“March 17 – Bloomberg (Kelly Bit): “Ray Dalio, founder of the world’s largest hedge fund firm, Bridgewater Associates, told investors there’s a risk that the Federal Reserve could create a market rout similar to that of 1937 if it raises interest rates too fast… ‘We don’t know — nor does the Fed know — exactly how much tightening will knock over the apple cart,’ Dalio and Dinner wrote. ‘We think it would be best for the Fed to err on the side of being later and more delicate than normal.’”
“Sometimes I feel as if I’m living on a different planet. As much as I respect the intelligence and market acumen of Jeffrey Gundlach and Ray Dalio, I take strong exception with some of their comments on Fed monetary policy. Dangerously flawed policymaking is only perpetuated by further delays in rate normalization. I also reject the comparison to 1937. Even at its 1937 highs, the Dow remained about half the 1929 peak. Unemployment sat above 14%. Today’s parallels are much closer to 1929. Regrettably, the Fed drew the wrong lessons from the “tech” and mortgage finance Bubble episodes. Now, everyone wants this party to last forever.”
– Doug Noland, Credit Bubble Bulletin. (Bridgewater’s $169 billion under management might have something to do with it.)
Caesar: “What say the augurers ?”
Servant: “They would not have you to stir forth today.
Plucking the entrails of an offering forth,
They could not find a heart within the beast.”
– William Shakespeare, ‘Julius Caesar’.
Millions of investors across western economies have been peering nervously into the sky for clues about future market direction after unprecedented goings-on in the heavens. Analyst Marti Venal of CravenFokker Investments commented that a vast swathe of the earth’s surface being suddenly plunged into darkness was probably not a terrific omen for the stock market, although he was willing to make an exception for every IPO that his employer had underwritten. Senior astrologist Jed Meggar-Boom of Pimhole Securities disagreed, pointing to his firm’s proprietary research into clay models of sheep livers, and advocated taking aggressive leveraged positions in four year Danish mortgage securities. The executive management team of the ..AndIt’sGone Hedge Fund Consortium were taking no chances, having replaced their Chief Executive Officer for the duration of the solar eclipse with a substitute, atop a bronze throne, made up of twigs; former CEO Greg Ponzee was reportedly hiding under the coffee machine with one of his secretaries. Not all capital markets participants elected to flee the intriguing and possibly auspicious solar disturbance; market-makers at DweezilZap Securities, directly in the path of the moon’s umbra, as at press time had ritually sacrificed all the firm’s interns and were running around the dealing room smeared in camel dung. (Commentators pointed out that this was actually a regular occurrence, especially after a heavy Thursday night.) Typically, the closer observers were to the City of London, the more likely they were to experience utter diminution of their critical faculties. Those further away had an uninterrupted and entirely clear view of the spectacle. And not all sky-watchers enjoyed a cosmic display of equal duration. Two days after the event had concluded, and as Phoebus’ fiery chariot was once again wheeling through the heavens unassailed, Federal Reserve chairperson Janet Yellen admitted to being still completely in the dark.
We jest, of course. Or do we ? In a world in which hundreds of analysts spend thousands of man hours debating the presence or absence of the adjective ‘patient’ in the latest FOMC minutes, it’s sometimes difficult to distinguish between satire and reality. Keynes expressed the problem well:
“..we have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand. The result is that our possibilities of wealth may run to waste for a time – perhaps for a long time.”
The danger lies not just in mismanagement of a machine. The danger lies in the over-simplicity of the metaphor itself. What if the economy is not some machine offering essentially binary outcomes, what if the economy is in fact (as it surely is) a complex living, breathing thing reflecting the countless interactions between millions of individual economic actors, who are ultimately less rational than the economics ‘profession’ would have us believe ?
In such an economy, people err. The authoritarian instinct starts to reveal its limitations, rather publicly. It is facile to believe that a self-appointed committee of twelve people tasked primarily with protecting the interests of the banking system that ultimately employs them can assert the ‘correct’ price of money for the 320 million people in that economy and indirectly for the 6.7 billion who live outside it. It would be ludicrous to believe anything else. But that is the system we currently have.
It is, as Doug Noland points out, nearly two years since Ben Bernanke talked of winding down QE and starting to normalise monetary policy.
“The Fed’s current focus should not be the dollar, CPI or even the employment rate. The primary consideration after six years of zero rates and $3.6 trillion of monetisation should be Financial Stability. The Fed needed to be prepared to counter securities market and speculative excesses. They have failed to do the obvious, and Wednesday’s [FOMC] meeting confirms they will remain firmly in Bubble accommodation mode.
“I have argued for a number of years now that it was imperative for the Fed to begin extricating itself from market intervention and manipulation. It was never going to go smoothly, but when it comes to dealing with market distortions and Bubbles, the earlier the better. The scope of the Bubble has now grown to unprecedented dimensions – throughout virtually all securities and asset markets – and it’s global: stocks – small caps, mid-caps, large-caps – risky and “defensive” – growth and income; bonds – sovereign, corporate, “developed” and “developing”; and all varieties of derivatives. Anything providing a yield.
“The fundamental issue is a desperate need for the Fed to commence a process of normalising the pricing of market risk. Savings needs to generate a positive real return. The enormous ongoing flow of (unsuspecting) savings into grossly inflated risk markets only exacerbates systemic risk. The Bubbling corporate debt market needs to be tested – and some market discipline reinstated. The ETF and “bond” fund complexes, recipients of Trillions of flows, need to be tested – and market discipline allowed to run its course. The self-reinforcing stock buybacks, M&A and other “financial engineering” need to be tested by a period of tighter finance and associated risk aversion. Will they stand up ?”
The financial world has bifurcated sharply into just two camps: savers, and speculators. All the forces of the world’s central banks have been devoted to shafting the former and encouraging the latter. The process ends badly. When Danish borrowers are paid to borrow by their banks and Danish savers are penalised for keeping money in the bank, something has gone gravely wrong with the financial system. Something is rotten, and not just in Denmark.
Market historian Russell Napier develops this theme:
“..in the Eurozone the failure of monetary policy is more palpable. We have inflation and interest rates already in the world of ‘minus zero’. And it is not just the ECB’s deposit rate which has entered minus zero territory. The yield on seven-year German Bunds has fallen from 3.2% in 2011 to -0.03% today. At the short end of the curve the yield on three-month government paper has declined to -0.91% in Denmark, -0.80% in Switzerland and -0.25% in Sweden. There are now trillions of Euros of financial assets which yield less than banknotes.
“The Solid Ground has opined before on how such a development marks a distinct limit to monetary policy. The banknote is now becoming an increasingly attractive investment and any move to banknotes away from deposits creates a run on the banking system. This has not happened. Yet. However, with the vast bulk of ECB purchases of assets still to come, the move to negative nominal interest rates has just begun. At some stage a shift to banknotes will begin and the limits to monetary policy will become much clearer.
The spluttering torch of reflation will have to be passed to governments, and extreme government measures, such as outlawing cash holdings, are already under discussion. Investors should look to the imposition of a Tobin tax on capital inflows in Sweden, Switzerland or Denmark as a key indicator that central bank action will have to be bolstered by direct government intervention in markets.”
In all the annals of investing, few seemingly innocuous phrases incorporate as much by way of grave implication as those four words, “a shift to banknotes”. 2008 was bad. With central bank policy now at the outer reaches of the possible and even of the theoretical, the outlook is certainly uncertain. Not wishing to participate in the terminal stages of a momentum-driven bubble is not bearish so much as simply sane.