There is
little else left in the asset-pricing world than central bankers. The
redoubtable Ben Hunt, chief risk officer at Salient investment managers ($20
billion under management), wrote on David Stockman's Contra Corner:
"I've spent the past few weeks meeting Salient clients and partners across
the country.... When I had conversations [with clients and partners] six months
ago, I would get a fair amount of resistance to the notion that narratives
dominate markets and that we're in an Emperor's New Clothes world.
Today, everyone believes that market price levels are largely driven
by monetary policy and that we are being played by politicians and central
bankers using their words for effect rather than direct communication. No one
requires convincing that markets are unsupported by real world economic
activity. Everyone believes that this will all end badly, and the only real
question is when."
This might be referred to as "End-of
the-Cycle Mispricing, but, what a cycle! End-of-the-Cycle
Mispricing discussed the derangement of prices, in all assets. Money managers
as a whole have not considered protection for their funds when everyone runs
for the door at once. The "catastrophic bond" paper linked to the
discussion was specific, but, there are plenty of avenues to construct such
protection.
What follows is a transcription of just how
ignorant, moreover, willingly ignorant, and, it may be, enthusiastically
ignorant, was the Bernanke Fed when it decided that holding interest rates at
zero percent would be its policy. Before plunging through the looking glass,
here is the conclusion: If ever there was a time to protect one's assets from
further FOMC derangement, this is it. If you do not (and cannot) design a
Personal Protection Plan, buy cash, gold nuggets, and silver eagles.
Reading the transcript from the December
15-16, 2008, FOMC meeting, it is clear the Federal Open Market Committee was
embarking on its zero-interest rate policy (ZIRP - which is still all we've
got) as an experiment.
By way of background, the FOMC had cut the
Fed funds rate cut from 5.25% on June 29, 2006 to 1.00% on October 29, 2008.
Most of reduction had been over the previous few months as the pillars fell:
Bear Stearns, Merrill Lynch, Lehman Brothers, Goldman Sachs, and Morgan
Stanley. The last two converted to commercial banks and received government
protection as well as deposit-taking authorization.
The December meeting addressed whether the
funds rate should be cut to zero (ZIRP), or, to some halfway house. As has been
true throughout Bernanke's chairmanship, the 284-page debate could only have
been held in the Eccles Building. The funds rate had been trading below the
declared rate for a couple of months. One can only imagine the ecstasy at the
Fed on December 12, 2008, when the funds rate traded at 0.00%: the
"zero-bound." This had been Professor Bernanke's ad pitch since the
early 1990s.
Two members of the Committee stand out as
particularly itchy to get on with it, Chairman Bernanke and (then) San
Francisco Federal Reserve President Janet Yellen. Bernanke broke with precedent
by speaking first. Normally, the Chairman opens with a few remarks but waits
until all FOMC members (plus non-voting regional presidents) have voiced their
opinions before holding forth.
In
synopsis, there was no debate, not because fed funds were trading at
zero already. The FOMC was discussing Fed policy. In Bernanke's words:
"[W]e are at a historic juncture.... [o]f necessity, moving towards new
approaches.... [T]his is a work in progress." One might wonder if the Fed
chairman had created the "necessity" so that he could breathlessly
declare this "historic juncture," and he could experiment with his
textbook diagrams: His "work in progress."
Through
his great experiment, Bernanke seems not to have blanched at heaving new
innovations from the Eccles Building without knowing what might follow. At the
October 28-29, FOMC meeting, about three weeks after the Fed first paid banks
interest on their reserves, Federal Reserve Governor Elizabeth Duke reported:
"I asked [the banks] specifically this question about interest rates on
reserves, and every single one of them said: 'We haven't had time to even focus
on it. We don't even know what's going on with that.'" Bernanke responded:
"Learning theory in practice. Thank you very much."
You may
remember the many borrowing windows opened by the Fed in 2008. The transcript
shows there was little coherence to these conduits. At the December meeting,
Bernanke said: "We have adopted a series of programs, all of which involve
some type of lending or asset purchase.... [of] which even I do not know all of
the acronyms anymore." Anymore? A viewer of Bernanke during Senate
testimony would question whether he knew what they did to begin with.
St. Louis Federal Reserve President James
Bullard lamented later in the same meeting: "I would like to see us work
harder, maybe much harder, on the metrics for success of these facilities [the
various borrowing windows - FJS] and perhaps rework or discontinue facilities
that may not be meeting expectations.... Frankly, I am not sure in all cases
what the purpose of the programs is. We have a lot of them out there. We have
ideas. We should quantify that. We should be assessing, and then we should turn
around and say, 'This one is working. This one is not working.' I would like to
see a lot more in that direction. I understand that we haven't done it so
far...." The Bernanke Fed tendency might be summed: "Assess the
facilities? Why bother? Open another one."
Everyone had their say at the December
meeting, During the Greenspan and Bernanke pontificates, members who disagreed
with the FOMC vote were talking to a wall. In the meeting under discussion, the
topic was whether to confiscate the People's interest rates (and interest
earnings) or not.
The chairman opened: "I'd like to ask
your indulgence. There's an awful lot here, and I'd like to go first this time
and try to clear out some underbrush and to lay down some issues in the hope
that it will perhaps focus our discussion a bit more." The message is
unmistakable: the FOMC would vote to ZIRP the American people.
There were several members who contested
ZIRP. The FOMC member chosen for exposition here is St. Louis Federal Reserve
President James Bullard. This choice is two-fold. His concerns were worries a
college professor might express, one who talked about - in fact, Bernanke hid
behind - models, the "literature," and theory. Bullard has also been
selected since he holds the bone fides Bernanke cherishes. Bullard's papers
have been published in the American Economic Review, Journal of
Monetary Economics, Macroeconomic Dynamics, and Journal of Money,
Credit, and Banking.
The St. Louis Fed president explained his
demurral: "I do not find the Reifschneider-Williams paper, which I know
carries some weight around here, very compelling, so let me give the brief
reasons behind that. For one thing, you are taking a model and you are
extrapolating far outside the experience on which the model is based. That
might be a first pass, but that is probably not a good way to make policy, and
I wouldn't base policy on something like that."
What (you may not have the slightest interest
in knowing), is the Reifschneider-Williams paper? David Reifschneider and John
C. Williams wrote a paper in 2000, "Three Lessons for Monetary Policy in a
Low-Inflation Era." The paper describes "limits to policy
accommodation attributable to the lower bound on rates." The person who
described the paper in that phrase will be identified later, though anyone
who's been around the past few years probably has a hunch.
The second of Bullard's concerns: "There
are also important nonlinearities. This whole debate is about nonlinearities as
you get to the zero bound, and in my view, they are not taken into account
appropriately in this analysis. You have households and businesses that are
going to understand very well that there is a zero bound. It has been widely discussed
for the past year. They are going to take this into account when they are
making their decisions, so you have to incorporate that into the analysis. That
is a tall order-there are papers around that try to do that, and many other
assumptions have to go into that."
The fellow who has been widely published on
macroeconomic matters went on: "The third thing I think is important is
that, in other contexts, gradualism or policy inertia is actually celebrated as
an important part of a successful, optimal monetary policy. Mike Woodford, in
particular, has papers on optimal monetary policy inertia, and many others have
worked on it. In those papers, it is all about making your actions gradual and
making sure that they convey some benefit to the equilibrium that you will
get.
"All of a sudden, in this particular
analysis, when you are facing a zero bound, that [taking a gradual, deliberate
approach towards a zero percent interest rate - FJS] goes out the window, and I
don't think that it is taken into account appropriately in the analysis.
"Also, it is thrown out the window
exactly at a time when you might think that the inertia and the gradualism are
most important, which would be in time of crisis when you want to steer the
ship in a steady way." Yes, you might think.
Bullard had plenty more to say at the
December 2008 meeting. Others who zapped ZIRP were Dallas Federal Reserve
President Richard Fisher, Philadelphia President Charles Plosser, and Richmond
President Jeffrey Lacker. One of Plosser's many admonitions: "We still do
not understand why having interest rates on reserves isn't working to keep the
funds rate at its target, and there may well be unintended consequences of
moving our target to zero, beyond those well articulated in the Board's staff
notes." Plosser's audience had no interest in whether FOMC steps actually
worked or not. Bernanke had already said, regarding Governor Duke's lack of
knowledge by the banks: "Learning theory in practice. Thank you very
much."
I could probably list another hundred -
certainly at least fifty - other objections stated at that meeting against
establishing a zero-interest rate policy. Today, at least a thousand problems
created by ZIRP are throttling us.
There is not the slightest chance Chairman Yellen
will lift rates. The market will do that. Yellen, then San Francisco Federal
Reserve President, did not acknowledge any reason to deliberate over ZIRP:
"I see few advantages to gradualism, and certainly whenever we approach
the zero bound, I think the funds rate target should be quickly reduced toward
zero. [Outside of the Eccles Building, it was 0.00% - FJS] As to the level of
the lower bound, my default position is that we should move the target funds
rate all the way to zero because that would provide the most macroeconomic
stimulus." From current speeches, it is obvious she still believes
that final sentence.
The
answer to the pop quiz: Who said the Reifschneider-Williams paper describes
"limits to policy accommodation attributable to the lower bound on
rates?" Nobody. That is footnote number 24 to Ben S. Bernanke's speech on
August 31, 2012, at Jackson Hole, Wyoming, "Monetary Policy since the
Onset of the Crisis." He committed murder in his footnotes to speeches. The
claim to which he attached the footnote is as improbable as he is, and Bernanke
is abusing the paper (as Bullard warned the FOMC) by extrapolating its
conclusions to a situation (ZIRP) which is "far outside the experience on
which the model is based" to bilge his way past the crowd at Jackson Hole.
That is never hard to do. Some investment manager.
Given
the FOMC's ad lib policymaking, it is difficult to believe they have any idea
what to do when - yes, when - the run on the markets start, other than to close
markets. This is the time to construct an avenue of personal protection.
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