• 12 hours Putin Signs “Digital Iron Curtain” Into Law
  • 15 hours Russian Metals Magnate Sues U.S. Over Sanctions
  • 18 hours Tesla Looks To Jump Into Indian Market
  • 20 hours Global Banks Lay Groundwork To Re-Inflate Asset Prices
  • 2 days Homeowners Experiment With Risky New Investment Trend
  • 2 days U.S. Tech Stocks Look Increasingly Vulnerable
  • 2 days De Beers To Expand World’s Most Profitable Diamond Mine
  • 2 days Ford CEO Gets Raise After Massive Layoff Round
  • 3 days Germany’s Flirtation With Recession Could Cripple The Global Economy
  • 3 days Where To Look As Gold Miners Inch Higher
  • 4 days Google Faces Billions In Fines From European Regulators
  • 4 days The Energy Industry Has A Millennial Problem
  • 5 days Russian Banks Scramble For Sanction Loopholes
  • 5 days Gold ETFs Take A Hit After Four-Month Run
  • 6 days European Union Takes Aim At Ten New Tax Havens
  • 6 days Goldman Defends Trillion-Dollar Corporate Buyback Spree
  • 6 days $600 Billion At Risk As Boeing Fallout Continues
  • 6 days Venezuela Has Yet Another Crisis Developing
  • 7 days Wells Fargo Accused Of “Ongoing Lawlessness”
  • 7 days Hollywood Agency Returns $400M Investment To Saudi Wealth Fund
The Chatroom Cartel Running Global Bond Markets

The Chatroom Cartel Running Global Bond Markets

Eight major banks have been…

Lending: The Good, Bad, And Ugly

Lending: The Good, Bad, And Ugly

Aristotle said, “The most hated…

  1. Home
  2. Markets
  3. Other

Fed a Creature of Financial Markets; The Draghi PUT; Global Crisis Coming Up

Creature of Financial Markets

Stephen Roach, former Chairman of Morgan Stanley Asia and the firm's chief economist, blasts the Greenspan Fed, the Bernanke Fed, and the Yellen Fed in his latest post The Perils of Fed Gradualism.

After an extended period of extraordinary monetary accommodation, the US Federal Reserve has begun the long march back to normalization. It has now taken the first step toward returning its benchmark policy interest rate - the federal funds rate - to a level that imparts neither stimulus nor restraint to the US economy.

A majority of financial market participants applaud this strategy. In fact, it is a dangerous mistake. The Fed is borrowing a page from the script of its last normalization campaign - the incremental rate hikes of 2004-2006 that followed the extraordinary accommodation of 2001-2003. Just as that earlier gradualism set the stage for a devastating financial crisis and a horrific recession in 2008-2009, there is mounting risk of yet another accident on what promises to be an even longer road to normalization.

The problem arises because the Fed, like other major central banks, has now become a creature of financial markets rather than a steward of the real economy. This transformation has been under way since the late 1980s, when monetary discipline broke the back of inflation and the Fed was faced with new challenges.

The challenges of the post-inflation era came to a head during Alan Greenspan's 18-and-a-half-year tenure as Fed Chair. The stock-market crash of October 19, 1987 - occurring only 69 days after Greenspan had been sworn in - provided a hint of what was to come. In response to a one-day 23% plunge in US equity prices, the Fed moved aggressively to support the brokerage system and purchase government securities.

In retrospect, this was the template for what became known as the "Greenspan put" - massive Fed liquidity injections aimed at stemming financial-market disruptions in the aftermath of a crisis. As the markets were battered repeatedly in the years to follow - from the savings-and-loan crisis (late 1980s) and the Gulf War (1990-1991) to the Asian Financial Crisis (1997-1998) and terrorist attacks (September 11, 2001) - the Greenspan put became an essential element of the Fed's market-driven tactics.

The Fed had, in effect, become beholden to the monster it had created. The corollary was that it had also become steadfast in protecting the financial-market-based underpinnings of the US economy.

Largely for that reason, and fearful of "Japan Syndrome" in the aftermath of the collapse of the US equity bubble, the Fed remained overly accommodative during the 2003-2006 period.

Over time, the Fed's dilemma has become increasingly intractable. The crisis and recession of 2008-2009 was far worse than its predecessors, and the aftershocks were far more wrenching. Yet, because the US central bank had repeatedly upped the ante in providing support to the Asset Economy, taking its policy rate to zero, it had run out of traditional ammunition.

Today's Fed inherits the deeply entrenched moral hazard of the Asset Economy. In carefully crafted, highly conditional language, it is signaling much greater gradualism relative to its normalization strategy of a decade ago. The debate in the markets is whether there will be two or three rate hikes of 25 basis points per year - suggesting that it could take as long as four years to return the federal funds rate to a 3% norm.

But, as the experience of 2004-2007 revealed, the excess liquidity spawned by gradual normalization leaves financial markets predisposed to excesses and accidents. With prospects for a much longer normalization, those risks are all the more worrisome.

Only by shortening the normalization timeline can the Fed hope to reduce the build-up of systemic risks. The sooner the Fed takes on the markets, the less likely the markets will be to take on the economy. Yes, a steeper normalization path would produce an outcry. But that would be far preferable to another devastating crisis.


Beholden to Financial Markets

Roach provides a nice historical perspective but he misses the boat in regards to risks.

Not only is the Fed a creature of the Financial markets, it is beholden to the markets. For some treasury durations, the Fed became the market.

Unfortunately, it's not just the Fed.


Global Crisis Coming Up

Global imbalances have never been worse.

The Bank of Japan is the only market for Japanese government debt. And in Europe, government debt trades at preposterously low and sometimes negative yields. The "Draghi PUT" is at least as big as any PUT by Greenspan.

The risk is not that the Fed (central banks in general) will spawn more asset bubbles. It's far too late to raise that concern. Massive bubbles in equities and bonds have already been blown.

Banks that were "too big to fail" are far bigger now than ever before.

Beggar-thy-neighbor competitive currency debasement is the order of the day in China, Europe, and Japan.

Let's not pretend we have a choice that will prevent another devastating financial crisis. We don't. Only the timing is in question.

 

Back to homepage

Leave a comment

Leave a comment