Bravo, Dallas Fed President Richard Fisher. You gave a speech that even the talking heads on TV could comprehend. The speech, titled, “Beer Goggles, Monetary Camels, the Eye of the Needle and the First Law of Holes,” lays out the dilemma for the FED as it not only begins tapering but actually has to begin unwinding its massive balance sheet.
The problem, according to Fisher, is one I have discussed ad nauseam in this blog. In speaking about the vast pile of reserves parked at the Fed, Fisher says: “Currently this is not an issue. But as the economy grows, the massive amount of money sitting on the sidelines will be activated; the “velocity” of money will accelerate. If it does so too quickly, we might create inflation or financial market instability or both.” Fisher goes on to say: “Excess reserves are currently 65 percent of the monetary base and rising. The only other time excess reserves as a percentage of the base have come anywhere close to this level was at the close of the 1930s, when the ratio hit 41 percent. We are in uncharted territory.”
It is the clarification of this point–why those predicting rampant inflation up to the present time because of the QE programs have been wrong–because if you are right at the wrong time in the world of trading and investing, YOU ARE WRONG [h/t HG]. Richard Fisher’s suggestion to his FOMC colleagues is what he calls “The First Law of Holes” and my readers know it well. STOP DIGGING. In short form this means NO MORE FED BOND PURCHASES!
To control the problem of monetary velocity can possibly cause the Fed great political and economic problems as the need to raise interest rates will result in a potential slowing of growth. It will also mean that the Fed will no longer be transferring its balance sheet earnings to the Treasury but will instead be absorbing large losses on its assets as interest rates rise. Many of the current cheerleaders of Fed actions will be screaming as FED losses become a fiscal drag. As I discussed the other night, the Fed is experimenting with reverse repos as its tool to drain reserves from the system and as Fisher reminds us, “We have never implemented them on anywhere near the scale envisioned.”
This is an important speech because it emanates from a voting member of the FOMC and, more importantly, because it represents the thoughts of a FED President who actually has a seat at the table. Richard Fisher is no ROCKET SCIENTIST but he is a Fed President steeped in the knowledge of finance and years of practical application. Unlike the academics that populate the Board of Governors, President Fisher’s knowledge has been attained in the battle of market investment (a TRUE MAN OF PRAXIS.)
***In today’s Financial Times, there was a column by Satyajit Das, which provides some more criticism to the Fed’s reliance on “forward guidance.” Central banks have a history of using language that hedges its decision-making. (Think Alan Greenspan’s desire to be an oracle and have his words cloak Fed policy in mystery.) As Das states: “Ultimately, it will not be the words but the potency of central bank weapons and actions that will determine the impact on economic activity.” Furthermore, he says, “… with central banks forced to experiment with techniques of unknown of unknown efficacy and potentially toxic side-effects.”
The importance of Richard Fisher’s speech and the Das article in the FT is to alert all traders and investors that the outcome to theQE programs is not as certain as the pundits of “access journalism” would have us believe and it is why I think that the markets are going for a wild ride as the uncertainty of the outcomes become better understood.
To sum it up, I will borrow from my friend B.C. who quotes Nigel Lawson, the Chancellor of the Exchequer under Margaret Thatcher in a 2012 speech at Davos: “Economics has been supplanted by mathematicians who can’t hack it as mathematicians and become economists. It has no connection to practical policy decisions whatever. It helps the investment banks to construct models which proved disastrous and were a contributory factor to the banking meltdown.”
It may not be ROCKET SCIENCE but I sure wish it was…