Money matters

I have been a bit sluggish in posting here. One goes through these spells every now and then. No matter what we write, stocks keep going higher every day without fail. Either one feels stupid or powerless or, I guess, it is a bit of both. No amount of analysis, history and potential risks matter. The only thing that matters is free money. Financial markets have been getting plenty of it.

Five years after the crisis, central banks are still cutting rates. The European Central Bank cut rates on November 7. Apparently, it was hotly discussed in the policy meeting and that members of the Monetary Policy Committee from the Bundesbank dissented. Draghi had to use his casting vote.

There is plenty of reassurance – strenuous ones – in the speeches of the current Fed chairman and the chairwoman-to-be on how long they can keep interest rates low.

From the chairman on 19 November 2013:

In particular, even after unemployment drops below 6-1/2 percent, and so long as inflation remains well behaved, the Committee can be patient in seeking assurance that the labor market is sufficiently strong before considering any increase in its target for the federal funds rate.

To the extent that this third factor–a perceived reduction in the Fed’s commitment to meeting its objectives–contributed to the increase in yields, it was neither welcome nor warranted, in the judgment of the FOMC.

When, ultimately, asset purchases do slow, it will likely be because the economy has progressed sufficiently for the Committee to rely more heavily on its rate policies, the associated forward guidance, and its substantial continued holdings of securities to maintain progress toward maximum employment and to achieve price stability.

In particular, the target for the federal funds rate is likely to remain near zero for a considerable time after the asset purchases end, perhaps well after the unemployment threshold is crossed and at least until the preponderance of the data supports the beginning of the removal of policy accommodation.

Five days before him, the Vice-Chairman (Ms. Janet Yellen) spoke at her confirmation hearing in front of the Senate Banking Committee:

We have made good progress, but we have farther to go to regain the ground lost in the crisis and the recession. Unemployment is down from a peak of 10 percent, but at 7.3 percent in October, it is still too high, reflecting a labor market and economy performing far short of their potential. At the same time, inflation has been running below the Federal Reserve’s goal of 2 percent and is expected to continue to do so for some time.

For these reasons, the Federal Reserve is using its monetary policy tools to promote a more robust recovery. A strong recovery will ultimately enable the Fed to reduce its monetary accommodation and reliance on unconventional policy tools such as asset purchases. I believe that supporting the recovery today is the surest path to returning to a more normal approach to monetary policy.

Neither of them, for all their commitment to transparency, addressed the question of why they feel compelled to continue with these policies fully five years after the crisis occurred. Hence, follow-up questions hardly came up:

Could it be that monetary policy is not the answer and, worse, could monetary policy be creating more problems, even as it is not solving existing problems?

Nor did they, in the interests of transparency, choose to address the issues raised by Andrew Huszar. He was a former Fed Staffer who oversaw the implementation of Quantitative Easing (asset purchases by the Federal Reserve). Of all platforms, he wrote in the Wall Street Journal that the quantitative easing programme had been a feast for Wall Street:

Even when acknowledging QE’s shortcomings, Chairman Bernanke argues that some action by the Fed is better than none (a position that his likely successor, Fed Vice Chairwoman Janet Yellen, also embraces). The implication is that the Fed is dutifully compensating for the rest of Washington’s dysfunction. But the Fed is at the center of that dysfunction. Case in point: It has allowed QE to become Wall Street’s new “too big to fail” policy. [Link]

Kevin Warsh, a former member of the FOMC, politely called Quantitative Easing (QE) an untested and incomplete policy experiment. He said that long periods of free money do not augur well for long-term growth or financial stability.He goes on to discuss the winners and losers that the Fed policy creates, international consequences of its policy and the obligations the Federal Reserve carries as the issuer of international reserve currency, etc.

The blog Cyniconomics has an interesting re-interpretation of Kevin Warsh’ polite article. Well worth a read. It is really not for laughs, though.

Another polite article (perhaps, too polite) is that of Mohamed El-Erian who just cautions that investors should opt for greater portfolio differentiation and that Wall Street should not deviate too much from the Main Street. More forthright comments from him might not have really been heard, anyway.

Today, FT reported that the Bank of England might not raise interest rates as soon as the 7% unemployment rate was reached. What a surprise?!

Hence, what Yours Truly wrote in MINT two weeks ago is a message that likely fell on deaf ears – both that of policymakers and that of investors.

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