Items of Interest:
More criticism of the Federal Reserve.
Jeremy Grantham / GMO:
Jeremy Grantham's 3Q 2010 letter [pdf] -- The Ruinous Cost of Fed Manipulation of Asset Prices
My diatribe against the Fed’s policies of the last 15 years became, by degrees, rather long and complicated. So to make it easier to follow, a summary precedes the longer argument. (For an earlier attack on the Fed, see “Feet of Clay” in my 3Q 2002 Quarterly Letter.)
Purpose: If I were a benevolent dictator, I would strip the Fed of its obligation to worry about the economy and ask it to limit its meddling to attempting to manage inflation. Better yet, I would limit its activities to making sure that the economy had a suitable amount of liquidity to function normally. Further, I would force it to swear off manipulating asset prices through artificially low rates and asymmetric promises of help in tough times – the Greenspan/Bernanke put. It would be a better, simpler, and less dangerous world, although one much less exciting for us students of bubbles. Only by hammering away at its giant past mistakes as well as its dangerous current policy can we hope to generate enough awareness by 2014: Bernanke’s next scheduled reappointment hearing.
- Long-term data suggests that higher debt levels are not correlated with higher GDP growth rates.
- Therefore, lowering rates to encourage more debt is useless at the second derivative level.
- Lower rates, however, certainly do encourage speculation in markets and produce higher-priced and therefore less rewarding investments, which tilt markets toward the speculative end. Sustained higher prices mislead consumers and budgets alike.
- Our new Presidential Cycle data also shows no measurable economic benefits in Year 3, yet point to a striking market and speculative stock effect. This effect goes back to FDR, and is felt all around the world.
- It seems certain that the Fed is aware that low rates and moral hazard encourage higher asset prices and increased speculation, and that higher asset prices have a beneficial short-term impact on the economy, mainly through the wealth effect. It is also probable that the Fed knows that the other direct effects of monetary policy on the economy are negligible.
- It seems certain that the Fed uses this type of stimulus to help the recovery from even mild recessions, which might be healthier in the long-term for the economy to accept.
- The Fed, both now and under Greenspan, expressed no concern with the later stages of investment bubbles. This sets up a much-increased probability of bubbles forming and breaking, always dangerous events. Even as much of the rest of the world expresses concern with asset bubbles, Bernanke expresses none. (Yellen to the rescue?)
- The economic stimulus of higher asset prices, mild in the case of stocks and intense in the case of houses, is in any case all given back with interest as bubbles break and even overcorrect, causing intense financial and economic pain.
- Persistently over-stimulated asset prices seduce states, municipalities, endowments, and pension funds into assuming unrealistic return assumptions, which can and have caused financial crises as asset prices revert back to replacement cost or below.
- Artificially high asset prices also encourage misallocation of resources, as epitomized in the dotcom and fiber optic cable booms of 1999, and the overbuilding of houses from 2005 through 2007.
- Housing is much more dangerous to mess with than stocks, as houses are more broadly owned, more easily borrowed against, and seen as a more stable asset. Consequently, the wealth effect is greater.
- More importantly, house prices, unlike equities, have a direct effect on the economy by stimulating overbuilding. By 2007, overbuilding employed about 1 million additional, mostly lightly skilled, people, not counting the associated stimulus from housing related purchases.
- This increment of employment probably masked a structural increase in unemployment between 2002 and 2007, which was likely caused by global trade developments. With the housing bust, construction fell below normal and revealed this large increment in structural unemployment. Since these particular jobs may not come back, even in 10 years, this problem may call for retraining or special incentives.
- Housing busts also help to partly freeze the movement of labor; people are reluctant to move if they have negative house equity. The lesson here is: Do not mess with housing!
- Lower rates always transfer wealth from retirees (debt owners) to corporations (debt for expansion, theoretically) and the financial industry. This time, there are more retirees and the pain is greater, and corporations are notably avoiding capital spending and, therefore, the benefits are reduced. It is likely that there is no net benefit to artificially low rates.
- Quantitative easing is likely to turn out to be an even more desperate maneuver than the typical low rate policy. Importantly, by increasing inflation fears, this easing has sent the dollar down and commodity prices up.
- Weakening the dollar and being seen as certain to do that increases the chances of currency friction, which could spiral out of control.
- In almost every respect, adhering to a policy of low rates, employing quantitative easing, deliberately stimulating asset prices, ignoring the consequences of bubbles breaking, and displaying a complete refusal to learn from experience has left Fed policy as a large net negative to the production of a healthy, stable economy with strong employment.
ZeroHedge: Grantham On The Ruinous Cost Of The Fed's Manipulation Of Asset Prices
ZeroHedge: Eric Sprott On Bonfire of the Currencies
David Kotok / Cumberland Advisors: Quant. Easing II: Yabba Dabba Doo!
Jeff Matthews: “QE 2” or “Ben’s Titanic”?
Laurence Kotlikof & Richard Munroe / Bloomberg: U.S. Debt Is Child Abuse
QE2 a ‘Ponzi scheme’, says Pimco’s Gross -- The Federal Reserve’s highly anticipated plan to engage in quantitative easing to pump money into the economy is a “Ponzi scheme,” said Bill Gross, who manages the world’s biggest bond fund for Pimco.
The actions of the Fed, led by Chairman Ben Bernanke, will “likely signify the end of a great 30-year bull market in bonds and the necessity for bond managers and, yes, equity managers to adjust to a new environment,” he wrote in a commentary posted on Pimco’s website Wednesday...
Bill Gross / Pimco:
Run Turkey, Run -- Check writing in the trillions is not a bondholder’s friend; it is in fact inflationary, and, if truth be told, somewhat of a Ponzi scheme. Public debt, actually, has always had a Ponzi-like characteristic. Granted, the U.S. has, at times, paid down its national debt, but there was always the assumption that as long as creditors could be found to roll over existing loans – and buy new ones – the game could keep going forever...
-----Peter Orszag, former Director of the Office of Management and Budget under President Obama, NY Times:
Sailing the Wrong Way with QE2? -- the net effect of “QE2” is similar to having the Treasury sell short-term T-bills and using the proceeds to buy back 10-year bonds. The result is thus that the average maturity of government debt held outside the government falls. (From a debt management perspective and given current interest rates, the Federal government should probably be lengthening the average maturity of debt held by the public rather than reducing it, but let’s not worry about that for now.)
What are the benefits of such a reduction in the average maturity of government debt in the current economic environment?
They’re quite limited for two reasons...
----The Fed's Quantitative Easing (QE) will lead to a vicious currency war.
A Vicious Circle -- By increasing the amount of dollars in the world, the Fed would depress the greenback's value. Mere anticipation of the Fed's strategy has already weakened the dollar in global markets. That, in turn, places greater strain on the yuan. China's central bank would have to intervene on an even bigger scale by buying more and more dollars to stop the yuan rising in value. (On Oct. 19, the bank hiked its benchmark interest rate, signaling it would not fight potential inflation by allowing the yuan to appreciate.)
Can the U.S. force Beijing to loosen its grip on the yuan simply by generating more dollars? In theory, yes. The Fed has the ability to produce as many dollars as it wishes, potentially placing limitless pressure on China to let the yuan appreciate...
----Another big problem with the Fed's Quantitative Easing (QE) money printing is "leakage". All the money the Fed creates leaks out of the United States and flows around the world to jack up asset prices.
Chris Ciovacco / Ciovacco Capital:
Who Receives the Fed's Printed Money? -- To give a hypothetical example of how the Fed’s newly printed money can make its way around the globe...
Understanding the global footprints of the primary dealers and their clients allows us to visualize the broad geographic reach of the Fed’s printing press. Understanding the buying power and investment influence of large clients of the primary dealers, like sovereign funds, helps us understand how QE2 may potentially impact a wide range of markets from currencies to commodities...
----Wall Street Journal:
Fed Gears Up for Stimulus -- Fed Chairman Ben Bernanke's push to restart the bond-buying program—a form of monetary stimulus known as quantitative easing—has been greeted with deep skepticism among some of his colleagues. In some of his strongest words yet, Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, said Monday that more expansive monetary policy was a "bargain with the devil."
In the next few months, internal opposition to Mr. Bernanke's approach could intensify as presidents of three regional Fed banks who have expressed skepticism about the plan—Narayana Kocherlakota of Minneapolis, Richard Fisher of Dallas and Charles Plosser of Philadelphia—take voting positions on the Fed's policy-making body. There are 12 regional Fed banks, and five voting seats on the Federal Open Market Committee rotate among them every year, with New York always keeping one.
Investors already expect Fed action. Stock prices have rallied since Mr. Bernanke broached the idea of bond buying in late August. But investors and analysts are divided on whether the gambit will work...
Fed Dissenter Hoenig Wages Lonely Campaign Against Easy Credit -- In Washington, he is the burr in Fed Chairman Bernanke’s saddle: the rogue heartland banker who keeps dissenting alone -- for the sixth straight time on Sept. 21 -- to protest the Fed’s rock- bottom interest-rate policy. Hoenig warns that the Bernanke majority is setting the country up for an as-yet-unknown asset bubble: the next dot-com or subprime craze. He can’t tell yet where the boom-and-bust will materialize, but he can feel it coming, like a Missouri wheat farmer senses in his bones the storm that’s just over the horizon...
Hoenig harbors powerful misgivings over not dissenting more often and more forcefully during the Greenspan years. “He regrets going along with the votes when Alan Greenspan was chairman to get rates so low and keeping them so low so long,” says his friend Fisher...
Another reason Hoenig wants to end super-low interest rates is that Wall Street banks and large corporations are currently able to borrow for almost nothing and either hoard cash, make acquisitions, or invest in long-term Treasuries for a guaranteed profit. Retirees and other bank depositors effectively subsidize this borrowing and earn almost nothing on their savings. “It’s a distortion, and it favors the large institutions over the smaller ones and Wall Street over the saver,” Hoenig says in an interview. “I just don’t like it. It’s not fair.”...