There is something profoundly pathetic about the fact that the dominant concern of the entire financial world for the last two weeks has been what the chairman of the Federal Reserve Board, Ben Bernanke, will say at the annual late-summer gathering of central bankers and senior economic figures, held at Jackson Hole, Wyoming. The words that will issue from Bernanke’s mouth will, supposedly, be critical for the financial markets and for the American and global economies.Whoah! Yesterday afternoon spoke to a sharp hedge fund manager in New York who was explaining to me how most economists and fund managers simply don't understand the way banks create money and the monetary policy transmission mechanism, "which is why guys like Paulson are snapping up gold believing QE will cause inflation" (he's in the debt deflation camp).
This is what it has come to, five years into the global economic crisis and four years after the “Lehman moment” that sent the crisis spinning out of control and placed the entire world on the very edge of a major depression. It is axiomatic in mainstream financial circles that: a) the actions of Bernanke and his fellow central bankers at that time prevented the descent into depression; b) his subsequent policies, meaning various iterations of “unorthodox monetary policy,” aka “quantitative easing” (QE), have enabled the American economy to mount a slow recovery from “the Great Recession” that occurred in 2008-09; c) ergo, if Bernanke will announce another round of QE, or some other form of what is now being called “unorthodox unorthodox policy” – since the old “unorthodox” is the new “orthodox” – then the outlook for the American and world economies will instantly brighten.
Thus, if Bernanke announces, or even discusses, or merely hints in his speech on Friday that the Fed will pump several hundred billion dollars into the markets, every market in the world will rally. If, on the other hand, he fails to announce, discuss or even hint that action is coming, then he will be deemed as having “disappointed” the markets, and they will promptly plunge.
Furthermore, it had been hoped or believed that Bernanke’s opposite number at the European Central Bank, Mario Draghi, would also attend the Jackson Hole conference and that he, too, would announce new steps, measures, actions – or at least substantive plans – whereby the ECB would buy large quantities of sovereign bonds of crisis-ridden European countries such as Spain and Italy. However, earlier this week Draghi announced that he was canceling his participation in the J-Hole show. That meant he had nothing to say there – and the cause of his silence is no secret, since the argument between him and the German central bank, the Bundesbank, and its representative on the Governing Council of the ECB, is being played out in full public view in the newspapers, news services and financial TV daily and almost hourly.
No such open opposition faces Bernanke. Nevertheless, after literally millions of words of analysis and commentary had been spoken and written during August as to whether and what he would say on Friday, a consensus emerged this week, one that embraced even the perma-optimists among the financial houses and their strategists: that he would not announce, discuss or hint at anything new or substantive.
Against this background, the hopeful expectation that had permeated the markets turned to ex ante disappointment, so that on Thursday the mood turned negative and the direction of prices of shares and bonds across the world followed suit.
However, what is both pathetic and tragic is the very fact that what Bernanke or Draghi say or do is seen as the be all and end all of financial and economic developments.
Implicit in this approach is not merely the belief, noted above, that the central bankers saved the world last time and their subsequent actions have kept things steady, but that they can and will do so again – and again, as many times as necessary. This is such obvious drivel that one wonders how anyone can believe it – after all, if a policy of zero interest rates and central banks buying government debt is so desirable, why did nobody do it before 2008? And if its benefits are so clear-cut, then why is there any hesitation or debate? Bring it on – the sooner the better, and the more the better.
Yet the Germans will not let Draghi run amok, and something is holding Bernanke back as well. This is actually not very mysterious, because any objective examination of the impact of the policies followed over the past four years reveals that each round of QE has had successively less impact, and that impact has lasted a shorter period each time. That’s what economists call “diminishing returns.” In addition to declining benefit (some leading economists believe there was none and that it was fiscal policy, especially the Chinese stimulus program, that saved the day in 2008), the pursuit of unorthodox monetary policy has costs, and these actually rise cumulatively. The distortions introduced into the economies of countries subjected to QE-type policies make it an unsustainable approach in the long run.
But the essence of policy these past few years has been to survive in the short run and push off the inevitable day of reckoning. In that context, QE makes a warped kind of sense – and that’s why the markets want it, if not now, then soon. The possibility that it will not come, or that if it comes it won’t work, is unpalatable – because the alternative to the make-believe “recovery” it sustains is unthinkable.
He also told me that the day the psychological effect of the Bernanke put is over, "will be the scariest day ever in financial markets." Luckily, he doesn't see such a doomsday scenario anytime soon, but if the Fed does go ahead with QE and markets don't react, or a significant selloff ensues, that will be damn scary.
We also talked about the pathetic performance of hedge funds and he agreed with me, most won't survive another annus horribilis. "The year is effectively done. With only 10% beating the S&P, the best they can hope for is a market crash in the next three months so their performance doesn't look as lousy." He added: "I agree with you, don't see a crash coming."
Not only do I not see a crash coming, regardless of what Bernanke of Draghi say or do, I see the opposite, a rally in risk assets. In fact, I have openly stated that the Fed doesn't need to engage in another round of quantitative easing, stoking another bubble. The US recovery is taking hold and employment data over the next six months will demonstrate this. Moreover, stock market is close to new highs, hardly any reason to panic.
But watching market action lately has been painful, akin to watching paint dry. It never fails to amaze me how risk assets drip lower right before a major monetary policy announcement as the brats on Wall Street want to force the Fed into action, providing them more money for nothing and risk for free.
Well, sorry to disappoint these brats but they can forget about more quantitative easing this Friday. If the Fed caves into their demands, it might backfire in a spectacular way, something that they can ill-afford at a time when the recovery is finally taking hold.
I for one think the Fed did an excellent job, managing the crisis as the political loonies demand more austerity. They used quantitative easing when they felt they had to and are going to take a wait and see approach before committing to more action (update: I was right).
Let me end by stating that markets will likely sell off on the news of no news, which will lead people will panic over the weekend. Whatever happens, don't panic, risk assets will come back, especially if the August US jobs report due out next Friday shows employment growth picking up stream.
If I was the Fed, I would disappoint the Wall Street brats looking for their QE fix. A polite but firm "fuck you" and let's all get back to investing and stop waiting for more Fed action.
Below, Federal Reserve Bank of St. Louis President James Bullard said he’d like to see more economic data before deciding on “big action” at the next meeting of policy makers. He speaks on Bloomberg Television's "Bloomberg Surveillance."
And Bloomberg's Peter Coy, Tom Keene and Sara Eisen discuss whether the markets need more quantitative easing by the Federal Reserve. They speak on Bloomberg Television's "Bloomberg Surveillance."
Finally, Michael A. Gayed, CIO at Pension Partners, was interviewed on Bloomberg discussing Europe, the ECB, stocks, bonds, and more. Listen carefully to his comments on 'central bank paranoia' and what will happen if stock markets collapse.