The financial system has
“gotten away from” the Fed’s ability to comprehend
by Paul Singer
The Fed is
primarily responsible for that state of affairs, and it is out of its depth.
Former Chairman Greenspan created – and reveled in – a cult of personality
centered on himself, and in the process created a tremendous and growing moral
hazard. By successive bailouts and purporting to understand (to a higher and
higher level of expressed confidence) a quickly changing financial system of
growing complexity and leverage, he cultivated an ever-increasing (but
unjustified) faith in the Fed’s apparent ability to fine-tune the American
(and, by extension, the world’s) economy. Ironically, this development was
occurring at the very time that financial innovations and leverage were making
the system more brittle and less safe. He extolled the virtues of derivatives
and minimized the danger of leverage and risky securities and dot-com stocks,
all while he should have been putting on the brakes.
It was not just the
disappearance of vast swaths of the American financial system into unregulated
subsidiaries of financial institutions, nor was it just government policies
that encouraged the creation and syndication of “no-documentation” mortgages to
people who could not afford them. It was also the low interest rates from 2002
to 2005, the failure to see the expanding real estate bubble caused by an
unprecedented increase in leverage and risk, and the general failure to
understand the financial conditions of the world’s major institutions.
Under Chairman
Bernanke, the combination of ZIRP and QE completed the passage of the Fed from
sober protector of a fiat currency to ineffective collection of
frantically-flailing, over-educated, posturing bureaucrats engaged in ever
more-astounding experiments in monetary extremism.
If you look at the
history of Fed policy from Greenspan to Bernanke, you see two broad and
destructive paths quite clearly. One path is the cult of central
banking, in which the central bank gradually acquired the mantle of all-knowing
guru and maestro, capable of fine-tuning the global economy and financial
system, despite their infinite complexity. On this path traveled arrogance,
carelessness and a rigid and narrow orthodoxy substituting for an open-minded
quest to understand exactly what the modern financial system actually is and
how it really works. The second path is one of lower and lower discipline, less
and less conservative stewardship of the precious confidence that is all that
stands between fiat currency and monetary ruin. Monetary debasement in its
chronic form erodes people’s savings.
In its acute and later stages, it
can destroy the social cohesion of a society as wealth is stolen and/or created
not by ideas, effort and leadership, but rather by the wild swings of asset
prices engendered by the loss of any anchor to enduring value.In that
phase, wealth and credit assets (debt) are confiscated or devalued by various
means, including inflation and taxation, or by changes to laws relating to the
rights of asset holders. Speculators win, savers are destroyed, and the ties
that bind either fray or rip. We see no signs that our leaders possess
the understanding, courage or discipline to avoid this.
It is true that
the CEOs of the world’s major financial institutions lost their bearings and
were mostly oblivious to their own risks in the years leading up to the crash.
However, as the 2007 minutes make clear, the Fed was clueless about how
vulnerable, interconnected and subject to contagion the system was. It is not
the case that the Fed completely ignored risk; indeed, several Fed folks made
“fig leaf” statements about the risks of the mortgage securitization markets,
as well as other indications that they appreciated the possibility of multiple
outcomes. But nobody at the Fed understood the big picture or had the courage
to shift into emergency mode and make hard decisions. In the run-up to the
crisis the Fed was a group of highly educated folks who lacked an understanding
of modern finance. After convincing the nation for decades of their exquisite grasp
of complexities and their wise stewardship of the financial system, they didn’t
understand what was actually going on when it really counted.
Ultimately, of
course, as the system was collapsing and on the verge of freezing up
completely, the Fed shifted into the (more comfortable and much less difficult)
role of emergency provider of liquidity and guarantees.
All this
background presents an interesting framework in which to think about what the
Fed is doing now. QE is a very high-risk policy, seemingly devoid of immediate
negative consequences but ripe with real chances of causing severe inflation,
sharp drops in stock and bond prices, the collapse of financial institutions
and/or abrupt changes in currency rates and economic conditions at some point in
the unpredictable future. However, the lack of large increases in consumer
price inflation so far, plus the demonstrable “benefits” of rising stock and
bond markets, have reinforced the merits of money-printing, which is now in
full swing across the world. In the absence of meaningful reforms to tax,
labor, regulatory, trade, educational and other policies that could generate
sustainable growth, “money-printing growth” is unsound. We believe that
the global central bankers, led by the Fed as “thought leader,” have no idea
how much pain the world’s economy may endure when they begin the
still-undetermined and never-before attempted process of ending this gigantic
experimental policy. If they follow the paths of the worst central banks in
history, they will adopt the “tiger by the tail” approach (keep printing even
as inflation accelerates) and ultimately destroy the value of money and savings
while uprooting the basic stability of their societies. Read the 2007
Fed minutes and you will understand how disquieting is the possibility of such
outcomes and how prosaic and limited are the people in whom we have all put our
trust regarding the management of the financial system and the plumbing of the
world’s economy.
Printing money by
the trillions of dollars has had the predictable effect of raising the prices
of stocks and bonds and thus reducing the cost of servicing government debt. It
also has produced second-order effects, such as inflating the prices of
commodities, art and other high-end assets purchased by financiers and
investors. But it is like an addictive drug, and we have a hard time imagining
the slowing or stopping of QE without large adverse impacts on the prices of
stocks and bonds and the performance of the economy. If the economy does not
shift into sustainable high-growth mode as a result of QE, then the
exit from QE is somewhere on the continuum between problematic and impossible.
Central banks
facing high inflation and/or sluggish growth after sustained money-printing
frequently are paralyzed by the enormity of their mistake, or they are deranged
by the thought that the difficult and complicated conditions in a more advanced
stage of a period of monetary debasement are due to just not printing enough. At
some stage, central banks inevitably realize, regardless of whether they admit
the catastrophic nature of their own failings, that the cessation of
money-printing will cause an instant depression. Even though at that point the
cessation of money-printing may be the only action capable of saving society,
that becomes a secondary consideration compared to the desire to avoid
immediate pain and blame. The world’s central banks are in very deep with QE at
present, and the risks continue to build with every new purchase of stocks and
bonds with newly-printed money.
* * *
And, as an added
bonus, Singer's thoughts on gold:
There are many
current theories as to why the price of gold had been drifting down and then
collapsed in mid-April. We are trying to sort out various possible
explanations, but we urge investors to be cautious in their thinking about what
circumstances would likely cause gold to rise or fall sharply. The correlations
with other assets in various scenarios (risk on or off, economic normalization,
inflation, the rise and fall of interest rates, euro collapse) may shift
abruptly as the macro picture evolves. Many people think that if stock markets
continue rising, and/or if the U.S. and Europe restore normal levels of growth
and employment, then the rationale for owning gold is weakened or destroyed.
This perception may be correct, and it is certainly a topic that is currently
much discussed, but ultimately another set of considerations is likely to
dominate.
The world is on a
seemingly one-way trip to monetary debasement as the catchall economic policy,
and there is only one store of value and medium of exchange that has stood the
test of time as “real money”: gold. We expect this dynamic to
assert itself in a large way at some point. In the meantime, it is quite
frustrating to watch the price of gold fall as the conditions that should cause
it to appreciate seem more and more prevalent. Gold may not exactly be a “safe
haven” in the sense of an asset whose value is precisely known and stable. But
it surely is an asset that, in a particular set of circumstances, becomes a
unique and irreplaceable “must-have.” In those circumstances (loss of
confidence in governments and paper money), there are no substitutes, and the
price of gold may reflect that characteristic at some point.
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