We wonder whether the economic discord that currently exists across the globe can legitimately be laid at the feet of all of the developed Central Banks. The ease of global capital flows, combined with a desperate grab for yield, has left us with the twitchy capital flight that so often happens when country specific internal imbalances are suddenly exposed. The social discontent stretching from Thailand to Turkey is undoubtedly political in nature, however some of this frustration is borne of a free-falling currency combined with the inevitable uncomfortable rise in the price of basic necessities. While it is true that Central Banks must make policy based on their own circumstances, some of the unintended consequences we have spoken about so often are real and are currently being displayed right in front of us on the front page. When Central Bankers force people into the risk pool, very little thought is put into just how many might not make it out. One can be sure however that if the local currency is not working, the alternative is not bitcoin. Buy Stuff.
The reasonableness and straightforwardness of comments by Fed Governor Richard Fisher makes one wonder: Who Invited this guy to the Party? Mr. Fisher, in a speech much similar to one given several weeks ago, continued to question the sanity of providing additional liquidity to a market that clearly does not need it. One has to wonder whether Mr. Fisher is even on the same team as other Fed officials when he states ” Of greatest concern to me is that the risk of scrutiny and criticism might hinder policymakers from acting quickly enough to remove or dampen the dry inflationary tinder that is inherent in the massive, but currently fallow, monetary base”. Compare this with other Fed Governors who have made numerous calls to tie further Treasury purchases to some minimum level of inflation. We have to believe that mentality of the group advocating higher inflation has been driven to such conclusions by their perception that each new iteration of QE deals with the micro rather than the macro. These Fed officials know we are not dealing with bazookas anymore like we were in 2008/2009, but instead most at the Fed believe we are simply working around the edges of a precise, targeted balance sheet management program, which can be reversed at any time. This would all be wonderful if this thinking even came close to resembling the reality of Fed policy transmission. As we have stated before, Fed policy even under the most normal of circumstances, works with a most undefined lag. Governor Fisher understands this, the others understand this as well but have chosen to ignore it(For Now). There is no new Central Bank Paradigm: Buy Stuff.
Once again, another year has passed and we are now inundated with the end of year projections as to what will happen in 2014. We generally find these projections without merit, but we have a particular distaste for such guesstimates given the self-reinforcing behavior that currently overwhelms todays capital markets. Early on in these various monetary science experiments market participants looked at the potential mismatch between objectives and the measures taken. Today, however, it would appear that this analysis has fallen by the wayside along with any concern over the possible unintended consequences. There is no longer talk of whether we should be going down this path, but rather what will be the harm if we shift to another path. Forget the fact that the current path may take us in directions or places we never imagined. Many scoff at comparisons between today’s Central Bank actions and those of the Central Bank of Japan during the 90s and beyond. However, recent comments by the BOJ Governor should validate those comparisons. In a recent FT interview, the BOJ Governor remarked that they were the first to enact quantitative easing back in 2001, and even though it has essentially accomplished nothing, they continue to push forward with a program to double (at least) its holdings of JGBs. The recent actions by the BOJ are driven by a desire to break the deflationary spiral that has existed in Japan for over a decade, the question however becomes at what price. If Inflation comes purely as a result of a rapidly depreciating currency, and does not necessarily translate into wage growth then the “benefits” of inflation for the population in general is moot. More importantly, the BOJ Governor also does not rule out using other more radical tools should the current ones prove, yet again, unsuccessful. What also stands out from this interview is the disconnect between what is happening on the monetary side and what is occurring on the fiscal side. The Governor acknowledges the potential for a sharp rise in rates as a result of their current strategy, however he soft peddles the effect such a rise would have on Government finances. The BOJ has travelled down this QE path for years, but rather than shifting to another possibly more advantageous side road, they have instead chosen to simply proceed at a higher rate of speed. If the definition of insanity is doing the same thing over and over and expecting different results, choose rational thought: Buy Stuff.
I have been thinking a lot about anchors lately. Not to get too nautical here, but my thoughts have centered on the anchors, or perceived anchors we currently see all around us. The front end of the Treasury Curve anchored by the various forms of QE, the attempt to anchore investor expectations by all global central banks, the lack of any attempt by those in Washington to provide any kind of anchor to the credit worthiness of the U.S. Government, the complete lack of anchor associated with any fiat currency. Maybe what got me thinking in this vein was an interview with former Fed Chairman Alan Greenspan. The wide ranging interview, which mostly consisted of trying to box the former chair into some critique of current Fed policy, stood out for two divergent points that were made by the Maestro. When asked about the difficulty with stepping away from Central Bank balance sheet management, Greenspan stated that “it really is not that difficult, it is merely a bookkeeping entry”. The fact that the Fed could conjure up $4Trillion in reserves, and just as easily un-conjure a like amount speaks to the anchorless world in which we live. However, the former Chairman was not done there. When asked about the presence of a Bitcoin bubble, he responded ” I don’t understand where the backing is… there is no intrinsic value”. Buy real anchors(Stuff) Sell perceived anchors(paper).
Recent suggestions in Japan that public and private pensions disavow themselves of their JGB holdings in exchange for more risky assets, imply that the Government is possibly beginning to suggest more firmly that the private sector take a more active role in the reflationary process. While our Central Bank has preferred to be more subtle, perhaps this subtlety is about to end as evidenced by comments from a commercial banker when asked about the potential for The Fed to start charging banks for excess reserves. The banker comments about charging interest are as follows ” it would turn it into negative revenue-banks would be disincentivised to take deposits and potentially charge for them”. While the actions of Central Banks over the past several years might have only slightly resembled command and control, an environment whereby Central Banks are expressly encouraging the extraction of rent from those not predisposed to risk taking is a whole new ball game. Our suggestion that investors begin to allocate a greater portion of net worth into hard assets was derived from our belief in a nascent secular shift away from paper assets and into hard assets. However, recent Central Bank actions such as these might imply that investors should start thinking about such shifts as protection against Central Bank confiscation.
We all should be happy to know that we now can become familiar, and concurrently sick to death of, a new Fed related term: Forward Guidance. A recent Fed sponsored study showed that there might be some potential benefit to tapering current bond purchases while extending the end date of said purchases to coincide with a new lower target unemployment figure ( possibly 5.5%). This change in targeting coincides with shifting targets across a number of other Central Banks, particularly the ECB where lower than expected recent inflation figures have prompted some officials to, once again, suggest the possibility of imposing negative nominal rates of interest. While this entire Central Bank lab experiment might have started out with un-conventional methods, designed to meet somewhat specific goals, we are now faced with un-coventional methods designed to meet goals that seem to be shifting by the week. One might think that such a scattershot approach would elicit a broad sense of concern across all capital markets, however concern seems to be in short supply as of late. The question we now must ask as proactive investors is: Where does the liquidity flow, now that Financial Assets of all stripes have been sufficiently bid up? The problem with un-conventional and untested methods should be self evident, but when these methods involve massive inflows of liquidity into global asset markets, one has to wonder what the secondary beneficiaries of this massive influx of liquidity might be. The recent Economist cover should provide some clues ( it is generally the perfect contra-indicator) as it is titled: The Perils of Falling Inflation. Buy Stuff.
Alan Greenspan has been on the news circuit as of late in support of his new book: The Map and the Territory. We found some of the interviews quite telling, particularly one interview in which he discusses a revelation regarding risk. He states “Fear and Euphoria are dominant forces, and fear is many multiples the size of euphoria. Bubbles go up very slowly as euphoria builds. Then fear hits, and it comes down very sharply. When I started to look at that, I was sort of intellectually shocked”. Are you kidding me, he was shocked by the the severity of the damage caused by unsustainable, irrational behavior (hence the term bubble) suddenly coming undone. I do however agree with his assessment of future Central Bank behavior, when he states that the Fed’s balance sheet must curtailed as he comments ” Historically, there are no cases where central banks blow up their balance sheets or where countries print money which doesn’t hit (with higher inflation)”. I will not pass judgement on the book as I have not read it, but it would appear that the Maestro is coming to the realization (quite late we might add) that econometric modeling when applied to markets driven by human behavior is not effective. We would suggest however that the same tools used by the Greenspan Fed, still reside in the toolkit of the current all knowing Fed.
While the idiotic behavior in Washington marches on, the endless tongue in cheek discussions about default and what that means in terms of the full faith and credit of the United States continues. As we mentioned in our previous blog, some debtor nations have weighed in on the process but have yet to add to any real discourse on the broader context of our serious debt load. However, the Central Bank Governor of Sri Lanka has saved the day by both cutting rates ( in case of a default) and also providing some commentary on the lasting collateral damage done to our global reputation. The Governor stated ” Even if the U.S. were to get their act together and get past the debt ceiling, I think the fact that the global economy has been put under so much stress is something that many policy makers would not forget. That’s going to lead to various changes in the way central banks will perceive the safety and quality of investments”. Standard and Poors take note.
One has to wonder whether we are seeing Act One in what we have termed the “flight to tangibility”. Our original thesis involving the shift towards hard assets involved a sharp decline in the dollar brought about by a crisis of confidence involving governmental finances. While we have no doubt that this latest food fight in Washington will be resolved, the ease with which lawmakers were willing to create a crisis of their own making gives us pause as to their ability to make the truly hard choices should a real crisis occur. I am absolutely staggered by the ignorance displayed on both sides regarding the real world implications of a default( soft or not). While large scale holders such as the Chinese and Japanese sit in amazement at our inability to exhibit any kind of fiscal restraint, they should both hold their fire to some extent as they have both been willing participants (Japan especially) in this world wide game of print and spend.
Back in November, we discussed the Nassim Talib concept of anti-fragile as it related to the U.S. Treasury Market. We described a Treasury Market which has been manipulated, shaped and coddled by the Federal Reserve and thus been rendered more unstable. Well, the action over the last several weeks provides us with fresh evidence of this instability. The comments that the Chairman made, post FOMC meeting, seemed to smack of micro-management as he described a situation whereby the Fed would either add to, or subtract from, its current asset purchase plan depending on whether its target variables are being met or exceeded. We all know that conventional monetary policy works with a definitive lag, we were however surprised to hear that this highly unconventional monetary policy has an almost immediate feedback loop. We don’t wish to belabor a point, but this latest round of bond market upheaval, in our opinion, is directly related to a diminished lack of credibility afforded by the Bond Market to the Central Bank. The process of micromanaging the Treasury curve to ensure stability has finally reached its apex, and the most recent instability in the market is the byproduct. In our opinion, this instability in rates should begin to translate into a severe dislocation in the dollar as well.