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Jim Cook



Every once in a while I switch the TV channel from Fox to CNBC to see what the liberals are saying.  After listening awhile I get a deep sense of hopelessness and foreboding for our country.  The most important thing for the left is giving money to people.  They are happy to see the growth of food stamps, disability payments, housing subsidies, free healthcare and all the other welfare benefits.  They utterly fail to see the damage it is doing to the recipients.  Whole cities that once flourished have deteriorated into rotting eyesores populated with shambling hulks of chemically dependent drones.  These people are no longer employable.  They have become incompetent and helpless and the liberals can’t see that it’s their doing.

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The Best of Jim Cook Archive

Best of Doug Noland
March 5, 2010
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For now, the markets are confident that the Bernanke Federal Reserve and Treasury enjoy all the flexibility they require to sufficiently expand system Credit.  And it is this confidence that has ensured marketplace accommodation of massive U.S. federal government Credit expansion.  Greek – and other European – policymakers, on the other hand, enjoy little capacity to reflate.  This leaves market participants fearful of Credit constraints feeding a cycle of economic weakness, asset market problems and general angst. 

In my readings of the history of monetary management and central banking, I was repeatedly struck by the long history of European scorn for U.S. monetary practices.   Going back to at least the nineteenth century, there has been a longstanding view that we lacked both monetary discipline and the proper framework to ensure a stable Credit system and currency.  Traditionally, our policymakers lacked an understanding of Credit and, when in a jam, would invariably resort to inflationism.

I was reminded of this history this week when I read European policymaker responses to an IMF paper proposing that central banks consider raising their inflation targets to 4%.  The IMF paper, co-authored by IMF chief economist Olivier Blanchard (MIT and Harvard), suggests that crisis-period policymaking would have benefited from a higher pre-crisis inflation level.  ECB member and Bundesbank President Axel Weber said the IMF was “playing with fire” and that such a proposal was “grossly negligent and harmful.”  ECB Executive Board member Juergen Stark called the proposal “most unhelpful” and stated that “there is no evidence whatsoever to support that deviating from price stability and aiming at an inflation rate of 4% would enhance economic prosperity or growth.”  He added, “I do see the temptation for governments to ask for higher inflation in order to monetize the dramatic buildup of public debt in nearly all advanced economies.”

Nowhere does the temptation for higher inflation seem as indomitable as it does here at home.  And the markets are fine with it.  In the old days, at least the bond “vigilantes” would have objected.  But we live in the financial age where “spread trades,” myriad Credit instruments, and speculator profits are all bolstered by reflationary policymaking.  Throughout the system, many feel they would benefit from some additional inflation, while few fear they would be disadvantaged.  Federal Reserve monetization is cheered.  Inflationism dogma is as beloved as ever.

Former Fed governor Frederic Mishkin teamed up with Goldman’s Jan Hatzius, Deutsche Bank’s Peter Hooper, New York University’s Kermit Schoenholtz, and Princeton’s Mark Watson for a paper presented today at the University of Chicago.  Their work introduces a new measurement of financial conditions.  This research also details their study that suggests that financial conditions tightened at the end of 2009 and remain “impaired” because of problems in the so-called shadow banking system.  Dr. Mishkin (now at Columbia) was on CNBC this morning trumpeting the view that “monetary policy needs to be accommodative…for an extended period.” 

From the Wall Street Journal’s Jon Hilsenrath’s:  “One of the most important drivers of the economists’ financial-conditions index was the asset-backed securities markets, where commercial real estate loans, car loans and many other kinds of bank loans were financed during the credit boom.”  And from these economists:  “The new financial conditions index would be the only means available to assess the impact of policy choices with interest rates near zero”

Well, I’m compelled to disagree with both the focus of this research and the premise that financial conditions are anything but loose.  The post-Bubble ABS market is today an especially poor indicator of system financial conditions.  It would be akin to significantly weighting private-equity financing of technology startups as an indicator of general financial conditions after the bursting of the technology Bubble.  The housing, mortgage and ABS manias/Bubbles have burst and will not be meaningful reflationary forces, at least directly.  It is a major, yet predictable, error to use unavoidable post-Bubble Credit impairment as justification for loose financial conditions and policymaker accommodation of new excesses and additional Bubbles. 

The pricing and expansion of mortgage Credit was by far the most important indicator of problematically loose financial conditions from 2002 through the Bubble period.  Today, financial conditions should be gauged primarily by the market pricing and associated expansion of government finance.  It is the unfolding Government Finance Bubble that today poses great systemic risk – not the ABS, “repo” or other components of the wreckage formally known as the “shadow banking system.”  That was the old Bubble.  First and foremost, policymakers should be focused on ensuring that they do not foment even more dangerous Bubbles and systemic fragilities.  The Creditworthiness of our entire Credit system and the credibility of our monetary management and “money” are at stake.

For now, the markets are pleased to accommodate U.S. reflationary policymaking.  The dollar has been strong of late, with Treasury/agency/GSE MBS yields remaining incredibly low.  The market backdrop kind of makes ECB comments extolling the virtues of price stability – while lambasting inflationism - seem arcane and out of touch.  Meanwhile, the markets have begun to impose discipline on profligate borrowers in Europe, while rewarding profligacy here at home (and elsewhere).  One would not expect such a divergence to last forever.  And I don’t expect our current competitive advantage in all things “inflationism” to pay lasting dividends for our nation’s currency, debt markets or economy.


Doug Noland is a market strategist at Prudent Bear Funds. Their website is