Friday, September 25, 2015

Do the Financial Markets Regulate the Fed?

When the Federal Reserve decided last week to hold short term interest rates at zero, the stock market's reaction was to drop.  Even though easy money has been a shot of glucose for stocks since the 2007-08 financial crisis, the market seemed to be saying that there can be too much of a good thing.

Yesterday, Fed Chair Janet Yellen stated her view that rates should rise sometime this year.  The market reacted positively, even though rising interest rates logically should push stock prices down (since fixed rate investments that compete with stocks would offer higher yields than before).

The implication is that the market is leading the Fed.  The market wanted rates to rise, and when they didn't, the market pouted.  That may have prompted Chair Yellen to make more noise about rates rising, and then the market cooed with approval.

Why would the market want rates to rise when conventional wisdom holds that stocks should love easy money?  Maybe it's because the stock market absorbs information from a variety of inputs, both short and long term.  Easy money is positive in the short run, but can be corrosive in the long run.  Accommodative policy by the Fed and other central banks has continued for almost 8 years now, and is distorting asset values and relationships to the point where the social contract may be changing.  With interest rates so low, the ability of pension funds, insurance companies and other asset managers to provide pension and annuity income is becoming impaired.  (For more, see  When private parties can no longer provide retirement income, greater responsibility falls on the government.  Social Security and similar programs become more essential.  If these programs suffer from fiscal imbalance, taxpayers become more burdened.  We can't toss retired and disabled people into the gutter, but who besides taxpayers can cover their needs?

Another change in the social contract is that easy money favors the wealthy.  Low interest rates have pushed up the value of risk assets--stocks, real estate, commodities and so on.  The distribution of income and wealth have become more skewed in favor of those who need the money the least.  Such growing inequality makes it more difficult to attain social and political compromises and consensus.  A resentful and angry society may lack the optimism and initiative for investment and risk-taking that would foster strong economic growth.  (Note that jaded, cynical Europe is hardly a hotbed of innovation.)

The voices that are heard at the Fed tend to be those of elites--Wall Street executives, influential academics, power players like IMF Managing Director Christine Lagarde.  A lot of these voices have advocated keeping interest rates at zero.  But the accumulated knowledge of many thousands of participants in the real financial world seems to signal that continued distortion of asset values is doing more harm than good.  Maybe the market is regulating the Fed.  And maybe, at least this time, that's a good thing.

Tuesday, September 15, 2015

The Fed's International Data Dichotomy

The Federal Reserve Board is meeting to decide whether or not to raise interest rates.  The costs and benefits of its decision, whichever way it goes, will fall to a large degree along international borders.

Most of the data favoring a rate hike are domestic.  The U.S. economy is growing, moderately but steadily (especially after data revisions).  Unemployment has fallen to the level generally regarded as full employment.  Jobs growth continues, not at a blistering pace but indicative of continued expansion.  Inflation is very low, but if you strip out energy and food prices (which are volatile), the rest of the price structure is pretty close to the Fed's 2% target.

Most of the data arguing against a rate hike is from overseas.  Chinese stocks have been volatile and China's growth is slowing.  Europe's and Japan's economies are  barely growing.  Emerging nations and commodities producing nations are on the ropes, with many facing shrinking economies.  The Greek debt crisis has temporarily simmered down, but the most recent "resolution" was just another kick of the can down the road.  So we can be confident that a Greek default will loom anon, and we'll have to revisit familiar angst.  A rate increase will strengthen the dollar, which will possibly exacerbate these international problems.

Much of foreign anxiety stems from the fact that the dollar is the international medium of exchange.  The entire world uses the dollar in numerous trade and cross-border transactions.  The Fed's monetary policy unavoidably affects people in distant lands.  A rate hike may help the domestic economy by easing asset distortions and increasing certainty (and desperately desired income for savers).  It is likely to have a negative impact overseas.  No wonder the IMF and other voices reflecting foreign perspectives argue against a rate hike.

What will the Fed do?  Most likely, not even the Fed knows before its meeting.  We've been told that its decision is data dependent.  What we don't know is how it weighs and balances the data.  What data receive greater consideration?  What data are downplayed?  What thought is given to the effect of the Fed's decision on foreign relations? Central banking is distinct from diplomacy, but the Fed can't ignore foreign concerns.  A rate hike will produce smiles and frowns, mostly on different sides of the border.  After World War II, America became the pre-eminent economic power in the world, and it cannot now avoid the consequences of its dominance.

Friday, September 4, 2015

Deflategate and the Growing Legend of Tom Brady

Some people believe that, on the field, Tom Brady is the best quarterback in the NFL.  There are those who would even contend that he's the best NFL quarterback ever.  He's destined for the Pro Football Hall of Fame--that's for sure.

But now, Brady has prevailed over the NFL Commissioner in federal court.  Federal judge Richard Berman took a highly skeptical view of Commissioner Roger Goodell's four-game suspension of Brady for Deflategate, finding the Commissioner more or less handled disciplinary matters by the seat of his pants.  Concerned about deficits of fairness and due process in the Commissioner's decision, the court tossed Brady's four-game suspension.  Even though the NFL appealed the court's ruling almost immediately, its chances of prevailing on appeal aren't pretty.  Most of the time, appealing parties lose and Judge Berman doesn't appear to have given the Court of Appeals much room to find problems with his decision, assuming it's even inclined to try.  And if the NFL loses at the Court of Appeals and petitions the U.S. Supreme Court to take the case, it will likely be grasping at straws.  The Supremes have much more important stuff to deal with than football inflation levels.

Tom Brady was drafted in the next-to-last round of the 2000 draft, and barely played during his rookie year.  The next year, when starting quarterback Drew Bledsoe was sidelined due to injury, Brady stepped in and took the Patriots to the Super Bowl, where he led them to their first Super Bowl victory.  Since then, Brady has led the Patriots to five more Super Bowls, with three more victories.  All the while, he built a record of on-the-field performance and awards that's too long to reproduce here.  He married a Brazilian super model and lives a glamorous life supported by multi-million dollar wealth.  The man has become an NFL legend. 

His courtroom victory over Roger Goodell will only fuel that legend.  Twenty-five or thirty years from now, only football aficionados will remember most of today's star quarterbacks.  But Tom Brady will likely be remembered as the guy who whupped the Commissioner's arse in court.  When you consider Goodell's decision, you have to wonder what on Earth was he thinking?  What was the point of coming down so hard on Tom Brady for being "generally aware" of underinflated footballs?  Why did the NFL make such a big deal over this case?  Has anything constructive come out of the Commissioner trying to administer such a high-profile walloping?  Whatever Goodell was trying to accomplish, he's managed to do just the opposite and make the legend of Tom Brady greater than ever before.

Why The Donald Would Sign the No Third Party Pledge

Just a short while ago, Donald Trump was keeping his options open for a third party candidacy for President.  Yet, he just signed a pledge not to run as a third party candidate.  Republican establishment types seem to be patting themselves on the back for securing Trump's pledge.  But perhaps they're celebrating too soon. Let us consider why Trump would make such an abrupt turnaround.

The Donald is an experienced businessman who thinks things through.  He wouldn't tie his own hands.  That would mean he probably doesn't think the pledge actually ties his hands.  He very likely has concluded that he can get the Republican nomination, using his aggressive brand of political campaigning 2.0.  The fact that just about no Republican insiders think Trump can secure the nomination makes them vulnerable to the insurgency tactics he's been using.  The Republican establishment may now think it has Trump under control.  But the reality may be that he has figured out how to checkmate them.