I’m not a fan of the enhanced communications of the Federal Reserve.  In general, I think central banks should say nothing.  Nothing.  Just do your work through fed funds, and make sure you squeeze out bad debts before you stop tightening.  That was the way Martin and Volcker did it, arguably the best men ever to have been Fed Chairman.

The idea that more transparency is needed stems from the wrongheaded idea that giving people more data will make them do what the Fed wants.  Rather, they will more quickly react to the hints of policy change.  If you are a smart central banker, you should want people/firms to be confused.  Confusion is helpful because when people finally figure out what is going on, they react with more punch.

I am amazed that economists imagine things, and then they expect the world to act ideally, rather than the messy way that it normally does.  It is worse that we let them control policy with their bankrupt theories that may bankrupt many.

So to the Fed, I say “Be quiet.  Act in silence and your powers will be enhanced.”

But now, what of the Fed’s enhanced communications?  Let’s look at their expectations of GDP:


In general, FOMC participants have been optimists.  That is what they are paid to do.  GDP has consistently been lower than what they predicted.  They give us the “smiley face,” and then explain disappointment quarter after quarter.


Again, optimism is the operative word, that is what they are paid to do — be optimistic shills for the US Government.  In this case, they have been more accurate, as the unemployment rate has come down.  Please ignore the discouraged workers, and all of the new people on disability.  I’m sure that last four years have injured far more people than the four years prior, not.


This graph is different.  Because we are listening to FOMC participants, we must get a dose of their religion.  Long-run future PCE Inflation will be 2%, they guarantee it.  But in the present, their expectations for inflation keep falling.  We are in a deflationary world where labor has no ability to improve wages, and thus stimulate inflation.

Fed Funds

Regarding predictions of the Fed funds rate, for the most part expectations for the rate have declined for 2012-2014.  Only today has 2015 expectations expanded, as the Fed hints at the end of QE.  As I have said before, at inflection points, markets often react in a wild fashion, because the received wisdom gets called into question.


When the Fed started their enhanced communications, they had no dream that they would be trapped in easing for so long.  As it is, it is only over the last half year that expectations for when policy would tighten have coalesced at September 2015.  I don’t know if that is the right time or not, but it is interesting to see the views of the FOMC converge here.

The last two graphs reinforce each other as they indicate tightening two years from now.  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.

Please be aware that the the Fed is not working off of established theory here, but only presumption.  They are imitating the failed policies of Japan, because the theories tell them it will work.  With economics, theories have a bad track record.  Maybe they should get out of the prediction business, and in the process, replace the Fed with a currency board based on gold, commodities, or limited fiat money that does not let the yield curve gat too steep or too flat/inverted.

Photo Credit: duncan c || It wasn't my intent initially to compare the words of the FOMC with the scrawlings of a vandal, but ya know some things are surprise fits

Photo Credit: duncan c || It wasn’t my intent initially to compare the words of the FOMC with the scrawlings of a vandal, but ya know, some things are surprise fits


I wasn’t surprised to hear in the FOMC minutes that members of the committee thought:

For these reasons, participants generally saw maintaining the target range for the federal funds rate at 1/4 to 1/2 percent at this meeting and continuing to assess developments carefully as consistent with setting policy in a data-dependent manner and as leaving open the possibility of an increase in the federal funds rate at the June FOMC meeting.


Participants agreed that their ongoing assessments of the data and other incoming information, as well as the implications for the outlook, would determine the timing and pace of future adjustments to the stance of monetary policy. Most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen, and inflation making progress toward the Committee’s 2 percent objective, then it likely would be appropriate for the Committee to increase the target range for the federal funds rate in June. Participants expressed a range of views about the likelihood that incoming information would make it appropriate to adjust the stance of policy at the time of the next meeting. Several participants were concerned that the incoming information might not provide sufficiently clear signals to determine by mid-June whether an increase in the target range for the federal funds rate would be warranted. Some participants expressed more confidence that incoming data would prove broadly consistent with economic conditions that would make an increase in the target range in June appropriate. Some participants were concerned that market participants may not have properly assessed the likelihood of an increase in the target range at the June meeting, and they emphasized the importance of communicating clearly over the intermeeting period how the Committee intends to respond to economic and financial developments.

I was surprised to see some of the markets take it seriously.  Here’s why:

1) The FOMC loves to talk hawk and them be doves.  They don’t think the costs to waiting are significant, particularly given how low measured inflation and and implied future inflation are.  Five-year inflation, five years forward implied from TIPS spreads is not high at present as you can see here:

2) The FOMC is well known for giving with the right hand and taking with the left.  They would like if possible to have the best of both worlds — gentle movement of what they view as key variables, while usually not dramatically changing the forward estimates of those

3) The FOMC’s natural habitat is wishful thinking.  Their GDP forecasts are usually high, and they suspect their policy tools will move the economy the way they want and quickly, and it’s just not true.

4) LIBOR rates have done a better job of the FOMC at estimating future policy, and they have barely budged since the FOMC minutes came out.

5) The FOMC always has more doves than hawks, and that is the way the politicians who appoint and approve the board members like it.  They will live with inflation.  That was yesterday’s problem.  Today’s problem is stagnant median incomes — and looser monetary policy will help there, right?

Well, no, but I’m sure they clapped when Peter Pan asked them to save Tinkerbell.  There is no link between inflation and faster real growth over the long haul.  There may be measurement errors in the short run.

6) They don’t like moving against foreign rates, but that’s not a big factor.

7) GDP isn’t showing much lift at all.


Unless we have a change in management at the Fed, where they are not trying to manipulate markets through their words, but maybe one that said little and acted quietly, like the pre-1986 FOMC, they really aren’t worth listening to.  They act like politicians.  Let them study Martin and Volcker, and learn from when the FOMC was more effective.

PS — I’m not saying they can’t tighten in June.  I’m just saying it’s unlikely, and to ignore the comments in the FOMC minutes.  What the FOMC says is of little consequence.  It’s what they do that counts.  They are like a little dog that barks a lot, but rarely bites.

Photo Credit: DonkeyHotey

Photo Credit: DonkeyHotey

Here are two ideas for the Fed, not that they care much about what I think:

1) Stop holding regular press conferences and holding regular meetings.  Only meet when a supermajority of your members are calling for a change in policy.  Don’t announce that you are holding a meeting — perhaps do it via private video conference.

Part of the reason for this is that it is useless to listen to commentary about why you did nothing.  You may as well have not held a meeting.  Another reason is that governors could act more independently if a meeting can’t be called unless a supermajority of voting members calls for it.

Yet another reason is that the frequent and long communication has not eliminated the Kremlinology that exists to interpret the Fed.  When changes to the FOMC statement are small, they get over-interpreted — remember the “taper” comment?  Far better to say nothing than to repeat yourself with small meaningless variations.

Along with that, you could eliminate issuing statements altogether, and go back to the way things were done pre-Greenspan.  Need it be mentioned that monetary was executed better under Volcker and Martin?  We don’t need words, we need to feel the actions of the Fed.  That brings me to:

2) Stop trying to support risky asset markets.  It is not your job to give equity or corporate bond investors what they want.  If you do that, too much liquidity gets injected into the system, creating the financial bubbles of 2000 and 2007-9.

Instead, give the risk markets some negative surprises.  Don’t follow Fed funds futures; make them follow you.  Show them that you are the boss, not the slave.  Let recessions do their good work of clearing out bad debts, and then the economy can grow on a better basis.  Be like Martin, and take away the punchbowl when the party gets exciting.

Do these things and guess what?  Monetary policy will have more punch.  When you make a decision, it will actually do something.

Realize that policy uncertainty is not poison for risk markets. It forces businessmen to avoid marginal ideas — things that only survive when the weather is fair.  The accumulated underbrush of bad debts doesn’t keep building up until the eventual fire is impossible to control.

If were going to have fiat money, do it in such a way that bubbles do not develop, which means not caring about the effects of policy on risky asset markets.  This might not be popular, but it would be good for the economy in the long run.


As a final note let me end with one chart from the recent data from FOMC participants:

central tendency_1915_image001

I suspect the FOMC will tighten in December, but remember that the FOMC doesn’t have a roadmap for the environment they are in, and they are acting like slaves to the risky asset markets.  Another burp in the markets, and lessening policy accommodation will be further delayed.


I hesitate to write this piece, because I think doing this would be a bad thing.  Then again, I don’t believe that most of the jawboning done by the Fed is useful.

So let the Fed put its money where its mouth is, and, hey, improve its asset-liability match in the process.  After all, over the last five years, the Fed discovered that they have an asset side of their balance sheet.  They decide that they can try to twist the Treasury curve, lowering long rates, and stimulate the housing market via QE.

But aside from monetizing debt, which often leads to serious inflation, QE has not shown much potency to do anything good.  Thus the Fed thinks that enhanced guidance will be the tool to use to breathe life into this over-leveraged economy.  A possible example: “We promise not to raise the Fed funds rate until 2017.”

Deeds, not words, I say.  I challenge the Fed to do the following: Offer multiple tenors (maturities) of Fed funds.  At present, Fed Funds is an overnight rate.  Offer 1, 3 and 6-month Fed funds.  Offer 1, 2, 3, 5, and 10-year Fed funds.  Give the banks the ability to lock in funds for lending or investing for longer amounts of time.  Create the Fed funds yield curve.

Rather than merely promise that Fed funds will remain low for so many years, offer banks a way to have a guarantee of low Fed funds rates for that time period.  That would be powerful.  Whether it would be powerful for good is another matter.  Personally, I doubt it would be good, and I think the same of enhanced guidance.

In doing this, the Fed might realize that they have a liability side of the balance sheet, and one that does not have a zero duration.  If they have long term assets, why not long term liabilities?

Sigh.  In the old days it was easy.  The Fed did not have an over-leveraged economy, and so they invested in short-dated Treasuries, and adjusted Fed funds as their major policy lever.  Open market operations took care of the rest.

Introducing long term liabilities to the Fed means that policy accommodation can no longer be removed instantly.  The longer dated Fed funds would only shift as it matures.  It would give strength to monetary policy in the short run, but weaken it in the long run.  But hey, we are a short-run society, so why should we care?  Bleed our grandchildren dry, and have the great-grandchildren ready to be bled for our good.

Eventually we have to question why we are pursuing policies that harm the long-run in order to goose the short-run. Once we start doing that, we might be on the road to maturity, even if it means we get a severe recession, or even a depression.  The “greatest generation” was the greatest because of character formed out of depression and war.  Sad that they sucked the blood of their grandchildren via Social Security and Medicare.  We live with the results of their short-term thinking.

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.