Counterparties: ‘Bridges to nowhere’ in central banking

April 12, 2012

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Traders and financial journalists have a favorite game: guessing when the Fed will step in and juice the markets. “The Fed signals possibility of something!” “Fed governor leaves door open for potential action at an unknown date!”

We all know this pattern; it still moves markets and sends CNBC anchors into a lather. But it’s worth taking a step back and taking in the latest comments from Mohamed El-Erian and George Soros about central banks. The real problem here isn’t Fed-obsessed traders making the market more volatile. Rather, they suggest, the world’s central banks could be doing more macroeconomic harm than good.

Both El-Erian and Soros are adamant that the European crisis is getting worse, despite the ECB’s huge interventions. Soros says: “the crisis has entered what may be a less volatile, but potentially more lethal phase.” The ECB’s LTRO operation, he writes, has helped the markets but “obscured underlying deterioration” that threatens to break up the EU.

El-Erian, for his part, says “the problems in Europe are getting bigger.” But his most fascinating comments are focused on the U.S. (His full speech, given at the Federal Reserve bank of St. Louis, is a must-read.) Cut through the wonkiness of El-Erian’s speech, and you have some of the harshest warnings about modern central banking in recent memory.

Among the potential consequences of central bank actions, according to El-Erian: damage to pension and money market funds; “artificial pricing, lower liquidity and a more cumbersome price discovery process”; contributions to higher commodity prices; pressure on emerging economies to lower rates; a gusher of speculative cash destabilizing emerging economies; and, last but not least, exacerbated income inequality, as the stocks and bonds owned by the wealthy become more valuable.

The broader idea, says El-Erian, is that the world’s central banks have transformed the world’s priorities, so that traders with a short-term outlook are dominating investors who might be able to make distinctions more useful than simply “risk on” and “risk off”.

We trade too much and invest too little – and a lot of that is the fault of the Fed and the ECB. Their liquidity helped to put out the fires of 2008, but looking to central banks to fix the world’s economic problems, El-Erian says, is just asking for expensive “bridges to nowhere.”

On to today’s links.

Double Agents
Meet the “Fox News Mole” – Gawker

Tax Arcana
“Accountants are today’s cowboys” – David Foster Wallace’s tax classes – New Yorker
A brief reminder on how the Buffett Rule actually works – WashPo

Treasury fund for “hardest hit” homeowners has spent just 3 percent of its funds in two years – NYT

The Fed
El-Erian: “central banks can no longer – indeed, should no longer – carry the bulk of the policy burden” – Pimco
Philly Fed Chairman: conditions don’t justify to new action – WSJ

Raging Bulls
Even excluding Apple, the S&P 500 has doubled since 2009 – Bloomberg

Goldman settles charges related to trading “huddles” for $22 million – SEC
Goldman sheds leveraged loans, and Buffet is the buyer – WSJ

Centralized Banking
Chanos says Chinese banks are instruments of state policy and won’t be broken up – CNBC

Positive Indicators
New York’s subway had more riders in 2011 than any year since 1950 – NY1

Old Normal
Gated communities: “we used to call them castles” – Atlantic Cities

Impatient Capital
Fred Wilson on what private equity can teach entrepreneurs about staying independent – AVC

Department of Collections
Recovering economy boosts tax revenue and shrinks the deficit by $50 billion – WSJ

Jamie Dimon ready to fight any repurchase claims on $95 billion of mortgage securities – Bloomberg

Sitting down is killing you, but a standing desk is a power trip – Kempt

New Normal
More people are quitting their jobs – and that’s decidedly good news – WSJ

Good News
At a state level, housing pricing prices and economic performance are decoupling – SF Fed

World Bank says China will be able to achieve a soft landing – World Bank

Oaktree’s IPO was marked to Howard Marks –  Reuters Breakingviews

The U.S. has a higher percentage of low-wage workers than any other OECD country – Economist’s View

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