The annual meeting of the financial elite in Jackson Hole this year came up a little shy. Humility is typically in short supply in these circles, but the assembled Ph.D's walked away humbled at what they are up against. Alfred E. Neuman might not be worried, but many of the talking heads who attended were left shaking in their loafers, and the more pragmatic among them left frustrated with the lack of progress and understanding exhibited by the academics in attendance.
Paul McCulley, in particular, left the Teton's disappointed:
This was my third year attending the Kansas City Fed’s annual Jackson Hole Symposium. As always, I was honored to be invited and found the event, both the formal meetings and the informal discussions, to be engaging. But, quite frankly, I found this year’s confab to be the least intellectually satisfying of the three I’ve attended. Why? Policy makers, and even more so academics, just don’t seem to collectively “get it” when it comes to understanding what is unfolding in the capital markets right now, and the implication for a whole array of policies, not just monetary policy. Pimco
McCulley was willing to let Ben Bernanke off the hook, but the rest of the gang might want to consider quitting the day jobs. Most of his disappointment stems from the great inflation debate...and the ongoing asset deflation that is taking place as well. To be sure, there are no easy solutions, but McCulley is not pulling any punches, and taking on the inflation hawks.
aka "the inflation nutters"
...right now, a 2% Fed funds rate is not doing much at all to stimulate aggregate demand relative to aggregate supply, reducing resource slack in the economy, engendering increased pricing power by capital or labor, or both. To the contrary, resource slack is going the other way, notably in the labor market, with the unemployment rate up over a full percentage point since its cyclical low. Thus, if anything, a 2% Fed funds rate is restrictive, not stimulative.
And the reason is simple: the economy is caught in the paradox of deleveraging, as I detailed in this space two months ago.1 Terms and conditions for private sector credit creation, the fuel for private sector aggregate demand growth, are tighter, much tighter than when the Fed funds rate was 5 1/4% a year ago. Thus, the current 2% Fed funds rate is not providing any tinder whatsoever for an inflationary fire.
Rather, the ongoing deleveraging of levered credit creators is fueling asset price deflation in a vicious downward spiral, known in central bank circles as a “negative feedback loop.” And as long as that loop is looping, it would be a colossal policy mistake to get wrapped ‘round the axle about the fact that the real Fed funds rate is negative. It is, as it should be.
I have learned not to bet against the boys at Pimco; the remarkable performance against their peers is all you need to know. And they have gained the trust of the regulators as well, it would appear the numerous conversations they have had with financial market regulators are having an impact.
If Bernanke follows through om what he inferred it is likely future business cycles will not be your similar to your father’s business cycles...Bernanke is likely to move counter to the prevailing winds, to some extent smoothing out the nuttiness that prevails at the tail end of cycles.
Are you ready for the macroprudential regulatory environment?
As Ben Bernanke put it:
“A systemwide focus for financial regulation would also increase attention to how the incentives and constraints created by regulations affect behavior, especially risk-taking, through the credit cycle. During a period of economic weakness, for example, a prudential supervisor concerned only with the safety and soundness of a particular institution will tend to push for very conservative lending policies.
In contrast, the macroprudential supervisor would recognize that, for the system as a whole, excessively conservative lending policies could prove counterproductive if they contribute to a weaker economic and credit environment. Similarly, risk concentrations that might be acceptable at a single institution in a period of economic expansion could be dangerous if they existed at a large number of institutions simultaneously.
I do not have the time today to do justice to the question of the procyclicality of, say, capital regulations and accounting rules. This topic has received a great deal of attention elsewhere and has also engaged the attention of regulators; in particular, the framers of the Basel II capital accord have made significant efforts to measure regulatory capital needs ‘through the cycle’ to mitigate procyclicality.
However, as we consider ways to strengthen the system for the future in light of what we have learned over the past year, we should critically examine capital regulations, provisioning policies, and other rules applied to financial institutions to determine whether, collectively, they increase the procyclicality of credit extension beyond the point that is best for the system as a whole.”
Of course if this is indeed put into place John Paulson will likely hold the record for annual compensation in Hedgistan for years to come.
Betting against the excesses makes playing the game fun. Those days might be over, at least in their extreme.
A sad development, at least for those of you who feast on fading the moves.
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Nutter
A Nutter (or nut) is a person obsessed with a particular item/sport/concept to the point of knowing a maddening amount about the said topic. For example: A Formula 1 fan, who knows all the drivers and their respective teams, starting positions and finishing places for all races for the last 20 years, could be referred to as a “Formula 1 Nutter”.
In the Fullness of Time Pimco Central Bank Focus --------------------------------------------------------------------------------------------------------------
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Comments:
The argument is moot. Excessive regulation encourages risk taking rather than eliminating it. You could have bank profits or banker bonuses vest over time but that would just encourage them to make time bombs with longer fuses.
The reality is that despite all the turmoil of the last year, the US economy has continued to perform shockingly well. This is not Japan, their is not sufficient incentive for bankers to engage in collective denial with regard to the value of the products on their balance sheet, now that the risks have become apparent. Like Merrill everyone will be forced to recapitalize.
Forget about stimulating US consumer demand, the balance of trade will make up the difference. The US consumer can sell their house in florida for 30 cents on the dollar and buy the exact same house in spain for 20 cents on the dollar.
The only thing that really matters is that, the US is the only major economy with complete control over both its monetary and fiscal policy. Relative to all the other economies we will improve faster and receive the commiserate foreign investment.
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