Federal Reserve Bank

The US Federal Reserve’s recent surprise announcement that it would maintain the current pace of its monetary stimulus reflects the ongoing debate about the desirability of cooperation among central banks. Discussion of central-bank cooperation has often centered on a single historical case, in which cooperation initially seemed promising, but turned out to be catastrophic. We are thus left with a paradox: While crises increase demand for central-bank cooperation to deliver the global public good of financial stability, they also dramatically increase the costs of cooperation, especially the fiscal costs associated with stability-enhancing interventions. As a result, in the wake of a crisis, the world often becomes disenchanted with the role of central banks – and central-bank cooperation is, yet again, associated with disaster.

There is a considerable amount of debate in alternative economic circles as to whether a federal government shutdown would be a “good thing” or a “bad thing”. Sadly, a government shutdown is sizable threat to the American financial system, and few people seem to get it.  Perhaps because the expectation is that any shutdown would only be a short term concern.  And, this assumption might be correct.  But, if a shutdown takes place, and, if “gridlock” continues for an extended period of time, We have little doubt that the U.S economy will experience renewed crisis.  Here's why...

While the commemoration of the 5 year anniversary of the start of the Great Financial Crisis is slowing but surely fading, another just as important anniversary is revealed when one goes back not 5 but 15 years into the past, specifically to September 23, 1998. On that day, the policy that came to define the New Normal more than any other, namely the bailout of those deemed Too Big To Fail, a/k/a throwing good (private or taxpayer) money after bad was enshrined by Wall Street as the official canon when faced with a situation where capitalism, namely failure, is seen as Too Dangerous To Succeed. This was first known as the Greenspan Put, subsequently the Bernanke Put, and its current iteration is best known as the Global Central Banker All-In Systemic Put. We sow the seeds of bailing out insolvent financial corporations to this day, when instead of making them smaller and breaking them up, they are rewarded by becoming even bigger, even more systemics, and even Too Bigger To Fail, and their employees are paid ever greater record bonuses.

"If you add up all the promises that have been made for spending obligations, including defense expenditures, and you subtract all the taxes that we expect to collect, the difference is $211 trillion. That's the fiscal gap," he says. "That's our true indebtedness."

As it turns out, a lot... and also very little.

Deflation - A derangement of money or credit, a symptom of which is falling prices. Not to be confused with a benign, i.e., downward shift in the composite supply curve, a symptom of which is also falling prices. In a genuine deflation, banks stop lending. Prices tumble because overextended businesses and consumers confront the necessity of selling assets in order to raise cash. When prices fall because efficient producers are competing to deliver lower-priced goods and services to the marketplace, that is called “progress.”  In 2013, central bankers the world over define deflation as a fall in prices, no matter what the cause. Nowadays, to forestall what is popularly called deflation, the world’s monetary authorities are seemingly prepared to pull out every radical policy stop. Where it all ends is one of the great questions of contemporary finance.

To say that bonds are under pressure would be an understatement. Over the last few months, sentiment about fixed income has flipped dramatically: from a favored investment destination that is deemed to benefit from exceptional support from central banks, to an asset class experiencing large outflows, negative returns and reduced standing as an anchor of a well-diversified asset allocation. Similar to prior periods, history will regard the ongoing phase of dislocations in the bond market as a transitional period of adjustment triggered by changing expectations about policy, the economy and asset preferences – all of which have been significantly turbocharged by a set of temporary and ultimately reversible technical factors. By contrast, history is unlikely to record a change in the important role that fixed income plays over time in prudent asset allocations and diversified investment portfolios – in generating returns, reducing volatility and lowering the risk of severe capital loss. Understanding well what created this change is critical to how investors may think about the future.

There is a saying: if in doubt, ask an economist, and do the opposite.

There is also consensus among the people inhabiting the real world -the one that is found outside the ivory towers of the economics departments of all US and global Tier 1, 2 and 3 universities - that the only reason the world is currently in its sad, deplorable and deteriorating economic state (which however keeps making the rich richer), is precisely due to these same economists, whose tinkering and experimentation with DSGE models, differential equations, curved lines, and all such things all of which have no real world equivalent, and specifically due to economists like Greenspan and Bernanke. These two men, both of whom barely have seen the real world for what it is or held a real job outside of their academic outposts, who surround themselves with brownnosing sycophants and who do the bidding of Wall Street, are the primary reason for the current centrally-planned quagmire. Which is why we wonder: is the fact that some 313 economists (and counting) have signed a petition pushing for Janet Yellen (aka Freudian slip "he" if you are the president), and against Larry Summers, sufficient grounds to actually like the outspoken former Harvard head?

San Francisco Fed head John Williams - known for his extremely dovish views on monetary policy (and support of record accomodation)  - appears to have taken some uncomfortable truth serum this morning. In a speech reminiscent of previous "froth" discussions and "irrational exuberance" admissions, Williams explained:

• *WILLIAMS SAYS POLICY MAY YIELD ASSET BUBBLES, UNINTENDED RESULT
• *WILLIAMS: ASSET-PRICE BUBBLES AND CRASHES 'ARE HERE TO STAY'
• *WILLIAMS: ASSET-PRICE BUBBLES ARE 'CONSEQUENCE OF HUMAN NATURE'

His words appear to reflect heavily on the Fed's Advisory Letter (from the banks) from 3 months ago - warning of exactly this "unintended consequence." This, on the heels of Plosser's recent admission that the Fed was responsible for the last housing bubble, suggests with the black-out period before September's FOMC about to begin, the Fed is sending us a message that Taper is coming - as we know they are cornered for four reasons (sentiment, deficits, technicals, and international resentment).

With no keynote speaker at the Federal Reserve Bank of Kansas City’s Jackson Hole Economic Symposium, there was no opportunity for Fed officials to send signals about their policy intent. However, while it’s unlikely that the papers discussed did much to change opinions of the FOMC participants, as Morgan Stanley's Vince Reinhart notes, there were themes discussed that may reflect committee members’ views regarding how tapering should proceed: all signs are still that the Fed will start the process of trimming its asset purchases at its meeting on September 17-18. Further, we wouldn’t be surprised if they initially trim just Treasury purchases. So it seems the primary dealers will get what they expect and the market (ever-hopeful of its bad-news-is-good-news meme) will be disappointed.

• Critics Decry Risks Posed by Link Between China's Banks and Bonds (WSJ)
• U.S. retailers say uneven recovery keeps consumers cautious (Reuters) - er, what recovery?
• Easy Credit Dries Up, Choking Growth in China (NYT)
• Fed's Bullard Floats Idea of Small Cuts to Bond Buying (WSJ)
• EU wants one definition of bad loans for bank tests (Reuters) - because in Europe they can't even agree what an NPL is...
• Nagasaki Bomb Maker Offers Lessons for Fukushima Cleanup (BBG)
• With Gmail Overhaul, Not All Mail Is Equal (WSJ)
• Snowden downloaded NSA secrets while working for Dell, sources say (Reuters)
• Apollo co-founder buys into New Jersey Devils (FT)
• Republicans to vote on debate boycott because of Clinton programs (Reuters)
• J.C. Penney Heads for Ninth Quarter of Plunging Sales (BBG)

So is President Obama the worst President in history?

In the world these days the markets often believe the rhetoric. This would be political rhetoric, corporate rhetoric or the prayers and hopes of the talking heads. This is especially true in the equity markets. Critical advice in this environment is, "forget what they tell you; just look at the numbers." So what is the Fed doing? As of July 31, 2013 they have parked $1,157 billion in foreign banks as compared with $1,112 billion in U.S. banks. To us this is a telling sign. The European banks are in trouble and the Fed is propping them up. One of the consequences of tapering, when it comes, may well be less available cash for this task and then the cracks in the European banks may well blow into gaping holes... "There is the plain fool, who does the wrong thing at all times everywhere, but there is the Wall Street fool, who thinks he must trade all the time."

In May 22 testimony to the Joint Economic Committee of Congress, Fed Chairman Ben Bernanke issued another of many similar positive interpretations of central bank policy. Yet again, he continued to argue that quantitative easing has decreased long-term interest rates and produced other benefits. The Fed's polices have not produced the much-promised re-acceleration in economic growth. The standard of living - defined as median household income - has fallen back to the level of 1995. The best approach would be for the Fed to recognize the failure of QE and end the program immediately, thereby allowing price distortions in the markets to correct themselves. By ending the illusion that the Fed can take constructive actions, this might even serve to force federal government leaders to deal with the growing fiscal policy imbalances. Otherwise, debt levels will continue to build and serve to further limit the potential for economic growth.