Archive for December 2010
During my days at Capital Group, we had an opportunity to bring Paul Harrison in to give a presentation at an internal research conference. This was prior to the crisis when people were still feeling good and were still confident that the Fed had conquered the business cycle. They even called it the Great Moderation.1
Paul was great. I truly enjoyed his presentation and he was very gracious with his time afterward putting up with my questions. I remember he was examining the term structure of credit spreads and the information that can be extracted from it. His presentation and subsequent question and answer session had a lasting impression on the way I look at fixed income markets.
However, one thing about it always seemed odd to me. Paul was the head of the Capital Markets Section at the Federal Reserve. That wouldn’t be so odd in itself, but what I found odd about it was that they actually managed a risky fixed income portfolio. Why was the Federal Reserve managing a portfolio of corporate bonds? Talk about conflict of interest. Not to mention the potential for insider information.
Soon afterward, Paul left the Fed to work at a big investment bank and I left Capital. I hadn’t put much thought into it since then, but the “odd” feelings came rushing back when I read the following article from Zero Hedge:
Please go have a look.
Although quantitative easing is quite a different animal than the fixed income portfolio at the Capital Markets Section, the market risk is the same. The mark to market losses the Fed is now exposed to are astronomical. The sad thing is, I have very little confidence they even understand those risks. Bernanke is quite confident he can raise rates, but that is exactly the thing he should fear most. What is going to happen to yields in the US when they get their wishes and China floats the RMB (which I expect them to do within 4 years)?
It is difficult to inflate your way out of debt obligations when the Fed is the largest holder of US treasuries. When the RMB floats, China will take a hit on their USD holdings, but that will be hedged to a large extent by their improved purchasing power, which will only accelerate their evolution to a consumer economy. The US will once again increase manufacturing as promised but at the huge cost of quality of life as prices of all imports skyrocket.
Be careful what you wish for. It is sad for me to watch my country deteriorate like this at the hands of Bernanke and Geithner. History books will not be kind to either of them.
1: You dont hear that term very often anymore. I remember debating colleagues about the concept and told them when history books were written they’d look at the period of the Great Moderation as the most irresponsible period of monetary policy in history, but that is another story.