Valuable Insight from Jackson Hole

By: Doug Noland | Fri, Aug 26, 2011
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For the week, the S&P500 rallied 4.7% (down 6.4% y-t-d), and the Dow jumped 4.3% (down 2.5%). The Banks surged 7.4% (down 27%), while the Broker/Dealers rose 5.0% (down 27.3%). The Morgan Stanley Cyclicals jumped 5.7% (down 19.7%), and the Transports gain 5.7% (down 12.7%). The Morgan Stanley Consumer index gained 3.3% (down 7.4%), and the Utilities added 1.9% (up 4.2%). The S&P 400 Mid-Caps rose 6.1% (down 7.9%), and the small cap Russell 2000 jumped 6.2% (down 11.7%). The Nasdaq100 gained 6.1% (down 2.5%), and the Morgan Stanley High Tech index rose 6.0% (down 14.8%). The Semiconductors rallied 6.0% (down 16%). The InteractiveWeek Internet index jumped 6.7% (down 11.5%). The Biotechs increased 3.4% (down 12.1%). With a hyper-volatile bullion down $25, the HUI gold index gained 2.7% (up 4.1%).

One and two-month Treasury bill rates remained at zero, nothing, nada. Two-year government yields were unchanged at 0.19%. Five-year T-note yields ended the week up 4 bps to 0.94%. Ten-year yields rose 13 bps to 2.19%. Long bond yields jumped 14 bps to 3.53%. Benchmark Fannie MBS yields increased 10 bps to 3.30%. The spread between 10-year Treasury yields and benchmark MBS yields narrowed 3 to 111 bps. Agency 10-yr debt spreads dropped 9 to one basis point. The implied yield on December 2012 eurodollar futures increased 3 bps to 0.51%. The 10-year dollar swap spread increased 3 to 13.75 bps. The 30-year swap spread was unchanged at negative 35 bps. Corporate bond spreads widened further. An index of investment grade bond risk rose 3 bps to 126 bps. An index of junk bond risk jumped 24 bps to 726 bps.

Investment-grade issuers included Pepsico $1.25bn, Illinois Tool Works $1.0bn, John Deere $500 million, Duke Energy $500 million, Yum Brands $350 million, and Arizona Public Service $300 million.

Junk bond funds saw outflows of $127bn (from Lipper). I saw no junk issuance this week.

I saw no convertible debt issued.

International dollar bond issuers included Swedbank Hypotek $1.0bn and Eksportfinans $750 million.

German bund yields rose 5 bps to 2.15% (down 81bps y-t-d), and U.K. 10-year gilt yields jumped 11 bps this week to 2.50% (down 101bps). Greek two-year yields ended the week up 570 bps to 41.78% (up 2,954bps). Greek 10-year note yields jumped 113 bps to 17.29% (up 483bps). Italian 10-yr yields increased 14 bps to 5.06% (up 24bps) and Spain's 10-year yields rose 4 bps to 4.99% (down 45bps). Ten-year Portuguese yields jumped 56 bps to 10.88% (up 430bps). Irish yields fell 63 bps to 8.63% (down 43bps). The volatile German DAX equities index increased 1.0% (down 19.9% y-t-d). Japanese 10-year "JGB" yields jumped 5 bps to 1.04% (down 8bps). Japan's Nikkei rallied 0.9% (down 14%). Emerging markets were mixed. For the week, Brazil's Bovespa equities index gained 1.7% (down 23%), and Mexico's Bolsa rallied 2.7% (down 11.7%). South Korea's Kospi index jumped 2.0% (down 13.3%). India's equities index dropped 1.8% (down 22.7%). China's Shanghai Exchange rallied 3.1% (down 7.0%). Brazil's benchmark dollar bond yields rose 6 bps to 3.61%, and Mexico's benchmark bond yields rose 4 bps to 3.41%.

Freddie Mac 30-year fixed mortgage rates rose 7 bps to 4.22% (down 14bps y-o-y). Fifteen-year fixed rates jumped 8 bps to 3.44% (down 42bps y-o-y). One-year ARMs increased 7 bps to 2.93% (down 59bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates up 4 bps to 4.95% (down 37bps y-o-y).

Federal Reserve Credit declined $5.7bn to $2.843 TN. Fed Credit was up $435bn y-t-d and $548bn from a year ago, or 23.9%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 8/25) increased $12.5bn to a record $3.491 TN. "Custody holdings" were up $141bn y-t-d and $294bn from a year ago, or 9.2%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg - were up $1.599 TN y-o-y, or 18.7% to a record $10.136 TN. Over two years, reserves were $3.048 TN higher, for 43% growth.

M2 (narrow) "money" supply gained $5.1bn to a record $9.522 TN. "Narrow money" has expanded at a 12.3% pace y-t-d and 10.1% over the past year. For the week, Currency added $1.1bn. Demand and Checkable Deposits fell $11.7bn, while Savings Deposits rose $6.0bn. Small Denominated Deposits declined $3.6bn. Retail Money Funds increased $13.4bn.

Total Money Fund assets slipped $2.1bn last week to $2.629 TN. Money Fund assets were down $181bn y-t-d, with a decline of $204bn over the past year, or 7.2%.

Total Commercial Paper outstanding fell $29.5bn to a 17-week low $1.117 Trillion. CP was up $146bn y-t-d, or 19% annualized, with a one-year rise of $30bn.

Global Credit Market Watch:

August 26 - Bloomberg (Tony Czuczka): "German Chancellor Angela Merkel said that markets are trying to 'blackmail' governments. Merkel made the comments... at an election rally in Brandenburg, Germany."

August 22 - Bloomberg (Christian Vits and Jeff Black): "Germany's Bundesbank criticized European leaders' handling of the region's debt crisis, saying their latest decisions threaten to weaken the euro's institutional framework and compromise the inflation-fighting role of the European Central Bank. 'By shifting extensive additional risks to the countries providing assistance and to their taxpayers, the euro area has taken a major step toward pooling risks arising from unsound public finances,' the Frankfurt-based Bundesbank said... 'Overall, the decisions of July 21 threaten to reduce the consistency of the initially agreed institutional framework of the currency union,' the Bundesbank said. Fiscal policy is still determined by national parliaments, 'but risks and burdens are increasingly being dealt with by the community, and in particular by financially strong states,' it said."

August 25 - Bloomberg (John Glover): "Finland's demands for collateral on loans to Greece may trigger a default on 18 billion euros ($26bn) of bonds sold by Europe's most-indebted country. The securities, which represent less than 7% of Greece's 286 billion euros of bonds, are governed by English, not Greek, law, and include conditions that insist on equal treatment for all investors. Giving collateral to Finland as a condition for aid may breach the requirement that fresh debt doesn't win repayment priority over existing notes."

August 25 - Bloomberg (Sapna Maheshwari): "Speculative-grade bonds are at risk of erasing this year's gains with the debt headed for its worst month since November 2008 as the faltering economy threatens the neediest borrowers. Hawker Beechcraft..., PMI Group... and NewPage... are leading high-yield, high-risk bonds worldwide to a 5.2% loss this month, trimming this year's gains to 0.4%..."

August 26 - Bloomberg (Sapna Maheshwari and Tim Catts): "U.S. company bond sales are falling, with speculative-grade issuance headed for the slowest month since December 2008, on growing signs the economy is faltering. PepsiCo... led $5.7 billion of sales this week, a 72% decline from $20.4 billion in the period ended Aug. 19... There were no offerings of high-yield, high-risk bonds this week, leaving August's total at $1 billion, compared with the monthly average this year of $28.5 billion."

August 23 - Bloomberg (Krista Giovacco): "Wall Street banks are being forced to sell buyout loans at the steepest discounts since the third quarter of 2010 after committing $24.2 billion to finance mergers and acquisitions. The average original-issue discount needed to sell the debt is at 98.5 cents on the dollar this quarter, down from 99.4 cents in the first three months of the year..."

August 25 - Bloomberg (Esteban Duarte): "The 'vast majority' of European collateralized loan funds will wind down in the next three years, casting doubt on the ability of borrowers to refinance $88 billion of maturing debt and threatening defaults, Standard & Poor's said... CLOs, the primary source of funding for European leveraged loans, are disappearing as managers face hurdles from regulators and lack of investment."

August 25 - Bloomberg (David Yong and Yumi Teso): "A dollar-supply crunch in Europe is creating a shortage in Asia's financial centers, pushing up the cost of obtaining the greenback through the swap market. ...Singapore's five-year basis swap and Hong Kong's one-year contract dropped to the lowest since at least 1999 this month, which means parties paying for the U.S. Currency must accept a discount to benchmark interbank rates for their local currency.... 'European banks are having difficulties with their dollar funding and that has spread to Asia, but it isn't yet as bad as in 2008,' said Tetsuo Yoshikoshi, a senior economist at Sumitomo Mitsui Banking..."

August 22 - Bloomberg (Jody Shenn): "Investors should avoid taking risk in all categories of U.S. securitized debt because American and European policy makers may damage financial markets as they respond to a slowing economy and government deficits, according to Bank of America Merrill Lynch analysts. 'Rather than a repeat of 2010, when the Fed saved the day with QE2, we think we are moving closer to a repeat of 2008, when major policy errors devastated the economy,' the analysts led by Chris Flanagan wrote... 'The pressure to 'do something' is now far more likely to result in more desperate or radical measures, even if it is bad policy.'"

August 26 - Bloomberg: "The cost of insuring China's banks against default rose the most of the largest emerging nations this month as executives failed to convince investors during earnings presentations that they can curb bad loans. Credit-default swaps on debt of Bank of China Ltd. Jumped 88 bps this month to 241 bps, the biggest increase since October 2008..."

August 25 - Bloomberg (Doug Alexander): "Canadian companies sold C$2.04 billion ($2.07bn) in debt in August, on pace for the slowest month for corporate issuance in almost three years after relative borrowing costs rose to a two-year high."

Global Bubble Watch:

August 22 - Bloomberg (Esteban Duarte): "Citigroup Inc. and Bank of America Corp. were the reigning champions of finance in 2006 as home prices peaked, leading the 10 biggest U.S. banks and brokerage firms to their best year ever with $104 billion of profits. By 2008, the housing market's collapse forced those companies to take more than six times as much, $669 billion, in emergency loans from the U.S. Federal Reserve. The loans dwarfed the $160 billion in public bailouts the top 10 got from the U.S. Treasury, yet until now the full amounts have remained secret. Fed Chairman Ben S. Bernanke's unprecedented effort to keep the economy from plunging into depression included lending banks and other companies as much as $1.2 trillion of public money, about the same amount U.S. homeowners currently owe on 6.5 million delinquent and foreclosed mortgages."

August 23 - Bloomberg (Bradley Keoun): "As markets convulsed in September 2008, Morgan Stanley Treasurer David Wong briefed the Federal Reserve on a 'dark' scenario in which the U.S. firm would need at least $10 billion of emergency loans from the central bank. It got 10 times darker by month's end. Morgan Stanley borrowed $107.3 billion, the most of any bank, according to data compiled by Bloomberg News... Morgan Stanley's borrowing -- more than twice the amount all banks got from the Fed in the market squeeze that followed the Sept. 11 terrorist attacks -- peaked after hedge funds pulled $128.1 billion from the firm in two weeks, documents released by the Financial Crisis Inquiry Commission show."

August 24 - Bloomberg (Jim Brunsden): "Regulators said they might not have enough information to assess the threat over-the-counter derivatives pose to the financial system. Shortfalls in available data may undermine attempts to use so-called trade repositories as a tool to improve market oversight, the Committee on Payment and Settlement Systems and the International Organization of Securities Commissions said... The lack of details on the value of trades 'presents a potential gap in the data that authorities may require to fulfill' their mandates, the organizations said... The value of outstanding OTC derivatives was about $601 trillion at the end of last year..."

August 23 - Bloomberg (John Simpson): "The crisis threatening the global financial system exceeds the capabilities of developed nations and requires a new International Monetary Fund 'debt facility,' former IMF head H. Johannes Witteveen said. 'Unusual problems require unconventional solutions,' Witteveen wrote in an opinion piece in the Financial Times today. 'The world's financial system is threatened by a new crisis that could be even worse than that of 2008." He was IMF managing director from 1973 to 1978."

August 26 - Bloomberg (Cormac Mullen): "Norwegian, Spanish, Belgian financials performed best; Irish, Greek and Danish financials worst in an analysis of one-month returns post QE-related Fed speeches, according to Bloomberg data..."

Currency Watch:

The U.S. dollar index slipped 0.4% this week to 73.71. (down 6.7% y-t-d). For the week on the upside, the New Zealand dollar increased 2.8%, the Norwegian krone 1.8%, the Australian dollar 1.6%, the Swedish krona 1.5%, the Canadian dollar 0.7%, the Danish krone 0.7%, the Singapore dollar 0.6%, the South African rand 0.6%, and the South Korean won 0.5%. On the downside, Swiss franc declined 2.6%, the Mexican peso 1.3%, the British pound 0.6%, the Brazilian real 0.2%, the Taiwanese dollar 0.2%, and the Japanese yen 0.1%.

Commodities and Food Watch:

August 24 - Bloomberg (Whitney McFerron): "A yearlong drought from Kansas to Texas has created the driest conditions on record for farmers preparing to plant winter wheat, dimming crop prospects for a second straight year in the U.S., the world's largest exporter. Dry weather already has cut output of hard, red winter wheat, the most common U.S. variety, by 22% from 2010... If drought persists into the planting months of September and October, next year's harvest will be even smaller, and prices on the Kansas City Board of Trade may jump 50% to $13 a bushel, said Dan Manternach, a wheat economist with researcher Doane Advisory Services..."

August 26 - Bloomberg (Jeff Wilson, Justin Doom and Whitney McFerron): "The hottest summer since 1955 in Iowa and Illinois is eroding yield prospects for corn and soybean crops in the U.S., the largest grower and exporter."

The CRB index increased 1.8% this week (up 0.7% y-t-d). The Goldman Sachs Commodities Index jumped 2.6% (up 4.1%). Spot Gold declined 1.4% to $1,826 (up 29%). Silver dropped 3.6% to $41.39 (up 34%). September Crude rallied $3.07 to $85.48 (down 7%). September Gasoline gained 3.2% (up 20%), and September Natural Gas increased 0.5% (down 10%). December Copper rallied 2.9% (down 7%). September Wheat gained 4.3% (down 4%), and September Corn jumped 5.8% (up 20%).

China Bubble Watch:

August 22 - Reuters (Chris Buckley): "The 'Black Death' of debt crisis across the Euro zone will hurt China by sapping demand for exports, although Beijing's relatively small holdings of euro assets will limit any damage to foreign exchange reserves, the nation's top official newspaper said... The bleak diagnosis for the euro's prospects appeared in the overseas edition of the People's Daily, the top newspaper of China's ruling Communist Party... About a quarter of China's record foreign currency reserves of more than $3 trillion are held in euro assets, analysts estimate."

August 26 - Bloomberg (Sapna Maheshwari and Tim Catts): "China should urge the U.S. government to reduce its fiscal deficit as part of measures to protect China's foreign-exchange reserves, the Financial News reported... citing Wang Tianlong, a researcher at the China Center For International Economic Exchanges."

August 26 - Bloomberg (Stephanie Tong): "China's five biggest banks posted first-half profits that surpassed the total of their 14 largest U.S. and European rivals, highlighting the Asian nation's financial power as other economies falter. Industrial & Commercial Bank of China Ltd. said... net income rose 29% to a record $17 billion, pushing combined profits of the nation's biggest banks to $57 billion... China's banks have increased profits as the world's second-largest economy sustained growth of more than 9%, helped by a record credit boom that powered its rebound from the global recession."

August 25 - Bloomberg: "In the Lakeville apartment complex overlooking Shanghai's downtown bar and shopping district, the yellow jade bathroom sink alone would cost the average Chinese worker three years' pay. The entire four-bedroom, ground-floor apartment with a terrace, which sold in May for 60 million yuan ($9.4 million), would take 3,140 years of toil. Such luxurious properties are in demand for the swelling ranks of millionaires chasing status and a hedge against soaring inflation even as the government steps up curbs on real estate investment. High-end home prices rose 17.4% in Beijing last quarter from a year earlier..."

August 25 - Bloomberg: "Beijing's state-owned infrastructure companies face a record amount of bonds maturing next year as China's capital city pays the bills for the $70 billion 2008 Olympic Games. Fifteen local government financing units based in Beijing must pay 16.2 billion yuan ($2.5 billion) next year plus interest to investors, breaking last year's record 12 billion yuan... A further 11.6 billion yuan matures in 2013 and 37.6 billion yuan in 2014."

August 23 - Bloomberg (Sophie Leung): "Hong Kong's inflation surged to the fastest pace since 1995, encouraging workers to press for higher pay even as the economy teeters on the edge of recession. The consumer price index rose 7.9% from a year earlier after a 5.6% increase in June..."

Japan Watch:

August 25 - Bloomberg (Toru Fujioka and Aki Ito): "Japan unveiled a $100 billion effort to help companies cope with a surging yen, signaling that officials may be resigned to the currency remaining high. The government will release foreign-exchange reserves to the state-run Japan Bank for International Cooperation for funding to aid exporters and spur purchases overseas... The announcement came hours after Moody's... lowered the nation's debt rating one step to Aa3, with a stable outlook."

Latin America Watch:

August 22 - Bloomberg (Bill Faries and Matthew Bristow): "Morgan Stanley cut its forecast for Latin American economic growth this year and next, saying the region is 'unlikely to be spared' from a global slowdown. The region's economies will expand 3.6% next year from a previous forecast of 4.6%, as slower growth in Europe and the U.S. takes its toll on demand for the region's commodities..."

Unbalanced Global Economy Watch:

August 26 - Bloomberg (Jennifer Ryan): "U.K. economic growth slowed in the second quarter as manufacturing shrank and services showed signs of losing momentum... Gross domestic product rose 0.2% from the first quarter..."

August 22 - Bloomberg (Maud van Gaal): "House prices in the Netherlands fell the most in 14 months as buyers were discouraged by rising interest rates, lending restrictions and Europe's debt crisis. Prices of existing residential properties dropped 2.3% in July from a year earlier..."

August 22 - Bloomberg (Jeffrey Donovan): "Italy's austerity drive, enacted in exchange for European Central Bank bond purchases driving down borrowing costs, may backfire as it chokes the economic growth needed to ease Europe's second-biggest debt burden. Prime Minister Silvio Berlusconi's Cabinet approved 45.5 billion euros ($66bn) in deficit reductions in Rome on Aug. 12, the nation's second austerity package in a month, to balance the budget in 2013 and convince investors that Italy can trim debt of about 120% of gross domestic product."

August 25 - Bloomberg (Angeline Benoit): "Spain's producer-price inflation rate accelerated to a four-month high in July as commodity costs increased. Prices of goods leaving Spain's factories, mines and refineries rose 7.4% from a year earlier..."

U.S. Bubble Economy Watch:

August 25 - Bloomberg (Natalie Doss): "U.S. trucking companies may face a 30% surge in wage bills by 2014 as rising demand for freight shipments threatens to push the industry's driver shortage to the longest on record."

Central Banking Watch:

August 26 - Bloomberg (Kartik Goyal and Anoop Agrawal): "The Federal Reserve's decision to keep record-low interest rates and the possibility of further steps to spur the U.S. economy may stoke commodity prices and fan inflation in India, the Asian nation's central bank said. 'Given the fiscal limitations and growing signs of weakness in the U.S., the Fed has already indicated that it will pursue its near-zero rate policy at least till mid-2013... It has also hinted at another dose of quantitative easing. This policy stance may keep the commodity prices elevated.'"

Real Estate Watch:

August 23 - Bloomberg (Prashant Gopal): "New York City construction starts plunged almost 40% in the first half as building weakened following a surge last year, according to an analysis by the New York Building Congress. About $6.4 billion of building projects began in the first six months of 2011, down from $10.6 billion a year earlier...All types of construction had 'significant declines' from last year, the group said."


Valuable Insight from Jackson Hole

I've been an outspoken critic of Federal Reserve policymaking. Yet I do have great respect for Federal Reserve Bank of Kansas City President Tom Hoenig, soon to retire after a 20 year tenure at the helm of the Kansas City Fed and almost 40 years of service at the Federal Reserve. Dr. Hoenig is a statesman in an age where they are in too short supply. It is my hope that, as a private citizen, he will become more outspoken. I thought CNBC's Steve Liesman did an outstanding job interviewing Dr. Hoenig in Jackson Hole. I have excerpted from the CNBC transcript of this insightful interview:

CNBC's Steve Liesman: "Tom, let's just start off with the easy part, which is talk about the conference and what we're trying to figure out here.

Federal Reserve Bank of Kansas City President Tom Hoenig: I hope it's obvious, but one thing you tend to do in periods like this is move from one crisis to the next, one short-term event to the next. And the only way you solve problems is to begin to look to the long run. Where do you need to be, so you can begin to map how you get there? And that's really what we want to do with this conference. Take a moment, even though we have all this activity whirling around us. We need to begin to think a little bit longer term and see what kinds of solutions might be out there that will actually solve the problem.

And if you go back and think about it, we have gone through well over a decade... as a nation, the United States and maybe other parts of the world have systematically consumed more than they produce. And so we've been able to do that by increasing our debt, increasing leverage. Increasing leverage of the consumer, increasing leverage and debt of states, increasing leverage of the federal government - again, increasing leverage of our financial institutions. Living, in a sense, beyond our means. So there's not going to be an overnight solution to that. We can pour liquidity into the market, yes, but that doesn't really solve the debt problem and the need to rebalance our national and our international economies. So what about the long run? How might we begin charting a course towards that? That's the goal of our conference.

Mr. Liesman: You've obviously thought a lot about this. What are your thoughts? How do you end up reducing the amount of debt? Is it a government thing? Is the about the Fed's interest rate?

Dr. Hoenig: It's not something you can do overnight. Everyone knows that. My own view is that we have an opportunity with the plan that Simpson-Bowles put forward last December. It was a long-term plan, 25 years or more. It began to show how you both reduce spending and do some revenue reforms and so forth. And I think if we started with that, and taking that as a starting point, it would give us the real opportunity to begin to map a way out of this. There's no quick fix. And I think they realize that, and that's why they gave us a very reasonable long-term plan. That's what we need to begin to focus on again.

Otherwise, you build the debt. You kind of push for aggregate demand increases. I understand that. But what you're doing is keeping interest rates very low. You're encouraging debt over time to help demand. But all that does, then, is help continue to build more debt for the future. Those are not solutions that will get us to where we need to be in the long run.

Mr. Liesman: The question has been raised by some. Are we pushing for an economic growth number that is beyond our means?

Dr. Hoenig: Well, I think the potential growth rate in the economy hasn't changed a lot. I mean, over the hundred years or so, our average growth rate in this nation, real growth rate, is about 3% - just a little more. There's no reason why we can't continue to maintain that in the long run. But it doesn't come automatically just because you name it. If you begin to think about the policies that encourage production - I mean, people talk about jobs, but jobs come from increasing production, either of things or some kind of goods. That means you have to give an environment for business, not just a zero interest rate, but an environment where you know what your costs are going to be - [where] you can think longer-term...

Mr. Liesman: And let's talk about the near-term a little bit. There's been a lot of weak data out there... Are you concerned about a recession?

Dr. Hoenig: Well, first of all some of the surveys that were done that have been reported on, Philadelphia and so forth - were done during the most volatile week that we had. So I want to wait for a little more data than came out that particular week... I have always said we would have modest growth. It's going to take time because of the leverage. It's not going to be straight-up. We need to be mindful of that. So yeah, we have a long path ahead of us, a long, if you will, almost struggle to rebuild our confidence in our economy, to rebuild our economy. But I am confident we can do that if we look a little further down the road and choose policies that are more long-term focused.

Mr. Liesman: Do you think the debt ceiling debate had a direct impact on the economy?

Dr. Hoenig: I think it did. Yes. It made people wonder, "Can we agree? Can we look forward? Is there a solution? Why have they ignored other solutions?" I think it did have a negative impact. People were less sure of where things are going to be now, and they don't see necessarily a clear path forward...

Mr. Liesman: What's your opinion of those members of Congress who refused to increase the debt ceiling because they opposed any revenue increases?

Dr. Hoenig: I don't have an opinion. Because... here's my issue. I think people are - politics being what politics are - I think people are well-intentioned. I think people who see the debt growing are concerned, and maybe-- very concerned. And so they're saying, "We can't live like this, so the only way out of this will be that we inflate our way out. So I don't want to see it..." I don't criticize that. I understand that. And other people say, "Yes, but if we clamp down now, forcefully, we may actually-- put ourselves into a recession." I understand that. There's the well-intentioned.

That's why I am disappointed in a lot of individuals for not picking up... Simpson-Bowles. A long-term plan that recognizes we cannot go on as we have; that we have to make change; here's how we go about doing it. Yes, it is longer-term, but it is firm. It is thought through. Here are the consequences. We need to bring our spending down. We need to reform. And go along this track. I think it would raise the confidence of businesses; it would raise the confidence of consumers, and the idea of shared sacrifice. We talk about it, but unless we all know we're all in it together, then we piecemeal it. And so, "Why should I talk to many people in agriculture? Why should I give up my subsidies when no one else will? Why should I give up the house-- the home mortgage-- deduction when no one else will?" That's why you have to come together, and it has to be a firm plan, legislated eventually.

Mr. Liesman: Let's talk about the recent [FOMC] meeting... There were two huge developments. One was a pretty severe downgrade of the economy, and the other was the extension of the exceptionally low language till mid-2013. I wonder if I can get your opinion on those... What's your opinion of the sense of the FOMC statement that downgraded the economy?

Dr. Hoenig: Well, I think it acknowledges that these recent events have been traumatic. We can see it in the volatility of the market. And I think it says we need to be thinking about this. To me, it also says to others - Congress and others - that let's come on. People need assurances. We need that long-term plan. So I think in that way it's a good message...

Mr. Liesman: The language that extended the exceptionally low language till mid-2013?

Dr. Hoenig: Well, I didn't like the extended-period language to begin with. So I can't say that I was enamored with this at all. I don't think you can give guarantees to some parts of the market and not to others. I think it encourages speculation. "Oh, yeah, you're safe. Here's a safe haven." I think people have to make calculated judgments based on events. And that forces the markets to run more efficiently. One of the things... that we've had as a consequence of these very low interest rates, extended period, I see it in my region. You get these artificial asset price movements. You get misallocations of resources. When I see land that goes from $6,000 to $12,000 an acre and I can't get the cash flows to work on it. That's a speculative bubble. When I see bond markets that have yields that are so low that it doesn't make sense, then it doesn't make sense. And I don't think we necessarily are going to have good outcomes... I don't see how good outcomes will follow from that.

Mr. Liesman: The ten year is around 2%.

Dr. Hoenig: That's my point.

Mr. Liesman: Is that a result of Fed policy? Is that a result of the economic [backdrop]?

Dr. Hoenig: Any price is a result of a combination of things. So part of it is Fed policy, obviously. Part of it is the uncertainty, the safe haven movements of funds. Hard to sort out how much can be attributed to which cause, but they all play a role. But [the yield] is incredibly low, and I think only time will tell - what were the more dominant causes of that. But I still think monetary policy itself needs to move away from zero and needs to move away from extended-period language. I think it would allow the credit markets to give better signals, still knowing that things are unstable and unsettled. But it would give better signals that would help lead us over time on a better path of growth long-term.

Mr. Liesman: And just so I understand your position right, you would have been in favor throughout this period of a weak economy, of a 1% Fed funds rate, that would've been a sort of floor that you think the Fed ought to adopt?

Dr. Hoenig: Well, here's what I've said in many a speech. What I wanted to do early on was as liquidity went into the market and as the liquidity crisis... You begin, then, to re-normalize and you would try and move to 1% in a fairly expeditious manner. And I think it was in the spring when I said by fall... you pause and you say, "All right. How's the economy? What are the signals? The Fed is confident we're moving. It's going to be modest growth, we know that, but it's systematic." And then you begin to think about can you move that towards 2%, which is a more normalized, historic level?

And then you watch the economy and you start making decisions, then, based on where the economy is moving at that time. That allows you, in a sense, to recalibrate and to judge the economy as it evolves, and then to say, "Yeah. Here's what's happening now, but here's where we are and here's where we're looking for to the long run. And we will judge our policy based on how those two are in synch or out of synch."

Mr. Liesman: So if you were able to set the rate right now, it would be at 1%? That would be your level for now?

Dr. Hoenig: Well, I wouldn't do it overnight...

Mr. Liesman: You would've been there already?

Dr. Hoenig: Right. I would've done it.

Mr. Liesman: But when I read your speeches... what's clear to me is you don't like zero. And the point you made in the recent congressional testimony was [the] market can't set a price at zero.

Dr. Hoenig: Right.

Mr. Liesman: You don't like this zero to a quarter?

Dr. Hoenig: I do not like it because you're misallocating resources. I mean, it contributes to that. And that's not healthy for an economy. I mean, we have... I'm not saying there's a bubble, but if prices are misaligned in particular segments, they have to correct. And the longer you allow the misalignment to continue, the harsher the correction. And maybe I am a product of my own experiences because I was in bank supervision in the '80s and I can't tell you how many farms were closed, how many banks - we closed 350 banks. How many commercial real estate projects collapsed in front of us; how many people lost their jobs as a result. It's that concern, that part that you can't see now because you're focused right here, that you've got looking right in front of you. You can't see what's over the hill, and sometimes what's over the hill is pretty difficult terrain.

Mr. Liesman: I just want to be clear about this. You would've dissented from that vote?

Dr. Hoenig: Well, I'm not saying what I would've done because I didn't vote. You know, you've got to be careful. But my record would suggest that I probably would have [dissented]. But I think it's important to push forward, and that it is the role of monetary policy to give you an environment where prices are stable, where resources are allowed to be allocated based on proper price signals. And when you try and do more than that's capable of doing, you can get distortions and you can pay a price. Because a capitalistic economy - if you really believe in its long-term benefits - has cycles. People do make mistakes. See, the market is valuable not because it's the smartest in the world, but because it's the harshest. It captures mistakes and punishes and forces a correction. It's when you then interfere with that that you allow the path to go off longer and the correction to be more severe and harder on people. And that's what you can't lose sight of when you say you're for Capitalism, but not really.

Mr. Liesman: I thought the market was better than government.

Dr. Hoenig: Well, but that doesn't make it smart.

Mr. Liesman: Right.

Dr. Hoenig: It just makes it better than government.

Mr. Liesman: Let me ask you how the market should think about these [FOMC] descents. We haven't been here in 20 years. Does it mean the Fed is divided? Is there then... what's the right word? Is there uncertainty to the [rate] guarantee... because of all this descent?

Dr. Hoenig: Nonsense. If everyone always agreed, you don't need everyone. Debate is healthy. Discussion is healthy. Different views are healthy. And then you come to a conclusion, the majority carries the day, but you've had this big-risk debate. Would it be credible to the American people to say -- "It's 100%, everyone agreed," and no one believe it? Then you would say, "Well, what's going on behind the scenes? ...It would undermine people's confidence in the very institution that they're relying on. Debate is what leads to good decisions over time, and when you stifle that and when you're afraid of it, people might misunderstand. I have too much regard for people. Those who have interest to read about it, study it, have an opinion of their own, I have too much regard for them to be afraid of descent.

Mr. Liesman: But what should we make of this? Should we make that the policy is not very certain?

Dr. Hoenig: I think you should make of the fact that people are struggling with a very difficult time. Volatility is everywhere. And that there are those of us who are thinking that this has consequences, and we weigh [the] short run and long run different than others on the committee. And therefore, we should express that view, and people should know about that view. And yet, the majority carry the day. They have this view. And the American people should know that. It doesn't mean that people don't have confidence in the leadership. It means that we have rigorous debate. If it's a one-man show, then I think we're really open to serious error.

Mr. Liesman: Presidential candidate Rick Perry used the word "treasonous" to talk about Chairman Ben Bernanke and additional quantitative easing. What's your response to that?

Dr. Hoenig: I don't have a response, but I think the best reply was from another individual who was a critic of the Federal Reserve, and that's Ron Paul who said, "Well, I would never say you were treasonous. I have accused him of counterfeiting for some time now." You know, everyone's got an opinion. And I think we'll see how it all plays out over time.

And, yesterday from Bloomberg: "...Thomas Hoenig said there's a limit to how much more the central bank can help the U.S. economy and that the focus should now be on solving the country's fiscal problems. 'We can't do it all,' Hoenig, the central bank's longest- serving policy maker, said... 'We have a problem in this country with debt' and 'if we don't turn to the long run, we will be dealing with overnight crises for as far as the eye can see... Monetary policy is an important tool, it is a valuable tool, but it is not an exclusive tool... it does not solve all problems.'"

 


 

Doug Noland

Author: Doug Noland

Doug Noland
The Credit Bubble Bulletin
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