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On the Fed’s “Automatic Stabilizer”

The closing paragraphs of Doug Noland’s latest Credit Bubble Bulletin seemed worth sharing here, not that anyone really cares about this sort of thing anymore, but just as a reminder of how far out into the deep water we have collectively been swimming.

Fed QE operations (“leveraging”) have incentivized what I believe is unprecedented leveraged speculation on a global basis. This additional leveraging has unleashed only more liquidity/purchasing power that has exacerbated inflationary distortions. I argue strongly that all this leveraging has created a deep systemic (financial markets and real economy) dependency to ongoing balance sheet growth (liquidity creation) by the Fed. It has reached the point where even zero rates, massive QE, highly speculative securities markets, pockets of overheated real estate and asset markets, and record securities values spur only modest growth in the general economy.

From Yellen: “If the public understands and expects policymakers to behave in this systematically stabilizing manner, it will tend to respond less to such developments. Monetary policy will thus have an ‘automatic stabilizer’ effect that operates through private-sector expectations.”

The traditional gold standard was so effective because it in fact provided an “automatic stabilizer.” If Credit was created in excess, an economy would suffer a loss of gold. The reduced gold reserve would dictate higher rates and a (stabilizing) contraction in lending. Bankers and politicians understood the mechanics of the system (and were committed to sustaining the monetary regime), so they would tighten their belts when excess first emerged. In this way, the gold standard for the most part provided a stabilizing and self-correcting system. These days, everyone knows the Fed will not respond to excess. Our central bank, however, will be predictably quick to print additional “money” at the first sign of a faltering Bubble, liquidity that will reward financial speculation. Excess begets excess. Today’s system is the very opposite of “automatic stabilizer.”

This all could sound too theoretical. But with the Fed intending to conclude balance sheet leveraging later in the year, this theory might soon be tested.

That highlighted passage is key – all the Fed’s work hasn’t done much for the economy.

Naturally, stocks are higher today along with bonds, real estate, and other asset classes.

Janet Yellen and the “B-Word”

John Cassidy writes in the New Yorker that Federal Reserve Chair Janet Yellen didn’t see fit to once mention asset bubbles in her speech at the Economic Club of New York the other day and that, in itself, is a bit disconcerting.

But what was most striking to me about Yellen’s remarks was that she didn’t even discuss the financial markets and the overriding need to avoid another damaging speculative bubble, like the ones that the American economy experienced in the late nineteen-nineties and mid-two-thousands. Indeed, Yellen didn’t use the B-word at all. Given that her immediate predecessors, Alan Greenspan and Ben Bernanke, will be remembered for, among other things, their roles in inflating the bubbles in the stock market and the housing market, that was a pretty remarkable omission.

Recent history can’t be avoided, and neither can the task of maintaining financial stability and avoiding boom-bust cycles, particularly in the credit markets. Together with maintaining an adequate level of over-all demand in the economy, which is necessary for investment and job creation to proceed, it is the key challenge that all central banks face. But Yellen didn’t even mention it. Instead, she couched her remarks in terms of the old-fashioned inflation-unemployment trade-off, which is precisely the conceptual framework that encouraged Greenspan and Bernanke to shrug off what was happening in the financial and housing markets.

It’s hard to believe that Yellen will be any different than her predecessors in spotting a looming crisis be it of the bursting asset bubble variety or something different.

Moreover, when considering that history rarely repeats, but often rhymes as Mark Twain purportedly quipped, the Fed will probably be more attuned to spotting something they’ve already seen (e.g., stock bubble, housing bubble, etc.) rather than the more likely case of something completely different (e.g., currency crisis, sovereign debt crisis, etc.)

Bridgewater Warns on Pensions

Since the financial crisis, there haven’t been too many warnings about the dim prospects for pension funds living up to their long-term promises as a result of their overly optimistic assumptions about rate of return, however, Bridgewater reinvigorated the debate as recounted in this USA Today story today that might make some Holiday Inn Express patrons choking on their cinnamon rolls.

Influential and well-regarded hedge fund Bridgewater Associates Wednesday warns public pensions are likely to achieve 4% returns on their assets, or worse. If Bridgewater is right, that means 85% of public pension funds will be going bankrupt in three decades.

Bridgewater came to these conclusions by stress testing the nation’s public pension plans, much the way banks need to be evaluated on what could happen given a wide range out outcomes.

Public pensions have just $3 trillion in assets to invest to cover future retirement payments of $10 trillion over the next many decades, Bridgewater says. An investment return of roughly 9% a year is needed to meet those onerous obligations.

This is just one more reason why the U.S. has a national imperative, ably assisted by the folks at the Federal Reserve,  to create bigger and bigger asset bubbles.

How else are pension funds going to pull this off?

Bloomberg editor-at-large and TV host Trish Regan shares some insight on what’s roiling the stock market these days in this commentary at USA Today that is full of contradiction that quickly becomes apparent in the first two paragraphs which, by themselves, may be enough to send investors scurrying back up to their hotel room to sell some tech stocks.

Use of the term “virtual” was prompted by the recent Facebook acquisition of Oculus, the virtual reality headset maker, however, it was probably ill-advised to combine virtual with insanity when referring to bubbly tech stocks.

The recent sell-off in names such as Amazon, Facebook and Netflix is spurring many to wonder whether investors are waking up to the virtual insanity that’s gripping the technology space.

It’s still too early to tell how this plays out; however, there are signs that suggest investors should proceed with caution.

Take the new term to describe a hot new tech company. Forget start-up or pre-revenue. Instead, try this: pre-product. It carries more cachet.

With U.S. markets opening just a short time ago, stocks are shrugging off their recent difficulties and the latest developments in Ukraine, but that may not last.

If it doesn’t and this becomes a much more serious decline for share prices, at least we’ll have those wonderful images of people wearing Oculus headsets.

It’s just too bad that we couldn’t get anyone wearing a virtual reality headset to ring the opening bell on some stock exchange – that would have been priceless.

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