Economics

• If you look in the back, it seems that there were 58 respondents. From page 13: Methodology & Panel Selection Invi… http://t.co/p8sVZl9g Feb 06, 2012
• Will the great interest rate gamble pay off? http://t.co/hgj5XSKc People want to believe that you can get something for nothing; ain’t true. Feb 05, 2012
• Central Planning at the Federal Reserve http://t.co/X8qmqU6C Fed: we can create prosperity by holding interest rates down, right? $$ #wishes Feb 05, 2012
• Labor Force Participation Rate: 28-year Low http://t.co/kLgQ61iK Everyone still happy about the lower unemployment rate? $$ Feb 05, 2012
• Bill Gross: Free Money Ain’t Really Free http://t.co/LXWxpxp5 It will lead to stagflation, IMO, depending on what fiscal policy does $$ Feb 05, 2012
• Life & Death Proposition http://t.co/XuZS5Snn Where does credit go when it dies? Back where it came. It delevers, slows & inhibits ec growth Feb 02, 2012
• US unemployment “progress” http://t.co/WoIVZPGp If you add back the discoraged workers, all of the improvement in U-3 goes away $$ Feb 02, 2012
• The Perniciousness of ZIRP http://t.co/dYlFMbLe Gonzalo Lira on how ZIRP loses effectiveness b/c people think it’ll b there a long time $$ Feb 01, 2012
• Why Neoclassical Economics Doesn’t Work In The Age Of Deleveraging http://t.co/D3IAhTyv Steve Keen explains y Krugman & others r wrong $$ Feb 01, 2012
• Warning: Goat Rodeo http://t.co/JQ2FV9LS Hussman makes his case that equities are overvalued and could pull back 25% $$ Feb 01, 2012
• Who Owns World’s Financial Assets? & Why R US Households So Fascinated W/Stocks? http://t.co/5rp52OM4 American Exceptionalism in investing Feb 01, 2012
• As an aside, that is one reason why the US net foreign debt hasn’t spiraled up. We own equities abroad & they own our debt. $$ declines + Feb 01, 2012
• $$ declines reduce the value of our debts, but not the value of r foreign holdings. I think the US will come out of this crisis rel well $$ Feb 01, 2012

Housing

• Home Prices Tumble http://t.co/N1gdNslr No surprise here with all of the dark supply; houses come onto mkt when ppl can bear loss $$ Feb 01, 2012
• Too lazy to be knowns http://t.co/flXRR6fM I know many who understood what would happen if home RE prices fell, but none who got the size $$ Feb 01, 2012
• Freddie Mac’s “inverse floater” allowed more loan origination http://t.co/5devKZ17 Other side to the Propublica story http://t.co/KjXJHU1x Feb 01, 2012
• I’m no fan of the GSEs; I think they should be abolished, but the GSEs have always made a variety of bets on prepayment over time. $$ Feb 01, 2012

International

• On China, Henry Kissinger and Fareed Zakaria see Domestic Tension and Risk of Geopolitical Conflict http://t.co/1bhvrI3U Ferguson is wrong. Feb 05, 2012
• Tightening lending standards vary materially across the Eurozone http://t.co/ciWUK9cm Conditions tight in Italy & France, but not Germany $$ Feb 02, 2012
• Japan Auto Sales Notch Record Jump http://t.co/0VzF4WST Another small bright spot. Of course, bouncing back from a low level $$ Feb 02, 2012
• Socialist Hollande, Who Wants Full European Treaty Renegotiation, Increases Lead Over Sarkozy http://t.co/J3qCpZZ3 Eurozone Wild Card $$ Feb 01, 2012
• Hong Kong Homes Face 25% Drop as Loans Fall in Year of Dragon http://t.co/ifg1146H And this is with wealthy mainlanders fleeing China. $$ Feb 01, 2012

Markets

• RBC Takes On High Frequency Predators http://t.co/MfA5qdxm Where there is offense, there will b defense; nothing goes unanswered in the mkts Feb 05, 2012
• Global Strategists Abandoning Bearish Views http://t.co/dOXCUMA7 Makes me think we r getting close to a turning point. Feb 02, 2012
• Dividend stocks: Buyer beware http://t.co/SvMCHtCj Makes the valid & missed point: high qual div paying stocks r stocks & can lose $$ #yeah Feb 01, 2012

Credit

• 6 High-Yield Canaries-in-the-Coalmine http://t.co/4pz6SSQc 6 reasons y high yield is overheated http://t.co/fKnHmBqD & http://t.co/UPVev0iD Feb 02, 2012
• QOTD: Regulators Watching Aggressive Yield Chasing http://t.co/iWimo3eg FINRA warns of undue risk in income seeking. Advisors take note $$ Feb 02, 2012
• Contra: The Safest 7% Yield in America http://t.co/VrXoLEFH Poor analysis does not take into account the highish leverage on mtge repo $$ Feb 02, 2012
• Shipping Loans Go Bad for European Banks http://t.co/y5Z0wt3R Highly glutted area w/many dead firms walking; how far down will the losses go Feb 02, 2012

Politics

• Group lists top stock investments by members of Congress http://t.co/CarxUCjS Top 50 hldgs -> in top 100 cos by mkt cap. Hard2manipulate $$ Feb 05, 2012
• Obama Re-Election Odds Versus the Stock Market http://t.co/F5EETcve Example of 2 variables that r correlated b/c they anticipate GDP changes Feb 05, 2012
• RE: @abnormalreturns Gold is mostly political philosophy. How much control do you want the government to have over mo… http://t.co/hRxIkaoo Feb 03, 2012
• Getting back to the gold standard http://t.co/pCk8Ij6j Gingrich & Ron Paul have said they would like to appoint James Grant as Fed Chairman Feb 02, 2012

Companies

• Carlyle’s proposed IPO disaster http://t.co/OqGke8eN So there’s no board. Most boards don’t do much. Mgmt will have no board 2 shield them Feb 05, 2012
• For These Fans, a Day With Buffett Offers Wealth of Photo Opportunities http://t.co/UpcwVKe7 I think Buffett is enjoying life more now. Feb 05, 2012
• Buffett Railroad Boosts Capital Plan to $3.9B http://t.co/9XEw2gyT Buffett changes; organic investment in capital-intensive biz $$ #olddog Feb 01, 2012
• Pep Boys Seen Gaining 27% as Cheapest Value Lures Bids http://t.co/GyfH7qRL Could a bidding war start? Company is undermanaged $$ Feb 01, 2012
• Jefferies Allows Bonus Recipients to Swap Stock 4 Cash With 25% Discount http://t.co/pfGB3Vmc Fair way2 let employees disconnect from $JEF Feb 01, 2012

Financial Services

• I’ve just started “Acts of God and Man,” by Michael Powers. In the intro, he goes through the various meanings of th… http://t.co/tX7uAlWl Feb 05, 2012
• When evaluating Investment Funds, use Dollar-weighted Returns http://t.co/N5g7PI0d This is a neglcted concept that is enjoying a rebirth $$ Feb 02, 2012
• After a Delay, MF Global’s Missing Money Is Traced http://t.co/4s6U8yOe Investigation moves to how to recover the $$ and who is at fault. Feb 01, 2012
• http://t.co/wBbJTe3D FINRA Alert: Do you use complex products? What additional work do you do 2 assure that they are being used properly? $$ Feb 01, 2012
• Banks Need Higher Interest Rates to Start Making Money http://t.co/SneRACCi Flat front end of yield curve squishes bank interest margins $$ Feb 01, 2012
• 401(k) Plans Step Into the Sunshine http://t.co/fvKeup2L But as with DB plans, as costs rise, companies will offer them less. $$ Jan 31, 2012

Value Investing

• The SEC’s “90% Convergence” Fantasy http://t.co/bkWaAS5S US GAAP has many flaws, but we know them. IFRS will introduce abusable flexibility Feb 02, 2012
• But on the bright side, value investors may do relatively better as financials become less trustworthy; the accruals anomaly will sing $$ Feb 02, 2012
• Need to consider (Cost of goods sold)/user $$ RT @ErikSchatzker: Facebook gets $4.39/yr of revenue per user. ESPN gets $4.69/mo. Feb 02, 2012
• Berkowitz: Fund Plunge ‘Makes Little Sense’ http://t.co/pcoPLahW BB, appoint someone in your group 2 seek out opinions contrary 2 yours $$ Feb 01, 2012
• @ADayforRabbit I have argued in the past that BB is not paying attention to the delevering, which is a real headwind for the banks. $$ Feb 02, 2012
• New Fund Hopes to Prove Outspoken Analyst’s Thesis http://t.co/cuVpRzvO I bet @rcwhalen does well like my friends @ Hovde or M3 Partners $$ Feb 01, 2012

Hedge Funds

• Are Hedge Funds Worthwhile Investments? http://t.co/Lw2EhRPr Yet another “Hedge Fund Mirage” citation; the book is having a lot of influence Feb 02, 2012
• Are the hedge fund and private equity boys pulling a fast one? http://t.co/TNXFJo62 Beginning 2c the args of “Hedge Fund Mirage” everywhere Feb 02, 2012
• Did Hedge Funds Trigger the Financial Crisis? http://t.co/lNIb2dgF Secured asset classes can be overlevered; when they collapse, big mess $$ Feb 01, 2012

Miscellaneous

• Do the Job You’re Meant to Do http://t.co/wR3OX20N LIfe is too short to work with people you don’t respect, or tasks unfit for you $$ Feb 02, 2012
• Millionaire adopts girlfriend as daughter http://t.co/zffGCWbu Asset shelter. Does incest rely on consanguinity or on legal relationship? Feb 02, 2012
• Charles Murray Reiterates Willpower http://t.co/smeXZKNh Lack of self-control can destroy relationships, jobs, firms & lives $$ Feb 02, 2012
• I ran into @twitalyzer today. Lots of interesting analytics for tweeting. Here are some for me: http://t.co/HDdcFYaU & http://t.co/8uFFOMuP Feb 01, 2012
• At the first blogger summit at the UST, I recommended to the powers that be that they issue floaters. I also recommen… http://t.co/R3U8OHSi Feb 01, 2012
• California Faces Cash Shortfall by March on Low Receipts, Controller Says http://t.co/QxH1a6Re Could be interesting given the elections $$ Feb 01, 2012

Transparency is Overrated

Ever heard of the phrase “data overload?”  Greenspan would do that verbally in his testimony to Congress, providing them with more data than they needed, and occasionally contradictory so that each side could quote what they wanted.

Well, the present transparency policy of the Fed is another version of data overload.  Give lots of data — some similar, some different.  Opinions, forecasts, policies — average people have a hard time with the nuances; even some professionals do.

After a certain point, the more data you reveal, the harder it gets to evaluate what is going on.  Far better to reveal to the public the core data that explains policy than to make them slog through big data releases.

Transparency is overrated.  Not sure which foolish economist thought of this one, but more data does not mean better decisions, or better public understanding.  Humans are not Vulcans (only logical), nor Ferengi (only greedy); we are complex, and that makes prediction of actions difficult.

Bernanke does not Understand Savings

Twice in his press conference yesterday, Bernanke showed that he was out of touch with average Americans.  He argued that average people could keep up with a 2% increase in the price level by investing in stocks and (presumably short-term) bonds.

(Speaking to The Bernank)

I’m sorry, Ben, but ya gotsta come down from the uneducated ivory tower and wallow in the mud wit da restov us.  There are three problems with what you said:

• It’s hard to earn 2% (after-tax) consistently when the Fed funds rate is zero.
• Only the top 20% of the wealthy have enough assets to keep themselves afloat using the asset markets.  Most people would like to do something to protect themselves from inflation, but lack the means to do so.
• Average people do not invest, they save at financial intermediaries like banks, S&Ls, and life insurers.  Fed policy kills rates for savers.  They will not become investors, because they lack the knowledge to do so.

I am again sorry, Ben, because your policies discriminate against the poor, and the lower middle class.  Yes, the rich and the upper middle-class clever can escape the penalties stemming from your policies, but the lower-middle class and the poor can’t.

Think of it this way: your policies are making it more palatable for average people to buy gold, because the alternatives in savings are lousy.  If there is no income, why not grab safety from inflation?

Are you really trying to wrest the thorny crown of “worst Fed Chairman” from Arthur Burns?  If so, well done, you are achieving your goals.  Even Alan Greenspan did not do that, though he tried.

My advice to you is simple.  Raise the Fed funds rate to 1%, and stop the QE, and pseudo-QE.  At the zero bound, monetary policy has no punch, and the same for QE.  It affects asset markets; it does not affect goods markets.

Time to abandon useless theories about the Depression, and embrace the practical difficulties that we now face.  Ben, grow up and abandon your failed theories on the Great Depression.  And resign, if you can’t grow up.

They moved this paragraph up from last time.the Committee decided today to continue its program to extend the average maturity of its holdings of securities as announced in September. The Committee is maintaining its existing policies 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. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.The Committee also decided to continue its program to extend the average maturity of its holdings of securities as announced in September. The Committee is maintaining its existing policies 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. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in a context of price stability.No real change.  Central bank asset policy does not have that big of an impact on economic activity.

They moved this paragraph down from last time.The Committee will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools to promote a stronger economic recovery in a context of price stability. Deletes meaningless sentence.Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen.Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Dennis P. Lockhart; Sandra Pianalto; Sarah Bloom Raskin; Daniel K. Tarullo; John C. Williams; and Janet L. Yellen.Three new regional Fed presidents.  Storm and fury, signifying nothing.Voting against the action was Charles L. Evans, who supported additional policy accommodation at this time.Voting against the action was Jeffrey M. Lacker, who preferred to omit the description of the time period over which economic conditions are likely to warrant exceptionally low levels of the federal funds rate.Make that four, with a dissent from Mr. Lacker, who is likely the only one to dissent in 2012.  Talked with him at the Cato Monetary Conference – he is skeptical of the asset policy at the Fed.  This dissent disagrees with the Fed trying to give a time period for how long the Fed funds rate will remain low.

Comments

• So they extend the period of accommodation by a little more than a year.  Sends financial markets flying, and especially TIPS prices, but will have little impact on the economy.  (Do they want the yield on 30 year TIPS to go negative?  Looks that way.)
• GDP growth is not improving much if at all, and the unemployment rate improvement comes more from discouraged workers.  Inflation has moderated, but whether it will stay that way is another question.
• In my opinion, I don’t think holding down longer-term rates on the highest-quality debt will have any impact on lower quality debts, which is where most of the economy finances itself.
• Also, the reinvestment in Agency MBS should have limited impact because so many owners are inverted, or ineligible for financing backed by the GSEs, and implicitly the government, even with the recently announced refinancing changes.
• The key variables on Fed Policy are capacity utilization, unemployment, inflation trends, and inflation expectations.  As a result, the FOMC ain’t moving rates up, absent increases in employment, or a US Dollar crisis.  Labor employment is the key metric.
• The Fed is out of good policy tools, so it will use bad policy tools instead, and for longer than before.

Questions for Dr. Bernanke:

• Why do think extending the period of accommodation by a little more than a year will have any significant effect on the economy, aside from stock and bond prices?
• Is it possible that you don’t really know what would have worked to solve the Great Depression, and you are just committing an entirely new error that will result in a larger problem for us later?
• Discouraged workers are a large factor in the falling unemployment rate. Why do you think the economy is doing so well at present?
• Why do you think that holding down longer-term rates on the highest-quality debt will have any impact on lower quality debts, which is where most of the economy finances itself?
• Why will reinvestment in Agency MBS help the economy significantly?  Doesn’t that only help solvent borrowers on the low end of housing, who don’t really need the help?
• Couldn’t increased unemployment be structural, after all, there is a lot more competition from labor in emerging markets?
• Isn’t stagflation a possibility here?  I mean, no one expected it in the ‘70s either.
• Could we end up with another debt bubble from keeping short rates so low?
• If the Fed ever does shrink its balance sheet, what effect will it have on the banks?

Inflation expectations determined the much of the value of the S&P 500 for the last nine years.

And you can see the relationship here as well:

The short answer is “yes, inflation expectations have driven stock valuations for the last nine years.”

I’ve been spending time on issues like this for a variety of reasons, and I’ll try to explain them in the near term, but that’s all for now.

I would argue that the overall model for investment banking failed.  No major investment bank survived the crisis intact.  Goldman Sachs and Morgan Stanley had to seek banking charters to survive and receive help from the Treasury/Fed (one entity, but like Janus, two faces).  Everyone else needed help from the Feds, or failed, or merged.

I would also argue that the overall model for commercial banking failed, with many making loans that were horrendously underwritten.

So, what aspects of the crisis stemmed from the repeal of Glass-Stegall? Remember, the Fed was chipping away at it for some time.  Feel free to comment below, but if you don’t want to do that, email me.  Thanks.

But what of credit? It isn’t that hard to create, but it is hard to create well, particularly when debt levels are high, as in this environment.

It’s not just the US, debtor-friendly as it has been for most of its existence.  Most of the rest of the world has debt problems.

China has indebted municipalities and banks, and debts to many projects from Party members that will not pay off.  The EU is  overly indebted everywhere, not just the PIIGS, and finds its overall borrowing rates rising as lenders wonder what a Euro will be worth if the Eurozone dies.

In the US, government debt rises more than corporate and consumer debt falls.  We’ll pay the government debt off later.  Don’t worry.

The simple solution to every problem is to say the it is a liquidity problem, not a solvency problem.  How do does one solve a liquidity problem?  Get a loan.  If the assets are really worth more than the liabilities, there should be some unencumbered assets that you can secure a loan with, and pay off the liquidity squeeze.  But absent that, it’s insolvency, regardless of what notional price one places on the assets.

But what if the problem is really a solvency problem?  Will a loan help cure that? No.  You can’t solve a debt problem with debt.

There are generally few liquidity problems relative to solvency problems.  As an example, most corporate bonds don’t default on principal payments, but on interest payments.  For individuals, balloon payments on loans might be relatively more of a problem, but since most people finance their homes, etc., on relatively thin ratios of income to debt service, interruptions of income lead to insolvency more often than balloon payments.

Consider for a moment that every liability is the asset of someone else, but not vice-versa, because some assets are owned free and clear.  Now pretend that we take everything in the world (the same could be applied to a nation), and put it on a single balance sheet, but we don’t net out the liabilities that would cancel out.

Which system would be more stable?  One where the liabilities are roughly equal to the net worth, or one where they are roughly five times the net worth?  The former, of course.  Now, not all liabilities are the same — long-dated claims like pensions only claim a little bit of the assets of the world at a time, whereas a large number of short-dated liabilities would make the system less stable, or perhaps lead to inflation.  Many dollars chasing few goods, or assets, or both.

I’m not sure exactly where the boundary line is for “peak credit.”  It would depend on the structure of the liabilities in question.  But once the fuzzy limits get exceeded:

• Growth can slow.  (Think of the book, “It’s Different This Time.”)
• Debt deflation may arrive. (Extend, Compromise, Default)
• Inflation may arrive for assets, goods, or both, depending on the propensity to save versus consume.
• And, if the debt gets high enough, and immediate enough, any entity may hit the “tipping point” where the market concludes that it is no longer possible for the entity to pay off its debts.  Short-term rates skyrocket, and the prices on long debt discount expected recovery levels.  For countries with their own currency, it may involve a lot of inflation, though a negotiation with creditors might be simpler.

In general, if we were starting over again, there are a lot of things that we should have done differently:

• Dividends would be deductible, and not interest.
• This would apply to all personal and corporate interest, including mortgages.
• We would eliminate the GSEs, and all government lending programs.
• We would run balanced budgets as a nation, and live with the modest volatility that induces.  We would not engage in fiscal stimulus.
• We would eliminate or constrain the Fed, such that it could never let the difference between ten and two year Treasury yields exceed 1.5%, or be less than -0.5%.  We would let recessions do their work of eliminating bad investments, because if you don’t, you end up with the debt deflation we are facing now.
• Or, go back to a gold standard, after analyzing what the proper value for the dollar would be, so as to avoid inflation or deflation.
• We would constrain banks to match assets and liabilities, and not engage in maturity transformation.

Banks would be a lot less profitable under such an arrangement, but it would prevent debt bubbles.  Besides, the banks would make up for it by charging for deposit/checking accounts.

Summary

We may be near “peak credit” at present, and that is true of much of the world.  Better we should have had a smaller financial sector, and avoided the financialization of the economy.  As it is, we face many years of slower growth ahead as we bleed debt out of the economy, or a number of years of inflation ahead, as we inflate away debts.  I suspect the former, but I can’t ignore the latter.

 Getting more optimistic about growth.  I think they are going to get surprised on the downside again.Nonetheless, recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated.While indicators point to some improvement in overall labor market conditions, the unemployment rate remains elevated.The unemployment rate is down, but jobs aren’t being created, as people drop out of the labor force.  This is improvement?Household spending has increased at a somewhat faster pace in recent months. Business investment in equipment and software has continued to expand, but investment in nonresidential structures is still weak, and the housing sector remains depressed.Household spending has continued to advance, but business fixed investment appears to be increasing less rapidly and the housing sector remains depressed.Shades down their view on business investment.  Shades up their view on consumer spending.Inflation appears to have moderated since earlier in the year as prices of energy and some commodities have declined from their peaks. Longer-term inflation expectations have remained stable.Inflation has moderated since earlier in the year, and longer-term inflation expectations have remained stable.Gets more definite about inflation moderating, except that it hasn’t moderated.Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.No change.The Committee continues to expect a moderate pace of economic growth over coming quarters and consequently anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate.The Committee continues to expect a moderate pace of economic growth over coming quarters and consequently anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate.No change.Moreover, there are significant downside risks to the economic outlook, including strains in global financial markets.Strains in global financial markets continue to pose significant downside risks to the economic outlook.Focuses the risks on the financial sector, particularly as the risks in Europe & China could affect the US.  “Not our fault!”The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee’s dual mandate as the effects of past energy and other commodity price increases dissipate further. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee’s dual mandate. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.Drops language on commodity prices.To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to continue its program to extend the average maturity of its holdings of securities as announced in September. The Committee is maintaining its existing policies 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. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to continue its program to extend the average maturity of its holdings of securities as announced in September. The Committee is maintaining its existing policies 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. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.No change.The Committee also decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.The Committee also decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.No change.The Committee will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools to promote a stronger economic recovery in a context of price stability.The Committee will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools to promote a stronger economic recovery in a context of price stability.No change.Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen.Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen.No change.  Won’t miss the hawks that weren’t.Voting against the action was Charles L. Evans, who supported additional policy accommodation at this time.Voting against the action was Charles L. Evans, who supported additional policy accommodation at this time.No change.  Won’t miss Evans.

Comments

• The more I read the Fed statements, the more I think that they are paid to be Pollyannas.  The rose-colored glasses are glued to their faces.  There is never any criticism of their actions; blame always goes elsewhere.  They are similar to modern teenagers that lack talent, but have incredible self-esteem.
• GDP growth is not improving much if at all, and the unemployment rate improvement comes more from discouraged workers.  Inflation has not moderated significantly, either.
• They point to the risks coming from global financial markets.  The Fed is the lead regulator in the US of banks and SIFIs; if trouble abroad leads to trouble here, they have no one to blame but themselves.
• In my opinion, I don’t think holding down longer-term rates on the highest-quality debt will have any impact on lower quality debts, which is where most of the economy is located.
• Also, the reinvestment in Agency MBS should have limited impact because so many owners are inverted, or ineligible for financing backed by the GSEs, and implicitly the government, even with the recently announced refinancing changes.
• The key variables on Fed Policy are capacity utilization, unemployment, inflation trends, and inflation expectations.  As a result, the FOMC ain’t moving rates up, absent increases in employment, or a US Dollar crisis.  Labor employment is the key metric.
• The Fed is out of good policy tools, so it will use bad policy tools instead.

Questions for Dr. Bernanke:

• Discouraged workers are a large factor in the falling unemployment rate. Why do you think the economy is doing so well at present?
• Why do you think that holding down longer-term rates on the highest-quality debt will have any impact on lower quality debts, which is where most of the economy is located?
• Why will reinvestment in Agency MBS help the economy significantly?  Doesn’t that only help solvent borrowers on the low end of housing, who don’t really need the help?
• Couldn’t increased unemployment be structural, after all, there is a lot more competition from labor in emerging markets?
• Isn’t stagflation a possibility here?  I mean, no one expected it in the ‘70s either.
• Could we end up with another debt bubble from keeping short rates so low?
• If the Fed ever does shrink its balance sheet, what effect will it have on the banks?
• Is it possible that you don’t really know what would have worked to solve the Great Depression, and you are just committing an entirely new error that will result in a larger problem for us later?

Ask yourself this: where does investor put his money if he wants to stay safe?  Most people are savers not investors, so ideally they would want to put their money on deposit and earn a real return with the ability to access their money at any time.  Then there is the alternative asset, gold.  Gold is a hedge against inflation, but it throws off no interest.  But at some level of real return, savers begin to conclude that they aren’t earning all that much, so they may as well hold gold.  Vice versa when real rates rise.

One more thing: gold doesn’t benefit from productivity increases, as stocks do.  Rapidly increasing productivity makes gold less attractive than stocks.

Eddy’s model boils down to this (in my implementation):

Percentage change in gold price = Multiplier * Percentage change in (Deflator Index / Real return Index)

where the Real Return index compounds three month T-bill yields less inflation via the 12-month CPI-U in arrears.

Here is how well the mode works, since 1970:

The first model attempts to minimize absolute dollar price differences between actual and model.  The second attempts to minimize the ratio between actual and model prices.  Both have R-squareds over 90%.

The deflator return is constant in percentage terms.  For the two models it is around 2.3%/yr, which is not far from productivity gains.

As for the multiplier, it is near six.  The multiplier is like a duration figure with bonds.  What this means is that the percentage change in real interest rates, three-month T-bills less CPI-U inflation, is projected to persist for six years.  Six years is a reasonable figure, because monetary policy changes slowly, but not glacially.

Now, at present levels of real interest rates, with T-bill yields near zero, and the CPI above 3%, it implies a gold price rising at 3% per month.  If inflation stays where it is and the Fed holds good on its promises, that means a gold price in the $3000s in mid-2013.

Do I believe this?  Partially.  I own lots of oil stocks, but nothing in metals at all.

Eddy’s model helps to clarify the value of gold.  It is a store of value, as its price anticipates the degradation and strengthening of the dollar, because changes in real rates will persist on average for six years.

Now for my own thoughts.  I have a sympathy for anyone that wants to take monetary policy out of the hands of the government, because they don’t do it well.  Some sort of hard money standard is necessary, whether gold, silver, or a commodity basket.

Ideals

I have one major ideal here, and I don’t care as much how it is accomplished: get the government out of the monetary policy business.  My secondary ideal is regulating banks properly.

A gold standard could do the job, but I am not wedded to the idea.  Gold standards can be inflationary or deflationary.  It depends on the price at which you link the currency to gold.  Post-WWI, Britain pegged it too high, and got deflation.  France pegged it too low and got inflation. Getting the right level would be important.  Fortunately, we know where it trades now relative to the dollar, and that would be pretty close to the right level, if the stated gold levels of the Fed and the Treasury are accurate.

Practical

A full audit of the Fed is a minimum, as is an audit of the gold at Fort Knox.  Do it once, so that all doubts can be dispelled.

I think that bank regulation for leverage and asset-liability management is more critical than monetary policy itself. Banking crises stem from inadequate asset-liability management.  As James Grant pointed out from the historical example that he gave, deposits should back only self-liquidating assets.  Longer term assets must be backed by matching funding, or equity.

Unseasoned asset classes (i.e., asset classes for which we have no real loss statistics because they have never had failure as a group) should be disallowed as investments for banks except against surplus.  After that, risk based capital should be based off of strict actuarial studies, with a significant provision against adverse deviation, and no credit for diversification.  And, don’t allow banks to score their own riskiness, a la Basel.  That is ridiculous; the fox guards the henhouse.  If a bank has superior risk control, they will earn the results over time; they should not as a result lever up more.

Now, I really don’t care if it makes banks unprofitable, or earn less than their cost of capital.  In that case, we will get fewer banks, the margins of the remainder will rise, and you end up with a genuinely stable system with occasional bank failures that don’t threaten the system as a whole.

There was one idea that I thought could be put into practice immediately, Treasury Trust Bonds optionally backed by gold.  If nothing else, like TIPS, it would give the Fed another indicator on how credible their monetary policy is.

Conference Zeitgeist

The Taylor Rule got some respect.  Many suggested that if it had been followed, we would not have gotten into this crisis.  I’m a little less optimistic there, because bank regulation was co-opted allowing for too much risk to be taken relative to liquidity and capital.

Most felt that the Fed was the major player in causing the crisis, with the GSEs playing a lesser role.  The overpromotion of home ownership, and the constant provision of liquidity to the markets led borrowers to become reckless amid asset price inflation.

Incentives also played a role. Managerial and shareholder liability at banks would help prevent reckless behavior.  Wall Street worked better when it was a bunch of partnerships, rather than limited liability corporations.

Most thought that things are worse now than the ’70s.  The debt levels are higher, which makes demand punk, and businessman more skittish to expand and hire.  Government policy is less predictable as well.

The speakers largely expect more inflation; more debt monetization is the path of least resistance.  Politicians get what they want without a vote being taken.  On the question of where to invest, everyone was an inflationist.  Gold, silver, TBT, were trotted out.  Personally, I’ll stick with my stock investing.

People

Jeffrey Lacker showed courage in coming to the conference.  He made a really good point that the Fed should focus on its liability policies, and limit itself to investing in Treasuries.  The Fed gets bad press and popular dislike when it uses its assets for special lending programs and bailouts, leading to charges of favoritism.

Zoellick was a reasonable guy regarding the problems in the Eurozone.  Germany has to figure out what it wants.  To me, it boils down to this:

1. You can have a suboptimal euro that is not a good store of value, and bail less well-disciplined governments out via the ECB sucking in their debts, or,
2. You can have a smaller Eurozone en route to no Eurozone, or,
3. You can have a Federal Europe, and dissolve Germany into Europe as a state of the whole, as the 13 colonies did after the Articles of Confederation.

Personally, I would choose #2, because people in Europe identify themselves with their nations, not as Europeans.  Political and economic systems must derive from cultural systems or they will not work in the long haul.

It was fun seeing my old professor, Dr. Steven Hanke.  I reminded him of nine years earlier, when he gave a talk to the (then called) Baltimore Security Analysts Society, and we discussed why we thought the Euro would have a tough time surviving.  Most of that discussion is now taking place.

Ron Paul was Ron Paul.  He doesn’t change much — that’s one of his apolitical virtues.

John A. Allison was entertaining; he argued that capital levels are too low, and regulation too high.  He thinks that you can’t expect much, and don’t get much from regulation.  Especially interesting were the discrimination in lending allegations by the regulators that BB&T fought and won twice.

Conferences like this attract cranks.  Lots of people with odd political agendas hoping to get noticed, others with odd business propositions.

Other

As a final note, the concept of free banking and/or competitive currency issuance, I think invites more problems than it solves.  Think of it this way: people aren’t very good at evaluating financial promises.  The fewer the better, and the lower level of complexity, the better as well.  There has to be some monitoring of financial promises, some intelligent regulation of banks, or things can go badly wrong.  US history backs such an idea up, regardless of whether we have a gold-, silver-, or commodity-backed currency, or a fiat currency as we do now.

Update — thanks to Eddy Elfenbein for catching a typo/thoughtless mistake in paragraph 4.  For France, it was inflation, not deflation.