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FRED
08-29-07, 12:54 PM
http://www.itulip.com/images/blairBNPS.jpgThe Myth of the Slow Crash

Just because it's big, doesn't mean it can't go down fast. In a debt deflation, the extreme rate of change even fools central bankers.

by Eric Janszen

(Image: Second Officer David Blair. Before the Titanic sailed, he left with the key to the locker that contained the pair of binoculars for the designated lookout. Historians believe (http://www.thisislondon.co.uk/news/article-23410094-details/The+man+who+sank+the+Titanic+by+walking+off+with+v ital+locker+key/article.do) that if the crew had access to the binoculars the iceberg would have been seen in time to avoid the collision that sank the ship. Nice suit, though.)

The business press this morning attributed the 280 point DOW rout yesterday afternoon to investors' worries that the ongoing credit crunch and declining housing market may damage the so-called real economy. But the timing suggests that the market reacted to the release of the Fed's meeting minutes.

The minutes of the early August 2007 closed-door meeting of the Federal Open Market Committee were released late in the afternoon. The markets plunged shortly thereafter. The Fed's stated hope for a "return to more normal market conditions" without intervention is not what investors wanted to hear. They were hoping to read Fed minutes expressing worries that justified the move to cut the discount rate and pour tens of billions into the banking system ten days later. The minutes imply that the Fed was surprised.

The heart if not the soul of the Fed's role in The System, as Greenspan calls it, is as the all-knowing Wizard of Oz. How can the Wizard be surprised and still be the Wizard? Is the Fed really on top of this?

This raises a key question about Bernanke. While we deeply respect Bernanke's intellect, is he well suited for the role of head Wizard? He's an academic, not an astute politician and gun-for-hire like Greenspan. Does he have the instincts and nerve for the job, or will he do what comes naturally to him and wait for the data to stop showing apparently conflicting trends and align, at which point reaction will be too late? Can he convey that he is on top of events, even if he isn't, to maintain the appearance of control?

Watching him in front of a congressional committee at the last hearing, I winced as members of Congress interrupted him when he spoke, chuckled at some of his answers to questions, and generally dissed him. Having run more than 80 board meetings in my career as CEO, my advice to Bernanke is to watch a few tapes of Greenspan and do what he used to do at senate hearings. No matter how badly things are going, never accept disrespect. If you do, you're dead.

Greenspan, not his inquisitors, controlled those hearings, even when the missiles were flying, such as after the 2000 stock market crash. When he asked a ill-informed question–which, given the average Congress person's knowledge of economics and finance, is most of the time–he'd respond with a short meaningless answer. The more ill-informed the question, the shorter and more meaningless the answer. At one hearing I recall Greenspan was asked a question that was outrageously absurd, even by the standards of the US Congress. Greenspan's answer, after a pregnant pause: "I'm speechless."

The Fed's Foggy View

If slashing the discount rate half a percent ten days after hoping aloud that the markets might self-correct appears flip floppy, remember that the Fed considered rate hikes, versus cuts, as recently as May when inflation remained the Fed's predominant concern. Investors have reason to worry that this Fed does not know how to apply, now that the fire is burning, what it learned during the drills.

Coming off the housing bubble, the Fed is worried about the US experiencing a flavor of runaway debt deflation such as it suffered in the 1930s, and a less severe but no less worrisome debt deflation episode as Japan suffered after since the end of their stock market and real estate bubble collapsed starting in 1992. Preparedness for that eventuality was the gist of Bernanke's now famous helicopter money speech in November 2002 (http://www.federalreserve.gov/boardDocs/speeches/2002/20021121/default.htm), two and a half years before the housing bubble peaked. The monetary downdraft potential of a US recession under current household debt conditions with financial markets risk polluted (http://www.itulip.com/riskpollution.htm) at red alert levels is severe.

In my last article, I explained how a financial market crash caused by credit contraction is a long process (http://itulip.com/forums/showthread.php?p=13997#post13997). As the Japanese learned, when a credit bubble finally pops, the negative economic impact of credit contraction is swift.


http://www.itulip.com/images/japanzero.jpg


http://www.itulip.com/images/japandeflation.jpg


Charts from No Deflation! Disinflation then Lots of Inflation (http://itulip.com/forums/showthread.php?p=2795#post2795)


A recession is a self-reinforcing process. The Fed is, and should be, afraid of where such a process might take the debt-laden US economy with so much debt riding on housing prices, housing prices riding on employment, and employment riding on consumption. Commentators point out that housing prices are now falling for the first time since The Great Depression. Another respected academic, Professor Robert Shiller, reiterated this point in an interview yesterday. He should also point out that this is the first time national housing prices have declined – ever – in the absence of a recession or depression. Question: what might happen to housing prices when the economy finally goes into recession Q4 2007? The Japanese know: prices collapse and stay there a long time.


http://www.itulip.com/images/surfdom17.jpg

Charts from New Road to Serfdom (http://www.itulip.com/forums/showthread.php?p=7343#post7343)


The Fed can guess as well as you or I what the next US recession has in store, and isn't interested in confirming their theories by experimentation. We saw that movie in the US in the 1930s and the Japanese are still watching their own version, fifteen years later.

The lesson the Fed learned from the Japanese experience is: once debt deflation forces are in play, don't delay cutting rates. In a credit contraction, disinflation can get away from you quickly, driving up real rates of interest and shutting down the money creation machinery. Keep inflation above zero at all costs.


http://www.itulip.com/images/USdeflation.png

Don't let this happen




http://www.itulip.com/images/Japandeflation.png

Or this




http://www.itulip.com/images/USnodeflation.png



Do use all means to keep inflation above the zero bound, like this



Charts from Ka-Poom Theory is a Rhyme not a Repeat of History (http://itulip.com/forums/showthread.php?p=2905#post2905)


The Greenspan Fed applied this lesson effectively after the stock market bubble crash in 2001. But that was an easier crisis to manage in many ways. A crashing stock market is a negative wealth effect sledgehammer to be sure, and managing its falling on the US economy meant flooding the system with money and creating new asset bubbles. But a stock market crash is not a credit contraction. Credit is the life blood of the economy and markets. Shut it off, and the economy quickly stalls. A technology stock bust wiped out a lot of equity, forced technology companies out of business, and wiped out a few venture capital finds. But housing bubble bust threatens to bring down the credit markets and banking system, and spread crisis to foreign buyers of securitized debt, spill over into the consumer credit markets, cutting demand for exports and wreck economy havoc generally.

The confusing and contradictory nature of the economic data may in itself be strong evidence of major dangers that confront the Fed's decision-making process.

It is of the utmost importance to realize this: given the actual facts which it was then possible for either businessman or economists to observe, those diagnoses -- or even the prognosis that, with the existing structure of debt, those facts plus a drastic fall in price level would cause major trouble but that nothing else would -- were not simply wrong. What nobody saw, though some people may have felt it, was that those fundamental data from which diagnoses and prognoses were made, were themselves in a state of flux and that they would be swamped by the torrents of a process of readjustment corresponding in magnitude to the extent of the industrial revolution of the preceding 30 years. People, for the most part, stood their ground firmly. But that ground itself was about to give way.

- Joseph A. Schumpeter, Business Cycles, 1939As well prepared as the Fed appears to be theoretically to handle the current crisis, helicopters and all, the conditions for applying the cure this time for this purpose are far more challenging than in 2001 and 2002 when they were conceived. An already heavily depreciated dollar, already lowered taxes, a massive fiscal deficit versus a surplus, oil trading over $70 compared to $22, and a low Fed funds rate base of 5.25% all mean that the Bernanke Fed's and fiscal policy options cannot be executed today in the same hell-for-leather way they were in 2001.

The paradox is that to prevent the recession that can develop into a run-away debt deflation, the Fed needs to cut early and often, but to avoid crashing the bond market and dollar, the Fed has to wait until it sees the whites of bond and currency traders' eyes. Timing, wording, and execution will be critical. And the bond market might get it wrong, too.

As we've discussed several times in past iTulip ShadowFed meetings, in a perfect world for the Fed, a random event occurs outside the U.S. that the Fed can use as a reason to cut. The greatest challenge for the Fed is that this crisis is US-centric. As David Bloom (http://itulip.com/forums/showthread.php?t=708), currency guru at HSBC, said: "The US needs a trillion dollars a year just to stand still." Modern financial crises have always begun on the peripheries of global economy, setting off a chain reaction. Mr Bloom says the seizure this time will be at the heart of the system as the dollar buckles, pressing down on the "aorta of capitalism."

Assuming the Fed pulls off a magical combination of rate cuts with global central banks' cooperation, which appears to still be in place given the ECB's recent noises about suddenly halting its rate hikes program, along with more tax cuts and fiscal stimulus to prevent a hard crash at this time, in the long run the Fed is still a one trick pony. It can print or not. When, not if, the US goes into recession in Q4 this year as unemployment begins to rise, the housing market will take its next and more serious turn down. As inflation falls toward negative rates the Fed will cut drastically. But if they wait that long, the Japanese experience is that the moves will then be too late.

iTulip Indicators of a Sharp Reaction

We are starting to collect iTulip Prosper Lending Group members data. One of our reasons for setting up the group last year was to establish a baseline so we'd have more proprietary data for the iTulip ShadowFed to use to make its decisions. We checked with a few other members informally this week and they are seeing a huge spike in defaults in August after almost no defaults before July 2007. One reported only one default among 100 loans and that was in July 2007, then six so far in August. Things can change very quickly, as I've said, and this may be an indicator. If you are an iTulip Prosper Lending Group member, please send default data to info@itulip.com (http://itulip.com/forums/info@itulip.com).

iTulip Select (http://www.itulip.com/forums/showthread.php?t=1032): The Investment Thesis for the Next Cycle™
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Mega
08-29-07, 04:17 PM
But i Want HIGH rates!
Sky HIGH!
In fact i think the Banks will want it to help recoup their lossers?
Mike

dbarberic
08-29-07, 06:33 PM
Poom won't start until the commentators on CNBC are screaming about deflation. That has not happened yet; but just wait, it will.

That is my personal buy signal.

Mega
08-29-07, 06:51 PM
Buy what?
Mike

Jim Nickerson
08-29-07, 07:45 PM
Poom won't start until the commentators on CNBC are screaming about deflation. That has not happened yet; but just wait, it will.

That is my personal buy signal.

I don't watch financial TV, so when you get the signal will you annouce it here and email me too. Thanks.

Jim Nickerson
08-29-07, 07:47 PM
Buy what?
Mike

Things that you think will go up; if they don't go up, don't buy them--a la Will Rogers, -American cowboy and philosopher.

zoog
08-29-07, 11:30 PM
[EJ:] ...in a perfect world for the Fed, a random event occurs outside the U.S. that the Fed can use as a reason to cut.

Is that another one of these


We hope our market warnings July 25 "Before the Stroke of Midnight" and in our Newsletter Monday were not too subtle, and everyone was ready in their own way for this correction.

or was that just an academic hypothetical?

dbarberic
08-30-07, 09:45 AM
Buy what?
Mike

Investments expected to benefit from the Poom phase....

dbarberic
08-30-07, 09:57 AM
I don't watch financial TV, so when you get the signal will you annouce it here and email me too. Thanks.

The Fed would love to cut rates; but it is more than just the Fed interpreting the statistics, it is also “Great Theater” that the Fed is trying to put on.

Cut to quickly and the Fed looks week, the bond vigilantes come out, and the dollar gets crushed. But convince the market that a rate cut is not by choice, but out of necessity due to an exogenous random event or threat of deflation, and the bond vigilantes will be more forgiving as will foreign holders of USD.

Excluding a random exogenous event, when the roar of the main stream investment media turns into overwhelming screams of deflation (e.g. CNBC), they are simply providing the defense so that Ben can come in and do his lay-up shot into the basket.

Chris Coles
08-30-07, 10:06 AM
Something totally unexpected will trigger the collapse. And, because it will be "over everyone's horizon", there will not be time for the majority to adjust their thinking and act in a calm manner. Fear of the unexpected will trigger panic and then no one will be able to forecast the movement of the value of any asset. That is why the market rules supreme.

stumann
08-31-07, 05:03 AM
"The lesson the Fed learned from the Japanese experience is: once debt deflation forces are in play, don't delay cutting rates. In a credit contraction, disinflation can get away from you quickly, driving up real rates of interest and shutting down the money creation machinery. Keep inflation above zero at all costs..."

this was the wrong lesson to take away from the Japanese experience, and that's why the Fed has effectively destroyed America's future.

Japanese deflation wasn't caused by credit rates being too dear - it was the result of demographics - too many old folks depending on not enough young workers. ungodly low raters allowed the Japanese govt. to spend the past 15 years priming the pump to the point where all that Japanese "savings" we hear so much about is now probably deeper underwater than the typical spendthrift American's negative savings account.

when a population like Japan's is basically dying off and yet does not allowing immigration, housing prices will fall. America, on the other hand, saw the writing on the wall. that's why in the Simpson's episode where Lisa gives her speech to Congress, she says "250 million Americans". who wants to bet there's now about 320 million? ( US population figs are probably about as accurate as US financial date). That's 70 million in 20 years! that explains Greenspan's conumdrum. yet New Orleans is good example of why reckless amounts of immigration are a bad idea. so is traffic.

Spartacus
08-31-07, 03:22 PM
While I think demographics accounts for some of the effects, the major problem this theory does not explain is, why the SUDDEN drop?

Did the population age 30 years in one year?

Also look here

http://research.stlouisfed.org/publications/aiet/page7.pdf

http://research.stlouisfed.org/publications/iet/japan/japan.pdf

Where's the GENERAL deflation? I don't see it.

There may have been specific industries / economic segments that experienced falling prices, but GENERAL, widespread, economy-wide, across the board price drops did not happen.




Japanese deflation wasn't caused by credit rates being too dear - it was the result of demographics - too many old folks depending on not enough young workers. ungodly low raters allowed the Japanese govt. to spend the past 15 years priming the pump to the point where all that Japanese "savings" we hear so much about is now probably deeper underwater than the typical spendthrift American's negative savings account.

Black
08-31-07, 03:50 PM
Greetings ...newbie first post.

Looking at the news today suggests some sort of rate drop but as I understand it here one should look to a larger amount of deflationary MSM 'noise' to get a real idea of this?

I'm imagining this inflation would be a short term occurrence with either a return to the mean or into deflation?

(Bigger the noise the bigger the interest drop? Should one be watching Cramer for massive body twitches etc?:))

c1ue
08-31-07, 05:14 PM
I'm imagining this inflation would be a short term occurrence with either a return to the mean or into deflation?

The jury is of course still out - but I personally am a big believer in mean reversion: all of the housing price gains and inflation controls experienced in the past 10 years will be returned.

Thus inflation will not be a short term phenomenon; 10+ years of offshoring reducing prices here will be returned by a similar time duration multiplied by increased inflation.

Note that while housing prices didn't cause inflation to rise when house prices went up, neither will a housing price decline affect inflation in reverse.

Note that housing prices in the future will be a function of inflation as well...

Contemptuous
08-31-07, 05:22 PM
China to begin exporting a nascent inflation back out to the world? That trend could be a very big deal - first and foremost for America.

Welcome back C1ue.

Finster
09-01-07, 02:31 PM
Question For EJ

In another thread, (Fed Cuts Discount Rate - Post 15 (http://www.itulip.com/forums/newreply.php?do=newreply&p=14159)), you stated:


The 1987 type event I warned July 25 is coming does not happen until the market participants lose confidence in the ability of central banks to control events. Typically this happens some time after several of the kinds of Fed interventions that we saw today in a 50 basis point discount rate cut. If a major revelation follows soon after, then market participants start to wonder if there is a bottom at all. That's when the shit really hits the fan. Now there's still hope, and as long as their is hope there will be high volatility but no 1,000+ crash days. But those days are coming.

Later you commented in the opening post above as follows:




The lesson the Fed learned from the Japanese experience is: once debt deflation forces are in play, don't delay cutting rates. In a credit contraction, disinflation can get away from you quickly, driving up real rates of interest and shutting down the money creation machinery. Keep inflation above zero at all costs.

The paradox is that to prevent the recession that can develop into a run-away debt deflation, the Fed needs to cut early and often, but to avoid crashing the bond market and dollar, the Fed has to wait until it sees the whites of bond and currency traders' eyes. Timing, wording, and execution will be critical. And the bond market might get it wrong, too.



My question is whether your comments here relate to alternative scenarios or the same one. That is, do you foresee that this 1987'-type event comes even if the Fed does indeed "cut early and often"? The first quote forecasts that the Fed intervenes aggressively, it "hits the fan" anyway, hope is lost, and the stock market crashes. The second quote urges the Fed to intervene aggressively, suggesting that by such action dire consequences might be avoided. Does the second comment modify the first, or merely contemplate that 1987' still happens but that even greater consequences would be averted by aggressive Fed easing?

Rajiv
09-01-07, 03:08 PM
Question For EJ
. Does the second comment modify the first, or merely contemplate that 1987' still happens but that even greater consequences would be averted by aggressive Fed easing?

I am not EJ, but my impression on reading the entire thread was that it appears that the Fed is between the proverbial "Rock and a Hard Place" and the question really is whether it can find any cracks to squeeze though -- and that is yet to be determined. If I look at Hudson's theories, and also look at the state of leveraged debt -- I do not see any way out other than stagflation.

c1ue
09-01-07, 05:14 PM
Welcome back C1ue.

Lukester,

Did you miss me? Or did my admitting to buying a big pile of GLD put me on your posse? ;)

c1ue
09-01-07, 05:28 PM
My question is whether your comments here relate to alternative scenarios or the same one. That is, do you foresee that this 1987'-type event comes even if the Fed does indeed "cut early and often"? The first quote forecasts that the Fed intervenes aggressively, it "hits the fan" anyway, hope is lost, and the stock market crashes. The second quote urges the Fed to intervene aggressively, suggesting that by such action dire consequences might be avoided. Does the second comment modify the first, or merely contemplate that 1987' still happens but that even greater consequences would be averted by aggressive Fed easing?

Finster,

I can't speak for EJ, but it seems to me that the statements are pretty clear:

1) The worst won't come until the Fed (and all other 'saviors') lose credibility. At this point I think only the Fed has it; the government does not, nor do the banks/hedgies/PE etc.

2) The Fed knows it must cut early and often; dragging this out just results in Post-Japan

3) However, unlike Japan the Fed does not have the economic luxury of doing so. The US being a debtor nation and also with an unsound economy would be crushed if the dollar were then punished and US inflation/interest rates rose as a consequence.

The point - which I am perhaps completely off base on - is that the Fed does not have a safe path to proceed on to get out of this mess.

Thus unless Bernanke and Co. pull a Nobel Prize in Financial Engineering out of of their collective ivory throne seats, we're all in the pot.

The most likely outcome is thus a series of timid moves - none of which betray the Fed's weakness - all of which don't do squat in the market.

This will then be followed by the 'what the heck, we might as well cut anyway' capitulation which will do no good.

Then all heck breaks loose!

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Finster
09-01-07, 05:48 PM
I am not EJ, but my impression on reading the entire thread was that it appears that the Fed is between the proverbial "Rock and a Hard Place" and the question really is whether it can find any cracks to squeeze though -- and that is yet to be determined. If I look at Hudson's theories, and also look at the state of leveraged debt -- I do not see any way out other than stagflation.


Finster,

I can't speak for EJ, but it seems to me that the statements are pretty clear:

1) The worst won't come until the Fed (and all other 'saviors') lose credibility. At this point I think only the Fed has it; the government does not, nor do the banks/hedgies/PE etc.

2) The Fed knows it must cut early and often; dragging this out just results in Post-Japan

3) However, unlike Japan the Fed does not have the economic luxury of doing so. The US being a debtor nation and also with an unsound economy would be crushed if the dollar were then punished and US inflation/interest rates rose as a consequence.

The point - which I am perhaps completely off base on - is that the Fed does not have a safe path to proceed on to get out of this mess.

Thus unless Bernanke and Co. pull a Nobel Prize in Financial Engineering out of of their collective ivory throne seats, we're all in the pot.

The most likely outcome is thus a series of timid moves - none of which betray the Fed's weakness - all of which don't do squat in the market.

This will then be followed by the 'what the heck, we might as well cut anyway' capitulation which will do no good.

Then all heck breaks loose!

:eek:

Thanks, guys. I pretty much got that. Guess it was my question that wasn’t so clear. I was trying to get clarification on whether his call for the 1987' event is altered by whether the Fed follows his prescription for aggressive easing.

Rajiv
09-01-07, 07:01 PM
Here is what happened in Agentina -- that is not what I am suggesting will happen here, but the Argentinian case is worth reexamining.

From Argentina 2002 (http://www.sonic.net/~schuelke/Argentina_2002.html)



http://www.sonic.net/~schuelke/ArgentinaCover.JPG
"Don't Cry For Me Argentina" (from Andrew Lloyd Webber's Evita) was a big hit song around the world in the late 1970s. This year the world is lamenting Argentina's economic woes. The country is currently on course to set a record for the largest number of people to lose the most wealth in the shortest period of time. Argentina is surely an economy to cry for.

Unemployment in Argentina has climbed to 25%. The real GDP is projected to decline this year by approximately 10-15%, the largest single-year decline on record and following three consecutive years of recession that began in 1999. After nearly a decade of relatively stable prices, inflation is currently in triple digits. In April the IMF tentatively estimated that prices would increase by 30% or more this year. However, month-to-month prices jumped by 10% in April alone. If prices were to continue to escalate at that monthly rate for twelve consecutive months, then the annual rate of inflation would exceed 200%! Currency markets have already factored in April's inflation rate, and the floating peso has fallen to about $0.27 from the 1 peso = 1 dollar parity that Argentina managed to fix throughout most of the 1990s. Argentina's MERVAL stock market index has declined by nearly 75% since the end of last year. Measures of macroeconomic activity for a semi-industrialised economy rich in natural and human resources don't get much worse than these.

Like the Great Depression of the 1930s, the stagflation of the 1970s, and the economic implosion of the former Soviet Union in the 1990s, Argentina's economic collapse should remind us all of how fragile economic systems really are and how important it is to have sound economic institutions in place and effectual corrective policy on stand-by when things start to go wrong. The consequences of a dire economic performance have devastating and long lasting negative psychological effects on those persons who suffer and endure the hard times. Individual confidence is shattered, and hope is overwhelmed by despair. Fear and uncertainty paralyze the economy. Practical solutions get lost in a deluge of ideological polemic while the economy continues to flounder. Years, if not decades, of economic stagnation can pass by before confidence, stability and growth are eventually restored. This, it would appear, is Argentina's fate.
.
.
It was in 1999 that Argentina's economy turned "bad." Real GDP fell by 3.4%. Unemployment began to rise. Stock prices began to fall. Hopes for a quick recovery were dashed when the economy declined by nearly 1% again in 2000. The year 2001 was even worse when the economy recorded another 3.7% decline in real GDP. By this time, Argentina had become bogged down in an "L" shaped recession. There are several explanations for Argentina's downward slide. Most explanations focus on a series of adverse external shocks including a decline in international commodity prices, the rising cost of of capital for emerging market economies, the Brazilian real devaluation, an overvalued peso pegged to an appreciating US dollar, and higher interest rates caused by a restrictive monetary policy in the United States. Argentina's currency board system and commitment to a fixed exchange rate made it virtually impossible for monetary authorities to respond to these shocks.

This is where the proverbial rock and a hard place comes for the US. US is in a similar bind to Argentina. I don't think the "Helicopter Trick" will work -- Too much of the manufacturing infrastructure has been off-shored - and it will take a generation to rebuild.

My guess is that the situation will be similar to Argentina - but with very few options left until the infrastructure can be rebuilt. The big question in this will be -- can the US shift to a low volume oil economy while doing it - relying only on North American Petroleum resources. I am assuming that Mexican and Canadian economies are too intertwined with the US economy to be separable. If Canada or Mexico bailout, things will be extremely tough!

Rajiv
09-01-07, 07:16 PM
state of leveraged debt

See Rating Agencies : The Monopoly Of The "three Usa Sisters" (http://www.itulip.com/forums/showthread.php?t=1944)

jk
09-01-07, 11:06 PM
it is no longer as clear to me as it once was that cutting rates will tank the dollar. the ecb has backed off its hawkish stance as sarkozy et al are crying out about the difficulties of living with a strong euro. japanese rates remain very low, and the chinese are taking their own sweet time in allowing the renminbi to rise. coordinated cuts by cbs around the globe might be in store. all currencies will decline together against real goods, and the dollar might not look particularly bad, relatively to other fiat currencies. gold would do well in this scenario.

jimmygu3
09-02-07, 12:09 AM
Coming off the housing bubble, the Fed is worried about the US experiencing a flavor of runaway debt deflation such as Japan suffered after their real estate bubble collapsed starting in 1992. Preparedness for that eventuality was the gist of Bernanke's now famous helicopter money speech in November 2002 (http://www.federalreserve.gov/boardDocs/speeches/2002/20021121/default.htm), two and a half years before the housing bubble peaked.

I must admit, I just read the full text of that speech, and I would encourage anyone who hasn't to do so. In context, the helicopter line is not such a big deal in my opinion. He's simply saying that a money-financed tax cut is a way to get dollars directly to Americans as an extreme method of combating deflation, provided that rate cuts are ineffective and rates are approaching zero. What's so bad about that?




What I was a bit shocked to read was Bernanke's footnote regarding inflation measurements and price indexes.
6. Several studies have concluded that the measured rate of inflation overstates the "true" rate of inflation, because of several biases in standard price indexes that are difficult to eliminate in practice. The upward bias in the measurement of true inflation is another reason to aim for a measured inflation rate above zero.Does he really think the rigged CPI overstates inflation?!? What are these "studies" to which he refers?

Jimmy

zoog
09-02-07, 03:34 AM
As well prepared as the Fed appears to be theoretically to handle the current crisis, helicopters and all, the conditions for applying the cure this time for this purpose are far more challenging than in 2001 and 2002 when they were conceived. ... The paradox is that to prevent the recession that can develop into a run-away debt deflation, the Fed needs to cut early and often, but to avoid crashing the bond market and dollar, the Fed has to wait until it sees the whites of bond and currency traders' eyes. Timing, wording, and execution will be critical. And the bond market might get it wrong, too. ... When, not if, the US goes into recession in Q4 this year as unemployment begins to rise, the housing market will take its next and more serious turn down. As inflation falls toward negative rates the Fed will cut drastically. But if they wait that long, the Japanese experience is that the moves will then be too late.

According to a Marketwatch report (http://www.marketwatch.com/news/story/view-hazy-gloomy-jackson-hole/story.aspx?guid=%7B7AFF0319%2DC87B%2D4233%2DBFE0%2 DA5CD9943AD5B%7D&dist=MostReadHome), it sounds like a rate cut in September is likely.


Most of the economists at Jackson Hole believe that a rate cut by the Fed is a foregone conclusion unless there is a dramatic turnaround in the economy before the Federal Open Market Committee meeting on Sept. 18.

Influential economist Martin Feldstein told the Jackson Hole forum that the Federal Open Market Committee should lower the federal funds rate by as much as a percentage point.Hatzius of Goldman Sachs said that his expectations of a rate cut later this month "were cemented" by Friday's speech by Fed Chairman Ben Bernanke. He would not rule out a half a percentage-point cut in September.

...

In effect, Mussa said, Bernanke "has promised a rate cut on Sept. 18 unless the problems in the credit market miraculously disappear." ...

Mickey Levy, chief economist at Bank of America Corp. ... "I am virtually certain [the Fed] will ease on Sept. 18," Levy said, adding that the move would be enough to keep the economy from going into recession.

...

Overall, Hatzius has forecast three-quarters of a percentage point in rate cuts by the end of 2007.They are also talking about recession being increasingly likely...


Hatzius agreed there was a "significant risk" of recession, putting the odds at one in three.

...

Gramley, the former Fed governor, said that the odds of a recession are somewhere between 33% to 50%. "This is a severe problem which will have to be dealt with," he said.Furthermore, as I believe EJ and others have surmised, the Fed may be ill-prepared to handle the current situation.


David Hale, an economist and a regular at the Jackson Hole conference, called the current environment "a crisis of information."

...

The hard data on the impact of the credit crunch and market turmoil on the U.S. economy is also a few months away. The third quarter was almost half over when the crisis erupted.


Economists at BNP Paribas wrote in a research note that it "will be months" before the impact shows up in unemployment data.


The tightening of financial markets is likely to have a negative impact on GDP, especially in the fourth quarter. Fourth-quarter GDP data won't be released until January 2008.


In the meantime, Fed officials "will have to play it by ear," said Michael Mussa, formerly chief economist for the International Monetary Fund.

GRG55
09-02-07, 05:02 AM
...My guess is that the situation will be similar to Argentina - but with very few options left until the infrastructure can be rebuilt. The big question in this will be -- can the US shift to a low volume oil economy while doing it - relying only on North American Petroleum resources. I am assuming that Mexican and Canadian economies are too intertwined with the US economy to be separable. If Canada or Mexico bailout, things will be extremely tough!

By dint of shared history, and geography, Canada has a high dependence on US markets that long pre-dates NAFTA. Canada is unable to insulate itself from the side effects of US economic contractions. The vocal minority of Canadians that advocate Canada restrict energy exports, if necessary, fail to recognize it would only greatly compound the damage. These are the same people that would hoard the food on a desert island for themselves, letting all others starve. They end up well fed. And alone.

I interpret the (heavily criticised) tripartite SPP initiative as recognition of this reality at the highest political levels.

GRG55
09-02-07, 05:38 AM
Thanks, guys. I pretty much got that. Guess it was my question that wasn’t so clear. I was trying to get clarification on whether his call for the 1987' event is altered by whether the Fed follows his prescription for aggressive easing.

Good question. Look forward to EJ's clarification.

One thought: Bernanke's Jackson Hole speech included "The Committee continues to monitor the situation and will act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets."

Seems the Fed still views their responsibility as "standing by ready to clean up the mess". If so, isn't any pre-emptive Funds rate cut (before a significant equity market decline) inconsistent, and therefore unlikely? :confused:

jk
09-02-07, 08:52 AM
Good question. Look forward to EJ's clarification.

One thought: Bernanke's Jackson Hole speech included "The Committee continues to monitor the situation and will act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets."

Seems the Fed still views their responsibility as "standing by ready to clean up the mess". If so, isn't any pre-emptive Funds rate cut (before a significant equity market decline) inconsistent, and therefore unlikely? :confused:

it's not inconsistent if they think someone's already made a mess.

Rajiv
09-02-07, 10:35 AM
To me that would result in a worldwide stagflationary trend -- one that cannot be sustained - because an exponetial rise in currency supply at some time becomes impossible to accomplish

zoog
09-02-07, 11:48 AM
What I was a bit shocked to read was Bernanke's footnote regarding inflation measurements and price indexes.
6. Several studies have concluded that the measured rate of inflation overstates the "true" rate of inflation, because of several biases in standard price indexes that are difficult to eliminate in practice. The upward bias in the measurement of true inflation is another reason to aim for a measured inflation rate above zero.Does he really think the rigged CPI understates inflation?!? What are these "studies" to which he refers?

Jimmy

I think you meant to say "Does he really think the rigged CPI overstates inflation?"

Probably the Boskin Commission (http://en.wikipedia.org/wiki/Boskin_Commission) report in 1996. Greenspan was claiming the CPI overstated inflation by around 1% back in 1994. So Bernanke is just repeating the party line. The Boskin recommendations resulted in further tampering with the CPI calculations, skewing them even further from reality, which is, of course, higher inflation than reported. I'm sure Bart could give you a more detailed answer.;)

WDCRob
09-02-07, 12:23 PM
it is no longer as clear to me as it once was that cutting rates will tank the dollar. the ecb has backed off its hawkish stance as sarkozy et al are crying out about the difficulties of living with a strong euro. japanese rates remain very low, and the chinese are taking their own sweet time in allowing the renminbi to rise. coordinated cuts by cbs around the globe might be in store. all currencies will decline together against real goods, and the dollar might not look particularly bad, relatively to other fiat currencies. gold would do well in this scenario.

JK, I never remember the titles of these things, but I'm pretty sure EJ said exactly that in his 'Gresham's Law' post last year. If CBs coordinate gold does well against all currencies. If they don't gold does well vs the dollar. Either way if you're in dollars gold is good.

But what happens when all rates are so low that there's no significant differential between rates in Japan and the US? Does that force a revaluing and a relative decline by the dollar?

Finster
09-02-07, 12:38 PM
Good question. Look forward to EJ's clarification.

One thought: Bernanke's Jackson Hole speech included "The Committee continues to monitor the situation and will act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets."

Seems the Fed still views their responsibility as "standing by ready to clean up the mess". If so, isn't any pre-emptive Funds rate cut (before a significant equity market decline) inconsistent, and therefore unlikely? :confused:

Strictly speaking, one can infer that EJ's 1987' scenario would stand intact even after aggressive Fed easing, because that was assumed in his original framing of it - that 1987' would occur after it became apparent that the Fed's machinations were impotent. So presumably 1987' happens regardless, and the aggressive Fed easing would instead act to stave off a subsequent multi-year Japanese-style deflationary mire. On the other hand, it's so widely assumed that Fed cuts would boost the stock market (the market has been rallying as Treasury and Fed funds price in expected easing), and the view EJ states above does not refer to the earlier 1987' outlook. And don't forget we have an avowed deflation-fighting printing-press-armed Fed chairman and a chief executive in the helicoper cockpit, so it's hard to imagine that even if deflation got rolling that it could not be reversed even if the Fed waited for clear evidence of "real economy" spillover before acting.

Finster
09-02-07, 01:12 PM
I must admit, I just read the full text of that speech, and I would encourage anyone who hasn't to do so. In context, the helicopter line is not such a big deal in my opinion. He's simply saying that a money-financed tax cut is a way to get dollars directly to Americans as an extreme method of combating deflation, provided that rate cuts are ineffective and rates are approaching zero. What's so bad about that?

What I was a bit shocked to read was Bernanke's footnote regarding inflation measurements and price indexes.
6. Several studies have concluded that the measured rate of inflation overstates the "true" rate of inflation, because of several biases in standard price indexes that are difficult to eliminate in practice. The upward bias in the measurement of true inflation is another reason to aim for a measured inflation rate above zero.
Does he really think the rigged CPI understates inflation?!? What are these "studies" to which he refers?

Jimmy

This is the one thing that truly worries me about Bernanke. If you just look at the way the Bernanke Fed has conducted itself, you have to give him pretty high marks. But his apparent endorsement of the notion that the CPI overstates inflation has to make you wonder what he's been smoking.

First the "headline" CPI omits a lot of inflation, mostly through its use of so-called "Owner’s Equivalent Rent", as Tim Iacono points out in his Seeking Alpha article (http://www.seekingalpha.com/article/45720-how-owner-s-equivalent-rent-duped-the-fed) "How Owner's Equivalent Rent Duped the Fed".

To make matters even worse, he is fond of taking it yet a step further and focusing on so-called "core" inflation stats. Barry Ritholtz remarks in a recent article (http://seekingalpha.com/article/38505-a-tale-of-2-inflation-rates) on Seeking Alpha: "The risk of focusing on the core is that Fed risks losing credibility in the eyes of the public. Future inflation expectations are not nearly as muted as the Fed's benign core rate."

You got that right! A Fed that persists in pretending inflation is much lower than we know it to be out here in the real world simply cannot be credible.

Cover Up Those Signs! The Problem With Gasoline Prices and "Reported Inflation"
(http://seekingalpha.com/article/18961-cover-up-those-signs-the-problem-with-gasoline-prices-and-reported-inflation)

zoog
09-02-07, 01:50 PM
Barry Ritholtz remarks in a recent article (http://seekingalpha.com/article/38505-a-tale-of-2-inflation-rates) on Seeking Alpha: "The risk of focusing on the core is that Fed risks losing credibility in the eyes of the public. Future inflation expectations are not nearly as muted as the Fed's benign core rate."

You got that right! A Fed that persists in pretending inflation is much lower than we know it to be out here in the real world simply cannot be credible.

And then presumably that eventually leads to, or at least ties into, this:


The 1987 type event I warned July 25 is coming does not happen until the market participants lose confidence in the ability of central banks to control events. Typically this happens some time after several of the kinds of Fed interventions that we saw today in a 50 basis point discount rate cut. If a major revelation follows soon after, then market participants start to wonder if there is a bottom at all.

c1ue
09-02-07, 03:35 PM
it is no longer as clear to me as it once was that cutting rates will tank the dollar. the ecb has backed off its hawkish stance as sarkozy et al are crying out about the difficulties of living with a strong euro. japanese rates remain very low, and the chinese are taking their own sweet time in allowing the renminbi to rise. coordinated cuts by cbs around the globe might be in store. all currencies will decline together against real goods, and the dollar might not look particularly bad, relatively to other fiat currencies. gold would do well in this scenario.

JK,

I agree that the dollar as a ratio to Euro, yen, or other currencies could possible be fairly stable.

However, I have never looked at this ratio as my primary cause for concern.

Rather, what I fear mightily is the purchasing power reduction of the dollar.

It is possible that although the dollar stays stable, that PPP drops dramatically just for the dollar.

My rationale is as for internal China: In the days when there were both 'internal' and 'foreign exchange' RMB, things like washing machines could only be bought with 'foreign exchange' RMB. Although theoretically the 2 currencies were equal, in reality you could by 6x 'internal' RMB (iRMB) vs. each 'foreign exchange' RMB (feRMB). But, of course, there was basically zero reverse trade (iRMB to feRMB) conducted by internal Chinese.

My fears are thusly:

1) Dollar depreciation - this is the most straightforward and perhaps best result: we get our inflation quick, but the incentives for internal manufacturing and labor employment are immediate. Interest rates go up somewhat but are kept from being too high by our government printing credit. This is due to foreigners not wanting to lend credit which will depreciated.

2) Dollar PPP depreciation - looks good, screws the economy really bad. We get the combo punch of inflation without internal economy compensation. Interest rates go up higher than 1) as this is a mild form of dollar repudiation.

3) Dollar repudiation - officially the exchange rates look good. But no one wants dollars. I call this the 'Ebay effect': in the past all transactions by foreign sellers were in dollars. These days it is all in AUS$ and GBp. Basically if you aren't exchanging a physical good, you won't get any foreign currency for it. Not an immediate effect as the rest of the world engages in dollar dumping, but once the dollars outside of the US run out...it gets bad.

Time for FAST kits...

All of these scenarios are based on my view that the US economy has basically sold out almost all physical value creation in favor of financial engineering. Thus even coordinated cuts around the world will affect the least healthy economies disproportionately. Would that be Europe? Russia? China? Brazil? I think not.

c1ue
09-02-07, 03:42 PM
But what happens when all rates are so low that there's no significant differential between rates in Japan and the US? Does that force a revaluing and a relative decline by the dollar?

Iinterest rates are set by the government, but trade flows are a function of the economy.

Japan's economy is much healthier than the US in terms of trade/currency account surplus.

Even with both countries at zero interest, Japan will be fine as they are exporting and bringing in foreign currency to offset their imports. Japan doesn't need high interest rates to attract new loans despite their fiscal indebtedness.

The US needs to import a lot, and has only its own crap currency - not to mention pay interest on the money already owed.

Thus in this scenario the interest rates are only a factor in the performance of the dollar. Ultimately the underlying economies will put pressure on currencies to conform to 'ideal' levels.

As mentioned before, Japan is looking to the US as a military balance point vs. China - they are happy to continue their part of the partnership so long as the US can maintain its military power.

However, the Japanese cannot offset 2.5x as many Americans with bad habits - especially given roughly par per capita wages.

GRG55
09-02-07, 04:00 PM
it's not inconsistent if they think someone's already made a mess.

Perhaps. But does the Fed think the mess already visible is the one THEY are supposed to clean up? It would seem not based on this from Bernanke's Jackson Hole speech: "...the further tightening of credit conditions, if sustained, would increase the risk that the current weakness in housing could be deeper or more prolonged than previously expected, with possible adverse effects on consumer spending and the economy more generally."


Strictly speaking, one can infer that EJ's 1987' scenario would stand intact even after aggressive Fed easing, because that was assumed in his original framing of it - that 1987' would occur after it became apparent that the Fed's machinations were impotent. So presumably 1987' happens regardless, and the aggressive Fed easing would instead act to stave off a subsequent multi-year Japanese-style deflationary mire. On the other hand, it's so widely assumed that Fed cuts would boost the stock market (the market has been rallying as Treasury and Fed funds price in expected easing), and the view EJ states above does not refer to the earlier 1987' outlook. And don't forget we have an avowed deflation-fighting printing-press-armed Fed chairman and a chief executive in the helicoper cockpit, so it's hard to imagine that even if deflation got rolling that it could not be reversed even if the Fed waited for clear evidence of "real economy" spillover before acting.

Good point about the market pricing in a Fed cut, but as long as that expectation is maintained doesn't it allow them to defer an actual cut? Does anybody know if the Fed has EVER pre-emptively cut the Funds rate prior to an equity market dislocation? The Fed claims not to be able see asset bubbles; a potential equity market crash would seem even more difficult for them to detect.

In addition to "the market will rally on a Fed cut", there appears an overwhelming consensus that Bernanke can hardly wait to use his rotary wing pilot licence. I am suspicious when opinions become so widely fashionable. The potential the Bernanke Fed may deliberately try to engineer a sharp, short deflationary shock can't be entirely dismissed IMHO. $50 oil and $500 gold (or less!) is not inconceivable in that circumstance. Very few would be expecting that.

Finster
09-03-07, 10:45 AM
Perhaps. But does the Fed think the mess already visible is the one THEY are supposed to clean up? It would seem not based on this from Bernanke's Jackson Hole speech: "...the further tightening of credit conditions, if sustained, would increase the risk that the current weakness in housing could be deeper or more prolonged than previously expected, with possible adverse effects on consumer spending and the economy more generally."

This may be because the Fed knows the mess is one of its own creation. I’d love to hear Bernanke admit that; just come out and say he realizes that it remained (mostly under Greenspan) tooo accommodative tooo long in 2004-2006. Both in keeping Fed funds too low too long and in being too predictable (euphemism: "transparent") in bringing them back up, thus encouraging the very speculation, housing bubble, and - most of all - credit bubble that threatens the financial system and economy now. Such an admission would be very encouraging to hear because it would allow the Fed to pursue its cleanup effort more vigorously without creating as much fear that it will yet again commit a similar error in doing so.

But we’re not holding our breath …


Good point about the market pricing in a Fed cut, but as long as that expectation is maintained doesn't it allow them to defer an actual cut? Does anybody know if the Fed has EVER pre-emptively cut the Funds rate prior to an equity market dislocation? The Fed claims not to be able see asset bubbles; a potential equity market crash would seem even more difficult for them to detect.

I think so, GRG55. In taking down Treasury yields across the yield curve (most conspicuously on the short end) the market has already cut interest rates (except for uncreditworthy borrowers). By cutting Fed funds, the Fed would merely be following and validating expectations. The next part is impossibly circular to fully answer. For if the Fed cut rates in advance of an equity market dislocation in an effort to prevent the dislocation, and if it were successful in doing so, there would be no dislocation with which to compare the preemptive action. Only an unsuccessful attempt would show up in the record.


In addition to "the market will rally on a Fed cut", there appears an overwhelming consensus that Bernanke can hardly wait to use his rotary wing pilot licence. I am suspicious when opinions become so widely fashionable. The potential the Bernanke Fed may deliberately try to engineer a sharp, short deflationary shock can't be entirely dismissed IMHO. $50 oil and $500 gold (or less!) is not inconceivable in that circumstance. Very few would be expecting that.

I don’t think it was deliberate, since the Fed obviously would have preferred a gradual adjustment, but we have already had at least one "sharp, short deflationary shock". Another such event would IMO be even less deliberate! But that doesn’t mean we won’t get one. Or two or more. But this is an inherent problem in allowing speculative credit excess to build up in the first place. Despite the Fed’s baby-step gradualism and "transparency" in trying to gradually reign in the excess, it just kept building until it collapsed of its own weight. That’s the way real markets work. As suggested above, the slow pace and predictability of the Fed’s "removal of accommodation" merely served to embolden speculation. If it had chosen instead to throw in a couple ad hoc inter-meeting 50 bp hikes back in 2005- 2006, it could have let off some of the steam before it blew out the boiler.

But as you suggest, whether we see $50 oil and $500 gold is very much in the Fed’s hands. Remember it has been on an avowed inflation-fighting mission. This latest market event is the first tangible evidence of success. If it is as gradual and "transparent" in cutting rates as it was in raising them, then it will have won that fight and we could well see your $50 oil and $500 gold. But that would also mean a genuine consumer-led recession. If instead it is determined to try and prevent such recession, then we will not likely see a five-handle on either one ever again.

Unless it’s with another zero at the end…

jk
09-03-07, 11:41 AM
In taking down Treasury yields across the yield curve (most conspicuously on the short end) the market has already cut interest rates (except for uncreditworthy borrowers). By cutting Fed funds, the Fed would merely be following and validating expectations.
treasury yields are low because of a flight to safety. meanwhile credit to borrowers other than the government is less available across the board.


"...the further tightening of credit conditions, if sustained, would increase the risk that the current weakness in housing could be deeper or more prolonged than previously expected, with possible adverse effects on consumer spending and the economy more generally."
credit tightens in 2 different ways. one is by raising the rate, the other is by restricting availability irrespective of rate via higher underwriting standards. thus even a lowered fed policy rate may not succeed in loosening credit conditions. in fact, credit will likely continue to constrict irrespective of cb action. the market has been reminded of the existence of risk, and this repricing of risk is a process that will go on for some time.

Finster
09-03-07, 12:38 PM
treasury yields are low because of a flight to safety. meanwhile credit to borrowers other than the government is less available across the board.

Nothing I said implies otherwise. Risk-free interest rates fell. But don't forget that credit spreads (rate differentials) between risk-free Treasuries and junk were notoriously, abnormally, low for a long time prior to this latest adjustment. It would be a little misleading to refer to a return to normalcy as a "flight to safety".

We had some fleeting overshoot that we could call the latter, but for the time being things have settled into a tentative equilibrium.


credit tightens in 2 different ways. one is by raising the rate, the other is by restricting availability irrespective of rate via higher underwriting standards. thus even a lowered fed policy rate may not succeed in loosening credit conditions. in fact, credit will likely continue to constrict irrespective of cb action. the market has been reminded of the existence of risk, and this repricing of risk is a process that will go on for some time.

Again, we have the phenomenon of abnormally loose credit returning to a more normal state. If we were to call lack of credit availability for uncreditworthy borrowers "tight" credit conditions, we may as well stand atop Everest and call the entire rest of the world a valley.

Nevertheless, we arrive at similar conclusions if by different routes. A lower Fed policy rate will not magically result in E-Z credit for the insolvent. At the margin, however, it will make credit within the quality spectrum a little more competitive with risk-free credit, and all else being equal, make it a little cheaper than it would otherwise be. The markets would not long tolerate a differential between Treasuries yielding 1% - 3% and lower-investment-grade credit at 7-9%, no more than they were able to sustain the microscopic differentials they sported barely weeks ago.

Chris Coles
09-03-07, 12:49 PM
credit tightens in 2 different ways. one is by raising the rate, the other is by restricting availability irrespective of rate via higher underwriting standards. [/size][/font][/font]

JK,

you have missed the third and, perhaps the most important reason for a tightening credit spiral, fear. I well remember during 1992 here in the UK that National Westminster Bank was paying big fat bonuses to their staff for the amount of funds they could get back by calling in overdrafts and had put a complete stop on sale of any loans to anyone.

Fear of a complete collapse and thus that, as the collapse spiralled downwards, their own fundamentals for the underlying capitalisation of the bank was driving total fear.

It is fear of what will happen if the collapse continues that has the most dramatic effect upon access to credit. A bank profits from the sale of loans, yes, but survives disaster by calling in everything it can lay its hands on when times get rough.

WDCRob
09-03-07, 01:12 PM
Iinterest rates are set by the government, but trade flows are a function of the economy.

Japan's economy is much healthier than the US in terms of trade/currency account surplus.

Even with both countries at zero interest, Japan will be fine as they are exporting and bringing in foreign currency to offset their imports. Japan doesn't need high interest rates to attract new loans despite their fiscal indebtedness.

The US needs to import a lot, and has only its own crap currency - not to mention pay interest on the money already owed.

Thus in this scenario the interest rates are only a factor in the performance of the dollar. Ultimately the underlying economies will put pressure on currencies to conform to 'ideal' levels.

As mentioned before, Japan is looking to the US as a military balance point vs. China - they are happy to continue their part of the partnership so long as the US can maintain its military power.

However, the Japanese cannot offset 2.5x as many Americans with bad habits - especially given roughly par per capita wages.

Thanks C1ue.

jk
09-03-07, 02:11 PM
Nothing I said implies otherwise. Risk-free interest rates fell. But don't forget that credit spreads (rate differentials) between risk-free Treasuries and junk were notoriously, abnormally, low for a long time prior to this latest adjustment. It would be a little misleading to refer to a return to normalcy as a "flight to safety".

We had some fleeting overshoot that we could call the latter, but for the time being things have settled into a tentative equilibrium.

with fed funds at 5.25, lower than inflation [in my books], normalization required all rates going up, with longer rates going up more. what happened mostly is that short riskless rates dropped sharply, while long risky rates went up only a bit. and whatever the absolute level of rates, spreads are still too low, reflecting a continued underpricing of risk.




Again, we have the phenomenon of abnormally loose credit returning to a more normal state. If we were to call lack of credit availability for uncreditworthy borrowers "tight" credit conditions, we may as well stand atop Everest and call the entire rest of the world a valley.

i am not privy to details on the credit markets, but the impression i receive from my readings is that credit is tight even for traditionally creditworthy borrowers. i suspect we are heading into an overshoot.

i also suspect that there is value in some of the debt instruments that are currently unmarketable. one real underlying problem is the lack of transparency in these instruments. the abcp market is evaporating rapidly, for instance, because people don't know how to value the underlying collateral. that doesn't mean the collateral is worthless. so this [abcp unmarketability] is already an element of overshoot.

i realize that the last remark appears to contradict my assertion that spreads are too low. the variability of risk pricing is what is striking. i think the generic junk bond market is still underpricing risk, while there are pockets in which risk is being priced at infinity and more exotic paper can't be sold at all. these disparities will be resolved, i guess, by risk being priced into junk, not by risk being priced out of exotic junk.

Contemptuous
09-03-07, 02:47 PM
JK wrote:

<< with fed funds at 5.25, lower than inflation [in my books], normalization required all rates going up, with longer rates going up more. what happened mostly is that short riskless rates dropped sharply, while long risky rates went up only a bit. and whatever the absolute level of rates, spreads are still too low, reflecting a continued underpricing of risk. >>

Bob Hoye [ Institutional Advisers ] in a Sept. 1st article is reiterating long rates are indeed due to rise soon ( is an inflationary acknowledgement by the long bond to be read as the definitive word on the direction of future inflation? ).

http://www.safehaven.com/article-8319.htm

I think I understand, he is further observing that changes in the yield curve within a < credit crunch > - can indeed be with an inflationary bias - with a steepening yield curve scenario, with plunging short rates being the first symptom of credit contraction (already seen). He says we'll also soon see rising long term rates (hence steepening a good bit further).

Meanwhile Prechter is sounding more apocalyptic on the "cusp of deflation" each passing week. For one to be right, the other must be wrong?

jk
09-03-07, 03:06 PM
JK wrote:

<< with fed funds at 5.25, lower than inflation [in my books], normalization required all rates going up, with longer rates going up more. what happened mostly is that short riskless rates dropped sharply, while long risky rates went up only a bit. and whatever the absolute level of rates, spreads are still too low, reflecting a continued underpricing of risk. >>

Bob Hoye [ Institutional Advisers ] in a Sept. 1st article is reiterating long rates are indeed due to rise soon ( is an inflationary acknowledgement by the long bond to be read as the definitive word on the direction of future inflation? ).

http://www.safehaven.com/article-8319.htm

I think I understand, he is further observing that changes in the yield curve within a < credit crunch > - can indeed be with an inflationary bias - with a steepening yield curve scenario, with plunging short rates being the first symptom of credit contraction (already seen). He says we'll also soon see rising long term rates (hence steepening a good bit further).

Meanwhile Prechter is sounding more apocalyptic on the "cusp of deflation" each passing week. For one to be right, the other must be wrong?

lucumone,

prechter has been calling for deflation since at least 1987. i suppose it is possible that at some point he will be right. hoye isn't really clear [in the article you link] why he thinks long rates are going to go up, but long tbonds must embody the pure time cost of money, and thus expectations of future inflation. so i don't see how they can both be right, unless you have a deflation we're on the cusp of, which nonethess brings with it inflationary expectations. i.e. ka-poom. [though "ka" really implies disinflation with deflationary fears, not true deflation.]

Finster
09-03-07, 03:29 PM
with fed funds at 5.25, lower than inflation [in my books], normalization required all rates going up, with longer rates going up more. what happened mostly is that short riskless rates dropped sharply, while long risky rates went up only a bit. and whatever the absolute level of rates, spreads are still too low, reflecting a continued underpricing of risk.

I agree fed funds @ 5.25% was definitely, by far, lower than inflation for most of the past four or so years. But that changed very fast just in the past few weeks. We hit a deflationary cliff. If anything this highlights the non-utility of very slow, lagging inflation indicators favored by conventional econometricians.

The real financial markets, however, respond instantaneously. The new, lower natural level of interest fell through a cataract. So this normalization occurred, but rather than with respect to past inflation, it was with respect to a rapidly moving target.

With a big caveat, of course. The above does not take into account default risk, real or perceived. That is, it is limited to consideration of the risk-free interest rate. So it does not even attempt to address your contention that spreads are "still too low" …


i am not privy to details on the credit markets, but the impression i receive from my readings is that credit is tight even for traditionally creditworthy borrowers. i suspect we are heading into an overshoot.

i also suspect that there is value in some of the debt instruments that are currently unmarketable. one real underlying problem is the lack of transparency in these instruments. the abcp market is evaporating rapidly, for instance, because people don't know how to value the underlying collateral. that doesn't mean the collateral is worthless. so this [abcp unmarketability] is already an element of overshoot.

i realize that the last remark appears to contradict my assertion that spreads are too low. the variability of risk pricing is what is striking. i think the generic junk bond market is still underpricing risk, while there are pockets in which risk is being priced at infinity and more exotic paper can't be sold at all. these disparities will be resolved, i guess, by risk being priced into junk, not by risk being priced out of exotic junk.

This is hard to dispute, given the infamously low degree of transparency in credit exotica. But worse yet, we have the veracity of credit rating agencies having been called into question. That being the case, shouldn’t we view the ratings as the tail and the actual market pricing as the dog? In other words, if the market is pricing a certain issue at X default risk and the rating agencies are assigning it a Y default risk, the market’s opinion is arguably more valid. So we have little concrete basis upon which to criticize spreads as being "too narrow" or "too wide", just armchair arguments. We will only have such basis for arguing whether risk was being mispriced when we can look back with 20-20 hindsight and identify areas that were being priced for default risk where it turned out to be rare and vice versa. Just as we can do now with issues once given AAA blessings!

GRG55
09-03-07, 03:52 PM
This may be because the Fed knows the mess is one of its own creation. I’d love to hear Bernanke admit that; just come out and say he realizes that it remained (mostly under Greenspan) tooo accommodative tooo long in 2004-2006. Both in keeping Fed funds too low too long and in being too predictable (euphemism: "transparent") in bringing them back up, thus encouraging the very speculation, housing bubble, and - most of all - credit bubble that threatens the financial system and economy now. Such an admission would be very encouraging to hear because it would allow the Fed to pursue its cleanup effort more vigorously without creating as much fear that it will yet again commit a similar error in doing so.

But we’re not holding our breath…

Agree. The only time I can recall the Fed admitting any reponsibility for anything was when Bernanke told Milton Friedman, at his birthday party, that the Fed caused the 1930's Depression.



I don’t think it was deliberate, since the Fed obviously would have preferred a gradual adjustment, but we have already had at least one "sharp, short deflationary shock". Another such event would IMO be even less deliberate! But that doesn’t mean we won’t get one. Or two or more. But this is an inherent problem in allowing speculative credit excess to build up in the first place. Despite the Fed’s baby-step gradualism and "transparency" in trying to gradually reign in the excess, it just kept building until it collapsed of its own weight. That’s the way real markets work. As suggested above, the slow pace and predictability of the Fed’s "removal of accommodation" merely served to embolden speculation. If it had chosen instead to throw in a couple ad hoc inter-meeting 50 bp hikes back in 2005- 2006, it could have let off some of the steam before it blew out the boiler.

But as you suggest, whether we see $50 oil and $500 gold is very much in the Fed’s hands. Remember it has been on an avowed inflation-fighting mission. This latest market event is the first tangible evidence of success. If it is as gradual and "transparent" in cutting rates as it was in raising them, then it will have won that fight and we could well see your $50 oil and $500 gold. But that would also mean a genuine consumer-led recession. If instead it is determined to try and prevent such recession, then we will not likely see a five-handle on either one ever again.

Unless it’s with another zero at the end…

I am not saying the Fed WILL deliberately try a sharp, short deflationary shock treatment on the patient; but IMO it's within the range of reasonable possibilities. Recognising it would take Fed courage (not an abundant character trait), in no particular order here's some reasons why they might try such a stunt, prior to the inevitable massive re-flationary actions (critique of the soundness of this line of reasoning welcomed):

period of pain much shorter than the slow drip Japan deflation experience - assuming they don't screw it up;
forces and concentrates the asset devaluation and debt write offs in the most egregiously inflated sectors (structured credit, real estate, finance sector equities);
reduces risk of deflationary bleed-through into other parts of the economy by time-function quarantining the really sick part of the economy (the FIRE economy part);
the more accumulated debt burden that can be euthanized in a deflation event, the less the Fed has to inflate away later, and the greater its future capacity to expand credit to goose the economy without creating excessive inflation;
magic of securitization has stuffed every foreign pocket with US asset backed credit risk; Volker once pointed out that the Fed is not responsible for the effect of its policies on foreign economies, its only accountable for what happens in the USA.
driving a wooden stake through the heart of the structured finance mania restores some future control over credit creation that the Fed lost in recent years.
finally, it would cement Bernanke's reputation (genius if it works, goat if it doesn't) as the man who caused the Greenspan Put to expire and didn't cave in to Wall St's clamour for an immediate rate cut.However, if they decide their mission is to act aggressively to prevent a recession then you are correct - a 5 handle is unlikely.

GRG55
09-03-07, 04:04 PM
JK,

you have missed the third and, perhaps the most important reason for a tightening credit spiral, fear. I well remember during 1992 here in the UK that National Westminster Bank was paying big fat bonuses to their staff for the amount of funds they could get back by calling in overdrafts and had put a complete stop on sale of any loans to anyone.

Fear of a complete collapse and thus that, as the collapse spiralled downwards, their own fundamentals for the underlying capitalisation of the bank was driving total fear.

It is fear of what will happen if the collapse continues that has the most dramatic effect upon access to credit. A bank profits from the sale of loans, yes, but survives disaster by calling in everything it can lay its hands on when times get rough.

There were reports that continental European banks were so desperate to raise cash some were calling borrowers during the week of August 13-17, trying to persuade them to make their mortgage payments a few days earlier than contractually required...

GRG55
09-03-07, 04:20 PM
...i am not privy to details on the credit markets, but the impression i receive from my readings is that credit is tight even for traditionally creditworthy borrowers. i suspect we are heading into an overshoot.

i also suspect that there is value in some of the debt instruments that are currently unmarketable. one real underlying problem is the lack of transparency in these instruments. the abcp market is evaporating rapidly, for instance, because people don't know how to value the underlying collateral. that doesn't mean the collateral is worthless. so this [abcp unmarketability] is already an element of overshoot.

i realize that the last remark appears to contradict my assertion that spreads are too low. the variability of risk pricing is what is striking. i think the generic junk bond market is still underpricing risk, while there are pockets in which risk is being priced at infinity and more exotic paper can't be sold at all. these disparities will be resolved, i guess, by risk being priced into junk, not by risk being priced out of exotic junk.

The vulture funds seem to be cashing up. Goldman, Blackstone, all da boyz are waiting to pounce. I would guess they are 1. waiting to see what the Fed and the Govt plan to do; 2. still raising their war chests; 3. waiting for someone else to be first mover; 4. trying to figure out how to value some of this stuff (yo, we need to build another model...). I would guess either they, or some Govt RTC-style entity, or both, will be the catalyst to get transactions underway again.

Finster
09-03-07, 04:24 PM
Agree. The only time I can recall the Fed admitting any reponsibility for anything was when Bernanke told Milton Friedman, at his birthday party, that the Fed caused the 1930's Depression.

You are more familiar with this anecdote than I am, GRG55. But Bernanke writings have suggested that the blame lay in the Fed’s having been too slow to ease when the bubble popped, rather than for in its role in inflating it in the first place. This is in contrast to Greenspan, who in a (pre-Fed) incarnation identified the Fed’s blunder with the first cause. Gold and Economic Freedom (http://www.gold-eagle.com/greenspan041998.html) Greenspan was right.


I am not saying the Fed WILL deliberately try a sharp, short deflationary shock treatment on the patient; but IMO it's within the range of reasonable possibilities. Recognising it would take Fed courage (not an abundant character trait), in no particular order here's some reasons why they might try such a stunt, prior to the inevitable massive re-flationary actions (critique of the soundness of this line of reasoning welcomed):

period of pain much shorter than the slow drip Japan deflation experience - assuming they don't screw it up;
forces and concentrates the asset devaluation and debt write offs in the most egregiously inflated sectors (structured credit, real estate, finance sector equities);
reduces risk of deflationary bleed-through into other parts of the economy by time-function quarantining the really sick part of the economy (the FIRE economy part);
the more accumulated debt burden that can be euthanized in a deflation event, the less the Fed has to inflate away later, and the greater its future capacity to expand credit to goose the economy without creating excessive inflation;
magic of securitization has stuffed every foreign pocket with US asset backed credit risk; Volker once pointed out that the Fed is not responsible for the effect of its policies on foreign economies, its only accountable for what happens in the USA.
driving a wooden stake through the heart of the structured finance mania restores some future control over credit creation that the Fed lost in recent years.
finally, it would cement Bernanke's reputation (genius if it works, goat if it doesn't) as the man who caused the Greenspan Put to expire and didn't cave in to Wall St's clamour for an immediate rate cut.However, if they decide their mission is to act aggressively to prevent a recession then you are correct - a 5 handle is unlikely.

If Bernanke is a Volcker, then your scenario is well within the realm of possibility. There’s no denying the positive features of the getting-it-over-with-sooner-rather-than-later argument. But if he (as discussed above) believes the Depression was caused not by excessive Fed ease, but by too much Fed restraint …

GRG55
09-03-07, 04:29 PM
...Again, we have the phenomenon of abnormally loose credit returning to a more normal state. If we were to call lack of credit availability for uncreditworthy borrowers "tight" credit conditions, we may as well stand atop Everest and call the entire rest of the world a valley.

From the lofty heights of Wall St., with its breathtaking compensation, the entire rest of the world does look like a valley. Now that they are in danger of sliding off the peak, the chorus is calling for an alternate means of escape..."Somebody call Ben to send the helicopter. We need a "flight to safety..."

GRG55
09-03-07, 04:42 PM
You are more familiar with this anecdote than I am, GRG55. But Bernanke writings have suggested that the blame lay in the Fed’s having been too slow to ease when the bubble popped, rather than for in its role in inflating it in the first place. This is in contrast to Greenspan, who in a (pre-Fed) incarnation identified the Fed’s blunder with the first cause. Gold and Economic Freedom (http://www.gold-eagle.com/greenspan041998.html) Greenspan was right.

Good catch! You are correct. That'll teach me for taking on the Shadow Fed Chairman...


If Bernanke is a Volcker, then your scenario is well within the realm of possibility. There’s no denying the positive features of the getting-it-over-with-sooner-rather-than-later argument. But if he (as discussed above) believes the Depression was caused not by excessive Fed ease, but by too much Fed restraint …

Volcker is lionized for his actions in the early 1980's, but weren't the conditions for the loss of confidence that led to the 1987 market crash created on his watch?

Finster
09-03-07, 05:09 PM
Good catch! You are correct. That'll teach me for taking on the Shadow Fed Chairman...

:D

Not trying to 'catch' you at all, GR. ;) In reading your posts, it looks like we are much in accord. If we differ on something here, it's well into in the nit zone ...


Volcker is lionized for his actions in the early 1980's, but weren't the conditions for the loss of confidence that led to the 1987 market crash created on his watch?

You bet. On the other hand, the 1987 crash was less of an economic event and more of a market event. Despite the worry that a depression would follow, it turned out to be of little consequence to other than folks who were levered up into the crash or sold stocks immediately afterward.

Even Greenspan would have to get good marks when he took the helm. His post-crash liquifaction was benign, as inflation continued to abate for several more years. It was sometime around the beginning of 1995 that things started to go really haywire. Reserve requirements were cut, the Boskin Commission dumbed down the CPI, we had the "Mexican Peso Crisis" bailout, and the Fed underwrote a 1920's stock market bubble redux.

GRG55
09-03-07, 05:38 PM
...You bet. On the other hand, the 1987 crash was less of an economic event and more of a market event. Despite the worry that a depression would follow, it turned out to be of little consequence to other than folks who were levered up into the crash or sold stocks immediately afterward.

Even Greenspan would have to get good marks when he took the helm. His post-crash liquifaction was benign, as inflation continued to abate for several more years. It was sometime around the beginning of 1995 that things started to go really haywire. Reserve requirements were cut, the Boskin Commission dumbed down the CPI, we had the "Mexican Peso Crisis" bailout, and the Fed underwrote a 1920's stock market bubble redux.

Given it was more market event than economic event can we infer Greenspan's motives for his liquidity injection response?

There was evidence that the market event was infecting the economy? Or...
There was no evidence of any impact on the economy, but Greenspan decided to pre-empt any chance of that? Or...
The Greenspan Fed saw protecting/supporting the equity market as within its mandate and an important responsibility?I wonder if the current financial community view that the Fed "should" protect the stock market, and today's accompanying Pavlovian chorus of "cut the rate, cut the rate...", had it's genesis way back in 1987? Just a thought...

Chris Coles
09-03-07, 06:00 PM
Multiply your own diverse scenarios by the number of players, world wide, and you get total chaos with no single player certain of anything other than that no one knows who holds the biggest loss and has to make an immediate move to try and avoid total collapse. Perhaps the best advice is indeed to wait for someone else to make the first move.

If EJ is correct, (was correct), to re-start itulip, then the best strategy is to wait for several months at least until you can be certain that the dust has settled. Time is definitely not of the Essence here. The patient war chest will win the best bargains. Buying half way down will only serve to waste resources.

Finster
09-03-07, 08:33 PM
Given it was more market event than economic event can we infer Greenspan's motives for his liquidity injection response?

There was evidence that the market event was infecting the economy? Or...
There was no evidence of any impact on the economy, but Greenspan decided to pre-empt any chance of that? Or...
The Greenspan Fed saw protecting/supporting the equity market as within its mandate and an important responsibility?I wonder if the current financial community view that the Fed "should" protect the stock market, and today's accompanying Pavlovian chorus of "cut the rate, cut the rate...", had it's genesis way back in 1987? Just a thought...

As a good a thought as any! We have no inside track on Greenspan's inner motives in 1987. I just view that response as benign in light of later policy actions. In 1987, the market had not become nearly so overvalued. In 2000, it had actually doubled after Greenspan's own famous 1996 musings on "irrational exuberance". Inflation did not skyrocket after 1987. After the 2000-2002 bear market, Greenspan's response produced phenomenal inflation, with commodity prices tripling, house prices going through the roof, and the most out-of-this world speculative credit bubble since 1720. With the repercussions we are seeing now.

All with no visible justification. By 2004-2005, the stock market was zooming skyward again, GDP data were robust, unemployment low, and inflation accelerating to the highest levels in decades, yet the easy money just wouldn’t go away. Greenspan was ever-so-grudging in "removing accommodation" in baby steps, and further incited speculation by being so predictable about it.

This is no mere 20-20 hindsight analysis. Plenty of analysts commented in awe on the credit bubble. The housing bubble was being tracked right here on iTulip. Even in officialdom, talk of a "world awash in liquidity" was becoming routine. Greenspan himself even cited "excessive risk-taking" as a potential danger, all while conducting policy that encouraged it.

In contrast, the 1987 post-crash response was … well … benign.

GRG55
09-04-07, 04:13 AM
Multiply your own diverse scenarios by the number of players, world wide, and you get total chaos with no single player certain of anything other than that no one knows who holds the biggest loss and has to make an immediate move to try and avoid total collapse. Perhaps the best advice is indeed to wait for someone else to make the first move.

If EJ is correct, (was correct), to re-start itulip, then the best strategy is to wait for several months at least until you can be certain that the dust has settled. Time is definitely not of the Essence here. The patient war chest will win the best bargains. Buying half way down will only serve to waste resources.

Chris: Agree fully that one doesn't want to act prematurely. For me, iTulip sharpens the ability to anticipate, in a world where most investors react. This thread is getting long, but I appreciate that you, Finster and j.k. have hung in there and I value the dialogue. Finster's expectations might come true reading the following about Jackson Hole. Clips from the Sept 3 Independent out of the UK, edited for brevity (emphasis mine):

"The Federal Reserve heard a plea for a full percentage point cut in US interest rates in order to forestall a recession, as central bankers debated the fall-out from the housing market slowdown.
The Harvard University economist Marty Feldstein…arrived at Jackson Hole to deliver a warning that sharp declines in house prices in many areas of the country could trigger a much broader recession, if the Fed did not act.
Lower rates may trigger a period of high inflation, which would have to be dealt with over time, but this was the "lesser of two evils", said Mr Feldstein, whose National Bureau of Economic Research is the recognised arbiter of whether the US </ST1:pis in recession. "The economy could suffer a very serious downturn," he said. "A sharp reduction in the interest rate, in addition to a vigorous lender-of-last-resort policy, would attenuate that very bad outcome."...

..."What we need to do as central banks, and we are clearly doing that, is to help them in the deleveraging process," said Axel Weber, president of the German Bundesbank and a member of the European Central Bank's governing council, who spoke in Wyoming. "There is no underlying problem of solvency, it's one of liquidity. So swift action is needed."...
<O:p</O:p
..."Addressing one of the underlying issues of the conference, Mr Mishkin (Fed Governor Frederic Mishkin) said the Fed should not use interest rate policy to prevent or prick bubbles in the housing market, but simply use its regulatory powers to ensure responsible lending and use rate changes to manage the wider economic consequences."<O:p</O:p

So here we have Finster's worst nightmare being advocated as sound policy. My reaction: To Feldstein - Maybe he should start a renominate "The Maestro" movement. To Weber - More than a few former hedge fund managers, foreclosed homeowners and economists (like Roubini) might disagree re: solvency problem. However, given CB's limited toolset, I suppose every problem must be defined as one of liquidity, with a monetary policy remedy, or CBs may appear impotent. To Mishkin - The Bernanke Fed is increasingly indistinguishable from the serial bubble-blower Greenspan Fed.

Clearly the visible political pressure on the Fed & ECB is rising very rapidly; one wonders just how much heat is being applied behind the scenes. Yikes! :eek:

Chris Coles
09-04-07, 06:36 AM
The underlying problem is not the potential for any action by the FED, but the lack of a free marketplace for capital. At grass roots the industrial inventor is unable to access capital at any cost because he has no access to a free marketplace to obtain it. The same applies to a whole host of micro businesses that as a consequence, never get started at all. Just one example is the demise of the Mom and Pop businesses throughout the western world, not just the USA. So what happened instead is the rules for access to capital became much more onerous and complex and that left all the capital of the nation in the hands of the savings institutions and they in turn had to find somewhere to invest. That led to the numerous different financial vehicles that we see today.

When my grandfather, Francis George Coles was a Jobber on the London Stock Exchange, all he ever dealt with were shares in companies that were being set up to trade in some way or other. Some were risky ventures, others very sound businesses. But all the capital was available to use for trade. Working capital was readily available as long term 25 year bonds at about 4%.

Today, nothing could be further from the truth and most of the capital is mired in an illusion of trading between the financial institutions and governments, many of whom now hold major holdings in the trading companies of other nations.

In my humble opinion, nothing the FED can do will change the underlying problem, other than to force the imposition of free markets, and I mean totally free markets, on capital. And I do not believe that will even enter their minds until the whole edifice has completely crashed as their boss, the government itself, has such a vested interest in the ongoing success of the present system.

GRG55
09-04-07, 09:00 AM
The Economist Intelligence Unit has published a report titled "Heading for the Rocks - will financial turmoil sink the world economy?" It contains some scenarios for the major economic regions. The link below...

http://a330.g.akamai.net/7/330/25828/20070831144222/graphics.eiu.com/upload/Heading%20for%20the%20rocks.pdf

Finster
09-04-07, 09:06 AM
Chris: Agree fully that one doesn't want to act prematurely. For me, iTulip sharpens the ability to anticipate, in a world where most investors react. This thread is getting long, but I appreciate that you, Finster and j.k. have hung in there and I value the dialogue. Finster's expectations might come true reading the following about Jackson Hole. Clips from the Sept 3 Independent out of the UK, edited for brevity (emphasis mine):

"The Federal Reserve heard a plea for a full percentage point cut in US interest rates in order to forestall a recession, as central bankers debated the fall-out from the housing market slowdown.
The Harvard University economist Marty Feldstein…arrived at Jackson Hole to deliver a warning that sharp declines in house prices in many areas of the country could trigger a much broader recession, if the Fed did not act.
Lower rates may trigger a period of high inflation, which would have to be dealt with over time, but this was the "lesser of two evils", said Mr Feldstein, whose National Bureau of Economic Research is the recognised arbiter of whether the US </ST1:pis in recession. "The economy could suffer a very serious downturn," he said. "A sharp reduction in the interest rate, in addition to a vigorous lender-of-last-resort policy, would attenuate that very bad outcome."...

..."What we need to do as central banks, and we are clearly doing that, is to help them in the deleveraging process," said Axel Weber, president of the German Bundesbank and a member of the European Central Bank's governing council, who spoke in Wyoming. "There is no underlying problem of solvency, it's one of liquidity. So swift action is needed."...
<O:p</O:p
..."Addressing one of the underlying issues of the conference, Mr Mishkin (Fed Governor Frederic Mishkin) said the Fed should not use interest rate policy to prevent or prick bubbles in the housing market, but simply use its regulatory powers to ensure responsible lending and use rate changes to manage the wider economic consequences."<O:p</O:p

So here we have Finster's worst nightmare being advocated as sound policy. My reaction: To Feldstein - Maybe he should start a renominate "The Maestro" movement. To Weber - More than a few former hedge fund managers, foreclosed homeowners and economists (like Roubini) might disagree re: solvency problem. However, given CB's limited toolset, I suppose every problem must be defined as one of liquidity, with a monetary policy remedy, or CBs may appear impotent. To Mishkin - The Bernanke Fed is increasingly indistinguishable from the serial bubble-blower Greenspan Fed.

Clearly the visible political pressure on the Fed & ECB is rising very rapidly; one wonders just how much heat is being applied behind the scenes. Yikes! :eek:

Funny you should mention the Jackson Hole criticism. Just this morning there was a piece on Bloomberg, Fed, Blamed for Asset-Price Inaction, Is Told `Tide Is Turning' (http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aLsu9feQITDY):


Federal Reserve officials, wrestling with a housing recession that jeopardizes U.S. growth, got an earful from critics at a weekend retreat arguing they should use regulation and interest rates to prevent asset-price bubbles.


Otmar Issing, former chief economist at the European Central Bank, and Stanley Fischer, head of the Bank of Israel, were among guests at the Fed's summer symposium in Jackson Hole, Wyoming, to challenge the hands-off approach. ... ``The position that `this isn't an issue for central banks' has lost some support,'' Issing said in an interview at the gathering, which ran from Aug. 30 to Sept. 1. ``The tide is turning.''


By cutting rates to a four-decade low in 2003, the Fed inflated property values, Ed Leamer, head of an economic forecasting group at the University of California at Los Angeles, said at the conference. The ensuing housing slump, the worst since 1991, and the credit-market turmoil that followed, threaten to undo the six-year economic expansion.

``Central banks, probably on more occasions than they would like to admit, should respond to asset-price bubbles,'' said Fischer...



Bernanke first appeared at Jackson Hole in 1999 with a paper arguing that central banks shouldn't target asset prices except when they affect the economy.

Ahhh, but asset prices are the canary in the inflation mine...

Chris Coles
09-04-07, 09:37 AM
Ahhh, but asset prices are the canary in the inflation mine...

And the noise from the canaries is becoming quite deafening...............

jk
09-04-07, 09:38 AM
Bernanke first appeared at Jackson Hole in 1999 with a paper arguing that central banks shouldn't target asset prices except when they affect the economy.

could someone explain to me how asset prices can NOT affect the economy?

GRG55
09-04-07, 10:58 AM
could someone explain to me how asset prices can NOT affect the economy?

...When all the assets are in the hands of the top 1%, and the rest of us are squatters and buy our food at the company store?

Seriously, there's a gold mine of material that has come out of the Jackson Hole proceedings (building on Finster's post above). I read Ed Leamer's paper on housing and recommend it. Compare it to Bernanke's views on the same topic from his keynote speech at J.H.

Otmar Issing was an increasingly vocal critic of the Fed's policy regarding asset prices and bubbles through the latter Greenspan years. Dr. Kenneth Rogoff holds the view that asset prices may, in some circumstances, provide the Fed with better and more timely information than lagging (and heavily massaged) inflation and employment data. Even Bernanke made a note that the data the Fed relies on may be less useful at times like this. The Fed is unlikely to adopt the canary as its official mascot any time soon, but might it gain some favour amongst the FOMC members after Jackson Hole?

c1ue
09-04-07, 02:31 PM
The Fed is unlikely to adopt the canary as its official mascot any time soon, but might it gain some favour amongst the FOMC members after Jackson Hole?

What? And displace the venerable head monetary lemming?

http://www.univ-ubs.fr/ecologie/Photos/lemming.jpg

Chris Coles
09-04-07, 05:19 PM
Wonderful c1ue, best laugh I have had in years.

I may have confused others by writing about singing canaries when they should be hanging upside down from their perches. It just does not feel like the right time to start talking about completely collapsed assets so I thought singing ones sounded better.

http://www.dm.net/~marg/CanaryWebRing.gif

Chris Coles
09-05-07, 05:27 AM
could someone explain to me how asset prices can NOT affect the economy?

It would seem you are not the only one to ask the same question.

September 5, 2007


Brown calls for asset transparency



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<!-- Print Author name associated with the article --><!-- Print Author name from By Line associated with the article -->Gabriel Rozenberg and Christine Seib


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As a second British bank revealed its exposure to the US sub-prime crisis, the Prime Minister said that he would support international calls for greater transparency.


http://business.timesonline.co.uk/tol/business/economics/article2388399.ece?EMC-Bltn

FRED
09-05-07, 10:37 AM
Today's Fast Economic Crash News:

Lay-offs surge 85 pct in Aug vs July: survey (http://biz.yahoo.com/rb/070905/usa_economy_jobs_challenger.html?.v=2)

Pending Home Sales Hit 6-Year Low (http://biz.yahoo.com/ap/070905/pending_home_sales.html?.v=3)

Chris Coles
09-05-07, 12:13 PM
Fund Of Hedge Funds To Blame?

09-05-2007 | Source: Hedge Fund Daily (http://www.institutionalinvestor.com/FreeSignup.aspx)

Redemption requests in July by investors in funds of hedge funds may have been the primary cause for the huge market sell-off this summer and its impact on the HF industry, according to the first Trim Tabs BarclayHedge Fund report.


” Biderman said. The good news is that all August HF redemption requests are in and, he noted, “more massive deleveraging in the hedge fund world is unlikely unless something deemed unexpected bad news materializes this month.”

http://www.institutionalinvestor.com/Article.aspx?ArticleID=1408177&LS=EMS139701

bill
09-05-07, 04:49 PM
The Economist Intelligence Unit has published a report titled "Heading for the Rocks - will financial turmoil sink the world economy?" It contains some scenarios for the major economic regions. The link below...

http://a330.g.akamai.net/7/330/25828/20070831144222/graphics.eiu.com/upload/Heading%20for%20the%20rocks.pdf


Nice report, thank you

The report confirms the unwinding of trades, paper freeze with reappraisal going forward, liquidity drying up, asset price and commodities down globally.

Flippers, speculators feel the liquidity squeeze and many investors run for safety. Who will be in a position to take advantage of such a buying opportunity? On page 30 the report mentions SWF as being a potential purchaser of assets when assets sell off. I agree, as said in my previous post http://www.itulip.com/forums/showthread.php?p=11992#post11992 the potential capital pool would have to be big and global.

SWF's will have to be politically positioned, no problem just call up an Investment Banker they will immediately dispatch a team over to help you.
http://biz.yahoo.com/ft/070902/fto090220071311121368.html?.v=1

September 2, 12:55 pm ET
Investment banks are creating dedicated teams in London, Hong Kong and Japan to advise sovereign wealth funds and cash in on the growing wave of activity from government investment companies.

Bankers also expect SWFs to take advantage of the credit crunch to undertake deals while private equity groups, unable to raise financing, are forced to sit on the sidelines. "The current investment climate has created a huge opportunity for many of these funds and they have become very real competitors to both private equity and strategic players," said Jeffrey Culpepper, head of investment banking for the Middle East and north Africa at Merrill Lynch.



Keep a eye on Japan ’s prospective SWF http://www.reuters.com/article/marketsNews/idUKT33753920070905?rpc=44 it may invest Japan ’s Sovereign Pension Fund GPIF.http://www.morganstanley.com/views/gsb/index.html

Sovereign Pension Funds
August 28, 2007

By Stephen L. Jen

While the emergence of sovereign wealth funds (SWFs) will be one of the key trends for the financial markets in the coming years, investors should also pay attention to some prospective changes in the way some of the sovereign pension funds (SPFs) may be invested. Specifically, we believe that we will witness a general rise in SPFs' exposure to foreign assets and riskier assets (i.e., equities), with logical implications for the global financial markets.
Numerous examples of SPFs which are 'outward oriented' and not risk-averse. Singapore's GIC manages part of Singapore's official reserves and the Central Provident Fund (CPF). Australia's Future Fund and NZ's Superannuation Fund are likely to have 80% of their portfolios in foreign assets. South Korea's National Pension Service (NPS) is large (US$220 billion) and will increasingly raise its foreign content. Last but not least, Japan's Government Pension Investment Fund (GPIF) - currently at US$1.37 trillion - will export another US$58 billion in the next two years, and possibly a further US$150-200 billion beyond 2009.
SPFs are large. The SPFs of the G10 countries total US$4.4 trillion. This is a large sum compared to the US$2.6 trillion managed by SWFs.
SPFs currently have a low exposure to foreign assets. The weighted average foreign exposure is only 19% for the SPFs in the G10 countries.
This will change, however. Global aging (declining fertility and mortality rates) will exert pressure on the SPFs to enhance their investment returns, and globalisation will encourage a reduction in the 'home bias' of these funds - precisely the same pressures that will propel SWFs. In my view, SPFs and SWFs should be considered collectively as a major factor for international financial markets in the coming years, as several SPFs may in fact become managed by SWFs in the future. Specifically, Japan's prospective SWF may be centred on its SPF - the GPIF.

GRG55
09-06-07, 02:07 PM
Fund Of Hedge Funds To Blame?...

Redemption requests in July by investors in funds of hedge funds may have been the primary cause for the huge market sell-off this summer and its impact on the HF industry, according to the first Trim Tabs BarclayHedge Fund report.


” Biderman said. The good news is that all August HF redemption requests are in and, he noted, “more massive deleveraging in the hedge fund world is unlikely unless something deemed unexpected bad news materializes this month.”

Hubris writ large..."it must be the fault of all those unsophisiticated investors in fund of funds..."

The hedgies are likely no where near finished marking to market. This sort of nonsense sounds much like: "sub-prime is contained", "housing has bottomed" and "the economy is strong"...and about as accurate. LOL :)

FRED
09-07-07, 09:50 AM
New Myth of the Slow Crash story:

Employers Cut Jobs in August (http://biz.yahoo.com/ap/070907/economy.html?.v=9)
September 7, 2007 (Jeannine Aversa – AP Economics Writer)

Employers Cut Payrolls by 4,000 in August, the First Drop in US Jobs in 4 Years

Employers sliced payrolls by 4,000 in August, the first drop in four years, a stark sign that a painful credit crunch that has unnerved Wall Street is putting a strain on the national economy.

GRG55
09-08-07, 04:52 AM
New Myth of the Slow Crash story:

Employers Cut Jobs in August (http://biz.yahoo.com/ap/070907/economy.html?.v=9)
September 7, 2007 (Jeannine Aversa – AP Economics Writer)

Employers Cut Payrolls by 4,000 in August, the First Drop in US Jobs in 4 Years

Employers sliced payrolls by 4,000 in August, the first drop in four years, a stark sign that a painful credit crunch that has unnerved Wall Street is putting a strain on the national economy.


Fund Of Hedge Funds To Blame?

09-05-2007 | Source: Hedge Fund Daily (http://www.institutionalinvestor.com/FreeSignup.aspx)

Redemption requests in July by investors in funds of hedge funds may have been the primary cause for the huge market sell-off this summer and its impact on the HF industry, according to the first Trim Tabs BarclayHedge Fund report.


” Biderman said. The good news is that all August HF redemption requests are in and, he noted, “more massive deleveraging in the hedge fund world is unlikely unless something deemed unexpected bad news materializes this month.”

http://www.institutionalinvestor.com/Article.aspx?ArticleID=1408177&LS=EMS139701

That probably qualifies as "unexpected bad news"...

Verrocchio
01-20-08, 07:47 PM
Buy yer Financial Apocalypse Survival Tackle kits here! [FAST(tm)]

1) 10 kW solar array
2) 'Mad Max' style solar/fuel cell 4x4 with armor, spare run flat tires, 40 gallon spare fuel tank
3) Stash of 1000 gold coins
4) 2 years per person of MREs
5) water filter and 100 gallon water tank
6) club card at North Sierra Nevada mountains survival club
7) shotgun with 500 rounds mixed 00 and solid slugs
8) 30.06 rifle with 200 rounds
9) .22 rifle with 1000 rounds (for game)
10) 30 pounds of mixed spices
11) 30 bottles of assorted liquers
12) Crate of assorted medicines including antibiotics, cough/cold, antifungal

All for the bargain basement price of $500,000! plus $10,000 per extra person.:eek:

Hmm, the kit includes 1000 gold coins and the other goodies, too? And for only $500k? I'll take your entire inventory.;)

Rajiv
01-20-08, 08:46 PM
1000 gold coins

Correction: It should have said 1000 golden coins!

Chris Coles
01-21-08, 05:44 PM
With the greatest of respects, with no salt, you would not last the first winter. You need to read "The River Cottage Meat Book" by Hugh Fearnley-Whittingstall.

c1ue
01-21-08, 06:28 PM
Hmm, the kit includes 1000 gold coins and the other goodies, too? And for only $500k? I'll take your entire inventory.;)

Sure.

How would you like to pay?

Note I never said WHICH gold coins, or what size they were...


2006

1/20th ounce

CANADIAN Maple Leaf small gold coin

Nice Uncirculated condition


*** Special ***

c1ue
01-21-08, 06:31 PM
With the greatest of respects, with no salt, you would not last the first winter. You need to read "The River Cottage Meat Book" by Hugh Fearnley-Whittingstall.

Actually I had included it in the 30 pounds of spices.

True, for the long term you probably need more than the 20 pounds of salt there, but on the other hand transportability is a factor...

Verrocchio
01-25-08, 12:00 PM
Sure.

How would you like to pay?


Ah, but if you were talking about gold coins of less than an ounce, I think about three wheelbarrows of Weimar Republic German 10 million mark Reichsbanknotes should be fair. Fair?
file:///C:/DOCUME%7E1/J/LOCALS%7E1/Temp/moz-screenshot-1.jpghttp://www.snyderstreasures.com/images/paper/currency/100MillionRM22Aug23F.jpg

Chris Coles
01-25-08, 12:33 PM
[quote=Verrocchio;25676]Ah, but if you were talking about gold coins of less than an ounce, I think about three wheelbarrows of Weimar Republic German 10 million mark Reichsbanknotes should be fair. Fair?[quote]

But the illustration is for a 100 million mark note, so if you are saying the deal is for three wheelbarrows of the illustrated notes, then that is ten times the offer......!!! Mint condition mind you, not like some of the worn out notes that I have seen in the past. :D

c1ue
01-25-08, 03:16 PM
Ah, but if you were talking about gold coins of less than an ounce, I think about three wheelbarrows of Weimar Republic German 10 million mark Reichsbanknotes should be fair. Fair?

Sorry, I'm in the business of selling FAST kits, not currency exchange.

Dollars only - limited time offer ;)

Verrocchio
01-25-08, 11:31 PM
[quote=Verrocchio;25676]Ah, but if you were talking about gold coins of less than an ounce, I think about three wheelbarrows of Weimar Republic German 10 million mark Reichsbanknotes should be fair. Fair?[quote]

But the illustration is for a 100 million mark note, so if you are saying the deal is for three wheelbarrows of the illustrated notes, then that is ten times the offer......!!! Mint condition mind you, not like some of the worn out notes that I have seen in the past. :D

Well, you've caught me out now. The actual offer was 3 barrows of 10 million mark notes, and the illustration was just a bit of flash to lure him into the deal. If he misunderstood the deal, well... caveat emptor! ;)