Benny and the Inkjets – Central Bank Focus
Guest post by Peter Tchir.
Today I will be attending Ben’s talk in NY. I’m curious to see him speak in person, but can’t help but think of the questions I would ask if I could.
- Do you think that low rates are hurting savers, allowing big established businesses to make money while stopping new entrants, and do you finally admit your wealth effect theory is totally wrong since the wealth isn’t well distributed and has failed to produce results?
- At one point will you admit that the ultimate exit strategy is to just forgive the debt? That for all the talk about fiscal cliff, it would still leave us with a large annual deficit and really no end in sight to a ever growing pile of debt, making debt forgiveness the logical next step since you already pay back all the coupon income?
Okay, those are the questions that I would like to ask, but if I was given a chance to ask those questions, I would probably be too nervous. They seem obnoxious, even by my standards, and as much as I’d like answers to them, here are some more likely questions I’d ask.
- Have you spoken to political leaders since the election and reminded them that monetary policy cannot do it alone and it is time for Washington to come up with some policy tools? Have you been encouraged or disappointed with initial talks out of DC on the fiscal cliff? Would you or have you threatened to pull monetary support if the government can’t get its act together?
- If the ECB could act as freely as the Fed, or BOJ, or BOE, would we even know we have a Eurozone debt crisis?
- As central bank balance sheets grow and virtually no major country in the world is going to run an annual deficit surplus any time soon, is there a chance that central banks either get forced to continuously roll the debt they have bought, or even start forgiving debt as a monetary policy tool?
I can’t say I agree with the policy for the Fed to continue to buy assets. I think it distorts prices without getting that much benefit. The market and business people see through the charade and don’t act as they would if these rates were there in a “normal” market.
While I may disagree with the policies, I don’t see them changing and now expect that some continued support for the treasury market will be given. That is in part because the Fed may well still believe in their policies or that they now see that they have created a junkie that needs a fix, and they haven’t figured out how to bring the junkie down.
Today Monti said that Europe had better finances than Japan, the U.K., and the U.S. After a bit of snickering, he may be right.
We don’t know where our bonds would trade if it wasn’t for Fed intervention. We can all wrap ourselves in the platitudes that we are the “flight to safety” but the reality is we have debt market anchored at one end by unlimited short term lending lines to banks at 0% for the foreseeable future, and by the Fed owning close to 30% of all longer dated treasury bonds. The front end of the curve will always respond to the Fed Fund rate, but the promise to keep it low forever hasn’t been enough to keep the longer end of the curve down, we have had to buy huge amounts of that debt. Ditto for the Bank of England and the Bank of Japan.
So Europe is a mess, but if the ECB could just buy bonds like the other Central Banks, would we even know there was a crisis? Probably not, which leads to the conclusion, at least in my world, that we have a crisis here and just don’t know it, because it is masked by the Fed purchases.
We all want to believe we are better, and the Fed makes it easy for us to believe that.
Fiscal Cliff and “Draconian” Cuts
One of my favorite reporters yesterday referred to the Draconian measures that would hit if we go over the fiscal cliff. I’m not sure why those words hit me like they did, but it made me think. Are these really draconian? Going back to taxes we all paid as recently as when Bush was president doesn’t seem that “draconian”. The country at one point was able to survive with those levels of taxes.
But more importantly, what is the fiscal cliff?
In 2008 we ran a budget deficit of $450 billion. That was big, but we had been over $400 billion in 2004. The deficits in recent years, though, have become jaw dropping with $1.4 trillion in 2009, $1.3 trillion in 2010, and $1.3 trillion in 2011. After the fiscal cliff, what would our annual deficit be going forward? Ignore the math, because while our budget projections might not be as bad as the Greek or Spanish estimates (which rarely make it past the first quarter), the record of our projections isn’t good. We tend to underestimate our future annual deficits. So what will it be going forward? Will $500 billion be a “good” annual deficit?
There is NEVER a good time to “cut” spending programs according to one side. There is NEVER a good time to “raise” taxes on the other side. All the loopholes, that everyone says they want to cut, get negotiated back in anyways, because someone gets direct benefit from them and is willing to pay for them, in one form or another.
I have not heard a single credible plan to get to budget surplus. I haven’t even heard many credible plans to just have a small deficit. The reality is that we are Spain. We give out too much, but are scared to take it away. We say we tax, but find loopholes around it. We say we will grow our way out with no real evidence growth will ever outstrip entitlement.
In the end, I think the most likely scenario will be official sector debt forgiveness on a global basis. I have to think about it more, but Greece will be the first, but I see it as a likely end game in the U.S. and Japan. Why not? If the possibility of paying it back isn’t there, if private savings don’t grow, then that is a logical outcome. I have to think about it more, and it is likely years away, but under long term scenarios this bears some scrutiny.
In the meantime, assume the politicians will reach some “compromise” where nothing really changes. No big near term hits, and the cuts will all come in some future that will inevitably be delayed again and again.
The French Downgrade
This might be the best thing that has happened to Europe. All of the weak countries have been crying for a central bank with more authority. They have wanted a bank that could just buy up all of their debt like in Japan, the U.K., and the U.S. The “core” hasn’t wanted that, but maybe France will now?
Maybe France will realize how scary it is to get downgraded and have to worry about actual buyers of bonds. The U.S. could get downgraded to CCC- and it wouldn’t stop the Fed from buying. And so long as the Fed could buy, others would buy. It isn’t rocket science.
So France may be the first big economy in Europe to really want a central bank with far more flexibility – whether that is the ECB or some new French Central Bank is a valid question, but I don’t see this downgrade hurting markets near term and may in fact be a catalyst for some changes in Europe that would ease monetary policy in ways we haven’t yet seen.
‘Tis The Season
Yesterday’s report stands. I am still bullish, and actually got more bullish as the day went on. That is unusual for me, as normally I would fade such a big move. I think the reasons for the bullishness remain, but I do have to admit, the market seems broken. Moves like yesterday, on so little, seem scary. It was like watching stop loss after stop loss get triggered.
The reason I’m more bullish on the strength of the move, is that it felt more like stop losses on shorts than true greed taking over. We may well have the greed stage yet to go, where people who didn’t “buy the dip” instead “chase the rally”.