts demand is the biggest risk of all. The Yellen Doctrine requires that central banks be both correct and able, abilities that have been (and can only be) in utter short supply. Her view would show more proactive and effective central bank management where only reactive and impromptu, last minute white-knuckling has abounded. Central banks have been in the past year only holding on for dear life, which is where obscurity has been their benefit. In the end, however, I think it their own downfall as it only serves to make matters worse. Yellen wants the central bank to be viewed as almost godlike, but they continually reveal themselves weak, deceptive and ineffectual; eschewing all long run sustainability in order to just make it through one day at a time.

They really don’t know what they are doing and China’s forwards put yet another exclamation on that point. That is why I have claimed these past few months that the central bank’s worst nightmare will be when wholesale exposure is revealed and appreciated as exactly the problem rather than the solution. Making Chinese banks “more short” the “dollar” is like giving a morphine addict keys to the medical locker and expecting the printed warning labels as enough to deter overdose.

 

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Sun, 10/25/2015 - 18:00 | 6709945 Cognitive Dissonance
Cognitive Dissonance's picture

Hope and belief die hard. It is far easier to continue to believe in failed policies and institutions than it is to enter the unknown and be responsible for the 'self'.

You can find my latest essay, "A Failure of Imagination", on www.twoicefloes.com

Sun, 10/25/2015 - 18:08 | 6709970 Stuck on Zero
Stuck on Zero's picture

The Fed is really truly incompetent like in ...

Ooops. We stole another trillion.

Whoops. Deary me. We stole another trillion.

Whups. Goof. We stole another trillion.

Sun, 10/25/2015 - 18:16 | 6709997 Money Counterfeiter
Money Counterfeiter's picture

Communism with peasants that work.

Sun, 10/25/2015 - 19:11 | 6710157 two hoots
two hoots's picture

 

The “Federal Reserve” name gives it a tricky public American apple pie secure official flavor.   Housed in a federal building, they are as Federal as JP Morgan and Citi and they have none of our Reserves, only $3-4T of our debt which enslaves us to their decisions.   They have managed to position themselves higher than any constitutional authority?

I suppose all elected officials fear the Fed could destroy their livelihood/their wealth, or stop the increase of it, so they let them do as they wish, unopposed?  The rest of us…………?

I know it is an old tiring quote but it rings truer today than ever:  "Give me control of a nation's money and I care not who makes the laws." 

   

Sun, 10/25/2015 - 19:38 | 6710253 BurningFuld
BurningFuld's picture

Fuck I thought that was a picture of Pluto when I scrolled down.

Sun, 10/25/2015 - 18:04 | 6709951 MFL8240
MFL8240's picture

Satan like is more the narative lady!   But, the arrogance is truley disturbing!

 

Yellen wants the central bank to be viewed as almost godlike..."

Sun, 10/25/2015 - 18:01 | 6709952 negative rates
negative rates's picture

Believe in, and let the Fed drive YOU into the ground!!

Sun, 10/25/2015 - 18:07 | 6709969 adr
adr's picture

Of course they don't know what they are doing. They are trying to keep a system of fraud and lies going.

You can't continue to lie by telling the truth.

Sun, 10/25/2015 - 18:10 | 6709978 buzzsaw99
buzzsaw99's picture

Of course they know what they are doing. They are trying to keep a system of fraud and lies going.

Sun, 10/25/2015 - 18:13 | 6709989 logicalman
logicalman's picture

The only thing Central Banks have ever been good at is theft.

 

Sun, 10/25/2015 - 18:18 | 6710000 Money Counterfeiter
Money Counterfeiter's picture

Media, politicians, industry, education, peasants.  Stalin would be proud.

Sun, 10/25/2015 - 18:14 | 6709991 dragoneyes74
Sun, 10/25/2015 - 18:20 | 6710006 lester1
lester1's picture

I am convinced that the Federal Reserve has been buying stocks via their primary dealer banks in order to prevent a stock market collapse.

 

Think about it. Lots of bad economic data comes out and stocks go up? Who else is powerful enough to reverse +500 points in just a few hours?

 

The Fed is already propping up the bond market, why not prop up the stock market too? What's to stop them?

 

Audit the Fed Now !!

Sun, 10/25/2015 - 18:25 | 6710015 God
God's picture

Hocus pocus alakazam! Your belief in jew confetti is part of the sham!

Sun, 10/25/2015 - 18:51 | 6710089 Colonel Klink
Colonel Klink's picture

Judenfetzen 2.0!

Sun, 10/25/2015 - 19:04 | 6710141 God
God's picture

Wir wollen keine Judenfetzen von America!

Sun, 10/25/2015 - 19:48 | 6710281 Colonel Klink
Colonel Klink's picture

Sorry but it's the world's reserve Judenfetzen, as they all are, except the reserve part.

Sun, 10/25/2015 - 18:44 | 6710038 Fukushima Fricassee
Fukushima Fricassee's picture

I have never had faith in these fuckers. I have lost faith in most Americans. There was a Nice toyota infront of me today at the gas pump with a "Bernie 2016" sticker . I asked the fucker filling it up if I could use that toyota to take a trip this week . When he looked at me cross eyed I added, I though thats what communisum was all about, I can take from you what I need simply because I am entiled . Idiot shit looked like a goverrnment worker or college proffesor.

Sun, 10/25/2015 - 18:42 | 6710067 JR
JR's picture

Bernanke and Yellen have grabbed onto Keynes just as Lenin grabbed onto Marx to give themselves a ready philosophy for their confiscation of wealth and cruelty.

Here is the parallel between the Globalists now controlling the EU and the USA and the teaching of Marx. As Marx declared, “The working man has no country.” And as the Globalists declare in their drive to break down all borders, “Sovereignty and nationalism must be abolished.”

Marx wanted to abolish capitalism. Likewise, Fabian Socialism, aka Keynesianism, wants to abolish capitalism.

And as NIRP and a cashless society emerge in Europe and America, remember, under a “pure communism” there is no money.

Sun, 10/25/2015 - 21:33 | 6710615 MASTER OF UNIVERSE
MASTER OF UNIVERSE's picture

You don't happen to have an old can of Capitalism lying around do you, JR? Frankly, it's been so long since anyone even saw an old can of Capitalism it's highly likely that we have all forgotten what it looks like.

 

p.s. Where did Marx state that 'the working man has no country'?

 

Greed killed Capitalism back in 1994 at a hotel in Miami over drinks.

Sun, 10/25/2015 - 18:50 | 6710085 Colonel Klink
Colonel Klink's picture

What the Fed fails to realize is there are a fair number of people doing all they can to thwart their efforts by not working, not spending, and not paying taxes.

Fuck the criminal Federal Reserve and our traitorous representatives.

Sun, 10/25/2015 - 19:12 | 6710168 bentaxle
bentaxle's picture

Those who can, do. Those who can't, blog.

Sun, 10/25/2015 - 19:52 | 6710205 Exalt
Exalt's picture

Great article. Whether the Chinese will be able to free themselves of the Dollar is one thing. Whether they can do so without destabilizing global finance and killing themselves is another. Hedging against the Dollar invests the PBOC in an orderly changing of the guard and a strong emphasis on preventing financial distress. I don't feel the PBOC nor FED/ECB/BOJ really have this situation under control at all. All it takes is one really big default or a confidence collapse to call US debt into question again and initiate Dollar destruction. Alternatively, for China's Dollar short futures to evaporate due to financial distress. What are their other options though? You can only sell so many Dollars and initiate so many swaps without saturating and sparking a fire. Sooner rather than later the Chinese have to demand payment in a currency other than the Dollar without disrupting US trade with them (or diversify their core export market immediately) and shed whatever Dollars they have accumulated as fast as they can. Who really wants Dollars (i.e. imports from US)? Canada? House of Saud? Seriously... No one wants this currency except for "safety". Some sucker has to be left with no chair here. Right now, that sucker to me looks like China. Unless China can convince the Americans to give them gold in return for goodies, which just gives me the giggles. Monopoly money indeed. Keep exploring Tyler.

Sun, 10/25/2015 - 20:26 | 6710435 Reaper
Reaper's picture

Trust is a fatal opiate.

Sun, 10/25/2015 - 21:37 | 6710608 teslaberry
teslaberry's picture

the fed isn't fucking stupid. they use their power on the way down as things fall apart. the only real end to bankers' powers is when dictators/tyrants take over who can find a way to use overwhelming force to take their treasure. that is why the REAL banker families keep their fortunes in vaults in switzerland and in unknown inaccesible off shore havens that are somewhat beyond the pressure of the 'governments'. 

if you think about what true 'libertarianism' and 'anarchy' realy means. we are living it. 

 

only, the succesful libertarians become bankers and then inevitably use the rising power of governmnet to enrich themselves even further. when society implodes, they go live far away. 

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