Efficient Markets versus Ben Bernanke

I’ve looked around for a transcript for Bernanke’s press conference, and I can’t find one.  Here’s my gripe, and I mentioned briefly at the end of last night’s article.

But if the tightening is two years away, why did the market react so badly?  Markets are discounting mechanisms, and react to expected future changes, not the mistaken view of Bernanke that stocks of debt still affect the markets.  No, it is changes in the stock of debt, and changes in the expected changes in the stock of debt that affect the markets.

Ben Bernanke either does not get markets, or is hiding what he knows from economic illiterates.  He insisted that maintaining the purchased assets in the monetary base would continue stimulus, even if they slowed down the rate of purchase.

Really, I should have made it simpler last night, and said, “Market prices change when new information changes the views of economic actors regarding the future.”  Markets are discounting mechanisms.  If you tell the market that you will suck $85 billion of the highest credit quality assets out of circulation for as long as it will take to get the economy moving again, and then later you say that you will reduce that flow within a year, you think that won’t change the views of market participants?  It certainly will, and with violence, as we have seen over the last two days.  The market’s forward path for cost of capital has risen, and stocks have fallen as a result.

Not that I will ever meet Bernanke, but if I did, I would point him to the Efficient Markets Hypothesis [EMH].  He probably believes it.  I view it as a limiting concept, that is, EMH is partly true, but only when lots of people who don’t believe in the EMH scour the markets looking for information advantages.  For a funny take on EMH, you can read this.

The short answer to Bernanke is that what has happened in the past should have no influence on current market prices.  That information has already been incorporated into the price.  Only changes of future expectations affect the current stock price.  The same applies to asset prices versus monetary policy; asset prices react to changes in expectations.

But maybe it’s not so bad, or maybe it’s even worse.  What if the Fed is wrong about improving economic prospects, and we see GDP disappoint over the next two quarters?  I think that is likely, as do Bill Gross and Jeff Gundlach:

Going forward, however, yields are likely to start falling. And that means the place to make money in the next few months is “everybody’s most hated asset class: long-term government bonds,” Gundlach said. “There’s really no inflation, no sign of inflation.”

Gundlach says he’s uncomfortable with the term “tapering” to describe the Fed’s expected approach to winding down its bond-buying program, saying it wrongly implies the central bank can achieve “perfection” in its effort to wind down quantitative easing. While the Fed will eventually look to slow the pace of bond purchases, it could subsequently speed them up as well if economic data weakens, he said.

The Fed is wrong about how much power they think they have.  The more aggressive the easing cycle is, the harder the tightening cycle is.  There has been no greater easing cycle than this one.  Thus even the slightest hint of reduction in accommodation hits like a ton of bricks.  Now to hear from Bill Gross:

Gross and his colleagues have been skeptical about the U.S. economy’s potential for growth since the financial crisis. Gross said last week the Fed won’t raise rates in a “meaningful way” for at least the next two years and investors should be cautious when it comes to all risk assets.

As interest rates have climbed over the past two months, Gross has recommended buying U.S. Treasuries. In a Twitter posting June 18, he recommended buying five-year Treasuries and earlier, on June 12, he called intermediate Treasuries with yields above 2 percent a “buy.” The “Fed’s not raising interest rates for years,” he said.


“We simply think the real economy won’t follow the path that the Fed thinks it will because the Fed is based on a cyclical model that’s inappropriate,” Gross said in a Bloomberg radio interview today with Tom Keene.

When there is too much debt, we tend to get deflation, because we slowly realize that all debt claims will not be honored.  That leads to uncertainty and slow growth, as people try to preserve the value of what they have, rather than take risks to grow their assets.  I’ll be writing more about this in a future book review.  Highly indebted societies tend not to grow rapidly.

I’ve been adding some long Treasuries to bond accounts, and I may add more.  Like Japan, I think we are in the midst of a “bad policy” trap that restrains growth and leaves the economy to muddle, until enough debt is paid down, and fiscal policy looks sustainable.  That may not happen for a long time, so that leaves me a bear at present.


  • jdmckay says:

    Hi David,

    Long time no see. Brief comment:

    > The short answer to Bernanke is that what has happened in the past
    > should have no influence on current market prices. < There's a problem with that: too many people simply don't know, what has happened, in our most consequential recent past. Example: Climate change. Without taking sides (man made, or not), we (US for sake of
    discussion) is experiencing several commensurate realities:

    a) available water supplies, nation wide, becoming insufficient for expected usage from *past* habits. Prices for food, water itself... all commensurately affected.
    b) droughts all over: getting worse, diminishing expected water supplies going forward (future).
    c) "Fire season" getting earlier each summer all over the west, burning more forest at hotter temps, diminishing much... but let's point out just one consequnce: reduced oxygen in atmosphere. Scripps and others have done studies suggesting, as early as 2030, available oxygen for mammals will begin to be in deficit.

    All this, is very much based on... *past* behaviors. And, intelligent coupling through available human knowledge has been eliminated largely, as mitigating factor, tieing consequences of this "stuff", to... future expectations.

    > That information has already been incorporated into the price. < Right. But not even beginning to incorporate cost, of corrective endeavors whereby, so much of what's done here on our shores needs to be eliminated. Thus, pricing *now* for old destructive activities, misses everything if new needed activities are not being discussed.

    > Only changes of future expectations affect the current stock price. <

    Agree. But… what’s currently (largely) driving “expectations” is missing soooo much of the inevitable, that… those expectations are going to get swallowed up in guaranteed eventualities which, we largely (collectively… the public knowledge of all that) are utterly uninformed, about.

    That’s the big problem. Lack of accounting for the cost of lies.

  • Greg says:

    Seems to me there are two changes hitting the bond market simultaneously — and I doubt Bernanke understands either one of them.

    1) There is no bond market right now. The FOMC is a committee of clueless academics and politicians, and are buying something close to 80% of new investment grade issuance. How can a system that is 80% dominated by arrogant central planners be labeled a “market”?

    We have no idea what yield a true market would put on Treasuries — if not for FOMC manipulation. Yields likely would have been, and still be higher, were it not for a price insensitive buyer sucking up 80% of issuance.

    So part of the chaos is the actual market (not the FOMC losers) trying to determine a correct market price — as opposed to the committee price — where prices “should be” (should be, if this were a free market).

    No one really knows where this would be, as we have been under clueless central planning now for (at least) five years. Lets call yesterday’s sell off as the market yawning after a long hibernation. Eyes adjusting to the sudden bright daylight and so forth.

    2) Nothing the FOMC has done since 2007 has done anything to fix a single problem. As hundreds of pundits have pointed out for years — all the FOMC really did was “kick the can down the road a little”. Delaying a problem does not solve it. All the structural problems that existed back in 2007 when the ^(&# hit the fan are still problems today.

    What would consumption be if we assume consumer debt remains a constant percentage of GDP, instead of growing for the past 3-4 decades?

    I don’t know the answer to this, but it is obviously much lower than it has been in recent memory. Once debt levels come down, they are going to stay at some lower level — consumption spending is going to be less.

    This adjustment process is going to take many years — once it finally gets started. Kicking the can down the road has not avoided these structural changes, and no matter what stupid BS comes out of the mouths of academics, the adjustments cannot be avoided. They also cannot be delayed forever.

    Generations X, Y and Millennials are under-employed if not unemployed. They have already put off getting married, buying houses and other “grown up” stuff for years — and they simply won’t tolerate much more delay. We are seeing riots in the UK, in Sweden, in continental Europe, in China, and most recently in Brazil. Authorities cannot tell young people to put their lives on hold indefinitely, and the will come off the rails even if young people were willing.

    All government debt is only as good as the tax base that backs it — and the future tax base is presently un-employed globally, and in the US is buried in student debts accumulated to pay for academics’ cushy tenured lifestyle.

    Without a functioning economy, the taxing authority of Detroit MI or Stockton CA isn’t worth anything — and neither is their debt.

    Without a functioning economy / tax base, US treasury debt isn’t any different from Greece.

    Bernanke’s economic recovery doesn’t exist outside his ridiculous models … and its the real world tax base that counts out in the real world.

    Governments with insufficient tax bases have irrelevant central banks.

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