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.”
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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!Â
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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.”
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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.)
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***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.”
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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 theQEÂ 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.
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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.”
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It may not be ROCKET SCIENCE but I sure wish it was…
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Tags: Fed, FOMC, forward guidance, QE, Richard Fisher
January 14, 2014 at 9:05 pm |
Hey, those rocket scientists are well paid for their hard work! 🙂
January 14, 2014 at 9:55 pm |
Yra, you mean the Princeton and Yale PhD’s running this show don’t already have this figured out?
We must keep the faith. To them it is rocket science that your average congress critter from Kansas could never understand. What’s a little velocity matter to the world’s biggest super power? We have the best and brightest traders running high speed trading firms that, according to recent press reports one in particular, has never had a bad day. Our ushers at the financial exchanges ensure everyone involved is properly margined and if past is prologue, a benevolent network of central banking that makes everyone good. I’ll quote a great American pragmatist born in the ’50’s, Alfred E. Neuman. “What? Me worry?”
January 15, 2014 at 2:42 am |
The operative phrase in your and his thesis is “As the economy grows.” The GDP is faley influenced by such items as capitalizing R&D. Ry, Jim
January 15, 2014 at 6:46 am |
Begin forwarded message:
> From: James Sinclair > Subject: Re: [New post] Notes From Underground: Subject: The Cure To the Fed’s Concern About Its Communication Strategy: Richard Fisher > Date: January 15, 2014 3:42:04 AM EST > To: Notes From Underground > > The operative phrase in your and his thesis is “As the economy grows.” > The GDP is faley influenced by such items as capitalizing R&D. > Ry, > Jim > > >
January 15, 2014 at 10:51 am |
Yra, I would look at the problem of velocity diametrically to the way Fisher is. M2 has been steadily dropping since about 1997, and M1 since about 2008. This is symptomatic of too much money/reserves in the system, weak loan demand, and a deteriorating economic infrastructure (I think).
Some uptick in velocity should be welcomed, as a sign of a strengthening economy. If we go back into recession, the drop in velocity would probably accelerate.
That said, I am a fan of Fisher’s….we need to get rid of dangerous QE.
January 15, 2014 at 12:47 pm |
I would take it on step further than Das on “forward guidance”………it’s pretty meaningless. Should we get another weak unemployment number in January, the FED may begin “double secret QE4”, regardless of what they are saying today.
January 15, 2014 at 3:02 pm |
Shocked–pretty funny and it will take more then QE–but the point is well taken.If the Fed has to reverse course it will scare investors–thanks,Dean Wormer
January 16, 2014 at 9:09 am |
While an increase in velocity would almost certainly indicate a strengthening economy, the risk is that the Fed will not be aggressive enough in tightening policy as the private sector gains confidence and the money that was pumped into the system is put to work while the Fed is dizzied by its dual mandate. Everyone is all uptight about the labour force participation rate. The economy has changed, the employment landscape has changed. I often wonder do any of the media ever compare the U.S. LFPR to other countries LFPR’s globally? The U.S. gained steadily on most countries employing more of their eligible workers since 1970 until the 1990’s. LFPR in the U.S. has been declining since 1999. Was it expected to plateau at those elevated levels and stay there forever? Beyond the economic decline in the U.S., tech is increasingly replacing all kinds of labour in which it then takes time to learn new skill sets and for business’s to find new applications for the surplus labour. If the Fed keeps watching their models and conditioning tightening policy on employment levels related mostly to past correlations and getting back to trend they might get themselves in trouble. It certainly wouldn’t be the first time. Paul Volcker was very public in saying it last year, scrap the dual mandate otherwise, it will not end well. Accelerated M&A activity will be a warning bell that if the Fed stays loose inflation might get ahead of them. Controlling inflation with such a bloated balance sheet could be particularly painful for the Fed. These impostor rocket scientists might just blow themselves up before it’s all said and done.
January 16, 2014 at 9:28 am |
Dustin–a wonderful post in the insights it provides—and the rocket scientists a re an oxymoron when it comes to economics—-I’ll take mine butter -side-down
January 16, 2014 at 10:37 am |
Dustin- You may be right on the inflation potential. What strikes me as odd, is that with all the FED shenanigans ( ZIRP, QE, and increase in monetary reserves), the inflation indicators I look at (CRB Index, EEM, Crude, Copper) all appear to be making major tops, and the next trend looks to be toward disinflation or deflation. I could be wrong.
January 16, 2014 at 4:47 pm |
Ben Bernanke at Brookings: We Did the Right Thing in 2008 via Brookings http://www.brookings.edu/blogs/brookings-now/posts/2014/01/ben-bernanke-at-brookings-we-did-the-right-thing#
January 16, 2014 at 5:22 pm |
According to that tribute at Brookings he should shortly be on his way to Rome to be canonized.
January 16, 2014 at 5:23 pm |
Remarkable improvement in the financial sector since they ceased the habit of making liar loans. Or, they found long sleeves are an effective way to cover their tracks.
January 17, 2014 at 7:46 am |
Shocked- You make good points and make clear that a clearer definition of what I mean is in order. It is an interesting paradox really. While it seems the U.S. has clearly become economically more competitive and very well might surprise people with it’s GDP growth over the next few years, this brings with it a strengthening USD as the TB shrinks and capital concentrates in the U.S. so this will naturally put downward pressure on all prices in USD.
On the flip side you have the Fed which if they maintain a dovish bias, which seems likely under Yellen, might stay too loose which could see the vast reserves make there way into the system and cause a flurry of activity. This would limit USD upside but not stop it as even the Fed will tighten some which may see other CB’s loosen globally. Globally, our expectation is for stronger growth as well but with pockets of weakness, particularly in the EU and Russia, while developing economies slow but do not collapse. So prices even in USD in general do look set to tick up over the year but I really don’t see anywhere near double digit inflation in the short-run. I think the risk for that kind of inflation rests in the longer-run and has more to do with lost confidence in the Fed as a result of the current trend which will cause rates to rise in a time when a lot of interest rate market risk sitting on the government and Fed balance sheet. So in terms of the indicators you are watching for inflation they very well could fall in my scenario, in particular Crude/USD in particular, but other currencies may tell a different story as well as other kinds of inflation working into the system in terms of rising wages, increased capital cost, various other commodities have been negatively correlated with Crude and could see a rise such as the softs and grains and are at depressed levels, protein prices keep rising on short supply. Once again it really matters what you price in, I am not particularly bullish anything priced in USD because I view this as the year the US economy catches up to the stock market which would see a rising dollar and a more muted move in stocks. Might be a good one to be long certain commodities in Euros. But, it really is something to watch, if the Fed doesn’t tighten enough it could come back to bite them. And since I like the way you ended your comment I will end mine the same, I could be wrong. 😉
January 17, 2014 at 9:54 am |
Dustin- Very good post. I guess what concerns me is that the FED and government did not allow creative destruction to occur in 2008-09, and basically propped up everything (except the belly pit). The most egregious action (I’m not sure who proposed it) was to do away with mark to market accounting for banks (which I believe is still the policy). My point is that I believe that there are still tons of bad assets hanging around, and the situation is still tenuous. Creating a new bubble, to fight the last bubble, does not sound rational, to me. Of course, they could get lucky.
January 17, 2014 at 12:10 pm |
These are great posts and beneficial additions to the conversation.The markets are trying to put some view into play but for the moment data dependent on a 24 hour basis.Look at the British Pound over the last twenty -four hours –the currency adjusts to the data releases and nothing more.The Euro adjusts accordingly also–very short term–much of the punditry is pushing an all clear signal for Europe and its financial institutions.But then comes news that Non-Performing loans at Spanish banks is making new highs—market seems to accept that data one day and totally deny its existence the next—the market is looking for some solid foundation and maybe it is that the U.S. is best breed as the Dollar Rally and EQUITIES are going together–no risk on/risk off game right now–maybe that will be the story—but it is a skittish market in search of direction
January 17, 2014 at 12:35 pm |
Yra- Gold and silver are trying to make a bottom. If they do (I hate hedging like this, but really not sure about gold/silver), my guess is that precious metals and equities will NOT go in the same direction for very long. Why own Gold if the Yellen put is good?
January 17, 2014 at 12:44 pm |
Yra- The performance of Spanish and Italian bonds is so bizarre, that I have to assume that the word has gone out sub rosa, to the the “right people”, that they will absolutely not default.
January 18, 2014 at 5:37 pm |
Shocked–not sure that is the reason.I think that Italian and Spanish banks have loaded up on their sovereign debt prior to the Quality Asset Review [QAR] because they will be deemed to be riskless and thus not subject to any capital reserves.I think that the ultra low rates will be a major trap for any foreign investors chasing yield and believing that the all clear on Europe has been given.
January 19, 2014 at 10:02 am |
Yra- aware of the “riskless” status, as sovereign debt. My point is that these bonds are pretty likely to default during the next European recession. QAR or not, a sane investor, bank or other, would not price these at sub 4%…….they must believe they come with a put. I question the value of that put.
I do not think Germany/ECB will be able to prop up all of Europe’s bonds, when the next recession hits. In my opinion, they are creating another dangerous bubble in junk bonds.
January 19, 2014 at 5:20 pm |
Shocked- I don’t disagree with your comments. But as a voluntary antagonist, I ask, hasn’t this generation of elite central bank monetary scientologists made the commercial recession extinct? The great economic minds of today have conditioned commentators and an educated populace that the remaining challenges of the future are to effectively regulate to avoid crisis. Are the world’s economies not managed by coordinated central bank policies? Unless the EU’s next recession results from some crisis, how can a relic, such as the business cycle, even happen? Investors might be more attuned to forecasts for the next EU crisis, rather than trying to hedge a recession which modern tools of monetary policy, we’re told, allow the best and brightest to smooth out all the rough bumps in the world of commerce. 🙂
January 20, 2014 at 12:05 pm |
Joe- Pardon my stupidity…….”The Big Bernowski” is a lead pipe cinch to eliminate recessions and depressions.
January 20, 2014 at 7:16 pm |
LOL. All anybody needs is a bigger lead pipe.