Uncertain Measures of Uncertainty; Fed Uncertainty Principle Revisited
Fed Chair Janet Yellen has been harping about the "uncertain" outlook for the US economy for years on end.
Perhaps this was inspiration for economists to devise an absurd new index that allegedly measures the amount of uncertainty in the economy.
Before diving into measures of uncertainty, let's view a few Yellen uncertainty citations.
- March 29, 2016: Yellen: The Outlook, Uncertainty, and Monetary Policy
- February 10, 2016: Outlook 'Uncertain' For Global Economy, Yellen Tells Congress
- July 15, 2014: Janet Yellen: 'Considerable Uncertainty' In US Economic Outlook
A quick search turns up dozens of such links.
On April 17, Davis Rosenberg said Janet Yellen's use of one word tells us something has gone wrong.
In a truly seminal speech on March 29th, Janet Yellen used the title, The Outlook, Uncertainty, and Monetary Policy.
I have been in this business for 30 years and have never seen a central bank chief slip the word "uncertainty" into the headline.
Not just that, but she invoked the term no fewer than 10 times to describe the domestic and global macro and market backdrop -- this even as we pass seven years since the worst point of the Great Recession and seven years into the most radical easing of monetary policy in recorded history.
It begs the question: what has gone wrong?
Facts of Life
Caroline Baum, one of my favorite economic writers (on Bloomberg for many years until they stopped using much of her material in favor of garbage), has an excellent column on uncertainty on MarketWatch.
Please consider Opinion: Uncertainty is a Fact of Life, So Get Used to It, by Caroline Baum.
A group of economists have put together an economic policy uncertainty index. It's not certain what the value of this index is.
My day begins with uncertainty. Will the rain hold off until this evening, as the weather forecast suggests? Or should I dash out to mow the lawn now in case it starts to drizzle this afternoon?
I boot up my computer to find a host of uncertainties confronting me. I read that U.S. stocks are starting the week in the red because of uncertainty over the Federal Reserve's meeting this week.
Then there's the first look at first-quarter U.S. gross domestic product on Friday. Will it be as soft as the Atlanta Fed's GDPNow predicts, an annualized growth rate of 0.4%? Or will it be closer to 1.3%, the average of economists polled by the Wall Street Journal?
That's just a taste of the certain uncertainties. What about uncertain uncertainties, such as a terrorist attack or a coup in some foreign country? An out-of-nowhere event that could rattle financial markets? Perhaps some newly unearthed revelation will disqualify one of the U.S. presidential contenders. (OK, if Hillary Clinton's shenanigans haven't dented her front-runner status by now, maybe nothing will.)
Uncertain uncertainties -- the equivalent of former Defense Secretary Donald Rumsfeld's "unknown unknowns" -- are a fact of life. So man up, you wusses!
It is axiomatic that markets hate uncertainty. That overused phrase has been around so long that it's impossible to determine the source. Which is just as well since the whole idea is pretty silly.
Fed Uncertainly Principle
Baum's humorously correct anecdotes on uncertainty reminds me of one of my favorite posts: Fed Uncertainty Principle.
The Observer Affects The Observed
The Fed, in conjunction with all the players watching the Fed, distorts the economic picture. I liken this to Heisenberg's Uncertainty Principle where observation of a subatomic particle changes the ability to measure it accurately.
The Fed, by its very existence, alters the economic horizon. Compounding the problem are all the eyes on the Fed attempting to game the system.
A good example of this is the 1% Fed Funds Rate in 2003-2004. It is highly doubtful the market on its own accord would have reduced interest rates to 1% or held them there for long if it did.
What happened in 2002-2004 was an observer/participant feedback loop that continued even after the recession had ended. The Fed held rates rates too low too long. This spawned the biggest housing bubble in history. The Greenspan Fed compounded the problem by endorsing derivatives and ARMs at the worst possible moment.
Here is a recap of the Fed Uncertainty Principle and its corollaries as I wrote them on April 3, 2008, before the crash.
Fed Uncertainty Principle:
The fed, by its very existence, has completely distorted the market via self reinforcing observer/participant feedback loops. Thus, it is fatally flawed logic to suggest the Fed is simply following the market, therefore the market is to blame for the Fed's actions. There would not be a Fed in a free market, and by implication there would not be observer/participant feedback loops either.
Corollary Number One:
The Fed has no idea where interest rates should be. Only a free market does. The Fed will be disingenuous about what it knows (nothing of use) and doesn't know (much more than it wants to admit), particularly in times of economic stress.
Corollary Number Two:
The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates, the more power it will attempt to grab. Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing.
Corollary Number Three:
Don't expect the Fed to learn from past mistakes. Instead, expect the Fed to repeat them with bigger and bigger doses of exactly what created the initial problem.
Corollary Number Four:
The Fed simply does not care whether its actions are illegal or not. The Fed is operating under the principle that it's easier to get forgiveness than permission. And forgiveness is just another means to the desired power grab it is seeking.
If and when the economists are ever "certain" about the economy, I am certain they will be wrong. Meanwhile attempts to measure uncertainty are ridiculous.