Bubble Watch: The Fed KNOWS We"re in a 1999-Type Mania...

The Fed raised rates another 0.25% the week before last.

This marks the 5th rate hike since the Fed embarked on its policy tightening in December 2015 and the fourth rate hike in the last 12 months. The Fed’s latest statement also indicates it plans on raising rates three more times in 2018.

It is easy to gloss over the significance of this, but the Fed’s actions are indeed unusual; other major Central Banks (the Swiss National Bank, Bank of Japan, European Central Bank and Bank of England) are all currently running QE programs (the BoJ, ECB and BoE) or openly printing new money to buy stocks outright (the SNB).

What precisely is the Fed doing? Why the urge to tighten when other banks are all printing new money by the billions?

The following quotes from Fed offer us clues.

Fed Monetary Policy Report, June 2017:

“Forward price-to-earnings ratios for equities have increased to a level well above their median of the past three decades,

Fed minutes, July 2017:

"Since the April assessment, vulnerabilities associated with asset valuation pressures had edged up from notable to elevated, as asset prices remained high or climbed further, risk spreads narrowed, and expected and actual volatility remained muted in a range of financial markets."

Janet Yellen response to question from IMF Panel, October 2017:

Market valuations “are at high level in historical terms” when assessed on metrics akin to price-earnings ratios,

Fed Minutes, October 2017:

"In light of elevated asset valuations and low financial market volatility, several participants expressed concerns about a potential buildup of financial imbalances,"

Janet Yellen during Fed presser December 13th, 2017:

Stock valuations are at high end of historical levels.

I want to be clear on the significance of these statements.

The Fed’s primary role is to maintain financial stability. This means that the Fed will always downplay risks in its public statements. Indeed, former Fed Chair Ben Bernanke once stated that Fed policy is “98% talk, 2% action.”

With that in mind, the above quotes are astonishing in their clarity: the Fed is explicitly stating (in Fed terms) that the markets are in a bubble. And the Fed didn’t just do this once, the Fed has been warning about asset valuations/froth in the system for six months straight.

So just how “frothy” are things that the Fed is being so explicit?

Try “1999-levels” frothy.

Perhaps the best means of measuring frothiness in stocks is the Price to Sales (P/S) multiple. Most investors prefer to use Price to Earnings (P/E), but I am wary of that method because earnings can easily be fudged via gimmicks (different methods of depreciation, write-offs, reducing loan loss reserves, tax loopholes, etc.).

Sales, on the other hand, are very hard to fudge. Either money came in the door, or it didn’t. And if a company gets caught fudging its revenues, someone goes to jail.

With that in mind, consider that the S&P 500’s current P/S multiple has surpassed its former all time peak from 1999: a period that is now widely considered to be the single largest stock bubble in history.

Put simply, stocks are extraordinarily overvalued by a reliable measure.

H/T Bill King

However, there is one main difference between 1999 and today...

Namely, that the Fed has been INTENTIONALLY creating bubbles for nearly 20 years today... and it"s out of more senior asset classes to use!

Let me explain...

The late ‘90s was the Tech Bubble.

When that burst in the mid-‘00s, the Fed created a bubble in housing.

When that burst in ’08 the Fed created a bubble in US sovereign bonds or Treasuries.

And because these bonds are the bedrock of the US financial system, the “risk-free rate” of return against which ALL risk assets are valued, when the Fed did this it created a bubble in EVERYTHING (hence our coining of the term “The Everything Bubble” and our bestselling book by the same name).

On that note, we are putting together an Executive Summary outlining all of these issues as well as what’s to come when The Everything Bubble bursts.

It will be available exclusively to our clients. If you’d like to have a copy delivered to your inbox when it’s completed, you can join the wait-list here:

https://phoenixcapitalmarketing.com/TEB.html

Best Regards

Graham Summers

Chief Market Strategist

Phoenix Capital Research

Watch Live: Janet Yellen And Mervyn King At NYU

The NYU Stern school of business is hosting the latest installment of the "In Conversation with Mervyn King" series featuring outgoing Fed chair, ?Janet Yellen, who in just over two months, will depart the Fed, making way for her replacement, former Carlyle partner Jay Powell.

While her speech is not expected to provide any market-moving revelations, it will be one of her last public appearances, and as such she is expected to give her perspective on the "4 rate hikes in 2015" fiasco, how central-planning and bubble blowing has changed over the past 4 years, and also her outlook on how this entire experiment in monetary insanity ends.

Enjoy.

"Carnival Barker" Krugman & The Inevitable Weimar Endgame

Authored by Jeffrey Snider via Alhambra Investment Partners,

Who President Trump ultimately picks as the next Federal Reserve Chairman doesn’t really matter. Unless he goes really far afield to someone totally unexpected, whoever that person will be will be largely more of the same. It won’t be a categorical change, a different philosophical direction that is badly needed.

Still, politically, it does matter to some significant degree. It’s just that the political division isn’t the usual R vs. D, left vs. right. That’s how many are making it out to be, and in doing so exposing what’s really going on.

As usual, the perfect example for these divisions is provided by Paul Krugman. The Nobel Prize Winner ceased being an economist a long time ago, and has become largely a partisan carnival barker. He opines about economic issues, but framed always from that perspective.

To the very idea of a next Fed Chair beyond Yellen, he wrote a few weeks ago, “we’re living in the age of Trump, which means that we should actually expect the worst.” Dr. Krugman wants more of the same, and Candidate Trump campaigned directly against that. As such, there is the non-trivial chance that President Trump lives up to that promise.

Again, it sounds like a left vs. right issue, but it isn’t. The political winds are changing, and the parties themselves are being realigned in different directions (which is not something new; there have been several re-alignments throughout American history even though the two major parties have been entrenched since the 1850’s when Republicans first appeared). Who the next Fed Chair is could tell us something about how far along we are in this evolution.

What Krugman wants, meaning, it is safe to assume, what all those like him want, is simple: success. He believes that the central bank has given us exactly that, therefore it is stupid to upset what works.

In particular, both Bernanke and Yellen responded effectively to a once-in-three-generations economic crisis despite constant heckling from back-seat drivers in Congress and on the political right in general. And their intellectual and moral courage has been completely vindicated by events.

This is right here is the very central point of political difference that is pulling the world slowly apart. Krugman offers no evidence for his assertion, that the Fed has performed admirably and successfully, he just states it as if it was so (a common tactic in the mainstream, the fallacy of authority). Whenever challenged on this contention, the argument will always go back to “jobs saved.”

A worse counterfactual downside is not a rational standard for evaluation in any discipline or context. The only benchmark that should matter is recovery, as any economy facing recession, even an unusually severe one, has to make it back to the prior condition. On that score the Fed has utterly and unambiguously failed.

One reason for it is the one thing Economists like Krugman never bring up; the 2008 panic. How can anyone claim the Fed under Yellen or Bernanke performed even minimally well? The very fact that the panic happened at all is a direct indictment on monetary policy and the people who were there during it (you had one job to do!).

That’s not really what is at issue here, only it has become one battle in what is a larger war. That struggle is betrayed in Krugman’s own words by which he means to raise up both Bernanke and Yellen as examples of what needs to continue.

For more than a decade the Fed chair has been a distinguished academic economist — first Ben Bernanke, then Janet Yellen. You might wonder how such people, who have never been in the business world, who have never met a payroll, would deal with real-world economic problems; the answer, in both cases: superbly…

Given this track record, you might expect to see either Yellen reappointed or an equally qualified technocrat take her place.

This is all really about Economics. It has failed and most publicly so in the form of its principle public adherents in the Federal Reserve piloted by Bernanke and Yellen. The technocratic stars of the faith have been dramatically dimmed by events. Economists are not scientists, clearly, and so they are desperately seeking to circle the wagons by rewriting history; the last ten years weren’t all that bad, and they really could have been worse if it wasn’t for Economics.

The irrational, emotional defense for the ideology is what is driving political upheaval, including Donald Trump’s occupying the White House.

To most people, Krugman’s ideas and assertions are nonsense. They don’t have to know anything about QE’s effect on the TBA market and dollar rolls, how exactly McDonald’s was borrowing from FRBNY, or what it was that AIG did that ultimately made the Federal Reserve profits. People know the Fed did a bunch of stuff that didn’t work because they can tell there is something very wrong with the economy.

And after ten years of being told not to worry about it, or that it was being expertly handled, the people are Fed up with the defense of ideology first at the expense of actual answers. That’s really where we are; Economics has no more solutions (more QE!), therefore Economists have been forced to re-evaluate everything but only along those lines. If Economics can’t solve the problem, then they believe this has to be as good as it gets. And everyone should just stop complaining and appreciate the heroic and inspired effort that “saved” so many “jobs.”

Trump’s candidacy, as Bernie Sanders’, as an ideal was a grave threat to the status quo because it started with the premise that, no, this isn’t as good as it can be and that we need to look for real solutions. Whether he forwards that ideal as President is and has been another matter, and who he picks as Fed Chair might be some small indication of where he currently stands consistent with that idea, or perhaps having second thoughts about it.

The technocracy doesn’t work because it isn’t technically competent (thus 2008).

That’s the real political debate in 2017 and going forward; technical incompetence where the defense of the technocracy refuses to even allow the suggestion that this might be true. I go back to Weimar Germany not because I expect a global hyperinflationary breakdown, but in how that one particular form of systemic breakdown exposed timeless flaws inherent in all economic and financial systems. They all run to some extent on trust and (good) faith:

In other words, German monetary officials, particularly Reichsbank head Rudolf von Havenstein and Minister of Finance Karl Helfferich, denied that Germany had an inflation problem at all – right up until the end. Minister Helfferich declared that Germany had better gold coverage after the war than before it, despite that more than quadrupling of currency volume. One economics professor, Julius Wolf, wrote in 1922 that, “in proportion to the need, less money circulates in Germany now than before the war.”

 

As much as the easy-to-see Versailles excuse played a part, there can be no doubt that beyond 1921 the German people themselves began to recognize that authorities had no idea what they were doing; worse, they came to see that even though policymakers were inept and incompetent, officials themselves would never admit as much and thus nothing would prevent Germany from its fate. That awakening meant an increase in danger that French occupation could never have unleashed on its own.

Krugman And The "Heroic" Fed

Once an avid reader of Paul Krugman’s New York Times twice-weekly columns, I admit to rarely even glancing at his work now, since I know that anything he writes is going to have the theme of “Trump evil, Democrats good” each time, and it doesn’t take long to get one’s fill of that, even if one disagrees with Donald Trump’s policies or cringes at some of his public statements. The real problem, however, is that Krugman also manages to endorse unsound and inflationary economic policies as a “solution” to what he calls “Trumpism.”

If one reads Krugman to see what “vulgar” Keynesian fallacies he is promoting, the man rarely disappoints, and a recent column in which he attacks what he believes will be Trump’s future choice to head the Federal Reserve System only burnishes Krugman’s Keynesian credentials. After claiming that Trump has been like a “Category 5 hurricane sweeping through the U.S. government, leaving devastation in his wake,” Krugman then worries if the Fed will suffer the same fate. One only could hope….

Before looking at Krugman’s worshipful commentary on the current Fed leadership, a brief point is in order regarding the rest of official Washington that Trump allegedly has devastated. People like Krugman believe that Washington and its gaggle of Alphabet-Soup agencies regulating nearly every aspect of individual lives is the very source of social stability and economic prosperity in this country – provided there are little or no restraints on what government agents can do. As Krugman and his fellow progressives see it, we need more, not less, bureaucratic control of our lives, and especially control by people of progressive bent with “elite” academic credentials, since they are smarter than the rest of us, so they should be able to tell us what to do.

In his classic 1945 paper, “The Use of Knowledge in Society,” F.A. Hayek wrote that the kind of knowledge needed within a growing and prosperous economy is not the distant academic knowledge, but rather the boots-on-the-ground knowledge undergirded by a price system held by entrepreneurs and others directly involved with enterprises. Ludwig von Mises in many of his writings, including Bureaucracy, pointed out that free-market pricing of goods, along with profit (and loss) management, serves as an irreplaceable guide for an economy.

Krugman is having none of that, and his academic biases are exposed in his recent column. He writes:

The Fed, which sets monetary policy, is by far our most important economic agency; its chairwoman (or chairman) is arguably the most powerful economic official in the world, more than the president himself. Its institutional status is peculiar: It isn’t exactly part of the executive branch, but it isn’t exactly independent, either. Its board members are appointed by the president subject to congressional approval, but have traditionally been technocrats expected to distance themselves from partisan politics.

That is, however, a norm rather than a legal requirement. And we know what tends to happen to norms in the Trump era.

For more than a decade the Fed chair has been a distinguished academic economist — first Ben Bernanke, then Janet Yellen. You might wonder how such people, who have never been in the business world, who have never met a payroll, would deal with real-world economic problems; the answer, in both cases: superbly.

In particular, both Bernanke and Yellen responded effectively to a once-in-three-generations economic crisis despite constant heckling from back-seat drivers in Congress and on the political right in general. And their intellectual and moral courage has been completely vindicated by events.

Given this track record, you might expect to see either Yellen reappointed or an equally qualified technocrat take her place. But remember, we’re living in the age of Trump, which means that we should actually expect the worst.

And what were the policies driven by “intellectual and moral courage”? More inflation. That’s right, printing money. Writes Krugman:

When the financial crisis struck in 2008, it was essential that the Fed engage in aggressive monetary expansion — loosely speaking, print lots of money. There are circumstances in which that kind of action would be inflationary, but economists (like Bernanke and, well, yours truly) who had studied the subject understood that this wasn’t one of those times. Indeed, inflation stayed quiescent even as the Fed quadrupled the monetary base.

Beyond debating Krugman and others regarding the presence of Keynes’s “liquidity trap” that supposedly turns laws of economics upside down, there is another point I believe needs to be made, and it goes back to the Hayek-Mises theme of economic calculation driven by profits and losses and a free price system. In Krugman’s view, it is the market economy driven by ignorant and greedy know-nothings and always is prone to collapsing into the maw of “underconsumption” that is the real problem. If academics like Krugman, Bernanke, and Yellen were in charge of the economy, things would work smoothly and rationally.

For example, Krugman and many of his fellow intellectuals believe that the mortgage securities which bundled mortgages considered to be “sub-prime” (and later collapsed, bringing down much of the financial system with it) were the “natural” result of a laissez-faire economy, something the Austrians would have created if left to their own devices. The Alan Greenspan-Ben Bernanke Fed, along with government housing policies, had nothing to do with the creation and distribution of these doomed securities. Indeed, Bernanke and his minions only wisely reacted to the crisis once the free market, which created the disaster in the first place, had run its destructive course.

This is a re-occurring theme in Krugman’s writings: the free market creates crisis after crisis and then the “adults” from the federal regulatory agencies must step in and repair the damage, and if Krugman could have political control, those agencies would have unlimited powers to control the economy, since the agencies consist of people who know more than everyone else.

There are exceptions to the academics-must-rule-the-economy theme: Austrians, who have the effrontery to hold to doctrines of sound money and who argue for free markets, are not included in the guest list. Austrians, after all, are delusional, and actually know little-to-nothing about real economics. Properly-vetted economists such as Krugman and Bernanke know that federal policies that promise to backstop banking losses, push home ownership through artificial financial means (including Fed policies of pushing down interest rates to near-zero), and then manipulate housing prices actually had nothing to do with the financial madness known as the Housing Bubble. (That Austrians, such as Mark Thornton, warned long before the 2008 meltdown that the housing market was destined to fail spectacularly garners Austrians no credit; even a broken clock is correct twice a day.)

People like Krugman perpetuate the myth that the U.S. economy is a pure, laissez-faire entity that is driven to collapse by free markets, only to be rescued by the Ph.D. economists and federal regulators that are more intelligent than everyone else and set things right again, like an unstable democracy that every so often experiences a coup by its army, which cleans out the corruption and steers the government back onto a righteous path.

The future picks Donald Trump may have for the Fed leadership really is not the issue here, no matter what Krugman claims. Far from being the incorruptible general whose troops must clean up the wreckage left by the hurricane of free-market economics, the Fed usually is ground zero (or at least nearby) when it comes to economic crises. Instead of the hero academic economist “who saved the world,” Ben Bernanke actually helped to create and nurture the crisis, and then prevented a full recovery – along with his successor, Janet Yellen.

One does not answer Krugman’s claim that progressive academics should run the world by urging the appointment of more “conservative” academics – who also should the run the world the “right” way. No, one replies by saying that the last thing any credentialed academic economist should be doing is becoming the “visible hand” that substitutes for free market processes. Let markets work on their own, period.

Could the Next Fed Appointment Crush the Housing Market?

As the end of Federal Reserve Chairwoman Janet Yellen’s first term approaches, financial markets are beginning to digest the increased likelihood that US President Donald Trump will opt to appoint a more hawkish individual to the position.  Even though the Federal Reserve is largely expected to continue tightening monetary policy over the coming months as it pares down the balance sheet and contemplates a dovish hike, Trump’s appointment could send shockwaves through the housing market. 

One of the nastier side effects of operating at or near the zero-bound for interest rates has been the rapid expansion of asset valuations.  Lower interest rates encourage individuals and companies to finance their purchases and then reinvest for more aggressive returns. However, this rapid valuation expansion has not been limited strictly to financialized assets, but also physical assets like real estate.  When seen in the context of the more hawkish leanings of Trump’s recent Fed Chair interviewees, the Administration’s next Fed appointment could pose the risk of a serious correction across asset classes.

Fed Frontrunners Exhibit More Hawkish Bent

Financial news outlets have been rife with reports covering the potential picks for Fed Chairman, with two of the leading candidates including Economist John Taylor and former Federal Reserve Governor Kevin Warsh.  Taylor, who currently serves as an economics professor at Stanford University, received high marks from Trump according to a Bloomberg report on the matter.  Trump was purportedly very impressed with his credentials, though unlike other candidates, Taylor is among the fiercest advocates of having policy measures closely reflect economic conditions.  

The “Taylor Rule”, titled after the economist, stipulates rates should rise when inflation is running at an elevated pace or unemployment is below the “full employment” threshold and should fall in the opposite scenario.  Applying this set of rules to current economic conditions indicates that the key Fed Funds rate should be 3.74% to reflect high levels of employment and rising prices.  At nearly 3 times the present rate, a selection of John Taylor to chair the Fed could rapidly dampen overextended valuations in equities and the housing market.  Already his interview with Donald Trump caused a palpable dip in gold prices considering his overtly hawkish stance.

By comparison, Kevin Warsh has also advocated for a tighter monetary policy regime, greater deregulation, and a general makeover of the Central Bank.  His attitude towards reform has won him positive mentions as well.  However, his overall degree of hawkishness and stated desire to overhaul the inflation target could put him at the epicenter of a dramatic policy shift that departs from the more cautious approach of current Chair Janet Yellen.

Factors Outside the Fed’s Control

While easy to label the rebuilding efforts in Texas and Florida as positive for the overall housing market, this deals more with the supply angle than demand.  On the buy side, a Fed determined to raise interest rates will assuredly presage rising mortgage costs which could in turn subject buyer interest to some downside as financing costs climb.  Though it is tempting to cite the foreclosure rate at an 11-year low as a sign of strength, it does not necessarily imply that the housing market is on stable footing, especially as prices reach past the realm of affordability.

Considering income growth has kept nowhere near the same pace as price growth for homes according to the monthly Case-Shiller home price index, the lack of affordable solutions may be another factor that hurts demand and concurrently weighs on pricing.  For the year through July, average hourly earnings climbed by 2.50% while housing prices of 20 major US metropolitan areas increased by 5.80% over the same period. With price growth outpacing wages by such a significant margin, the surge in values should be a worrying sign for prospective buyers thinking about diving in while mortgage rates remain not far from record lows.

However, a more concerning indication apart from unaffordability is the degree to which flipping has reemerged.  The move is eerily reminiscent of the years leading up to the last financial crisis as lending standards are relaxed.  House flipping reached the highest point since 2007 during the second quarter of 2017 and nearly 35% of the transactions were accompanied by mortgages.  Even Goldman Sachs is getting into the flipping game with its recent acquisition of Genesis Capital LLC, a move designed to help the institution build a bigger presence in the lending sphere.  Should mortgage rates rise in tandem with interest rates, it could spell doom for this substantial portion of residential real estate activity.

The Fed as the Deciding Factor

With the shortlist for the next Federal Reserve Chair realistically narrowed down to 5 candidates, those under consideration for the job have significantly more hawkish leanings than current Chair Janet Yellen and her predecessor Ben Bernanke.  While ultimately housing prices are a function of the interaction of supply and demand, demand largely behaves inverse to interest rates.  As rates climb, mortgage costs will echo the gains, potentially reducing interest.  Should demand fall, housing prices are likely to experience a correction as well after a near 8-year unabated rise in values.  Considering the unaffordability aspect and the degree of house flipping, the approaching Fed appointment has a higher propensity to cause a downturn compared to another leg of the ongoing housing market rally.

 

 

Where Trump is failing to fix the economy with monetary policy

(Elite E Services) 10/17/2017 — Dover, DE — It’s no secret that the US economy has diverged into a massive 2 world system where there is also a massive gap in between; the employed and the wealthy have increasingly good lives while the poor and unemployed have a deteriorating quality of life.  As we have explained in Splitting Pennies, it is monetary policy that ‘Trumps’ all else.  Using The Gini Coefficient we can visualize what this means:

In economics, the Gini coefficient (sometimes expressed as a Gini ratio or a normalized Gini index) ( jee-nee) is a measure of statistical dispersion intended to represent the income or wealth distribution of a nation’s residents, and is the most commonly used measure of inequality. It was developed by the Italian statistician and sociologist Corrado Gini and published in his 1912 paper Variability and Mutability (Italian: Variabilità e mutabilità).

Taking a look at basic 2013 data (it’s worse since then) we get a picture of reality vs. what is said in the media.  Using Russia as a good example to stay with the Trump theme, USA (41) has roughly the same Gini as Russia (40.9):

Remember that Russia is the unfair system that is a top-down Byzantine oligarchy, right?  Then why Russia and USA share almost identical Gini, being surpassed only by the Banana Republics in South America?

Everyone in finance knows there are several things that Trump can do to fix the economic problems of USA in about 5 minutes:

• Surprise increase interest rates to 5% or 10%


• Import tariffs on Chinese crap


• Unwind USA’s Petro Dollar system (drink it!)


• Repeal the Dodd-Frank Consumer Rip-Off Fraud Act that has caused billions to flow out of USA.  Make America the world’s banker once again.  (This is our industry – FX – we know that this alone would create thousands and thousands of jobs and be a huge boost for the economy – billions would flow into USA and we’d again be the world’s banker.  But this same approach likely applies to many industries.  Dodd-Frank regulations killed FX and have cost millions of jobs.)  We’ve outlined this in previous articles.

It’s not really practical to bring factories back to USA, however we have robot technology and the financial sector is a great example of how we can create high skilled high paid white collar jobs.  But Trump seems to be more obsessed with form not essence (and his form is not good).

Oh – you’re thinking that a President can’t do that, right?  President is a figurehead, only Congress can pass laws.  That’s true.  But Nixon did it.  Somehow, Nixon was able to accomplish all these things in 1 day and created the floating FX market as it exists today.  It was not Nixon’s only genius move, there were many.  Was Nixon’s real genius just listening to his advisors like Henry?  Either way, in practice, it fixed the problem – only to be unwound by future administrations.  Was it a temporary fix?  Of course – but that’s what we need.  We need to unwind QE which is practically impossible, so jacking up rates is a first good start.  Wall St. and the stock market will suffer.  But they’ve had a long bull run.

Winter is coming – it’s bear time.

For a primer on how the global money markets shape reality, checkout Splitting Pennies or for a Bitcoin Twist, Splitting Pennies 2.0 – Splitting Bits.

Trump Expected To Announce His Pick For Fed Chair In Next Two Weeks

In the latest update on Trump"s search for the next Fed Chair, Reuters reported that the search has narrowed down to 5 finalists - Yellen, Warsh, Taylor, Powell and Cohn (condolences to Jeff Gundlach: his dark horse candidate, Neel Kashkari did not make the cut) - and that after meeting Yellen on Thursday, Trump will have discussed the Fed job with all five candidates. More importantly was the news that Trump is expected to announce his decision for next Fed Chair in the next 2 weeks, before he leaves for his Asian trip on November 3.

• YELLEN, WARSH, TAYLOR, POWELL AND COHN ALL CANDIDATES FOR FED CHAIR -WHITE HOUSE OFFICIAL


• FED CHAIR SEARCH NOW NARROWED TO FIVE FINAL CANDIDATES, WHITE HOUSE OFFICIAL SAYS


• AFTER YELLEN MEETING, TRUMP WILL HAVE DISCUSSED FED JOB WITH ALL FIVE FED CANDIDATES -WHITE HOUSE OFFICIAL


• TRUMP EXPECTED TO ANNOUNCE FED DECISION BEFORE HE LEAVES FOR ASIA TRIP NOV. 3 -WHITE HOUSE OFFICIAL

Yesterday, the USD and bond yields turmoiled briefly following news that Trump had warmed to the candidacy of San Fran professor John Taylor, father of the Taylor Rule and advocate of rules-based monetary policy, and who is widely perceived as a mega hawk. The news sent the USD surging and hit bonds.

That said, Taylor"s hawkishness appears to have worked against him, and after surging to 2nd spot on Predictit yesterday, Taylor was tumbled to 4th spot this morning.

That said, Taylor"s hawkish reputation may be unwarranted. As SocGen"s Kit Juckes wrote this morning, what rate the Taylor Rule indicates is dependent on a variety of assumptions. To wit:

President Trump is reported to have taken away a favourable impression of John Taylor after he met the Stanford University economist and inventor of the ‘Taylor Rule". As the President ponders who to appoint as the next Fed Chair, he now only has Janet Yellen to meet with, and Professor Taylor is the new market favourite. That, in turn, has given the dollar a bit of support and sent yields a bit higher as everyone contemplates what the Taylor Rule would imply for monetary policy. It"s generally concluded that a rules-based approach would deliver higher rates faster than we would see under the current policy framework.

Anyone armed with a Bloomberg terminal can type in TAYL GO and see where a Taylor rule estimate of appropriate rates is, and if they want, they can play with the critical elements of the rue - the estate of ‘neutral" real rates, NAIRU, and the inflation target. On the basis of a 2% neutral real rate, and a 4% NAIRU, the Fed is a long way behind the curve, which may be reason enough to think that a Taylor Fed would be more hawkish. On the other hand, lower the NAIRU (which may be reasonable given what we"ve seen from the labour market data in recent years) and you can get that estimate down. A 3% NAIRU throws out a 1.5% Funds rate, for example. And if Professor Taylor really wants to fine-tune his rule, he can head down the road from Stanford to the San Francisco Fed, 36 miles away, and have a chat with Stanford alumni and head of the San Francisco Fed, John Williams. He developed an estimate of neutral rates with Thomas Laubach, which moves over time and is currently at -0.2%. See Professor"s comments on a debate about that here . Plug Williams-Laubach"s R* into Bloomberg"s TAYL function with a 4% NAIRU and rates ‘should" be 0.5%. Now cut NAIRU to 3% and we"re at -0.75%. By way of indication, I"ve plotted some variants of this below, though I haven"t adjusted the Wiliams-Laubach R* all the way through the time series so they are only relevant in the recent past. The lesson is clear however - the rule"s just a rule, it"s how it"s used that matters.

Choose your rule - but neither R* or NAIRU are necessarily constant through time

For now, however, Taylor"s hawkish reputation precedes him, and - for a president who realizes he needs rates as low as possible for as long as possible - that will hardly boost Taylor"s application. In fact, as we noted yesterday, the most likely outcome at this point is that Trump simply asks Yellen to continue for one more term.

Nobel Laureate Richard Thaler: "We Seem To Be Living In The Riskiest Market Of Our Lives"

Robert Shiller isn’t the only Nobel Laureate who’s worried the US stock market is sleepwalking toward disaster.

In an interview with Bloomberg’s Jeanna Smialek, Thaler, who was awarded the Nobel Memorial Prize in Economic Sciences on Monday for his pioneering work in establishing that humans are “predictably irrational”, said that the stock market’s complacency in the face of the North Korean nuclear threat and political uncertainty at home is disconcerting.

“We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping,” Thaler said, speaking by phone on Bloomberg TV. “I admit to not understanding it.”

Adding his voice to a growing chorus of Wall Street analysts who suspect that the Trump administration’s tax reform ambitions will be dashed by a handful of intransigent senators, Thaler said any investors who’ve been paying attention should have “lost confidence” by now.

“I don’t know about you, but I’m nervous, and it seems like when investors are nervous, they’re prone to being spooked,” Thaler said, “Nothing seems to spook the market” and if the gains are based on tax-reform expectations, “surely investors should have lost confidence that that was going to happen.”

US stocks have continued to hit a string of records since President Donald Trump’s upset victory over Hillary Clinton in November while volatility has plunged, with realized vol reaching its lowest level on record in October.

As Bloomberg points out, Thaler, who has made a career of studying irrational and temptation-driven actions among economic actors claimed that the market’s complacency was fundamentally misguided.

Thaler’s comments echoed comments from Shiller, a professor at the Yale School of Management who won his economics Nobel in 2013, who warned during a July interview with CNBC, Shiller expressed concern that his Shiller CAPE ratio had crossed above 30, signaling that equity valuations were dangerously stretched. During the history of the stock market, stocks have only traded at richer valuations during one period - June 1997 to September 2001 - as the dotcom farce blew and burst. Historical data for the index is available going back to 1881.

Thaler also took a shot at President Donald Trump, mocking the president’s fondness for bluster and notorious aversion toward reading books.

“His ratio of certitude to knowledge is nearing record highs,” Thaler said on Bloomberg Radio with Tom Keene and David Gura. “We all need a lot of humility, and especially about the economy.”

He also added that the UK’s vote to leave the European Union was decision based on emotions, not rationality.

“I don’t think that the leave votes were based on any implicit spreadsheet running in people’s heads - it was just like, ‘I’m angry, and I’m voting no,’” he told Bloomberg TV’s Vonnie Quinn and Mark Barton. Of the Brexit process, he said: “It doesn’t seem to be headed in any productive direction.”

Thaler was perhaps one of the world’s best-known contemporary economists before receiving his award. His theory of "nudge" economics,  where humans are subtly guided toward beneficial behaviors without heavy-handed intervention, was the theme of a 2008 book that was well received around the world.

Did the Fed's #2 Quit to Avoid Blame for the Coming Inflationary Storm?

Inflation is coming.

Vice-Fed Chair Stanley Fischer recently resigned unexpectedly from the Federal Reserve. Many were left wondering why Fischer would give up his role as the Fed’s second in command, arguably the second most powerful Central Banking position in the world.

Wonder no more:

The current soft patch of inflation will not last, the No.2 official on the U.S. central bank said Wednesday.

“I still believe we will have higher inflation,” Fischer said, in an interview on Bloomberg TV.

With unemployment declining, wages will go up “at some stage,” Fischer said.

“You have to wait a long time, usually longer than you expected to wait for something to happen, but then, if it is a very basic force... it will show up,” Fischer said.

Source: Marketwatch

It’s not difficult to connect the dots here. The last time the US had a major inflationary spike (the 1970s) the head of the Federal Reserve at the time (Paul Volcker) was fired.

So was Fischer abandoning ship in anticipation of another similar disaster?

Consider that the $USD has already collapsed over 10% this year. And that"s before inflation even clears the Fed target of 2%. Indeed, the long-term chart is even uglier with the $USD looking to collapse in a horrifying spiral over the next 12 months.

This is THE BIG MONEY trend today. Already the financial system is showing signs of it. And smart investors will use it to generate literal fortunes.

We just published a Special Investment Report concerning a FIVE secret investments you can use to make inflation pay you as it rips through the financial system in the months ahead

The report is titled Survive the Inflationary Storm

We are making just 100 copies available to the public.

To pick up yours, swing by:

https://www.phoenixcapitalmarketing.com/inflationstorm.html

Best Regards

Graham Summers

Chief Market Strategist

Phoenix Capital Research

Why Doesn't Janet Yellen Resign?

Authored by Raul Ilargi Meijer via The Automatic Earth blog,

You would think, certainly if you were as naive and innocent as I am, that when you get offered the job of Chair of the Federal Reserve, you must be sure, before accepting, that you have the credentials and the knowledge required. If you don’t, it looks as if you don’t take the job seriously. Janet Yellen, who’s been Chair since January 2014, doesn’t seem to agree.

In a speech Tuesday for the National Association for Business Economics Yellen ‘honestly’ admitted that she doesn’t understand inflation, control of which is the Fed’s no.1 task (it’s debatable whether that’s a good idea). She doesn’t understand a bunch of other issues either. Those are her own words, not mine. Here are these own words:

“My colleagues and I may have misjudged the strength of the labor market, the degree to which longer-run inflation expectations are consistent with our inflation objective, or even the fundamental forces driving inflation..”

Clear enough, you would think. But she didn’t offer her resignation. And for an important post like Fed chair, that is a major problem. As she undoubtedly does. So why is she keeping her job? Doesn’t she realize that when you don’t understand the issues you deal with, you’re prone to make disastrous mistakes?

Yellen and her colleagues work with models, and the models are wrong. The Fed’s predictions for things like inflation are ridiculously off, all the time. That may be news to her, but it’s old hash for many people in her field. So that she’s surrounded solely by people who don’t understand these things either is not an excuse.

So what does she expect now? That she will start to understand them all of a sudden, after years and years of not being able to? That reality will change to comply with her models? We can discount the option that she will suddenly begin using entirely different models, they’re all she has. But what then?

Under her predecessor Ben Bernanke, who never conceded he had no idea either but still didn’t, the Fed lowered interest rates to near zero Kelvin and bought trillions of dollars in bonds and securities. Now Yellen for some reason thinks it’s time to get rid of the stuff.

But on what basis does she make such a decision, if she self-admittedly doesn’t even understand the fundamental forces in play? How is that different from handing a box of matches to a 3-year old? Isn’t she really simply an academic dropped in a casino? From CNBC:

Yellen said a regular pace of rate hikes ahead is likely still warranted, though Fed officials are looking closely at the assumptions underlying those projections. While conceding that the Fed may need to slow the removal of accommodation, she also said the central bank “should also be wary of moving too gradually.”

There comes a point when naive innocent me starts asking: what does that even mean? Rate hikes are warranted but we don’t know why? Accommodative policies have been going too fast but they shouldn’t be too slow? Based on what? It can only be based on models that have proven faulty, can’t it, because they have no others.

*  *  *

Here are a few pointers for the occupants of the Marriner S. Eccles Federal Reserve Board Building.

Inflation is money velocity multiplied by money and credit supply. MV = PY. M is money supply, V is velocity, P is price level and real GDP is Y.

Velocity of money means consumer spending. 70% of US GDP is consumer spending. But American consumers are neck deep in debt and have very little money left to spend. Much of what they spend, they must borrow.78% of Americans live paycheck to paycheck. So forget about money velocity.

Moreover, as for the Fed’s second mandate after inflation, full employment, they don’t get that one either.

They seem to act on the presumption that any one job is just like the other. And then bleat: “My colleagues and I may have misjudged the strength of the labor market”.

But America has turned into a nation where the gig economy (the natural successor to first the knowledge economy, then the service economy), waiters, greeters and people working 3 jobs just to make ends meet have become the norm. When in the present circumstances you claim to have almost ‘achieved’ full employment, as Yellen and the Fed do, you must really be blind as a bat.

The other side of the equation is money supply. Interestingly, the Fed has issued tons of it, but handed it all to its owner banks. If they had spent it inside the economy itself, we could have been looking at a whole other picture. If those trillions would have gone to investment, manufacturing etc., instead of propping up banks and companies buying their own shares, Yellen might have actually seen some inflation.

If Americans have no money to spend, there can not be inflation. Simple. But the same stupid faulty predictions just keep coming:

So why is anybody still paying attention to Janet Yellen? Well, because she has her finger on the biggest financial trigger on the planet. No matter how shaky and uneducated that finger may be. Or do we pay attention exactly because we know what’s behind that shaky finger? Do we all put everything on red just because grandma does it too?

The craziest thing of all is that in reactions in the media to Yellen’s speech, she’s praised for admitting she has no clue what she’s doing. That takes the cake. And eats it too. Praised for admitting you’re terribly unfit for your job. That’s just great. That’s Bizarro world.

It’s well past best before time to get rid of Janet Yellen, and all the intellectual but idiots who work at the Fed. What is it, 1,000 PhDs, or was that 10,000? But the only thing that makes any real sense of course, the only thing that can save the nation, is to get rid of the Fed and its braindead mandates, interests and occupants altogether.

Hedgeye got this one painfully right:

And yeah, I know Yellen could be fired too if she doesn’t resign, but with Goldman Sachs all over the White House, what are the odds? And who would come in when she goes? She’s ideal, who’s going to get angry at a barely 5′ grandmother even is she clearly out of her depth and league?

Keynes: A Master Of Confused And Confusing Prose

[This article is a selection from Where Keynes Went Wrong]

Paul Samuelson, professor of economics at MIT after World War II and author of a best-selling economics textbook, was one of Keynes’s most ardent American disciples. Here is what he has to say about the latter"s General Theory:

It is a badly written book, poorly organized. . . . It is ar­rogant, bad-tempered, polemical, and not overly gener­ous in its acknowledgements. It abounds in mare’s nests and confusion.... 

In reading this, one recalls Keynes’s infatuation with paradox. Samuelson, the ardent disciple, is telling us that the master’s book is good because it is bad.

We do not, however, have to take Samuelson’s word about the bad writing, poor organization, and general confusion of The General Theory. Following publication in 1936, many lead­ing economists pointed to the same problems, although some of them hesitated to criticize or quarrel with Keynes and thus chose their words carefully.

Frank H. Knight, a leading American econ­omist, complained that it was “inordinately difficult to tell what the author means. . . . The direct contention of the work [also] seems to me quite unsubstantiated.”

Joseph Schumpeter noted Keynes’s “technique of skirting problems by artificial definitions which, tied up with highly specialized assumptions, produce paradoxical-looking tau­tologies. . . .”

 British economist Hubert Henderson privately stated that: “I have allowed myself to be inhibited for many years . . . by a desire not to quarrel in public with Maynard . . . . But. . . I regard Maynard’s books as a farrago of confused sophis­tication.”

French economist Etienne Mantoux added that the whole thing simply appeared to be “rationalization of a policy ... long known to be . . . dear to him."

In The General Theory itself, Keynes has a good word to say about clarity, consistency, and logic.He is quick to pounce on what he considers the errors of others. But he then leads us down a rabbit hole of convolution, needless and misleading jar­gon, mis-statement, confusion, contradiction, unfactuality, and general illogic.

It is not that Keynes is entirely opaque. It is quite feasible to make out what he seems to be saying, but it is worth taking a moment to focus on the particular rhetorical devices and obfuscations that Keynes employed.

Device One: Obscurity

A typical sentence from The General Theory:

We have full employment when output has risen to a level at which the marginal return from a representa­tive unit of the factors of production has fallen to the minimum figure at which a quantity of the factors suf­ficient to produce this output is available.

This means, in essence, that we have not reached full employ­ment until all factors of production are fully employed. We will recall that, per Keynes, only at this point do we have to worry about inflation.

Keynes took exception when other economists wrote in this convoluted way. For example, in a 1931 letter to the editor of The New Statesman and Nation, he charged Lionel Robbins with the same sin, even though Robbins was, on the whole, a very clear writer:

Professor Robbins wants “increased elasticity of local wage costs” . . . which means in plain English, I sup­pose, a reduction of average wages.

Given this stab at Robbins, can we at least assume that Keynes will avoid the term “elasticity” in The General Theory? No, not at all, he uses (and misuses) it repeatedly.

Device Two: Misuse of Technical Language

In the example above, Lionel Robbins was at least using standard economist’s jargon. Keynes liked to make up his own jargon, or worse, use standard jargon in a non standard way. This led to a scolding by economist Frank H. Knight in the review of The Gen­eral Theory that we have already cited: “Familiar terms and modes of expression seem to be shunned on principle.”

The only legitimate reason to use technical language is to make a sentence clearer, if not to the average reader, at least to the pro­fessional reader. Keynes habitually uses technical language to confuse, and as we shall shortly see, this may have been a deliber­ate strategy.

Device Three: Shifting Definitions

Keynes tells us in The General Theory that economists have not clearly defined the jargonish term “marginal efficiency of capi­tal” (which roughly means return on capital). He then proceeds throughout the book to use the term in many different ways, at least seven by Henry Hazlitt’s count. Another slippery word in The General Theory is wages, which can mean an hourly rate or total employee pay or something else. Keynes does not seem to notice the difference, which leads him into serious logical errors.

Once again, Keynes criticized the same lapse in others. In a book review early in his career, he took an author to task for

us[ing] the [same] expression some thirty times in some apparently eight different senses.

Device Four: Misuse of Common Terms

In some cases, Keynes stretches the meaning of a commonly used word beyond recognition without explicitly redefining it. For example, he tells us that for every commodity there is an implicit rate of interest, a wheat rate of interest, a copper rate of interest, a steel plant rate of interest, and so on. This confuses commodity options and futures pricing with interest rates, a clear case of mix­ing apples and bananas. We have already seen that Keynes uses the word equilibrium to describe what is actually disequilibrium.

Device Five: Reversing Cause and Effect

Keynes says that entrepreneurs calculate how much revenue they will earn from x employees. But they do not. They calculate how many employees they can afford from x revenue. Keynes says that prices are low if production is low. In actuality, it is the reverse: production is low if prices are low. Keynes seems to like these reversals, perhaps because they dress up the ordinary with a gloss of novelty, even of profundity. But it is really no more than a parlor trick, and just piles error on error.

Device Six: False Determinism

Keynesian economist Alvin H. Hansen, whose book A Guide to Keynes attempted to de-mystify the master, tells us that “Keynes’s most notable contribution was his consumption function.” The so-called marginal propen­sity to consume (consumption function) tells us that people tend to save more as their income rises. Stated as such, it is a common­place, certainly nothing new. But Keynes calls it a “fundamen­tal psychological law,” which it certainly is not. We can nei­ther predict with certainty that people will always save more as their income rises, nor can we work out a forecastable schedule of increased saving, as Keynes assumed.

In the Keynesian model, the marginal propensity to consume is also treated as an independent variable. (It is supposed to deter­mine other variables, not be determined by them.) This is clearly false. As Benjamin Anderson, economist and early Keynes critic, pointed out, “The so-called independent Keynesian variables (1. The marginal propensity to consume, 2. The schedule of the mar­ginal efficiency of capital, and, 3. The rate of interest) are all influ­enced by each other. They are interdependent, not independent. Keynes even forgets himself and admits at one point that #2 is influenced by #1.” 

Device Seven: Slipping Back and Forth between Mutually Inconsistent Categories

Keynes uses the word “wages” to mean either a wage rate or total wages. He is also prone to move back and forth between physical commodities and services and money prices for commodities and services, another case of mixing up apples and bananas.

Device Eight: Unsupported Assertion

In the entirety of The General Theory, there are only two refer­ences to statistical studies, one of which Keynes partly dismisses as improbable:

Mr. Kuznet’s method must surely lead to too low an estimate.

Even when he discusses a subject that especially lends itself to statistical analysis, such as a suggested relationship between agri­cultural harvests and the business cycle, he simply takes a posi­tion without bothering to search for relevant data.

Device Nine: Misstatement

Keynes mischaracterizes the purpose of corporate sinking funds. How could he make such an elementary error? Probably because he had said the same thing many times when speaking on his feet, and, being busy, did not take sufficient time to check his written work.

Sometimes Keynes seems too busy even to think. He says that if a lender lends money to a business owner, this doubles the risk of a business owner using his own money, which doubled risk is reflected in the interest rate. This makes no sense, as Henry Hazlitt noted. Risk is not doubled when a lender enters the pic­ture. The lender and the business owner share what is still the same risk of failure.

Device Ten: Macro or Aggregative Economics

Keynes is usually credited with “inventing” macroeconomics, which looks at economy-wide flows rather than the micro-eco­nomics of specific firms or industries. This is not entirely accu­rate. Other economists adopted an economy-wide perspective, although they often extrapolated from the firm or industry to the economy as a whole, which Keynes wrongly criticized. Ironi­cally, Keynes attacked Say’s Law which is, itself, an example of macroeconomics. It is certainly fair to say that Keynes developed his own type of macroeconomics, which his followers developed into the macroeconomics of today. It is also true that a macroeconomic viewpoint makes it easier for a skilled casuist to mislead and confuse, and that Keynes fully exploited this opening.

Device Eleven: Misuse of Math

Keynes refers to sales in one of his equations, but it is expected sales, not actual sales. Expectations by definition are not verifiable and thus do not belong in an equation.

As Henry Hazlitt has pointed out,

A mathematical statement, to be scientifically useful, must, like a verbal statement, at least be verifiable, even when it is not verified. If I say, for example (and am not merely joking), that John’s love of Alice varies in an exact and determinable relationship with Mary’s love of John, I ought to be able to prove that this is so. I do not prove my statement—in fact, I do not make it a whit more plausible or “scientific”—if I write, solemnly,

• let X equal Mary’s love of John,


• and Y equal John’s love of Alice,


• then Y = f (X)

—and go on triumphantly from there. Yet this is the kind of assertion constantly being made by mathemat­ical economists, and especially by Keynes.

Given the Alice in Wonderland quality of The General Theory, it should not surprise us that Keynes interrupts his own misuse of math to tell us that he (apparently) agrees with Hazlitt:

To say that Queen Victoria was a better queen but not a happier woman than Queen Elizabeth [is] a propo­sition not without meaning and not without interest, but unsuitable as material for the differential calculus. Our precision will be a mock precision if we try to use such partly vague and nonquantitative concepts as the basis of a quantitative analysis.28

He also warns of

symbolic pseudo-mathematical methods . . . of eco­nomic analysis.

After some of his own algebra he adds that:

I do not myself attach much value to manipulations of this kind.

It is quite typical of Keynes now to attack, now to disarm, now to shout, now to whisper, now to qualify his mathematical claims, now to ignore, even blatantly ignore, the same qualifications. On occasion, Keynes was even capable of a crude bluff. Writing a pri­vate letter to Montagu Norman, Governor of the Bank of Eng­land, he said that his theories (the same theories that would later appear in The General Theory) were a

mathematical certainty, [not] open to dispute.

Keynes certainly knew better. Some of his disciples did not. Economist Wilhelm Röpke noted in 1952 that

The [Keynesian] revolutionaries [take a stance of] . . . vehement self-assertion and barely veiled contempt, such as are habitual to the “enlightened” in dealing with those who remain in the dark. They seem to re­gard themselves as all the more superior in that they can point with obvious pride to the difficulty of their literature and to the use of mathematics, which lifts the “new economics” almost to the lofty heights of physics.

One could go on, almost indefinitely, citing Keynes’s obscuri­ties, convolutions, inconsistencies, factual or logical lapses,and so on, but it is time to ask the obvious question: why did he write The General Theory this way? Keynes could be orderly, orga­nized, consistent, relevant, clear, complete, and factual, in addi­tion to being playful and witty, when he wanted to be. This is apparent from the earlier books and many of the shorter pieces. There are some snippets from The General Theory that also reflect these characteristics. So why is most of The General Theory so different?

There are many possible answers. Historian Paul Johnson has said, unrelated to Keynes, that “In financial matters, the object of complexity is all too often to conceal the truth, to deceive.” The French economist Étienne Mantoux, reviewing The General Theory shortly after publication, quoted an earlier English econo­mist, Samuel Bailey, from 1825: “An author’s reputation for the profundity of his ideas often gains by a small admixture of the unintelligible.”

This may be part of the explanation, that Keynes intended to deceive or impress. But we must bear in mind that Keynes was a salesman. He was trying to sell a particular type of economic policy, and he was prepared to utilize any rhetorical device, from crystal clarity and wit all the way to complete unintelligibility, in order to make the sale.

Why would unintelligibility help to make the sale? Not just because it can be used to impress. Equally important, it can be used to intimidate. Keynes liked to make people feel, as his very intelligent friend Bob Brand said, like “the bottom boy in the class.”

Keynes probably developed obscurity as one of his speaking styles. He obscured, confused, and scrambled the mental “chessboard,” because he felt confident that he could always keep the position of the “chess pieces” in mind, and combine them as he saw fit for an attack in any direction, whereas his opponents could not. This is a very impressive skill indeed, especially when one is speaking extemporaneously. No wonder that Sir Josiah Stamp, a very respected economist who often partnered with Keynes on BBC broadcasts, said on the air that “I can never answer you when you are [verbally] theorizing.”

Whether this was a deliberate style on Keynes’s part, or just a habit, we cannot know. But it was natural for him to fall into the same scrambling, intimidating style when writing The Gen­eral Theory. The problem is that it does not work as well in print as in conversation or debate. When confined to print, it can be examined, and all the myriad flaws, the errors of fact or reasoning, the rhetorical tricks, the pseudo originality, may be revealed.

A few prominent economists, notably Ludwig von Mises, Friedrich Hayek, Wilhelm Röpke, Jacques Rueff, and Henry Hazlitt, among others, saw through it completely. Others per­ceived that something was wrong, but hesitated to say so out of fear of Keynes’s position and powers of retaliation. Regrettably, no major economist published an immediate book-length ref­utation, so that the influence of The General Theory spread and spread, notwithstanding its all too apparent flaws.

Today many people - economists, financiers, investors, busi­ness owners, and managers - say that Keynes is their intellectual hero. Have they actually read The General Theory? Have they read more than the few clear and witty passages so widely quoted?

Yet Another Theory Of The Fed (Or Why A "Major Policy Shift" Looms)

Authored by Daniel Nevins via FFWiley.com,

The world hardly needs another theory of the Fed, especially so soon after its Jackson Hole symposium. But we have a theory, too, and who knows, ours could be as close to the bulls-eye as any of the others. Plus, our theory is easy to explain - it rests on the simple premise that decision makers worry mostly about their reputations. We’ll propose that reputational risks are the primary drivers of central bank policies, and then we’ll use that belief to predict a major policy shift.

Why are reputations so important? Cynics might say they determine how much central bankers get paid once they leave the FOMC. Ben Bernanke, for example, wouldn’t collect $250,000 speaking fees and plush consulting contracts if he hadn’t bolstered his reputation during the Global Financial Crisis. And that’s not all—the crisis also lifted Bernanke’s power and importance beyond what it would have otherwise been. By landing in the Fed chair at an opportune time, he profited immensely.

But our theory doesn’t depend on that particular type of cynicism. We doubt that personal greed drives the Fed’s policy decisions. Whether they intend to cash their golden tickets or not (we’ll take the over on “intend to”), we view FOMC members as highly regarded folks who’d like to remain that way. They’ve reached a foothold at their profession’s highest mountain’s uppermost peak, from where the only direction is down. And remember—they didn’t arrive safely at their foothold by accident. If the president taps you for FOMC duty and sends you before Congress for approval, you’re already adept at protecting your reputation. You’ll probably do “whatever it takes” to steer clear of any reputational damage that could arise in the future.

When we talk about reputations, though, we’re not saying that a central banker’s legacy depends on whether her policies succeed or fail. Reputations are far more nuanced than that. Policies that fail can still preserve or even enhance the policymaker’s reputation, and vice-versa. What matters most is how the policymaker succeeds or fails.

Take Bernanke, again. During his first FOMC stint from 2002 to 2005, the committee responded to a deflation “scare” with successive rate cuts dropping the fed funds rate to a 45-year low of 1%. In just a few years time, people would see that boost to the credit markets as a mistake. And Bernanke was closely associated with it—he had long argued for fighting deflation with extreme measures. He then downplayed the risks of his preferred policies, as in his insistence that falling house prices were a “pretty unlikely possibility” and subprime mortgage troubles were unlikely to result in significant “spillovers.”

So Bernanke was a central figure in the lead-up to the crisis, but you already knew that. Our point is that it had little effect on his reputation. Among mainstream economists and in the mainstream media, he’s currently basking in the admiration of his “courage to act.” By comparison, his critics, mostly in the financial sector and outside the mainstream, point to his shortsightedness. Which perspective wins? As of today, the “hero tale” dominates. Just as presidents need only act presidential to gain plaudits during wartime, central bankers need only act aggressively to gain plaudits during financial crises. In either case, it doesn’t matter what came before.

Why the Fed’s Priorities are Changing

With those ideas in mind (that we’re dealing with perceptions more than realities), let’s look at the reputational risks faced by today’s FOMC. We’ll argue that the current decade’s primary risk - the risk of a 1937-style relapse into recession - is fading in importance. Until recently, an echo recession similar to the one that snuffed out the mid-1930s recovery would have been a reputation killer. It would have led people to question whether the 2008–9 recession would morph into another Great Depression, after all.

Even worse for the professional economists at the Fed, it would have lowered their status among the people who matter most to them—their peers. Consider that many economists (including Bernanke) blame the Great Depression on the Fed. Those economists would have surely piled on their policymaking contemporaries if the recent growth pattern had looked anything like the 1930s double dip. In any year from 2010 to 2016, a recession would have triggered a rethink of whether today’s monetary pooh-bahs are truly superior to those of the past.

As Dylan said, though, the times they are a changin’. The current expansion is now the third longest on record, as shown in the chart below. And if it continues through July 2019, it would become the longest on record. By that time, the Fed’s reputational armor would be as thick as ever.

It would be thick enough to deflect any attempts at equating current policies with the alleged 1930s blunders. Instead of the hit pieces that would have appeared after a recession in, say, 2015, pundits would pen bubbly narratives praising the superstars behind the longest-ever expansion.

But that’s not the whole story. We suggest asking the following: If the FOMC no longer fears an echo recession, what reputational risks remain?

Our answer is that the Fed’s reputation would tumble with any instance of severe financial turmoil. Imagine financial disorder slamming the economy once again, as in the 2008–9 crisis but taking a different form in the next iteration. In fact, many commentators warn that the Fed’s steady support for stocks and other risky assets could lead us into another mess. That may be a nonmainstream opinion and easily deflected, but only for as long as it remains just that—an opinion. If it proves prescient, it would flow into the mainstream. Regardless of the current expansion’s length, the FOMC’s reputation would be tarnished. (If you don’t believe us, just ask Alan Greenspan.)

Of course, we’re not saying anything that’s not already obvious, both outside and inside the Fed. That’s kind of the idea behind our theory—that the FOMC pays attention to its reputational calculus. Committee members may not discuss reputational worries for all to hear (few of us do), but those worries surely influence their policies. During the last few years, they worried mostly about an echo recession. By 2019, we expect them to worry mostly about the financial sector. And today, our theory suggests we’re in transition. We’re transitioning to policies that allow greater recession risks in order to reduce risks to financial stability. (Although a new Fed head might put the transition on pause for awhile if Janet Yellen isn’t reappointed next February.)

In other words, we agree with those Fed watchers saying the FOMC already shows greater sensitivity to financial risks. We expect further changes in policy priorities until, by 2019, avoiding a recession ceases to be a critical priority. And we expect those changes because we think FOMC members - perhaps even more than most people - care very much about their reputations.

Wall Street Journal Lashes Out At "Our Political Central Bankers"

While the concept of "independence" among the unelected central bank cognoscenti is as cute as the tooth fairy or santa claus, it is nevertheless defended by those on high as sacrosanct to our very democracy. That is until The Wall Street Journal"s editorial board finally had enough of Fed officials joining the "resistance" against financial reform...

Via WSJ,

Janet Yellen didn’t run for President, but you wouldn’t know it from her policy démarche Friday at the Federal Reserve’s annual Jackson Hole retreat. The Fed Chair unleashed a defense of post-crisis financial regulation that shows how political the world’s central bankers have become.

“Already, for some, memories of this experience may be fading—memories of just how costly the financial crisis was and of why certain steps were taken in response,” Ms. Yellen said.

She added that regulatory changes “should be modest” and retain the superstructure built under Dodd-Frank.

Ms. Yellen’s comments followed a blunter recent warning from Fed Vice Chair Stanley Fischer, who told the Financial Times that “one can understand the political dynamics of this thing, but one cannot understand why grown, intelligent people” would “reach the conclusion that” you should “get rid of all the things you have put in place in the last 10 years.” Thank you, Senator Warren, er, Fischer.

***

This is extraordinary. Fed officials are launching a political campaign to retain their vast discretionary control over the American financial system. The brazenness of the effort shows how far afield central bankers have roamed from their traditional remit of monetary policy, which Ms. Yellen barely mentioned. You’d think she’d focus on that duty given that the Fed faces a watershed as soon as next month as it decides whether to begin rolling back the $4.5 trillion balance sheet it has amassed since the 2008 financial panic.

The size and scope of that balance sheet is itself a political intrusion because the Fed’s bond purchases are a form of credit allocation. The purchase of mortgage securities favors housing, while the Fed’s focus on long-duration bonds has been a deliberate attempt to push investors into riskier assets.

These decisions haven’t done much for the real economy, which has grown at a historically slow pace since the recession ended in June 2009. But the Fed has succeeded in lifting some asset prices, and no one knows what will happen to those prices once the Fed begins unwinding its portfolio. Perhaps it will all unfold without a hitch, but some very smart people aren’t as sanguine.

As for the stability of the financial system, Ms. Yellen and Mr. Fischer are at pains to assure us that, due to their efforts, all is well. “Banks are safer,” she says, thanks to capital and liquidity mandates and the wisdom of financial regulators. Oh, and “credit is available on good terms.”

But Ms. Yellen wasn’t nearly as optimistic about lending in the later Obama years. She often fretted that tight credit conditions were limiting growth, and the facts bear out that concern. Bank lending in the current expansion has trailed that of seven previous recoveries, and lending for small business has been especially slow. None of this is cause for Fed triumphalism.

Banks are safer, but they should be after eight years of modest expansion. The real test of financial stability comes in times of economic stress, when interest rates rise or investors get nervous and rush to safer assets. The system has already had one liquidity panic, in October 2014, when the yield on U.S. Treasurys moved some 40-basis points in a day.

You have to ignore history to believe that regulators are suddenly so wise that they know the current regulatory regime will prevent the next crisis. The Fed misjudged the economy in the mid-2000s and kept feeding easy credit that produced the housing bubble. Fed officials Ben Bernanke and Tim Geithner then underestimated the financial risks in early 2008 when the stresses were already apparent.

That’s one reason to support a financial regime with high levels of capital to defend against potential losses but with less regulatory micro-managing. This is the trade-off that House Financial Services Chairman Jeb Hensarling has proposed, which contrasts with the lower capital and lower regulatory barriers that the Trump Administration seems to prefer.

This is the debate we should be having, but the Fed wants Americans to believe that Dodd-Frank is gospel and the only alternative is to return to pre-crisis policies. The irony is that Ms. Yellen is thus associating the Fed with the post-crisis status quo that has been splendid for Goldman Sachs and giant banks that have gained market share and can afford higher regulatory costs.

Ms. Yellen did concede that “there may be benefits to simplifying aspects of the Volcker rule” that limits propriety trading, which is the least she can do since the rule as written is more than 950 pages of text and explanation. But until she runs for public office, she and the Fed ought to stick to executing regulatory policy rather than trying to dictate it.

Ms. Yellen’s term as Fed chair expires early next year, and her Jackson Hole foray is a signal to President Trump about what he can expect if he reappoints her.

The Fed needs a leader who won’t bend to political pressure. But it also needs a leader who understands the limits of the Fed’s political role.

"It Is A Battle Between Data And Theory" - Fed PhDs Second-Guess Inflation Model After 5 Years Of Failure

Federal Reserve officials are finally waking up to the fact that there’s something wrong with their inflation models. It only took them five years.

As Bloomberg points out, the minutes from the Fed’s July policy meeting, released yesterday, included a debate about whether the models that help the central bank set its inflation target are no longer functioning properly.

“Federal Reserve officials are looking under the hood of their most basic inflation models and starting to ask if something is wrong.

Minutes from the July 25-26 Federal Open Market Committee meeting showed a revealing debate over why the economy isn’t producing more inflation in a time of easy financial conditions, tight labor markets and solid economic growth.

The central bank has missed its 2 percent price goal for most of the past five years. Still, a majority of FOMC participants favor further rate increases. The July minutes showed an intensifying debate over whether that is the right policy response.”

Some economists worry that if the Fed begins to publicly question their methods, it could ruin what little credibility the central bank has left.

“These minutes to me were troubling,” said Ward McCarthy, chief financial economist at Jefferies LLC in New York. “They don’t have their confidence in their policy decisions; and they don’t have confidence that they can provide the right kind of guidance.”

Of course, Fed officials did everything in their power to communicate that these questions were being raised by a small minority on the FOMC, and didn’t represent anything resembling an official opinion.

“In several passages, the minutes asserted that “most” officials were sticking with a forecast that higher inflation would eventually show up. However, the debate over resource slack models and whether standard data sources were telling them the whole story also showed convictions about their forecast are fraying.”

As Bloomberg explains, prices have been resistant to any upward movement even as the US unemployment rate has fell to a 16-year low of 4.3 percent in July. The U.S. consumer price index rose 1.7 percent for the 12 months ending July, while the PCE price index, the Fed’s preferred measure, which is tied to consumption, rose 1.4 percent in June. Another gauge calculated by the Dallas Fed, which trims index outliers to highlight the underlying price trend, rose 1.7 percent for the 12 months ending June. That was the same as May, which was down from 1.74 percent in April.

A few officials pointed out what many investors have believed for years: That the Fed"s inflation forecasting model is totally useless.

“The minutes said “a few” officials described resource slack models as “not particularly useful” while “most” thought the framework was valid.

Members also questioned whether there’s another theory that might better explain the inertia in prices.

The committee also pondered a number of theories as to why inflation wasn’t responding to tightening labor resources, such as “the possibility that slack may be better measured by labor market indicators other than unemployment.”

One notable economist described it as “a battle between data and theory.”

“It is a battle between data and theory,” said Ethan Harris, head of global economic research at Bank of America Corp. in New York.

But it almost doesn’t matter that the Fed’s vaunted inflation models no longer make any sense, because, the Fed is going to keep hiking no matter what now that the risks have struck the “appropriate balance” – at least that’s what one member of the leadership (probably Chairwoman Yellen) believes.   

“The minutes also included an unusual signal that someone - possibly a member of the committee’s leadership - saw additional rate increases as striking the “appropriate balance” on policy goals, dedicating two sentences to the views of “one participant.”

“That seems like an awful lot of air time as well as a very definitive answer coming from a mere ‘one participant’ - unless that single person happened to be someone really important - like, I don’t know, maybe the Chair?,” Stephen Stanley, chief economist at Amherst Pierpont Securities in New York, wrote in a note to clients, referring to Janet Yellen.”

Maybe in whatever model they concoct to replace this one, the Fed should include a metric probably more relevant today than economists realize: The amount of time Americans’ spend on Instagram per day.