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Jim Cook

 

RUNAWAY SOCIAL SYMPATHY

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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Best of Doug Noland
November 1, 2011
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The Fed is apparently fashioning its plan for additional quantitative easing.  The Wall Street Journal headlined Jon Hilsenrath’s article this morning, “Fed is Poised for More Easing.”  “Federal Reserve officials are starting to build a case for a new program of buying mortgage-backed securities to boost the ailing economy, though they appear unlikely to move swiftly… Moreover, Fed officials believe their past purchase programs helped to lift stock markets, by driving investors from low-risk investments toward riskier investments.”

Chairman Bernanke began dangling the “QE3” carrot a couple weeks back, as the global financial system came under heightened stress.  Vice chairman Janet Yellen this afternoon said the Fed is “prepared to employ our tools as appropriate… Securities purchases across a wide spectrum of maturities might become appropriate if evolving economic conditions called for significantly greater monetary accommodation.”  Chicago Fed President (and voting FOMC member) Charles Evans has of late become increasingly outspoken in his call for further policy actions, this week going so far as to state his tolerance for higher inflation in the cause of stimulating job growth.  And Mr. Evans again espoused “unemployment targeting” (more conventionally, “mileposts”) suggesting the Fed should consider a stated goal of zero rates until the unemployment rate dips below, say, 7.0%.  Some would argue “aggressive;” I’ll stick with “monetary policy lunacy.”

In a speech yesterday, Fed governor Daniel Tarullo called for the Federal Reserve to resume quantitative easing through another mortgage-backed security (MBS) purchase operation.  “Within the FOMC and in the broader policy community, there has been considerable discussion of possible additional accommodative measures, from communication strategies such as forward guidance on the likely path of the federal funds rate to additional balance sheet operations. I believe we should move back up toward the top of the  list of options the large-scale purchase of additional mortgage-backed  securities, something the FOMC first did in November 2008 and  then in greater amounts beginning in March 2009 in order to provide  more support to mortgage lending and housing markets…  A large-scale MBS purchase program has many of the benefits associated with purchases of longer-duration Treasury securities, such as inducing investors to shift to other assets, including bonds and equities. But it could also have more direct effects on the housing market.”

Is the Fed really poised to again expand its balance sheet through additional monetization of MBS?  Well, the Federal Reserve should not be in the mortgage business – and they know it.  It was not all that many months ago that the consensus view at the Fed was that it should move decisively to unwind its emergency operations and liquidate its holdings of mortgage securities.  Federal Reserve operations would be limited to Treasury securities in order to minimize the Fed’s influence on market prices and to avoid potential political pressures that would invariably arise if the Fed began picking and choosing sectors to support in the marketplace (the mortgage marketplace has been too politicized for much too long – with rather conspicuous consequences). 

These days, it’s easy to envision the closed-door discussions and backdoor agreements in Europe:  “They’ll never agree to this.  This is politically infeasible.  Could we get this by them?  Would the Bundestag revolt if we pushed it this far?  Can we make a legal case for such an approach?  Are the rules bendable?  Can we drop the word “leverage” and instead use “efficiency” and “firepower”?  Would the markets buy into this?  How can we make this appear credible?” 

And I find myself imagining back-room strategizing in some vacant office in the basement at the Federal Reserve Building in Washington, D.C.  Inflation is elevated and the U.S. economy is not falling off a cliff, yet the chairman is really fretting the unfolding global crisis.  So the “doves” quietly discuss the political realities, while concocting a strategy that will ensure they have the big “QE3” gun cocked and loaded.  Importantly, Dr. Bernanke is convinced that the Fed must be ready and willing to demonstrate to the markets that it has the necessary firepower to stem any crisis before disruptions gain too much momentum.  The hope is that, if the marketplace appreciates you carry a big bazooka and an itchy trigger finger, it significantly reduces the probability that the markets will stray to the point of requiring brute force. 

Simply buying more Treasuries these days risks a political firestorm.  Direct monetization of Washington’s reckless borrowing and spending is simply intolerable.  Besides, it would only increase the price of “safe haven” Treasuries at the expense of risk assets more generally and likely prove only more destabilizing when the markets fall into “risk off” mode.  And - who would have thunk at 9.1% unemployment - the “inflation targeting” trump card is inoperable with year-over year inflation standing at almost 4.0%.  So with all the public and political angst associated with a stubborn national jobs crisis, linking additional monetary ease to the unemployment rate might actually make for good political cover. 

Perhaps the FMOC doves strategize along these lines:  “As much as we’d rather not venture back into potentially risky MBS purchase operations, what politician would risk attacking the Fed for stemming foreclosures, reversing falling home prices, and allowing troubled borrowers to refi into lower-cost mortgages?  We could slash household borrowing costs and stimulate some extra consumption in the process.  We’d increase MBS prices and bolster market confidence, while incentivizing leveraged speculation throughout the massive mortgage marketplace.  This would boost marketplace liquidity more generally.  Plus, such talk would likely weigh on the dollar – and it is clearly better for the markets that dollar devaluation begins again in earnest.  Oh, this is good - workable.  Let’s get right on it. . .

At the Fed, it is clear that as an organization it has failed to learn important lessons.  Again, from Tarullo:  “A large-scale MBS purchase program has many of the benefits associated with purchases of longer-duration Treasury securities, such as inducing investors to shift to other assets, including bonds and equities.”  Boston Fed President Rosengren stated this week that he’s not happy with the risk premium the market is pricing in for MBS, and the Fed should be prepared to do something about it.  And today from Hilsenrath:  “Mortgage rates are already very low, but some Fed officials believe they might be pushed lower. Moreover, Fed officials believe their past purchase programs helped to lift stock markets, by driving investors from low-risk investments toward riskier investments.”

Does the Fed still not appreciate the damage wrought from distorting market pricing mechanisms, incentivizing speculation and cajoling savers into risk assets?  Do we really want to continue with this “tiered” marketplace that incentivizes mortgage lending and speculating at the expense of capital investment?  It is not a jobs crisis so much as it is a crisis of market dysfunction and resulting cumulative structural economic impairment.  Do our monetary officials today not appreciate the risks associated with pushing the vulnerable household sector further out of relative safety and into financial harm’s way?  Having for years nurtured today’s acutely fragile financial structure, do they even begin to recognize how U.S. and global markets have succumbed to “Ponzi Finance” dynamics?

For now, the markets seem ok with things.  It’s a fragile peace.  Some have been stunned by the markets’ resiliency in the face of near Europe and market meltdowns, while many see confirmation of their bullish view – especially when it comes to U.S. equities.  I tend to see confirmation of the thesis that markets are these days highly speculative and, in the end, dysfunctional.  Markets should not be so dependent on what has increasingly regressed into Policymaking by the Act of Desperate Measures. 

But it is what it is.  We’ve arrive at a troubling late-stage of historic Credit, financial and speculative excess.  The stakes have become incredibly high, and a speculation-rife marketplace has, strangely enough, turned comfortably numb playing this precarious game of chicken with global policymakers. 

I’m particularly bothered by a few things.  First, I fear policymakers are fighting a losing battle that essentially amounts to pandering to markets and more kicking the proverbial can down the road.  And as much as they don’t want to face a market breakdown, it is similarly not in their or the system’s interest to see global risk markets lurch back up to unsustainable heights.  The markets are playing for an inevitable “grand plan” from Europe but at the same time have little confidence that it will actually resolve very serious structural issues. 

Second, the policymaking and market backdrop has fomented extreme uncertainty and volatility – along with a general environment where markets have lost the capacity to smoothly discount deteriorating fundamentals.  Market adjustments now tend to arise violently, ensuring the most pain for the largest number of participants.  I see little on the horizon in Europe that changes my view that global markets are in the initial phase of what will prove a challenging de-risking/de-leveraging period.

And, finally, I fear global market dynamics and Fed policymaking are propagating the worst-case scenario for the U.S. government finance Bubble.  As was the case in Greece, Ireland, Portugal, Spain, Italy and elsewhere, a distorted market is content to accommodate profligate borrowing until it’s way too late.  Is another round of Fed MBS QE going to help?  A dysfunctional marketplace has, almost without exception, been incapable of imposing any degree of market discipline until the point when only exceptionally harsh and destabilizing “austerity” suffices.  This isn’t how policymaking, markets and Capitalism are supposed to operate.