The Non-Decision

This week's FOMC decision and the accompanying statement were so thoroughly unsurprising that it is barely worth commenting on them. As usual, Thomas Hoenig dissented, and as usual the yes-men (and women) otherwise occupying voting seats at the monetary policy committee all assented with keeping monetary policy as loose as possible.

 

In essence the statement was an almost exact copy of the preceding one – the Fed reiterated its commitment to 'QE2' and there was the usual pablum about 'watching incoming data' to help decide whether to adapt it.

 

The statement can be read in its entirety here.

 

More Hawks Are On Their Way

What may be noteworthy – and we have commented on this a few times before when discussing the 'hawks versus doves' issue – is that next year there will be a relative preponderance of noted hawks in a position to vote. In short, the good chairman, money-printer-in-chief Ben Bernanke, may finally face some serious opposition.

The WSJ reports in this context:

 

“Federal Reserve Chairman Ben Bernanke is likely to face some new dissenting votes when the make-up of the Federal Open Market Committee, the central bank's policy-making committee, changes in January. […]

Four presidents of regional Fed banks will step into the rotation at the Fed's policy meeting in late January: Charles Evans of Chicago, Charles Plosser of Philadelphia, Richard Fisher of Dallas and Narayana Kocherlakota of Minneapolis. They'll join the eight permanent voters on the FOMC: seven Fed governors (one position is now vacant) and the New York Fed president.

[…]

Most attention among regional bank presidents will likely go to Mr. Plosser and Mr. Fisher, two policy makers who have not been shy about casting dissenting votes. Mr. Fisher dissented five times in 2008, either calling for higher interest rates or objecting to committee moves to lower rates. He was joined twice by Mr. Plosser, who objected to rate cuts at the time.

The other incoming voter, Mr. Kocherlakota, will have his first voting seat on the FOMC since taking office in October 2009. He has at times questioned the efficacy of the low-rate policy for addressing the economy's ills, but this month he publicly supported the Fed's latest decision to embark on a new round of quantitative easing.

 

One noted dissenter and hawk, Thomas Hoenig is going to be 'rotated out', but three new potential dissenters are coming in. Given the rough wind blowing into Bernanke's face over 'QE2' (his public relations effort backfired mightily – rarely has a Fed chairman faced this much criticism and ridicule), and the chairmanship of noted Fed critic Ron Paul of the Congressional monetary policy subcommittee overseeing the Fed, we can probably expect Bernanke's policy to come increasingly under fire.

 

The Future of 'QE'

Consider now the typical 'it wasn't enough' (deficit spending or money printing or both) Keynesian excuse whenever Keynesian policies fail (which is always) in this context. If Bernanke had completely free rein, he would likely soon engage in 'QE3' (this time we're going to go big!) , 'QE4', etc. – but this is now far less certain than before. In fact, when he comes up for renewal of his chairmanship he may either have had enough and decide to go back into academia, or he may simply not be reappointed next time. He is almost certainly going to face an even more hostile Senate at his next confirmation hearing.

With these things in mind, investors should consider the possibility that the flood of free liquidity may subside rather sooner than is currently expected. 'QE2' may even end up – gasp! – curtailed. In such an event we would expect major cyclical bear markets in stocks and commodities to interrupt the so far still ongoing party in financial markets.

Indeed, secular bear markets all exhibit a surprisingly large degree of self-similarity, a fact that can probably partly be explained by socionomic arguments. Governments are eager to intervene in economic downturns and in the case of secular debt-deleveraging cycles will tend to make the downturn much worse by their interventions, as they hinder the liquidation of malinvested capital and bring about even more consumption of scarce capital in artificial bubble activities. However, society observes these efforts and will at some point conclude that blowing more bubbles is detrimental (we seem to be at that point actually). Then public pressure makes the government relent for a little while and a resumption of the earlier interrupted liquidation process once again pressures asset prices. This continues until the public is eager for another 'reflation' push. And so a secular contraction cycle can become very entrenched, long-lasting and painful.

One thing is clear though: risk asset prices won't be a one-way bet in such an environment. Rather, they will tend to fluctuate widely, and exhibit a long-term downward bias, unless the government actually chooses to go down the path that leads to hyper-inflation, as happened in Zimbabwe. We think in the US cooler heads will prevail, but there can be no guarantee of that, as sometimes such developments get out of control.

Ben Bernanke noted in his infamous interview on '60 minutes' that he is '100% certain' that the Fed will have the wherewithal to stop inflation in its tracks (by which he means: a rising general price level) once it rears its head. He probably thinks so because it looked easy when Volcker did it in 1979-1981. Alas, he economic circumstances of any given moment are always unique. What it was possible to do easily in 1979 may not be so easy next time.

 

China's Problem

On a related note, it appears to us that the nonchalance with which many observers react to the flare-up of inflationary pressures in China is not really appropriate. The Chinese planners have a problem that is already one step beyond the potential problems faced by the Fed – and they seem to underestimate it at this point, or rather, they seem to be hoping that things will right themselves on their own, even if they keep real interest rates in negative territory and try to keep rising prices in check with price controls and other measures that do not involve higher rates. Apparently China's planners fear a bursting of the real estate bubble – so they are prepared to accept to live with a less than optimal monetary policy to put it mildly. Money supply and credit inflation in China has been absolutely staggering in recent years. We can not see a good outcome to that. Printing money and expanding credit at stunning rates can not be a good thing, no matter who does it.

 

2011 promises to deliver more 'interesting times', that much seems almost certain already.

 


 

 

 

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5 Responses to “A Brief Comment on the FOMC Decision”

  • RedQueenRace:

    “Alas, he economic circumstances of any given moment are always unique. What it was possible to do easily in 1979 may not be so easy next time.”

    Define “easy.” And for whom? Volcker was burned in effigy over the effects of his tightening.

    As for the “not enough” auto-responses from the Keynesians why won’t someone with the authority make these clowns put up or shut up? Why doesn’t someone challenge them to:

    1) Explain how much is enough.
    2) Define success.
    3) Define failure.
    4) Be prepared to debate their standards of success and failure and arrive at some consensus where their strategy can be judged once and for all.

    • I would note that I did not really mean to imply that Volcker had it politically easy. That was certainly not the case; not least because he was a Carter appointee who spent most of his time as Fed chairman under the Reagan administration (of course, who knows how much of their protest was just for show? It is safe to assume though that politicians are as a rule in favor of easy money).
      No, what I meant wasn’t the political aspect, but the economic circumstances. When Volcker administered his tight money medicine (which he did for just as long as was necessary to restore trust and not one second longer…), the total credit market debt of the US stood at about 40% of what it is now relative to economic output. This is to say, a far larger debt level must now be serviced by a relatively much smaller share of real wealth generation. It will eventually pose a problem that is simply different in magnitude than Volcker’s was.
      As to holding the Keynesians to some definition of what constitutes success or failure, amen to what you wrote.
      Only, it will of course never happen (it should be fairly easy to find a whole stack of ‘i told you it wasn’t going to be enough’ posts penned by Paul Krugman for instance).
      Sometimes people will have a lucid moment, like FDR’s treasury secretary Morgenthau in 1939 when he admitted that after eight years of taxing, spending and regulating, they were right back at square one.

    • RedQueenRace:

      Actually, I was thinking more in line of the economic impact perceived by the masses than the political angle, though it is linked. They weren’t any too pleased with the short-term results, which is how things are judged by the majority (and politics are driven, the aforementioned linkage). Nonetheless, your clarification is appreciated and I now understand your position and agree.

  • White eagle:

    I am afraid that these three potential dissenters will not be worth one T. Hoenig.One of them has already endorsed QE2,as noted in the article.
    It seems these days that one has to be German or at least descendant of that nation,to have some sense of what is right in monetary/fiscal matters.
    The real game changer is November 2011 when A.Weber of Bundesbank should take ECB in his hands and stop buying PIIGS bonds.At the minimum,French will again rise threat of disbanding Euro and EU.It will be the biggest game of chicken since the end of Cold War.If Germans cave in,gold will not prove as a sufficient insurance(remember USA 1933?).I even hear voices from different parts of Europe-good God,today it came from my country also-to curtail use of pure cash,because of money laundering ,terrorism,tax cheating,security of small merchants,bla,bla,bla.These people want total control!What is left to normal people if they outlaw physical gold and cash?If there is no cash and with capital controls in place, you cannot escape from fractionally reserve bank system.Buy a ticket to a country with totally inefficient government,like D.Casey did in Argentina?

    • I agree that Hoenig is probably the most principled Fed board member right now – leaving aside for a moment that central planning of money can not work no matter how principled those entrusted with the planning are; it simply runs into the same calculation problem that bedevils communist command economies.
      Agree that things will become far more interesting if/when Weber indeed gets to chair the ECB.
      As to cash ban efforts, our best hope is that the elites themselves still find cash indispensable for various slush funds, bribes and other criminal activities (they certainly don’t care about the liberty and financial privacy of the tax cows or their ability to escape the banking system). Besides, the market always finds a way around such restrictions. It could not possibly be made to work if not all governments were to introduce it concurrently, since people would simply start using foreign cash or precious metals. I would say though the fact that the matter is lately more and more often ‘discussed’ in the corporatist media is extremely worrisome per se already.

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