Thursday, 19 September 2013

No Tapering Did Not Surprise Everyone

Alasdair Macleod was not surprised of the Fed's decision yesterday not to start tapering now. He lists six reasons why tapering was not going to happen:
1.       Monetarists and therefore central bankers believe that rising bond yields and interest rates will strangle economic recovery. They want to see more robust evidence of recovery before permitting that to happen.
2.       Rising bond yields would have required the Fed to raise interest rates sooner rather than later to stem the flight of bank deposits from the Fed’s own balance sheet held as excess reserves, which only earn 0.25%.
3.       Importantly, the global banking system has too much of its collective balance sheet invested in fixed-interest bonds, and is also exposed to rising interest rates through interest rate swap derivatives. Tapering would almost certainly have precipitated a second bank crisis starting at the system’s weakest point.
4.       The cost of funding the US Government’s deficit would have risen, difficult when the debt ceiling has to be renegotiated yet again.
5.       Rising US interest rates will most probably destabilise emerging market currencies, risking a new Asian crisis.
6.       It is a bad time to shift the burden of government funding back into the markets, because foreign holders have shown they will sell into rising yields.
Back in June this year, Detlev Schlichter didn't buy that QE was coming to an end as he explained in his article titled End of QE? – I don’t buy it,
The Fed believes it has healed an economy that was sick from easy money with more easy money. The patient is feeling better and can soon be released from intensive care. In my view, the patient is still sick and now suffers from a dangerous addiction to boot. The ‘feeling-better’ bit maybe, just maybe, a lingering drug high from Dr. Bernanke’s generous medication. Withdrawal symptoms may surface soon. If they do, Dr. Bernanke will simply open the medicine cupboard again. Don’t forget, only a few weeks ago the man appeared on TV and tried to talk up the Russell 3000 stock index.
I do not doubt that, if measured by overall GDP, the US economy is presently doing better. I would be foolish to take on the Fed on this point. The Fed has a staff of 200-plus economists, most of them, I assume, from America’s finest universities, which doesn’t mean they are good economists but at any rate they are probably good statisticians. If they say there are signs of life in the economy, that’s good enough for me.
Where I disagree is on the narrative. The deformations are largely still there. How can they not, given the enormous policy effort to suppress the very market forces that would – in a free market – have exposed and liquidated these deformations? They are still visible, among other indicators, in high degrees of indebtedness. And they matter. That is why I am mistrustful of the Fed’s projections. Their theories compel them to believe in virtuous cycles and ‘escape velocity’ and to disregard imbalances and distortions. Any sustained removal of super-easy money will allow these deformations to resurface and immediately cloud the near term cyclical outlook. According to my worldview, this should be allowed to happen as it is part of the essential healing process. But it runs counter to the Fed’s worldview and the Fed’s view of its own mission.
The one institution that lacks ‘escape velocity’ is the Fed. It will remain hostage to the financial monsters it created and the dangerous misconception of its own grandeur.
Benny "the printer" Bernanke cannot possibly not be aware of the issues stated above (can he?). These factors must surely have played a role in the decision yesterday not to start tapering.

In addition to the above, the fact that bank credit growth has been in free fall in recent months and money supply growth is slowing (see here) couldn't have made it any easier to start tapering. Bernanke believes in Friedman's explanation that the U.S. depression was caused, or certainly made it much worse than it needed to be, by tight money policies during the period 1929-1933 (unfortunatly he never listened to Austrian economist who explain that the loose money policies running up to 1929 was the cause). Bernanke said on Friedman's 90th birthday,
Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again. 
I believe him. Not in that he is correct, but that he will not do again what he believed was a mistake some 84 years ago. But he must surely now have realised that monetary policy, especially the unconventional type, does more damage than harm. The US economy is still struggling half a decade later since the "credit crunch" and he now has an expensive stock market and a government bond bubble combined with a government debt to GDP ratio of more than 100% to deal with.

His feet must be cold, very cold and he must be delighted that he will not be the Fed president (by the looks of it) for much longer. 

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