Stocks down 93 on the Dow yesterday. Gold down $19, closing below $1,300. Nothing serious. But the autumnal trend should start to reveal itself soon. Usually, markets begin to give hints as to where they are going in August. Then, in the autumn, they set out in earnest.
The bond market seems to have put in a top early May. Gold probably bottomed out in early July. And stocks? They could be topping out now. We’ll have to wait to find out.
But these trends, should they continue, are bound to cause weeping and wailing at the Fed. America’s central bankers have no idea what is going on, and no good idea what to do about it.
Barack Obama should call the National Security Agency (NSA). They’ll know how to get in touch with us.
On Monday, we announced that we would be open to talking about an appointment to the top job at the Fed. We didn’t expect to hear from Mr Obama immediately. It will take him a few days to figure out that his leading candidates for Fed chairman should turn their talents elsewhere – maybe to polishing the White House silver.
According to the press accounts, the race to replace Ben Bernanke is centred on two people – Janet Yellen and Larry Summers – with Summers on the inside track. Don’t discount Mr Obama’s concern for things that don’t matter, however. He could go for Ms Yellen simply for anatomical reasons. As we explained last week, a central banker who fails in his number one duty – to protect the nation’s money – should be castrated. At least in that sense, Ms Yellen has an edge.
Normally, no one would know or care who got the job at the Fed. But everyone says these aren’t ‘normal’ times. They all seem to think the times call for an extraordinary person… a ‘brilliant’ person. After all, who else would be able to carry out the mission President Obama has outlined for him: to keep the economy growing, hold inflation in check, and make sure we don’t create new instabilities? A tall order for anyone.
The whole thing is a set-up, designed to bring into focus the one candidate whom everyone agrees is brilliant – Larry Summers. Who do you call when times aren’t normal? Who else has such a brain? Quick as a viper, agile as a flimflam man, and as penetrating as rustoleum? Yes, for these reasons, the insiders believe Larry Summers is increasingly finding favour in his master’s eyes.
But what if times are really rather normal? And what if Mr Summers really weren’t so brilliant, after all?
Let us deal with the second question first. We set aside the fact that Mr Summers managed to turn almost the entire Harvard faculty against him, and that he cost the Harvard endowment a billion dollars, thanks to his wrongheaded interest rate speculations. Let us look at a larger and more obvious failing.
In 2005, in Jackson Hole, Wyoming, Professor Raghuram Rajan described the obvious. He laid out the contours of the financial bubble to an audience that included Larry Summers. He warned that it would pop. No special analysis or deep thinking was required from Mr Summers. He didn’t have to figure it out for himself. He just had to pay attention. In the event, he did pay attention. And, as is his habit, he misunderstood. “The basic, slightly Luddite premise of this paper”, he commented, “is largely misguided”. Get it? Mr Summers thinks that any mention of cycles or limits is anti-progress.
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We read Mr Summers’ commentaries regularly in the Financial Times. We don’t recall a single insight worth repeating or a single proposal that merits further discussion. Like Thomas Friedman, he sees problems everywhere and finds solutions for them readily. And every solution he comes up with would be neat, logical, and disastrous.
Unintended consequences? Has he ever heard of the concept? For him, reason has no limit, intervention has no risks and the world has no black swans. Seeing no danger to further monetary stimulus (consumer price inflation is still low), he will put the pedal to the metal and run at full speed, right into a brick wall.
Which brings us to the second question: how abnormal is this situation?
The US switched to a credit-based system in 1971. With this new paper money, Americans could borrow a lot more money than before. Was it not normal that they did so? Total debt went from about 150% of GDP to 350%.
Then, in 2007, when even unemployed household pets had mortgages on houses at inflated prices, was it really surprising that lenders panicked? Every credit bubble is followed by a credit bust. What’s not normal?
What next? The feds panicked too. Rather than let a correction do its work, they stepped in. First, a $700bn programme under George W Bush (with $23trn of additional guarantees). Then, another $700bn under Barack Obama. Then, the Fed went to work, with zero interest rate policy (ZIRP), QE I, QE II, the Twist, and QE III. Isn’t that just what you’d expect? The feds will do “whatever it takes” to keep the money flowing.
But adding more credit to an economy that already suffers from too much doesn’t really help. Nothing unnatural about that either. So, the economy didn’t revive, it just pushed up prices for rich people’s assets. Most people got nothing from this monetary and fiscal hullabaloo. There were 116 million Americans employed in 2008. There are only 113 million today. And the population has grown by eight million people in the meantime. What’s more, many more of today’s jobs are in the low-paying service sector.
What’s not normal? And what brilliant innovations will Larry Summers come up with to mask the fact that the Fed’s activism doesn’t work?
What’s needed is not brilliance at all, but dull forbearance. We need normal policies for a normal period of deleveraging. So far, only one candidate for the Fed chairmanship has demonstrated the lack of brilliance required. He alone understood what was happening in 2005-2007 and he now appreciates the limits of central bank activism. You know who that candidate is: yours truly.
Repeatedly, he warned, in sober economic terms, that “this Vesuvius of debt is going to blow sky-high”, or words to that effect. Then, when the lava flowed in 2008-2009, he foresaw the Fed response and predicted that it “won’t do a damned bit of good”.
And now, he knows what to do. The Fed should back off. Sit tight. And let markets do their work.
It’s time for a change.
Mr Obama, we’re standing by the phone.
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