Notes From Underground

     When the Jazzman’s Testifying

      A Faithless Man Believes

     He Can Sing You Into Paradise

     Or Bring You to Your Knees

                         –Carole King

Last night’s BLOG warned that the Twitter feeds would create great volatility as the Fed chairman appeared before the Joint Economic Committee and the markets were not disappointed. The precious metals, currencies and stocks all initially staged impressive rallies, until the questioning turned to the Fed’s plans to TAPER the large-scale asset purchases. Bernanke’s testimony was basically a rehash of NYFRB President Dudley’s speech from yesterday. In the prepared TEXT the chairman made it known that “withdrawing policy accommodation at this juncture would be highly unlikely to produce such conditions” (in referring to when the economy would be sound enough to have sustainably higher rates). Further, “a premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further.”

Chairman Bernanke would prefer to err on the side of staying easy too long than have to face the roller coaster ride of having to undo the damage of a “premature tightening” and the problems resulting from that misstep (Japan’s errors). Homage was also paid to Jeremy Stein as Bernanke said “another cost, one that we take very seriously, is the possibility that very low interest rates, if maintained for too long, could undermine financial stability.” This was important in context but there was very little discussion in the Q&A of any further relevance of the financial instability resulting from the FED‘s persistent liquidity adds.

Two areas were I found problems with Chairman Bernanke’s answers were with senators’ question about the possibility that the crisis could have been averted if Glass-Steagall had remained the regulatory guidelines. The Chairman replied, no, because some commercial banks that were not of Glass-Steagall class also got into trouble. This is a ludicrous response because the repeal of Glass-Steagall prepared the financial system for all around overleverage. The large investment banks allowed the entire financial system to search for risk because  as Chuck Prince famously said: “While the music plays, you have to dance.” SORRY BEN, YOU MISSED THE SYSTEMIC NATURE OF THE RISK CONTAGION SPONSORED BY THE TOO BIG TOO FAIL BANKS.

Secondly,the Chairman made it known that he is a believer in the concept of letting the MBS long-term securities ROLL OFF, thus resulting in a FED EXIT without the potential rapid rise in long rates.The problem is that the Fed chairman does not reveal how he will deal with the issue of the massive build up of reserves. Will the FOMC raise reserve requirements, increase collateral requirements or input a very restrictive LEVERAGE RATIO to prevent banks from ramping up the VELOCITY of MONEY? An ancillary issue is that the FED chief still maintains that you can’t value asset prices in any methodical way without harming the entire economy .Bernanke said that P/E ratios are fairly normal so there is no threat of being in an over-extended financial condition. The market’s sensing of a slowdown of FED BOND PURCHASES led to a tapering in the value of all assets … and the DOLLAR reigned supreme.

***Two bigger stories: 1. Swiss National Bank President Thomas Jordan said today, “An appreciation of the franc would endanger price stability and have structurally grave consequences for the Swiss economy.” The SNB President suggested that the bank had tools available and could raise the floor for EUR/CHF crossrate from its present 1.20 peg or even initiate a formal negative interest rate policy. The SWISS FRANC dramatically weakened against all major currencies. No currency war here … just move along.

Secondly, in what may be the most important piece is an article in the comment section of the Financial Times, David Li, a professor at TSINGHUA UNIVERSITY, wrote an INCENDIARY op-ed piece:”Abenomics Will Only Damage Japan’s Neighbours.” Professor Li complains that the new Japanese economic policy is merely directed at grabbing export share from other Asian nations. The YEN has depreciated more against the Chinese renminbi and the Korean won, resulting in large export growth for Japan. The professor hints that there could be retaliation against the policy of Abenomics through currency intervention or trade restrictions. Mr. Li goes so far to say the  “… YEN IS A LARGER ISSUE THAN WHETHER NORTH KOREA LAUNCHES A NUCLEAR MISSILE.” (emphasis mine).

The solution to Japan’s economic problems should be reform and restructuring through the implementation of removing problematic regulations within the productive structure of Japanese business. This is something to pay close attention to for an op-ed of this nature in an important global newspaper could not appear without the  approval of the Chinese authorities. The Chinese are upset by the Japanese monetary policy and its global impact. This is the exact opposite response from Chairman Bernanke, who told Congress that the current Japanese policy was domestically oriented and the fallout would help the entire global economy. Again, no currency war here. I wonder if the FED and the Chinese are working from the same economic models? Hey Ben, better hope that the faithless begin to believe or the world economy will be brought to its knees.