One of the assumptions that seems to be held as fact even by the best analyst is that the Central Banker’s objectives are simply maximum employment and stable prices. What is missing and inherent in every system is the objective of maintaining the system as it is–self preservation. The Federal Reserve is owned by many of the large banks it supports and the banks are part of the system. If the banks are damaged, insolvent or have a severely impaired balance sheets then the system is in danger and will take whatever means available to heal. This falls under the new mandate to “maintain the stability of the financial system…”
If one examines the Fed’s policy in terms of self preservation of the system as its first objective, then the Fed’s monetary policy becomes much clearer and less “baffling.” 1) Keeping interest rates extremely low allows the banks to borrow cheaply and then lend to the US government at a higher rate for a profit as well as pay lower interest rates in your money market accounts. These low interest rates are in effect a transfer from savers (savings accounts, pension plans, life insurance companies, etc.) to the banks and other borrowers to include the US government. Those living on interest have been forced to move to riskier assets in a reach for yield. 2) QE3 transferred much of the illiquid and probably impaired assets from the banks balance sheets onto the Federal Reserve’s balance sheet.
In Doug Noland’s 18 July Commentary, he wrote about how hedge fund manager Stanley Druckenmiller rightfully attained “legendary” stature after achieving a phenomenal 30-year track record. “Throughout his career, he has successfully implemented a “top down” macro approach to investing/speculating across global markets, including a highly successful stint partnering with George Soros. Druckenmiller provided cogent remarks Wednesday at the Delivering Alpha conference covered live by CNBC.”
Druckenmiller: “As a macro investor, my job for 30 years was to anticipate changes in the economic trends that were not expected by others – and therefore not yet reflected in securities prices… … “I hope we can all agree that these once-in-a-century emergency measures are no longer necessary five years into an economic and balance sheet recovery. There is a heated debate as to what a ‘neutral’ Fed funds rate would be. We should be debating why we haven’t moved more meaningfully towards a neutral funds rate. If for no other reason, so the Fed will have additional weapons available if the outlook darkens again. Many Fed officials and other economists defend their current policies by claiming the economy is better than it would have been without their ongoing stimulus. No one knows for sure, but I believe that is logical and correct. However, I also believe if you’d asked the same question in 2006 – that the economy was better in 2004 to 2006 than it would have been without the monetary stimulus that preceded it. But was the economy better in total from 2003 to 2010 – without the monetary stimulus that preceded it? The same applies today. To economists and Fed officials who continually cite that we are better off than we would have been without zero rate policies for long, I ask ‘Why is that the relevant policy time frame?’ Five years after the crisis, and with growing signs of economic normalization, it seems time to let go of myopic goals. Given the charts I just showed and looking at economic history, today’s Fed policy seems not only unnecessary but fraught with unappreciated risk. When Ben Bernanke and his colleagues instituted QE1 in 2009, financial conditions in the real economy were in a dysfunctional meltdown. The policy was brilliantly conceived and a no-brainer from a risk/reward perspective. But the current policy makes no sense from a risk/reward perspective. Five years into an economic and balance sheet recovery, extraordinary money measures are likely running into sharply diminishing returns. On the other hand, history shows potential long-term costs can be quite severe. I don’t know whether we’re going to end with a mal-investment bust due to a misallocation of resources; whether it’s inflation; or whether the outcome will actually be benign. I really don’t. Neither does the Fed.”…
Doug Noland writes, “with the Fed apparently having learned nothing from past experience, I find current policy somewhat more baffling. At this point, risks associated with loose monetary policy should be readily appreciated. It doesn’t make any sense that the Fed remains so dismissive of securities market excesses. And with Fed funds stuck at zero and the Fed’s balance sheet rapidly approaching $4.5 TN, our central bankers should recognize that the risks of stoking asset Bubbles are actually even greater today. After almost six years of post-crisis stimulus, Bernanke’s “mopping up” maxim has understandably disappeared from Fed discourse…” more
Categories: The Smart Bird