Saturday, October 16, 2010

Saving whose asset ?

Back in the olden days, the Federal Reserve's role in life was to assure price stability, which from the beginning tended to focus on stabilizing unemployment and moderating inflation.

You young-uns may not know that because when Greenspan took the reigns, his focus began to shift. And ever since, the primary focus, based on action and not words, has been on asset price protection. Indeed, the Greenspan legacy is his "put". Not a Laffer curve or other analysis of the natural rate of unemployment. Not the Volker strangle on inflation by raising interest rates, but on pumping money, 24/7.

So what? Well, by focusing on unemployment and inflation, the business cycle was a tangible notion based on real production of real goods and services. By focusing on asset prices, all that has changed. There is no longer a business cycle, and the wealth of the nation is now determined by the price of assets. Certainly not the price of its currency.

Financial policy has shifted heavily from fiscal responsibility and action to monetary irresponsibility and action, helped along the way by Wall Street's wholesale buy-off of Congress and its population of the Treasury and Federal Reserve with its own. See, Goldie as political hedge fund.

And if that sounds a bit scary, it is. Happy Halloween.

Commentary: Quantitative easing will work for only a short time
At one time, news that Americans might be enjoying a little happiness was enough to provoke saturnine Fed chairmen to jack up interest rates, thin the money supply and generally just bum us out.

So you can understand that investors have been slow to understand the new Fed, which appears to be populated by unicorns and leprechauns who spend their days paging through how-to manuals to find new ways to shower the markets with cheap money.

And as proof that asset price is the focal point of Central Bank policy, around the world, consider these articles, all current and easily accessed at a glance from amongst the plethora of same such from multiple public news items, blogs and academic papers: it is no secret nor conspiracy theory.

Policy makers need long-term plan to cut deficits, Kohn argues
Speaking just hours after Federal Reserve Chairman Ben Bernanke urged caution in proceeding with quantitative easing, Donald Kohn also raised some concerns about any plan by the Federal Reserve to buy additional long term securities. Kohn until September was vice chairman of the Fed and spent 40 years at the central bank.

Kohn added that additional purchases by the Fed of securities distort asset prices and lower interest rates to stimulate the economy.

“That’s the whole point of the purchases is to change asset prices and they do induce people to take more credit and interest rate risk than they otherwise would do. That’s the way they stimulate spending and borrowing,” Kohn said.
It seems the whole QE exercise is not to lead a horse to water, let alone try to make him drink it, but simply to increase the size of the water hole with the idea that a bigger hole will be so much more tantalizing to run to and drink from.

Commentary: Oil back above $80 raises question over Fed policy
As crude oil edged dangerously closer to $85 a barrel over the past few weeks, the buzz in oil trading pits and among a number of market strategists is increasingly about potential “demand destruction,” or the impact this might have on retrenched consumers and an already weakening economy.

Ironically, of course, crude’s more than 11% rally in September, and further gains so far this month, are largely symptoms of the Federal Reserve’s determination to help the U.S. economy avoid deflation by pumping more dollars into the system.

By itself, a weakening U.S. currency helps boost commodities, most of which are dollar-denominated. In addition, over the past two years, near-zero interest rates and the Fed’s so-called quantitative easing measures have fueled a carry trade: Investors have borrowed cheap and cheapening dollars to buy assets such as stocks and commodities.

But unlike the last commodity boom of 2007, the unemployment rate is currently at 9.6%, not under 5%.

“There’s definitely concerns about the recovery and demand destruction while crude is being [lifted] by the dollar,” says Tariq Zahir, managing member at Tyche Capital Advisors. “Fundamentally, there’s enough [crude] out there and we should head lower.”

And it’s not so much the exact dollar level that’s a cause of concern but rather the increasingly strenuous conditions in the rest of the economy.

Gluskin Sheff chief economist Dave Rosenberg notes that $84 a barrel means higher gasoline prices ahead, while at the same time food prices are also rising.

While higher food and gasoline prices are most likely not what the Fed wants to see, it might be good to remember that it’s likely there will soon be some reprieve in early November, when the Fed is believed to actually announce new quantitative measures.

But in the longer-run, the problem is likely to return, especially if the effectiveness of quantitative measures remain elusive, while the impact on the dollar and commodities is clear to all.
Note this, too: Cotton Prices Hit 140-Year High. Mrs Main Street won't even be able to afford yardage to make her own clothes.

The Fed is the biggest seller of volatility
Risk measures are inevitably going to become more correlated in a world where the Fed and central banks generally are playing a bigger role in determining market outcomes.

In a nutshell, the Fed has become the ultimate seller of volatility into the market and that is because it was always the Fed’s goal to force investors to make one decision and one decision only — to put their money in risk assets rather than cash.

And this is why all the are going up in unison.

By design, the Fed is seeking to punish those who want to hide in cash. As a result, investors are either embracing “risk assets” or unwinding exposure and raising cash. This leads to a high degree of correlation both among equities as company specific factors are overwhelmed by macro consideration and across risk assets that largely serve as proxies for one another.

Don’t get used to the new Fed
The bottom line is that QE2 should work for a spell. At some point, though, any rally that ensues will shut down if marked improvements in these indicators do not begin to appear: unemployment claims, payrolls, the First Call earnings revision index, the Rasmussen consumer confidence survey, the ECRI weekly leading index, the oil and gas rig count, and a rise in bond yields.

More specifically, here are some benchmarks that pessimists use to show the glass is half empty: ADP’s employment measure has stalled at a very depressed level; for the first time, the labor force is declining year-on-year (down 0.4% in September); state and local employment in September fell at a negative 5% annualized rate; the unemployment rate remained close to 10% for a ninth month; the global composite Purchasing Managers Index fell in September to 52.4%, from its recent peak at 57.3%; U.S. and U.K. house price surveys are weakening; and manufacturing and trade sales, after surging 13.3% from their recession low, have been unchanged for five months.

There are at least 15 similar points that optimists may use to buttress their own arguments, including a significant rebound in recent weeks in the ECRI leading index. The point is that the stock market can only rally for so long on the prospect that the new Fed is omniscient, caring, and will make everything better. At some point, that actually needs to happen.

Now, at this point in that last article, the author loses Guambat. He says:
Now the best weapon that the Fed has at its disposal is a rise in the market itself. A swell in stocks would be the cheapest stimulus measure available, as it increases confidence and household net worth, and makes businesses and individuals alike more confident to invest and spend.

Guambat cannot for the life of him understand how Mr and Mrs Main Street are going to be gladdened and have their confidence restored if Wall Street keeps getting wealthier. That will not be such a swell idea for those without jobs, homes and hopes.

Indeed, it will more likely engender greater resentment than already exists, social divide and political crisis, if not higher problems with law and order. It may be simply marvelous for those with assets who see their assets rise, but for those who have not been able to get back up off their assets after the shocks of this last decade of living with Greenspan's legacy, it will hardly be a party.

Wall Street confidence may be emboldened, but Main Street confidence cannot be lifted, in this economic environment, by a rise in stock prices. Not when there is no salary and no pension and no savings, and not when household net worth is generally zero to negative. You cannot get any confidence from household net worth until it rises to a point you can actually spend some of it.

The way those Wall Street hotshots do.

Keynes may not have been entirely right. At least, it may be that not all Keynesian follower's ideas have all worked out as planned.

But Guambat is now pretty sure that a busted economy needs real productive growth that comes with real spending on the ground that creates jobs and demand and tangible production.

Particularly in these circumstances, monetary policy in the main or on its own, cheap currency and artificially inflated asset prices is nothing but a bunch of fairy floss, peddled by people who know exactly what they're doing and grabbed up by people who don't know what's good for them.

And, at some point after the sugar rush, look out for the big let down.

MORE ON THIS: Our Fiscal Policy Paradox, by Alan Blinder
The practice of monetary and fiscal policy is fraught with difficulties, but the central concept is straightforward, compelling and, by the way, 75 years old: The government should push the economy forward when unemployment is high and slow it down when inflation threatens.

To do so, governments normally have two principal sets of weapons. Fiscal policy means moving some taxes or elements of public spending up or down to either propel or restrain total spending. In the United States, such decisions are made politically, by Congress and the president. Monetary policy normally (but not now) means lowering or raising short-term interest rates to either speed up growth or slow it down. That power, of course, resides in the technocratic Federal Reserve.

In 2008 and 2009, the U.S. government rolled out the heavy fiscal and monetary artillery to stave off Great Depression 2.0. Taxes were cut, spending was increased, and the Fed pushed the federal-funds rate all the way down to virtually zero. It worked.

But that was then and this is now. Today, the economy still needs a boost. But we seem to be trapped in what I call the paradox of macroeconomic policy: The policies that might work won't be tried, and the policies that will be tried might not work. If that sounds irrational, well, you've got the message.

There are plenty of powerful weapons left in the fiscal-policy arsenal. But Congress is tied up in partisan knots that will probably get worse after the election. On the other hand, the Fed stands ready—indeed, seems eager—to act. But it has already deployed its most powerful weapons, leaving only weak ones. That's the paradox.


Get Ready For The Fed's Great Experiment
The Board has used all of its conventional tools and some not so conventional, and now is in the position of entering into a great experiment with unknown outcomes and possible unintended consequences. The truth is that the Fed cannot use monetary policy to force companies, banks and consumers to take credit that they do not want.

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