Archive for the ‘Monetary Policy’ Category
On September 22, 2007, I said in Bye bye dollar (emphasis added)
I wasn’t particularly excited about the surprise 50 bps cut in both target and discount rates for the general long-term prospects of the US economy, although on a selfish level it was certainly good for my career stability. As far as I’m concerned, it is open season for Bernanke bashing. Greenspan bashing has been accelerating as well. Besides, if things really get bad with the USD, we’ll just move to Hong Kong or something
One of the things that I learned from Al Wojnilower was that the US economy could certainly keep chugging along for as long as the USD was the world currency. As he liked to repeat often, having the USD as the dominant world currency is like having an “American Express card with no limit”. One of the things that keeps the USD as the world’s currency is its position in sovereign reserves as well as the fact that oil is priced in USD. As far as I can see, both of these factors are beginning a worrisome decline.
With sovereign reserves continuing to diversify away from USD and Saudi Arabia refusing to cut rates in lock step with the US marks a real turn in the outlook for the USD dollar, and consequently the ability of the US economy to continue chugging along.
Then on October 31, 2007, I said in Xie xie ni Bernanke (emphasis added)
I just wanted to take a moment to say thank you to Mr Bernanke and the FOMC. I work in finance and these rate cuts are really great for my career sustainability. Without you’re gifts to the markets (at the expense of the USD, the long-term US economic health, and those who were responsible enough to actually save money instead of gambling), I don’t know what I’d do. I’m just glad that when this irresponsible monetary policy finally catches up to you that I have the option to move to Hong Kong.
With that backdrop, I am extremely excited to announce that I begin my new job in Hong Kong on November 23!
The move is both personal and strategic. Mrs Phorgy is from HK and we have a very large extended family there. Also, the asset management firm I’m working for is based in China. This is by far the most excited I’ve ever been about a new career opportunity. The people I’ll work with are phenomenally smart and lean towards being more quantitative (many with PhDs). For example, the PhD advisor of one of the guys who interviewed me was Nobel laureate Robert Engle.
The asset management industry in China is growing at a phenomenal pace and I am truly excited to be a part of that. As far as why a move to HK if I am concerned about the USD? I suspect in five years, it will seem far less mysterious as it becomes increasingly difficult and unpopular for HK to maintain its peg to the USD. Asia is definitely moving to an “Asian Bloc” and when that happens, the need and desire to peg the HKD to the USD will fade away.
The next 10-20 years will be transformative and I’m glad my daughter will grow up speaking both English and Mandarin. Speaking of which, it has been too long. Here is my princess:
From what I saw on my trip to China, it is obvious the reverse brain drain is well under way. Zai jian Bernanke!
Financial Armageddon points to the Reuters article:
where he argues that deflation is the next big worry. I have to humbly disagree. Sort of.
I do agree that financial asset prices are due for a massive correction, but the economy is made of more than just financial assets. Financial assets will see deflation, but physical assets will see inflation.
During the “New Economy”, financial assets have soared in value and I believe, like Jeremy Grantham, that financial assets throughout the globe have experienced a bubble.
Like I’ve said in a comment or two on Panzner’s blog, during past corrections in the financial sector, China and India were absorbing inflationary pressures. That structural shift is what will make this time different. Today, China and India are net exporters of inflation and loose monetary policy in the US will create domestic inflationary pressures that have no where to go this time.
This is the rift I saw between physical and financial assets when David Richards asked me what I thought about the markets back in December of 2006. That rift has been partially corrected with the rise in commodity and energy prices since then, but I think there is a long way to go before things are neutral. As usual, things usually will not reach a nice equilibrium and stay there. Inertia will carry it through neutral and beyond. Significantly beyond.
Wow. When I first began voicing my opinion about the Fed and monetary policy in a public phorum, it didn’t take long for me to be drawn to some papers by Anna Schwartz. On July 3, 2007, when I was asked what I would have done if I was in charge of monetary policy, I said:
If I were in charge from 2000-2007, I probably would have surrounded myself by smart people like Anna Schwartz, who wrote this gem (in 2002)
It is crucial that central banks and regulatory authorities be aware of effects of asset price inflation on the stability of the financial system. Lending activity based on asset collateral during the boom is hazardous to the health of lenders when the boom collapses. One way that authorities can curb the distortion of lenders’ portfolios during asset price booms is to have in place capital requirements that increase with the growth of credit extensions collateralized by assets whose prices have escalated. If financial institutions avoid this pitfall, their soundness will not be impaired when assets backing loans fall in value. Rather than trying to gauge the effects of asset prices on core inflation, central banks may be better advised to be alert to the weakening of financial balance sheets in the aftermath of a fall in value of asset collateral backing loans.
Now, she takes both Greenspan and Bernanke to task in this scorching article at the Telegraph:
Anna Schwartz blames Fed for sub-prime crisis
The high priestess of US monetarism – a revered figure at the Fed – says the central bank is itself the chief cause of the credit bubble, and now seems stunned as the consequences of its own actions engulf the financial system. “The new group at the Fed is not equal to the problem that faces it,” she says, daring to utter a thought that fellow critics mostly utter sotto voce.
“They need to speak frankly to the market and acknowledge how bad the problems are, and acknowledge their own failures in letting this happen. This is what is needed to restore confidence,” she told The Sunday Telegraph. “There never would have been a sub-prime mortgage crisis if the Fed had been alert. This is something Alan Greenspan must answer for,” she says.
That is a great article and although I should probably be a little more dignified that proclaiming “Bernanke sucks”, it is good to know that Anna Schwartz is also not a particularly big fan of those at the Fed right now.
Last Wednesday, I gave my call for monetary policy in the US and Eurozone
The Fed SHOULD hold rates, but I’ve lost all faith in the fed and they are just puppets for Wall Street.
ECB holds at 4%
Fed drops to 4%
So I was a bit shocked when the Fed only dropped rates 25 bps. I would have preferred 0 bps, but if you’re going to cut, cut enough to make some impact. A cut of 50 bps makes more sense the 25 bps even though if they had brains it would have been 0 bps, i.e. either do something or not. Don’t be a wet noodle.
So Bernanke doesn’t want to be Greenspan, eh? That much is clear. He is trying every tool in the chest other than lowering the Fed rate, but how on earth is this global bank bailout going to do anything other than bailout some new found buddies on Wall Street?
You should not really be surprised. After all, they are just as human as you and I. I’m probably better educated than most in the Fed anyway (as scary as that may sound).
Here is my advice to Helicopter Ben. The sooner you realize that some on Wall Street deserve to be insolvent, the better. Hold rates where they are (or even raise rates). Trashing the dollar isn’t really in anyone’s interest. Let the inevitable recession come over us. We’ll live. Trust me. We’ll even come out on the other side stronger. Leaner. Meaner. Greener.
The 0% APR on
Al Wojnilower’s American Express Card is about to expire and we’re likely not going to be able to roll over into a new one. But that’s alright. This country is still full of smart innovative people. Even if/when Citigroup defaults on its first interest payment, we’ll get through this. In every Econ 101 book I’ve ever glanced at (and tossed back on the shelf in fright), you see the words “business cycle”. It is natural. Recession are natural. Embrace it. Don’t let complacency take us beyond the point of no return. Make us work for a living. Don’t let us expect to be able to hold a job if we’re not giving 110% of our effort to be cost effective employees. We’re in a global competition with some super smart, super aggressive entrepreneurs and innovators in China and India, yet we’re feeding our lazy kids into diabetic obesity. This competition cannot be won through politics or military strength, it has got to be won through hard work, creativity, and dedication.
Ok. Why did I go off on that rant again? 🙂
Whenever I read about “subprime contagion”, I feel frustrated. When you get the flu, does the runny nose cause the muscle aches? No. Just because the runny nose came first doesn’t mean the flu can be described as “runny nose contagion”. The subprime mess was just the first symptom to appear in the bursting of a general credit bubble. The corporate high yield market saw very similar aggressive loan covenants. Commercial real estate. Emerging markets. You name it. We’ve been in the midst of a general fixed-income bubble since our friends at the Fed decided to keep rates far too low for far too long.
Think about this. Back in 2005, we were worried about the CDS market reaching $17 TRILLION notional. That is a HUGE number. But the notional amount is not indicative of overall exposure because of hedging, right?
If you want to see a perfect hedge, visit a Zen garden.
What is that number today? More like $45 TRILLION. That is insane. An entire new insurance industry has basically assumed that corporate defaults do not exist anymore. Not only that, a “hedge” can turn into naked exposure at the flip of a switch, i.e. what happens when the entity you bought insurance from no longer exists?
When I get a chance, I hope to start posting some more mathematical analysis of what’s going on (since that’s what I’m good at). For example, a primer on Leverage Mathematics 101 (which is partially complete) followed by Hedge Mathematics 101 would be a good start. In risk management, “hedging” basically means “let’s buy(sell) some similar securities so that we have more capital to buy other stuff.” In other words, hedging allows you to leverage yourself more.
Here is an article that may help spread the word, i.e. it’s not about subprime:
However, I would go even further. The truth is the current mess is not even about mortgages. Here is the word we should all be thinking about, “Fixed Income Bubble”.