Notes From Underground

On Friday afternoon Chair Janet Yellen delivered a speech at a conference sponsored by the San Francisco Fed, titled “Normalizing Monetary  Policy: Prospects and Perspectives.” Many analysts will delve into the speech to find a possible nugget of “forward guidance” in the predisposition of Chair Yellen’s desire to raise rates. After a second read and reviewing several pages of analysis, I am left with the same outlook of President Harry Truman: Please bring me a one-armed economist. The speech is filled with a back and forth on the desire to raise rates to a level of “NORMALIZTION” but with the headwinds facing the U.S. and global economies caution is to be maintained. The headwinds prevailing in the U.S. and acting as a drag on economic growth are:

1. Tighter underwriting standards;
2. Continued household balance sheet reduction;
3. Contractionary fiscal policy at local, state and federal levels;
4. Lack of capex for lack of robust demand; and
5. Recent appreciation of the dollar is likely to weigh on U.S. exports.

Chair Yellen opines that if the FOMC waits too long it could result in higher than targeted inflation levels. The Fed Chair cites the recent experiences of Japan and Sweden as a reason to be cautious “… in removing accommodation until the Committee is more confident that aggregate demand will continue to expand in line with its expectations.” Also, with “… an already large balance sheet. For example, the FOMC might be concerned about potential costs and risks associated with further asset purchases.” It seems it is better to err on the side of what Fed President Dudley has referred to as the economy running “hot,” which is inflation being sustained above the 2 percent level.

In a post-Yellen comment, Rick Santelli noted that during the brief Q&A session the Fed Chair said unequivocally, “Cash is not a very convenient store of value.” Santelli said this is the bogeyman of deflation and Gillian Tett picks up the argument in the weekend Financial Times with a piece, “How Deflation Gave Lower prices A Bad Name.” Readers of Notes from Underground have known that I refer to Ben Bernanke as a ’37er: An economist grounded in the belief that the early moves by the FED and the U.S. Treasury to prematurely tighten fiscal and monetary policy in 1937 led to a stifling of incipient growth and a renewed recession. “Cash is not a very convenient store of value” certainly signals that the Yellen Fed will keep rates as low as possible in order not to abort economic growth.

It has been my argument that the reason GOLD maintains its long-term strength is because of the fear of deflation and the policies employed by central banks to curb the possible threat of falling prices. In a continual effort to combat DEFLATION the world is awash in reserves, which presently support global equity markets. (It appears as if stocks are presently a better store of value than gold.) But as Tett wrote in her piece, falling prices are not always the BOGEYMAN of capitalism. Deflation is only a grave concern when an economy has accumulated for too much debt and then the fear of asset deflation brings about the asset liquidation of the 1930s and all the societal pain.

I believe the Bernanke Fed was correct in employing the first round of QE for it forestalled a massive round of asset liquidation in a very fragile financial environment. It is the continued use of QE that has created potential problems for the FED. Yes, I know as Senator Schumer proclaimed, “You are the only game in town.” I guess after reading the Yellen speech it appears that the Fed will remain data dependent but, more importantly, an aggressive easing of fiscal policy might be the real impetus for the Fed to raise rates. The ’49ers play in San Francisco while the ’37ers  dominate the Washington monetary scene.

***Global Politics — The news from the Middle East last week sent momentary scares into oil, precious metals and stock markets. The military response by the Saudis and a possible Sunni coalition of armed forces to recent events in Yemen was seen as a precursor of a new flash point in the already tense ME. By Friday, the oil markets sold off and the precious metals were in retreat as the conflict in Yemen was seen to be contained. IN MY OPINION THIS MOVE BY THE SAUDIS IS NOT TO BE MINIMIZED. WHY? If you look at a map of Yemen and its relationship to Saudi Arabia, and, of course Iraq, you will notice that both countries border the House of Saud. The Saudi family controls something greater than oil reserves. It controls the Islamic Holy Sites of Mecca and Medina.

The desire by Isis to rebuild the Caliphate necessitates the need to control the pivotal centers of the Muslim religion. While Isis is Sunni  the rebels in Yemen are a sect of SHIA and it is their Iranian support that causes the Saudis and other Arab states to militarily act to counter the perceived threat to the Saudi homeland. I have long believed that Mecca and Medina are the desired targets of any group or nation desiring to control the center of Islam. Those believing that Yemen is only about the control of Mandab Strait or Bab el Mandeb are fooling themselves. Yes, a choke point of oil transport is important. More than 3 million barrels of oil daily flow through the strait as crude moves to the Red Sea and out to the Mediterranean by way of the Suez canal. Yet there are also important elements in play in the struggle between Sunni and Shia.

In Friday’s FT, Richard Haass, President of the Council on Foreign Relations, wrote: “There are other reasons to predict limits to what the Saudis can be expected to do in Yemen. They lack much in the way of capable ground forces. Saudi arabia also has to worry about the home front. It is only a matter of time before it faces direct challenge from groups such as the Islamic State of Iraq and the Levant who will see ousting the government that controls the two holiest cities of Islam as essential to their ambitions.” If you believe the world is getting easier to decipher, think again. You need more than an MBA to know which way money will flow. The world is caught in the imbalances of 2+2=5.

***NOTE: I will be on with Mr. Santelli tomorrow morning at 9:40am Chicago time. I don’t know the topic but as my readers know, we’ll be prepared to go many places.