Month: November 2016

At the Cato Institute?s 34th Annual Monetary Conference (Panel 2)

At the Cato Institute?s 34th Annual Monetary Conference (Panel 2)

Photo Credit: Jeff Upson
Photo Credit: Jeff Upson

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PANEL 2: MONETARY MISCHIEF AND THE ?DEBT TRAP?

Moderator: Josh Zumbrun -?National Economics Correspondent, Wall Street Journal

Athanasios Orphanides -?Professor of the Practice of Global Economics and Management, MIT Sloan School of Management

H. Robert Heller -?Former Member, Federal Reserve Board of Governors

Daniel L. Thornton -?Former Vice President and Economic Advisor, Federal Reserve Bank of St. Louis

Zumbrun introduces the panel, saying they are monetary policy practitioners.

Athanasios Orphanides begins by praising Friedman, mentioning the book Monetary Mischief. (Note: Amazon Commission)

Limited space for fiscal policy given high debt levels. ?Monetary and fiscal are always linked, though central bankers are loath to discuss it. ?Puts up a graph of rising government debt 1998-present. ?Also graphs Italy, Germany, Japan. ?Is there a debt trap now? ?Is there monetary mischief, inflation, now?

(DM: Phil Gramm just sat down next to me.)

Can debt be sustainable over the long run? WIll there be policies that kill growth? ?Inflation is too low? ?Are there policies that raise the cost of financing debt? (Financial Repression)

Japan was already experiencing deflation prior to the crisis. ?ECB gets its own crisis as a result of their structure.

Puts up a graph of policy of ECB, BOJ, and Fed. ?Suggests that quantitative easing was warranted, and other abnormal monetary policies. ?Suggests that BOJ QE was mild until 2013.

Puts up a graph of Central Bank balance sheet sizes. ?Then one of average interest rates for government debt. ?Then one of real per capita GDP, suggests that Japan has not done much worse than the US, though demographics are a problem.

Comments that QE is a help to governments in financing their debts. ?Look at gross debt net of central bank holdings.

ECB great for strong economies, and poor for weak economies.

Fed — should we be concerned about the balance sheet? ?IMFsays we can grow out of the huge balance sheet if the balance sheet does not grow.

Unsound fiscal policy overburdens central banks.

Heller: everything I want to say has been said already. ?Monetary mischief: Monetary policy does not serve the nation. ?Debt trap: the det grows faster than GDP inexorably.

Suggests that a 0-2% target would be better than 2% for inflation. ?2% consensus under Greenspan — but that is not price stability — eventually Bernanke defines 2% as price stability.

QE was ineffective, and the Fed always overestimated its value. ?Limited room for future stimulus. Perverse effect on savings. ?Must save more to get the same amount of future funds. ?Growing income and wealth inequality.

Hyman Minsky: “Every expansion creates the seeds of its own destruction.”

Pension funds suffer and are underfunded. ?Life Insurers suffer a little. ?Stock market tracks QE. ?The rich do well as a result.

Moving closer to a Federal Debt trap. ?(Guy next to me says “Kaboom” when looking at the debt graph.) ?Interest payments double as interest rates normalize. ?(DM: that’s why they won’t normalize — at least not willingly.)

Thornton: The Fed’s policies are a disaster, and they are ongoing. ?QE and forward guidance on long-term yields. ?Risk-taking is reduced, and GDP grows more slowly. ?No empirical support for QE. ?Keynesian economics have led to a credit trap.

Puts up a graph of CD rates versus t-bills. ?Then Baa yields minus Aaa yields — markets had stabilized by 2010 by these measures. ?Bernanke also argued that QE reduced term premiums, but markets are not segmented.

That said, FOMC’s low interest rate policy, helped make long rates low. ?As the ’90s progressed, Fed funds became uncorrelated with long Treasuries. ?Detrended, after May 1988, behavior changed because the FOMC used the Fed funds rate as the main policy tool, which affects short rates predominantly.

Graph with high negative correlation between the Fed funds rate and the spread between 10 and 5-year Treasury yields. ?Quite striking. ?(DM: this is all bond math)

Graph of household net debt as as fraction of disposable income. ?New bubble of stocks plus real estate.

Argues that credit trap has been going on for 50 years or more. ? Reliance on credit is evident from the growth ?in government debt, which is a function of Keynesianism.

Q&A

Q1 Chris Ingles, CPA: Isn’t the Fed enabling the growth of a socialist state? ?Isn’t growth coming from government deficits?

Orphanides says blame governments, not central banks. ?CBs get forced into enabling the politicians in order to keep things stable.

Q2: Mike Mork, Mork CApital Management — wouldn’t it be better to let interest rates float to aid the market’s allocation of capital?

Thornton: Fed can’t really control interest rates. ?We could get out of the zero lower bond at any point by selling bonds and adjusting policy. ?Take away the excess reserves and the market will find its own level.

Orphanides: can use balance sheet or rates — focus on the results of price stability

Heller: Money supply prior to mid-80s under Volcker gave way to Fed funds under Greenspan. ?Existence of money market funds was a reason for that.

Patricia Sands from George Mason U: ?Were the central banks really surprised? ?Why do Central Banks exist in the first place?

Orphanides: we want to avoid inflation via monetizing the debt. ?We sometimes get second and third best solutions. ?We want to avoid the worst cases.

Heller: CBs can’t bail out governments without risking hyperinflation.

Thornton: interest rates are not the solution. ?They don’t create big changes in spending. ?(DM: Yes!)

At the Cato Institute?s 34th Annual Monetary Conference (Panel 1)

At the Cato Institute?s 34th Annual Monetary Conference (Panel 1)

Luis Guillermo Pineda Rodas Follow
Photo Credit: Luis Guillermo Pineda Rodas?

Moderator: Craig Torres -?Financial Reporter, Bloomberg News

John A. Allison?-?Former President and CEO, Cato Institute, and former Chairman and CEO, BB&T Bank

Mark Spitznagel -?President and CEO, Universa Investments, LP

James Grant -?Editor, Grant?s Interest Rate Observer

John Allison: Talk about Monetary vs Real economic effects. ?Wall Street did not cause the crisis. ?Was a combination of CRA and the GSEs, aided by the Federal Reserve.

When the dot-com bubble deflated, Greenspan ran monetary policy too loose, and deliberately inflated a housing bubble. ?Greenspan (DM: Bernanke) talked about the global savings glut. ?When rates rose, they rose rapidly in percentage terms rapidly.

Bernanke inverts the yield curve, incenting banks to take undue credit risk. ?Bernanke said that there would be no recession amid all of the bubbles. ?Many mainstream businessmen felt fooled by the Fed.

Average businessmen expect businessmen expect inflation, but it is not happening. ?Now they behave conservatively.

Regulation was worse than monetary policy. ?Risk-based capital. Privacy act. Sarbox.

A big deal, and I am the only one talking about it: Early ’80s: attacked bad banks and they failed — a good thing. ?Good banks kept operating. ?This time regulators saved bad banks and regulated good banks more heavily — perverse. ?Totally irrational.

Sheila Bair should not be viewed as a hero. ?Closed barn door after cow got out. ?Later “solutions” not useful.

Bernanke’s book: on the verge of global armageddon… JA thinks contagion was far smaller than perceived.

Liquidity requirements are restraining lending. ?Thinks that banks can’t aid in creating jobs. ?Lending standards are tight.

Likes a bill coming out that would loosen matters. ?Talks about the ’90s when BB&T opposed regulation on supposed racial discrimination in lending.

(DM: What a dog’s breakfast of clever and stupid)

Mark Spitznagel — management and hedging of extreme risks.

Mises — No laboratory experiments can be performed with respect to human action.

Talks about equilibria, correcting processes, etc. ?(DM: Loquacious, not going anywhere… boring.) ?Mentions Tobin’s q-ratio.

(DM: I remember that I didn’t give his book a good review. ?His talk validates that review.)

Tobin, a Keynesian, looked at the q-ratio as a monetary policy tool. ?But investment doesn’t get affected much by the q-ratio.

Shows how the q-ratio is negatively correlated with future returns, and the left tails get bigger as q-ratios get higher.

Trump can stimulate, but crashes will bring correction.

James Grant: Gruber, Obamacare founder said that it passed because the American people are stupid.

New ideas: what to do now after the election? Grant suggests older policies that existed over one century ago. ?Or, more modern: Taylor Rule? ?Friedman’s constant growth rate of money…

Monetary policy has been debated for the last 250 years… the Fed was viewed as a solution to the Money Trust, but brought its own problems. ?Pension fund problems…

The Fed has paid no price for its manifold failings. ?Double Liability would be a better method. ?Bank shareholders should bail out, not taxpayers. ?Monopoliies: PhD economists w/tenure, Federal Reserve.

$15 Trillion of government bonds have been sold with negative yields. ?A promise to store fiat money at a loss.

Panics used to occur at 10-year intervals, w/gold backing and double liability. ?The economy grew rapidly then.

Overstone: “the trouble with money is credit, and the trouble with credit is people.”

We like being spared volatility. ?How many truly want to have a Old Testament-level bear market?

Swiss National Bank? Creates francs to tamp down the currency and buys up euros, dollars, then stocks.

QE is a cautionary tale. ?It failed politically because it did not work. ?Failure of the PhD standard will lead to new thinking.

Q&A

Mark Q1: Trump sounds monetarist, not radical. ?Who will bring change? ?Who will swim against the tide of Statism?

Grant: Will swim against statism. ?Yeah!

Q2: Could gold trading be viewed by the US as a currency exchange? (lower taxes)

Grant: would be easy to do, but difficult to get done politically.

Q3: Isn’t the cost of funny money low productivity growth? ?(True everywhere it has been done)

Allison agrees. ?So does Spitznagel.

Q4 Julie Smith: recent events in India — the war on cash. ?Comments?

Grant talks about Ken Rogoff, and remove $50 and $10 bills so that negative rates can prevail. ?Someone picked up a copy in India — and it will be self-destructive. ?It murders the cash system, which is the real banking system in India.

Q5: Alex Billy Grad Student at Georgetown: Did the Mexican crisis in 1995 have an impact on future developments?

Allison: big New York banks got bailed out of an irrational risk. ?The cure for too big banks is to let them fail. ?Wall Street was bailed out at the cost of Main Street.

Bert Ely Q6: Support for Basel III is sagging. ?What would the effects be?

Allison: Great. ?Let’s just have a leverage ratio.

Me Q7: ?Risk based capital vs liquidity Life insurers vs Banks?

Allison: doesn’t see it that way. ?Insurers are very different than Banks. ?Buying too much MBS at banks as a result.

Q8: “Ships are safe in harbors, but that is not what ships are for.”

Grant: agrees. Goodhart: Banking and the finance of trade in New York. ?Banks had to remain liquid and well capitalized in order to survive. ?It was a good system.

Q9 (Torres): What should we do now?

Allison: Modify Dodd-Frank such that bank with a 10% leverage ratio could opt out of Dodd-Frank.

Grant: How to modify the Fed: End Humphrey-Hawkins. ?Don’t take a poison chalice… reform wisely after there has been a real crisis and want real solutions.

Spitznagel: end low rates so that economic actors don’t take marginal risks.

At the Cato Institute’s 34th Annual Monetary Conference (Prologue and Keynote)

At the Cato Institute’s 34th Annual Monetary Conference (Prologue and Keynote)

Photo Credit: Shawn Honnick
Photo Credit: Shawn Honnick

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Hi. For long-term readers of Aleph Blog, when I am at this Conference, there are a lot of posts. If you tire of monetary policy, or my view of it, you can leave me for a day, or, read the summary that I will write this evening.

I got here early for once, taking Google Maps’ pessimistic estimate a little too seriously. ?That said, I ran into more jams going early (6:40-8:10) than when I used to work in DC. ?In a little bit,?James A. Dorn,?Vice President for Monetary Studies at the Cato Institute should open the program. ?When I get spare moments, I will be tweeting at @alephblog. ?You can also watch the hashtag CatoMC16.

(Note: what you will get from me in the next series of posts is basically a series of my notes on what is said at the conference. ?I will highlight my thoughts with “DM”)

(Hey! James Grant just walked next to me. ?I got to greet him.)

James Dorn is introducing the program and other affiliated programs. ?Mentions unconventional monetary policy — low rates, negative rates, big balance sheets for central banks. ?Do financial markets lead the Fed or vice-versa? ?How can markets play a greater role in monetary policy? (DM: perhaps those are opposed to each other.) ? He now introduces:

Thomas M. Hoenig –?Vice Chairman, Federal Deposit Insurance Corporation

Talks about monetary policy and macroprudential supervision. Suggests that policy has been too short-run focused, leading to less stability. ?The dual mandate sometimes leads to short-run behavior, though it does not have to. ?(DM: politics leads that.)

End of Glass-Stegall with lower levels of capital led to the crisis, with Commercial and Investment Banks seeking financial protection amid risky activities. ?Monetary policy was very accommodative leading up to the crisis. ?The system was more sensitive to shocks. ?Central Banks and government pumped in a great deal to stem the crisis. ?(DM: badly targeted)

The Fed and other central banks discovered the asset side of their balance sheets, and began to allocate credit to non-standard assets.

Macroprudential policy is touted as something to undo excesses of monetary policy, but it will not undo inequities stemming from wealth effects.

We now experience low real growth. ?Arguments are coming now to weaken macroprudential policy to goose growth. ?He argues that that would be long-run foolish. ?The system is fragile enough already, so don’t undo what little progress has been made to make things more stable.

(DM: mentions rising interest rates as a threat, but if banks are doing asset-liability management right, that should not be a risk.) ?Argues that rates should rise at a transparent and deliberate rate.

Argues that the industry should pay out less of their earnings, and retain them as working capital, and aid in increase of lending. ?The government safety net should not be an implicit subsidy to big banks. ?Long-term growth will be best achieved with strong banks.

Q&A

Thomas Attaberry FPA Advisors: Nonbanks are providing a lot of finance. ?How do you work with that?

Banks lend to nonbanks. ?We should regulate that lending.

Q2: Different capital for different classes of assets. ?Why can’t we change that?

Not a fan of Risk-based capital. ?(DM: !) Good as internal tools, but not as an external measure. ?Would simply use the leverage ratio.

Victoria Guido, Politico: How does the election change your view/practice of regulations?

He’s going to follow the law. ?It’s all he can do.

Guy at US Bureau Labor Statistics: What do you mean about labor normalizing?

Not sure what the guy is talking about. Finds it difficult to believe that zero interest rates for 8 years is normal. ?Misallocation of capital. ?Look at long term history — eventually move to a policy that reflects that. ?Will not be simple to undo zero rates. ?Quick? Slow?

Walker Todd, Middle TN State U: Professors talking about ETF market — isn’t this like CDOs etc. prior to the crisis.

Does not know what to say, will look at it. ?(Lousy question and answer.)

Carl Golvin Fed.info: How can fiat money lead to a stable economy? ?Why can’t we go back to gold/silver — constitutional money?

There are still bank crises under gold standards. ?Supports central banks with greater limits.

Max Gilman U Missouri — Mentions Bagehot and reserves held at bank of England. ?Why doesn’t FDIC set up a safety net for all financial institutions on a risk-based basis?

We get lobbied on all sorts of things. ?We provide capital on a legislated basis. ?Shareholders and bondlholders should absorb loss first and second (DM: good answer).

Weird Begets Weird

Weird Begets Weird

Photo Credit: Steve Rotman || What could be weirder than President Trump?!
Photo Credit: Steve Rotman || What could be weirder than President Trump?!

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I have a saying “Weird begets weird.” Usually I use it during periods in the markets where normal relationships seem to hold no longer. It is usually a sign that something greater is happening that is ill-understood. ?In the financial crisis, what was not understood was that multiple areas of the financial economy were simultaneously overleveraged.

Well, we can say the same for many aspects of world affairs, including the US election. ?Many people?benefit from free trade, more than get hurt. ?Those who get hurt vote with greater probability. ?Though immigrants are actually a net help to the US economy, because many people think they hurt the economy, they vote accordingly.

After Brexit, there are related effects. ?People are less willing to surrender local advantages for matters that would be larger broad advantages. ?Who knows? ?Maybe the EU will break up next. ?Nah. ?Nothing good happens to continental Europe.

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Tomorrow, I will be a buyer. ?I don’t expect anything good out of Trump, but there is nothing worse from him than Clinton. ?I have 15% cash on hand for clients and me, and I will buy as the market falls.

The Sun Will Rise Tomorrow, DV

The Sun Will Rise Tomorrow, DV

Photo Credit: MDV
Photo Credit: MDV?|| May you live to see many beautiful sunrises!

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Regardless of your political point of view, life will go on after the election. ?Truth, given the two leading candidates, I get why many feel bad — they are both personally flawed to the degree that we shouldn’t want to entrust them with power. ?We all are sinners, myself included. ?That said, those who lead scandalous lives are unfit to lead society.

But under most conditions, cultures, economies, and governments survive bad leaders. ?This is true globally. ?This has been true in the US historically.

And guess what? ?The markets really don’t care that much about current politics. ?Markets in aggregate react to changes in the long-term view of economic activity. ?The only things that interfere with economic activity to that degree are:

Sudden

  • Wars (think of the World Wars, or the Thirty or Hundred Years Wars)
  • Plague (think of the Black Death, severe as it was the influenza epidemic of 1918 was just a speed bump in comparison)
  • Famine (usually associated with severe Socialism… think of the Ukraine in 1932-33, the Great Leap Forward 1958-61, Pol Pot in Cambodia, present-day North Korea or Venezuela…?and there is more)

Gradual

  • Changes in human fertility
  • Technological change
  • Gradual increasing willingness for people to be trusting in economic relationships, leading to investment, lending and trade on a wider scale, leading to lower costs of capital. (That included ending the teaching of Aristotle that money is sterile, which happened among Christians at the Reformation, and among Muslims in the late 20th century in some convoluted workarounds)
  • Cultural changes such as the willingness to not engage in subsistence agriculture, and trust the division of labor. ?Willingness to educate children (including women) rather than use them for immediate productive purposes.
  • Desire of the governing powers to wall off resources for their private use or non-use ?(think of governments owning huge amounts of land, and denying use of the land to most. ?Same for technologies?and resources.)

I’m sure there are things I left out, which could make for a lively conversation in the comments. ?But note this: in general, though the sudden events may have severe effects on economies and markets, they tend to be the most transitory. ?It’s the gradual changes that have the most effect in the long-run.

Also note that most of these do not get affected much by normal politics. ?Yes, the “one child policy” affected human fertility, but look at efforts by governments to get husbands and wives to have children and the effects are tiny at best. ?And even the “one child policy” is partially reversed, and I expect that it will be dropped in entire. ?(And then the Christians and Muslims can stop hiding their children…)

Governments can intervene in economies lightly or moderately, and people adjust. ?Overall productivity doesn’t change much. ?At severe levels of intervention, it ?changes a lot. ?Intelligent people look for the exits, even at the cost of being exiles.

Governments can go to war, and if it is small relative to a country that is involved, the effects are light. ?Big wars are different, and can destroy productivity for a generation, or permanently, if the culture doesn’t survive.

The Great Depression, bad it was, and loaded with policy failures of Hoover and FDR, ended in less than a generation. ?The markets recovered as if it had never happened, and then some.

Are our government policies, including those of the central bank, lousy? ?Yes. ?WIll they get worse under Trump or Clinton? ?Sure.

Things won’t likely be bad enough to derail the economy and the markets for more than a generation, so invest for the future. ?The Sun will rise tomorrow, Lord willing.

But,?the Son of God will reign forever.

 

Afterthought

The collapse of debt fueled bubbles can only affect less than a generation. ?Why? ?They don’t affect productive capital assets, they only affect who owns them, and receives benefits from them. ?That is why depressions have far less effect than major wars on your home soil or major plagues. ?Eventually a new group of people pick up the pieces at reduced prices, and use the capital to new and better ends.

Redacted Version of the November 2016 FOMC Statement

Redacted Version of the November 2016 FOMC Statement

Photo Credit: Norman Maddeaux
Photo Credit: Norman Maddeaux

Information received since the Federal Open Market Committee met in JulySeptember?indicates that the labor market has continued to strengthen and growth of?economic activity has picked up from the modest pace seen in the first half of?this year. Although the unemployment rate is little changed in recent months,?job gains have been solid, on average.Household spending has?been growing stronglyrising moderately but business fixed?investment has remained soft. Inflation has continued to runincreased?somewhat since earlier this year but is still below the Committee’s?2 percent longer-run objective, partly reflecting earlier declines in energy?prices and in prices of non-energy imports. Market-based measures of inflation?compensation have moved up but remain low; most?survey-based measures of longer-term inflation expectations are little changed,?on balance, in recent months.

Consistent?with its statutory mandate, the Committee seeks to foster maximum employment?and price stability. The Committee expects that, with gradual adjustments in?the stance of monetary policy, economic activity will expand at a moderate pace?and labor market conditions will strengthen somewhat further. Inflation is?expected?to remain low in the near term, in part because of earlier declines in energy?prices, but to rise to 2 percent over the medium term as the?transitory effects of past declines in energy and import prices dissipate and?the labor market strengthens further. Near-term risks to the economic outlook?appear roughly balanced. The Committee continues to closely monitor inflation?indicators and global economic and financial developments.

Against?this backdrop, the Committee decided to maintain the target range for the?federal funds rate at 1/4 to 1/2 percent. The Committee judges that the case?for an increase in the federal funds rate has strengthenedcontinued to?strengthen but decided, for the time being, to wait for some?further evidence of continued progress toward its objectives. The stance of
monetary policy remains accommodative, thereby supporting further improvement?in labor market conditions and a return to 2 percent inflation.

In?determining the timing and size of future adjustments to the target range for?the federal funds rate, the Committee will assess realized and expected?economic conditions relative to its objectives of maximum employment and 2?percent inflation. This assessment will take into account a wide range of?information, including measures of labor market conditions, indicators of?inflation pressures and inflation expectations, and readings on financial and?international developments. In light of the current shortfall of inflation from?2 percent, the Committee will carefully monitor actual and expected progress?toward its inflation goal. The Committee expects that economic conditions will?evolve in a manner that will warrant only gradual increases in the federal?funds rate; the federal funds rate is likely to remain, for some time, below?levels that are expected to prevail in the longer run. However, the actual path?of the federal funds rate will depend on the economic outlook as informed by?incoming data.

The?Committee is maintaining its existing policy of reinvesting principal payments?from its holdings of agency debt and agency mortgage-backed securities in?agency mortgage-backed securities and of rolling over maturing Treasury?securities at auction, and it anticipates doing so until normalization of the level?of the federal funds rate is well under way. This policy, by keeping the?Committee’s holdings of longer-term securities at sizable levels, should help?maintain accommodative financial conditions.

Voting?for the FOMC monetary policy action were: Janet L.?Yellen, Chair; William C. Dudley, Vice Chairman; Lael?Brainard; James Bullard; Stanley Fischer; Jerome H.?Powell; Eric?Rosengren; and Daniel K. Tarullo. Voting against the action were: Esther L. George, and?Loretta J. Mester, and Eric Rosengren,?each of whom preferred at this meeting to raise the target range for the?federal funds rate to 1/2 to 3/4 percent.

Thoughts

If the FOMC wanted to throw a curve ball at the markets (not that they have had the courage to do that in some time), there’s a simple thing that they could do, and it is not that big: ?Stop reinvesting the maturing proceeds from the Treasury debt, agency debt, and agency MBS. ?It would be an interesting test of the markets, and if things go nuts, they could always reverse direction.

As it is, with a flattish yield curve and financial companies hungry for safe yield, it would be a low cost way to estimate what normalization of policy might do. ?After all, the maturing proceeds are short duration assets; the investments of the Fed in longer duration securities would be mostly untouched. ?As the Fed receives “cash” and reduces bank deposits at the Fed, banks would look for replacement assets.

Just a thought. ?As for today’s announcement, it was a nothing-burger — not much change aside from Rosengren switching sides. ?After all, you can’t make that much out of seeming economic changes over a 6-8 week period. ?They are typically just noise that the FOMC over-interprets in their statement.

Personally, I think that the FOMC will do nothing in December. ?Remember, they always talk a good game, but bow to loose policy in the end. ?There will come a time when they surprise and tighten, but that time may come sometime in 2017, if not later.

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