Markets make prisoner of the Fed
“Market participants should not direct policy,” Kansas City Fed President Thomas Hoenig warned listeners at a town hall meeting in Lincoln, Nebraska, back in August. Unfortunately that is precisely what is now happening.
Hoenig noted that Wall Street’s clamour for cheap money was not disinterested: “Of course the market wants zero rates to continue indefinitely … they are earning a guaranteed return on free money from the Fed by lending it back to the government through securities purchases.”
Now the same pressure groups want the Fed to launch a second round of asset purchases so they can sell U.S. Treasury bonds to the central bank (in effect back to the federal government) at inflated prices.
A new round of securities purchases provides investors with an exit strategy from what might otherwise be a dangerous bubble in the bond market. Every bubble needs a “greater fool” prepared to pay a higher price for the asset to keep the bubble inflating. In this case, the guaranteed sucker is the Fed itself.
Meanwhile quantitative easing (QE) has pushed up the value of all the risk assets institutions and investors hold, giving the market a highly desirable insurance policy.
Set aside the question of whether the Fed should socialise investors’ risks and losses in this way. Set aside also the issue of moral hazard — whether by bailing out investors the Fed will encourage more excessive risk-taking behaviour in future. Most officials admit recent actions have increased moral hazard but believe it is a problem to be solved in the long term by appropriate supervision.
The immediate policy question is whether the prospective QE programme is contributing to stability in the financial markets and an environment likely to encourage more long-term investment by businesses and job creation. In other words, is QE succeeding in its own terms, meeting the objectives set by the central banks themselves? There are several reasons to be extremely doubtful.
Uncertainty, distributions and fat-tails
In a thoughtful article published this week in the Financial Times, PIMCO Chief Executive Mohamed El-Erian and Columbia Economics Professor Richard Clarida explore the implications of a shift in the shape of investors’ and policymakers’ expectations about the future.
“It seems that, wherever we look, the snapshot for ‘consensus expectations’ has shifted: from traditional bell-shaped curves — with a high likelihood mean and thin tails (indicating most economists have similar expectations) — to a much flatter distribution of outcomes with fatter tails (where opinion is divided and expectations vary considerably).”
They do not go quite as far as Bank of England policymaker Adam Posen, who suggested in a recent speech that the distribution of outcomes has inverted and become U-shaped. But their focus on a bell-curve with fatter tails agrees with Federal Reserve Chairman Ben Bernanke’s characterisation of the economic outlook as “unusually uncertain” at present.
El-Erian and Clarida draw five conclusions for investors:
(1) Investment strategies based on mean reversion will become less compelling. Fat-tailed distributions still have means but they will be realised less often in practice.
(2) Frequent risk-on/risk-off oscillations in sentiment will remain a persistent feature of the landscape.
(3) Hedging against tail-risks will become increasingly important.
Getting ready for the dollar’s fall
It just won’t go away, this needling worry about the U.S. dollar losing its coveted top-dog status.
No matter that there are plenty of reasonable arguments to support the dollar as the world reserve currency — namely there’s just no alternative — for perhaps decades to come.
Yet, in a world where once-rock-solid assumptions quickly turn to dust, investors should keep an eye on the dollar since changing perceptions are chipping away at its cherished status as currency to the world.
Much of the debate so far this year has centered on creating an alternative to the U.S. dollar, championed by China and Russia as a way to wean the world off its dependence on the U.S. as well as buffer individual nations against the missteps of those in developed world. Most recognize creating a new currency will take years and the chances of an existing currency, like the yuan, usurping the dollar anytime soon are remote.
But that doesn’t mean big money isn’t starting to prepare for world in which the buck isn’t the currency of choice.
Curtis Mewbourne, a portfolio manager at PIMCO, has suggested that investors diversify away from the dollar and to move into other currencies, especially those in emerging markets.
“And while we have not yet reached the point where a new global reserve currency will arise, we are clearly seeing a loss of status for the U.S. dollar as a store of value even in the absence of a single viable alternative,” he wrote in an article published on PIMCO’s website.
I keep reading articles like this which still seem to use the same old tired arguments concerning dollar status. This is very disappointing. A possible look at the real prevailing strategies used by China and other creditor nations easily reveals that the dollar has many enemies:
* According to a MarketWatch article, China has pulled all her gold bullion holdings from London and is moving them to a new high Security location near the airport in Hong Kong. This may be China’s own attempt to start her own bullion market in the Far East. This action also clearly restricts and damages the London Bullion Market’s gold leasing capabilities. The Gulf States have also done the same.
*China kicked off issuing her own Treasuries on Sept 28 of this year. These bonds are a direct competitor to US Treasuries.
*The Chinese govt is now discreetly buying gold from her own gold mines after suddenly becoming the largest producer of gold in the world.
*The Chinese people can now buy as much gold and silver as they like — all 1.3 billion of them. This is being heavily promoted by the Chinese govt.
*The Chinese govt is slowly buying gold on th markets. Every time the uS govt dumps dollars onto the gold markets, China just buys gold safely in the dips with her dollars. Therefore, the US has lost control of the gold price and has therefore lost control over dollar value. The Chinese are now in control of the greenback.
* China appears to be returning to a partial gold standard. If China controls the gold markets as well as backs her Yuan with gold, the strength and stability of the Yuan will be untouchable and unassailable when compared to other world fiat currencies.
*China’s own sovereign wealth fund — China Investment Corporation(CIC) — has spread its investments out rapidly and very effectively, investing around the world mainly in extractive commodity industries. The CIC has alot of weight to throw around — $300 billion — and, amongst others, has been investing heavily in the oil and precious metals markets. Effectively, China’s CIC fund is dumping dollars for gold and other more worthy hard asset investments now.
*It appears that other world central banks have also begun buying gold now, as a hedge against the China gold plays.
*Recently, in an UK Independent article called “The Demise of the Dollar”, the countries of China, Russia, France and the Gulf states all openly announced that they would be dumping the petro-dollar for the euro. Iran will also be doing the same.
In terms of economics and the markets — particularly pertaining to the adverse affects on the dollar — these are certainly not trivial economic events.
If the author would bother to actually research what’s really going on with the dollar, she could perhaps put 2+2 together and form a believable opinion. I’m not saying that all this will happen quickly, all I’m saying is that the dollar is well on its fading way, and will probably end up, after some years, as merely a regional currency amongst equals as opposed to being the top dog currency.
The trade of QE causing intense inflation harming primarily the poor and further QE to keep the S&P alive is a hard choice.
The Poor, rationing between food and fuel, now reaching to the lower middle class, which Mr. Bernanke when addressing food & fuel doesn’t consider as real inflation conflicting with Europe’s measurements; or propping up the S&P and Dow by maintaining a cheap dollar and pushing exports.
Unfortunately his positive arguments for QE is weakened by the Large corporate entities going rapidly offshore to avoid paying American Corporate taxes. It’s tough when your chosen constituents stick it up your rear.