I’m not sure what to title this piece as I begin writing, because my views are a little fuzzy, and by writing about them, I hope to sharpen them. That’s not true of me most of the time, but it is true of me now.
Let’s start with a good article from Dr. Jeff: 'Is the Fed Ahead of the Curve?' It’s a good article because it is well-thought out, and pokes at an insipid phrase “behind the curve.” In one sense, I don’t have an opinion on whether the FOMC is behind the curve or not. My opinions have been:
Now, there continue to be bad portents in many short-term lending markets. Take for example, this article on the BlackRock Cash Strategies Fund. In a situation where some money market funds and short-term income funds are under stress, the FOMC is unlikely to stop loosening over the intermediate term.
Clearly there are bad debts to be worked through, and the only way that they get worked out is through equity injections. Think of the bailing out of money market funds and SIVs (not the Super-SIV, which I said was unlikely to work), or the Sovereign Wealth Fund investments in some of the investment banks.
Now, one of my readers asked me to opine on this article by Peter Schiff, and this response from Michael Shedlock. Look, I’m not calling for a depression, or stagflation, at least not yet. At RealMoney, my favored term was “stagflation-lite.” Some modest rise in inflation while the economy grows slowly in real terms (as the government measures it). A few comments on the two articles:
One final note off of the excellent blog Naked Capitalism. They note, as I have, that the FOMC hasn’t been increasing the monetary base. As I wrote at the end of last week in RealMoney (The Fed Has Shifted the Way it Conducts Monetary Policy):
Understanding monetary policy isn’t hard, but you have to look at the full picture, including the presently missing M3. I have a proxy for M3: total bank liabilities from the H8 report ( ALNLTLLB Index for those with a BB terminal). It’s a very good proxy, though not perfect. Over the last years, it has run at an annualized 9.4%. MZM has grown around 12.8%. The monetary base has grown around 3%, and oddly, has not been spiking up the way it usually does in December to facilitate year-end retail.
The Fed is getting weird. At least, weird compared to the Greenspan era. They seem to be using regulatory policy to allow the banks to extend more credit, while leaving the monetary base almost unchanged. This is not a stable policy idea, particularly in an environment where banks are getting more skittish about lending to each other, and to consumers/homebuyers.
This has the odor of trying to be too clever, by not making permanent changes, trying to manage the credit troubles through temporary moves, and not permanently shifting policy through adding to the monetary base, which would encourage more price inflation. But more credit through the banks will encourage price inflation as well, and looking at the TED spread, it seems the markets have given only modest credit to the Fed’s temporary credit injections.
I am dubious that this will work, but I give the Fed credit for original thinking. Greenspan would have flooded us with liquidity by now. We haven’t had a permanent injection of liquidity in seven months, and that is a long time in historical terms. Even in tightening cycles we tend to get permanent injections more frequently than that.
Anyway, this is just another facet of how I view the Fed. Watch what they do, not what they say.
The Naked Capitalism piece extensively quotes John Hussman. I think John’s observations are correct here, but I would not be so bearish on the stock market.
After all of this disjointed writing, where does that leave me? Puzzled, and mostly neutral on my equity allocations. My observations could be wrong here. I’m skeptical of the efficacy of Fed actions, and of the willingness of foreigners to extend credit indefinitely, but they are trying hard to reflate dud assets (and the loans behind them) now. That excess liquidity will find its way to healthy assets, and I think I own some of those.
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