Tuesday, August 3, 2010

Cliff Diving Courtesy Of The Fed

Cliff diving as defined by Wikipedia is as follows:

http://en.wikipedia.org/wiki/Cliff_diving#Non-competitive_diving

The talk on the street today is the WSJ article about future Fed Monetary Policy.

Fed Mulls Symbolic Shift
http://online.wsj.com/article/SB10001424052748704271804575405113846708620.html

Why in the world these guys want to interfere in the business cycle is beyond me? This constant printing of money and montization of debt will lead us over the cliff a lot sooner than Japan's lost 2 decades.  This is on the backs of St. Louis Fed Governor James Bullard's missive last week on deflation.

The Seven Faces Of Peril - PDF Document
http://research.stlouisfed.org/econ/bullard/pdf/SevenFacesFinalJul28.pdf

It sure looks like drunken money printing and tax cut drivel is more respected than sensible policy at the Fed. The WSJ article basically lays out a plan by the Fed to reinvest Mortgage outflows into the treasury market. This will lower long term rates further to stimulate the economy. On this news, we are hitting new lows in treasury yields this morning. The USD is falling to its lowest level since mid April.

This is exactly the trade that Treasury and the Fed want. They want to kill the USD to spur exports as exports have taken it on the nose. They want to lower interest rates to make risk assets more compelling. If the Fed goes ahead with this plan, they have lost what ever credibility they had. They are 100% in the business of artificially raising equity prices because that will in their distorted view of the world will spur economic growth. Lowering long term rates also allows the Treasury to auction off more ponzy debt at lower costs.  As we have seen Treasury has lengthen the duration of its borrowings because of where they see long term rates going. No one is fooling anyone. Treasury knows the economy is dog meat. The Fed knows its dog meat. They are just trying to make catastrophic situation less catastrophic. In the end they will just hastened the eventual and inevitable. The Fed created this tragedy with their ultra low interest policy that stoked reckless lending and helped create complex financial products and derivatives. They tried to rectify the problem with ZIRP. Now that ZIRP is obviously not working lets try more money printing and more ZIRP? Its beyond imagination. You can't fix a debt and leverage problem with more debt and leverage.

Going back to James Bullards argument for more QE to fight deflation. Dr. Bullard says the Fed can stop deflation by outright buying U.S. Treasury's in the form of quantitative easing ("monetizing debt"). He states that a  ZIRP policy only encourages deflation and violates the Taylor Rule. He says ZIRP loses its effectiveness, creates expectations of lower prices, and increases the likelihood of deflation. He hits it right on the button! The Fed created and implemented ZIRP for the need to have higher inflation, higher risk premiums, and increased lending. What happened was the mother of all moral hazards of banks just playing the yield curve with tax payer money. Banks were parking all of their excess reserves directly with the Fed gaining 25 basis points for their pleasure. Lending went nowhere and thus the economy is stuck in quicksand. Normally ZIRP and QE would lead to higher levels of inflation, but not in the environment we have at the moment where the debt is simply too much to handle. Dr. Bullard also makes a point that base money can be easily removed from the system just as it was added. The devil as always is in the details. When will the Fed remove the stimulus? We keep hearing more stimulus, more gas, more pressure on the accelerator.

Dr Bullard then goes into Japan's Follies.

"In the Japanese quantitative easing program, beginning in 2001, the BOJ was unable to gain credibility for the idea that they were prepared to leave the balance sheet expansion in place until policy objectives were met. And in the end, the BOJ in fact did withdraw the program without having successfully pushed inflation and inflation expectations higher, validating the private sector expectation. The U.S. and the U.K. have enjoyed more success, perhaps because private sector actors are more enamored with the idea that the FOMC and the U.K.s Monetary Policy Committee will do whatever it takes to avoid particularly unpleasant outcomes for the economy."

From this I can say the following:

1-That the Fed is horrified of a Japan like deflationary spiral where asset prices plummet and GDP growth just languishes.

2-What ever the Fed has done so far has failed. That ZIRP and QE have failed to stem deflationary forces so more ZIRP and QE are needed?

3-That the Fed was behind the deflationary curve and that Bernanke a student of the Depression totally missed this. This is not surprising as Uncle Ben is an academic who doesn't believe that asset bubbles exist. So if bubbles don't exist why do we need to deflate them? Bernanke and other Fed hacks still hold onto the Neo-Classical Monetarist Econometric formula, which states that they can manipulate the economy to their will and that they can create inflation by simply increasing the money supply.

4-Japanese QE/ZIRP failed for the same reasons it failed here. When your financial policy is extend and pretend, bad loans stay on your balance sheet. Japan never figured out a way to take care of their bad lending decisions. ZIRP/QE only added to the problems via a huge deficit and increase in national debt.
Sound familiar? Japan like the USA wanted to keep business as usual, they tried to re inflate old bubbles but the private sector was simply tapped out. Here in the states consumers are tapped out and the public sector is bloated with debt that was used to prop up the private sector. Japan tried very hard to save their economy. To this day its a work in progress and their fiscal situation has shown the effects of this grand scheme.

5-ZIRP/QE has saved the Financial/Elite/Ruling/Wealthy of this country just like it did in Japan. This is what the intended benefit was from the beginning. Lets not fool ourselves here. What it has done is destroy everything else in the vicinity.

6-The last bullet that the Fed has left is simply monetizing debt. Which means monetizing bad lending decisions by the financial sector. This is 100% socializing losses while privatizing the gains.

What is the Fed really worried about? They want to make it sound like they are worried about jobs and the economy but its really plummeting asset values that keep them up at night.  The Fed can't create jobs or increase aggregate demand but they can sure re inflate asset prices and they intend to do so only because like Japan where investors and the private sector demanded more stimulus, they always received it. The Fed along with the Treasury are Wall Street's proxy for higher stock prices and bonus checks nothing more.

Continued high unemployment is not politically acceptable to Congress and the President, and the Fed will face tremendous pressure in the next several months as negative data continues to pour in. Again, Congress is clueless to the fact that the Fed knows what they are doing. The Fed can only do what they are good at, so beware of chainsaws and printing presses. 

Monetizing debt is a one way ticket over the cliff and onto the rocks below. Problem for the Fed is that they are in a corner and that's the only answer left.

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