Tuesday, August 30, 2016

Stephen Williamson and Current Fed Behavior

 Professor Williamson, VP of the St Louis Fed said this in a comment to his blog article, to a fellow who said NeoFisherism won't work, but may result in less consumer spending and just a bidding up of assets:

Your comment illustrates the problem with what David is looking for, which is some "intuition" that will somehow convince people who are not on board with the idea. Any "intuition" that people have comes from thinking about some model that is familiar to them. In some cases, that seems to be some undergraduate IS/LM/Phillips curve model with fixed inflation expectations. In that type of model, tighter monetary policy makes the interest rate go up, spending goes down and, via a Phillips curve effect, inflation goes down. If that's your "intuition," then nothing will convince you that higher nominal interest rates make inflation go up. Checking our ideas for internal consistency involves constructing rigorous models, and trying to understand what these models have to say about the real world, and whether or not the models fit the facts as we know them. That's the level at which the convincing gets done, not in telling "intuitive" stories. I have no idea why you think the underlying assumptions behind the idea are "unrealistic," but the theory is what macroeconomists have worked on for some 40+ years - it's boilerplate.
 I responded to the Fed VP, who is willing to get to the heart of some major issues:

40 years ago, Prof, we didn't have maddening bond hoarding. We didn't have banks and counterparties fearful that a little rise in interest rates would force collateral to decline in price, causing the need to hoard even more bonds, pushing the long yields down even further.

As far as NeoFisherism is concerned, the bond hoarding is what creates the conundrum, and Greenspan said this very thing in 2007:

"To be sure, the benefits of derivatives, both to individual institutions and to the financial system and the economy as a whole, could be diminished, and financial instability could result, if the risks associated with their use are not managed effectively. Of particular importance is the management of counterparty credit risks. Risk transfer through derivatives is effective only if the parties to whom risk is transferred can perform their contractual obligations. These parties include both derivatives dealers that act as intermediaries in these markets and hedge funds and other nonbank financial entities that increasingly are the ultimate bearers of risk."

Greenspan created, IMO, too big to fail, and put the risk squarely on the counterparties and off the TBTF banks. He wanted the S&L crisis to never happen to another bank. But what he failed to understand was that risk doesn't go away, it just goes to the counterparties and the clearinghouses that demand more and more collateral for derivatives.

So, I will bet you a dollar, Prof, that any efforts to raise short rates will continue the conundrum, which is really not a conundrum at all, but is exactly what Greenspan engineered to happen.

I honestly believe the Federal Reserve Bank knows long yields cannot go up, but it is in on this tantrum behavior.

The only thing I don't quite understand is if there is a real shortage of the treasury bonds as collateral, or if there are plenty of other bonds, like corporate bonds, which can be used with a haircut. I am thinking that Greenspan's investors don't want to pay that haircut premium, which is why Greenspan is now engaged in tantrums continually, to get weak hands to get rid of their long bonds.

I am sorry if I seem cynical, but how can anyone seriously not be cynical about this system.   

The banks want a little raise in yields so they can get a boost from IOR, which is like a welfare check to them from the people.

It is the counterparties and clearinghouses that are at risk. The banks are reporting less revenue and profits yoy,  but the folks with most of the collateral are counterparties to the banks. Greenspan wanted it that way. He wanted TBTF and he got it.

Of course, the counterparties can’t provide enough collateral to the casino if the Fed raises yields. You think bonds are hoarded now. Wait till short rates are raised and you will see a massive “conundrum” of demand for long bonds. And of course, really, it is not a conundrum at all. Even Greenspan knew this and said:

To be sure, the benefits of derivatives, both to individual institutions and to the financial system and the economy as a whole, could be diminished, and financial instability could result, if the risks associated with their use are not managed effectively. Of particular importance is the management of counterparty credit risks. Risk transfer through derivatives is effective only if the parties to whom risk is transferred can perform their contractual obligations. These parties include both derivatives dealers that act as intermediaries in these markets and hedge funds and other nonbank financial entities that increasingly are the ultimate bearers of risk.

It is clear that the counterparties could undermine the stability of the financial system. The betting and trading they do is a significant portion of all trades.As George Carlin once said, the elite don't care meaning the Fed (banker to the will of elite) doesn't much care. I have become more cynical and the Fed, first mispricing risk, then being slow to save the economy did more than destroy wealth. it transferred it from mainstreet to Wall Street. It almost looks preplanned, and there is a strong case that the Fed decided to liquidate the economy so that Wall Street could consolidate financial power in the Great Recession.

But of course, creating structured finance, bond hoarding and derivatives has just boxed the Fed in. It may be comfortable with that box, thinking not much could go wrong in the new normal it seems to relish. Although I am sure it is not without worry about what could go wrong.

If you read Stephen Williamson's blog (and by the way he has been very kind in posting my comments most of the time), you will see that the mind of the Fed as revealed by Prof Williamson is technical to the core, and involves just a little tinkering with rates and minimal Fed tools. The Fed really isn't worried too much about big moves, and as long as growth is slow, they seem fine with how things are, so far. And so far is no guarantee of future Fed success!

Friday, August 26, 2016

Sorting Out the Ryan Lochte Story

The Ryan Lochte story needs to be sorted out. While I support national sovereignty over loss of sovereignty to global alliances, I only support sovereignty that comes with mutual respect.

The old idea of the ugly American, or the ugly German, or sometime now, the ugly Israeli comes to mind as an abuse of sovereignty, a patriotism gone wrong.

One could even add Donald Trump to that camp, not respecting Mexico apparently because he lost a big deal there and had to pay up in a lawsuit. But this article isn't about that ugly American, Donald Trump. It is about the ugly American, Ryan Lochte.

Lochte and his friends were allegedly drinking and some vandalism occurred at a convenience store in Brazil during the Olympics. Lochte and his friends claimed, allegedly, that they were robbed at gunpoint. It turns out that security at the store simply demanded payment for the damage that the Americans caused.

That would have been the end of it, damages done, damages paid for. But when Lochte and his friends apparently filed a police report saying they were robbed, it looked to many as a coverup of what really happened.

The Brazilian government has since filed charges against Lochte for filing a false police report. He has lost most sponsors and is relegated to reality TV, like Dancing with the Stars. He has been banned from the 2020 Olympics, and more punishment from the Olympic leadership may follow.

Lochte made a minor situation worse because the Rio games were far safer than reports said prior to the games. Those reports were all over the news. Rio proved those authors wrong. But then came Lochte and company, placing a stain on the Olympic games themselves just to cover up vandalism.

A young person's mistake, minor vandalism, turned into a disastrous slander, in my opinion, against the nation of Brazil. That is why Ryan Lochte is in so much trouble.

He will always, being famous or infamous now, have reality TV to fall back on. One only has to look back to Tanya Harding, banned from skating when her team attacked a competitor, Nancy Kerrigan, in the knee.

It is a sad chapter in American behavior abroad. But as long as empire controls our leaders and their ambitions for world dominance, ugly American behavior will continue. It is almost bred into people from an early age, that the USA is number one.

Unfortunately, we are both number one in good things and number one in bad behavior, all the way up to and including regime change, which is a policy of the USA. It is disrespectful to sovereignty, and makes America the thug, not the policeman, of the world.

That role as policeman changed to role as thug came with the election of George W. Bush and Richard Cheney. We have not recovered from that behavior and will likely not anytime soon, under any president we elect. Absolute power corrupts absolutely.

Ryan Lochte apparently is a young example of a wider American problem, the arrogance of power, manifested for all the world to see.

Thursday, August 11, 2016

Fed Tricksters, Put Your Monetarism Where Your Mouths Are

 This article was first published by me on Talkmarkets: http://www.talkmarkets.com/content/economics--politics-education/fed-tricksters-put-your-monetarism-where-your-mouths-are?post=97455&uid=4798

Monetarists need to step up to the plate and provide a clutch hit in this very serious game of economics. It is a time for action. We have all heard the phrase:
Put Your Money Where Your Mouth Is.
That means to take action to support your claims, most commonly by backing your claims with a bet. It takes nerve and guts to take action to support your claims, in all walks of life. It is much easier to just play tricks on people than to think about the economy.

Well, it is time that monetarists to start putting their monetarism where their mouths are. Monetarists believe that the proper control of the money supply is a key element to the creation of prosperity, and the maintainance of a stable and growing GDP. Clearly, monetarism as defined by Milton Friedman is not operating on all cylinders. This is why monetarism gets such a bad name. It is seen as neo-liberal trickle down asset buying and nothing else. That trickle down has made the rich richer and the poor poorer.

But monetarism could offer so much more and the genius behind monetarism, Milton Friedman, knew it. Before talking about that aspect of genius, I have boiled monetarism down to two basic schools, and one controls the Fed:

1. The Market Monetarists seek more NGDP targeting in place of inflation targeting, which proved futile in the downturn of 2008, as NGDP was cratering and inflation held steady. The tool they want to use to create this stability is asset purchasing. Asset purchasing is sometimes the best game in town in a crisis. But as Mohammed El-Erian said, it falls short and has diminishing returns as time goes on, as it helps wealth gravitate to the top.

2. The New Monetarists control the Fed. I am not always sure they are monetarists, as the Fed often interferes in markets. But clearly, they are for limited monetary intervention. The do a little asset buying and selling and try to control interest rates whenever the market lets them. That limited involvement did not work out so well in the Great Recession, or in the Great Depression for that matter.

Fed Chairman Janet Yellen

The New Monetarists have brought the economy a little way back from the abyss, after they liquidated it with procyclical policies, but neoliberalism has made the poor, poorer, along with globalization and automation. Dropping interest rates actually does not affect these households much when asset prices rise. They generally get a raise by moving in with relatives, not by taking advantage of low borrowing rates.

Low rates cease to be a stimulus. And low nominal rates may even be too high already since growth has crawled to a halt. But going negative can be hazardous if it doesn't work and if there is a big downturn. Real rates are probably severely negative right now. We must consider Friedman at this critical time of Fed paralysis.

But the father of modern monetarism, Milton Friedman, had one trick left in his magic hat. That trick was pure helicopter money. Once the other tools of the Fed, like bringing interest rates lower to stimulate growth or by using asset purchases to stabilize prices, become less effective, the only real tool to make the society prosper is helicopter money. Friedman was not a street corner slight of hand lightweight like Janet Yellen. No, he was a big time magician.

Helicopter money should be distinguished 1. from guaranteed income, otherwise known as Universal Basic Income (UBI), promoted by Charles Murray, 2. from fiscally based QE, 3. from Keynesian deficit spending stimulus.


Milton Friedman did advocate a negative income tax, and helicopter money, but they two different things. Unlike helicopter money, UBI is financed through taxation. That could present a problem, making those who pay taxes more likely to cheat than if there was no UBI. Also, tax cuts promised by politicians could establish a massive deficit if we try UBI, which needs more taxation. And while we do have a negative income tax that is not universal, it is not as far reaching as is a universal and continual grant of money to all the people.

As for UBI, perhaps the economy could one day generate enough real wealth to allow a universal UBI, but I am uncomfortable with going beyond Friedman's negative income tax for the needy.

In Nevada, there is sort of a negative tax, as we have no state income tax because the casinos earn enough to pay the tax. So, elements of the plan for negative tax can be very appropriate.

Helicopter money, on the other hand, is worth implementing, in order to allow the Fed to raise interest rates. It is simply the application of base money to each person equally, within a certain time period, and with the goal of allowing interest rates to rise. It is not based on government debt. 

Base money is Fed money, and if the goal is to repair the balance sheet of the Fed, helicopter money could do just that, and quickly the dent created in the balance sheet by the dispersion of trillions of dollars would be repaired by more economic activity and by more general prosperity and by higher interest rates. Monetarism would create a general prosperity but with the understanding that it was not permanent grants. Without a general prosperity, higher interest rates are a Federal Reserve night time fantasy dream.

So, if we want higher rates, and not be like Europe, and not have monetary policy reach the end of the road and fail, it is time the monetarists started acting like monetarists and back helicopter money. They should make it clear that HM is not Keynesian big government fiscal stimulus, nor is it QE, with bond swapping with the treasury, nor is it UBI!

It is time to really see if monetarists really are monetarists, if they want to follow the genius, Friedman, or if they just don't have the guts to stand for the obvious next step in monetary policy. Come on monetarists, put your monetarism where your mouths are.

I have often wondered if the Fed pumps the threat of higher interest rates to push bond yields up, giving its banks a bargain opportunity to buy! That isn't a way to run the economic system, with slight of hand parlor tricks! No, the real way to run an economy is to fix the problem of declining real rates without pushing nominal rates negative. It can be done. Friedman said so. Follow the genius, monetarists!