The Dow fell 93 points yesterday. Gold fell $19 an ounce — closing below $1,300 an ounce.
Nothing serious. But the autumnal trend should start to reveal itself soon. Usually, financial markets begin to give hints as to where they are going in August. Then in the fall…they set out in earnest.
The bond market seems to have put in a top in early May. Gold may have bottomed out in early July. And stocks? They could be topping out now. We’ll have to wait to find out.
But these trends, should they continue, are bound to cause weeping and wailing at the Fed. America’s central bankers have no idea what is going on…and no good idea what to do about it.
President Obama should call the NSA. They’ll know how to get in touch with us.
On Monday, we announced that we would be open to talking about an appointment to the top job at the Fed.
We didn’t expect to hear from the president immediately. It will take him a few days to figure out that his leading candidates for Fed chairman should turn their talents elsewhere — maybe to polishing the White House silver.
The Inside Track
According to the press accounts, the race to replace Ben Bernanke is centred on two people — Janet Yellen and Larry Summers — with Summers on the inside track.
Don’t discount President Obama’s concern for things that don’t matter. He could go for Yellen simply for anatomical reasons. As we explained last week, a central banker who fails in his No. 1 duty — to protect the nation’s money — should be castrated. At least in that sense, Yellen has an edge.
Normally, no one would know or care who got the job at the Fed. But everyone says these aren’t normal times. They all seem to think the times call for an extraordinary person…a ‘brilliant’ person.
After all, who else would be able to carry out the mission President Obama has outlined for him: to keep the US economy growing, hold inflation in check and make sure we don’t create new instabilities? A tall order.
The entire thing is a setup and designed to bring into focus the one candidate who everyone agrees is ‘brilliant’: Larry Summers. Whom do you call when times aren’t normal? Who else has such a brain? Quick as a viper, agile as a flimflam man and as penetrating as Rust-Oleum? Yes, for these reasons, the insiders believe Larry Summers is increasingly finding favour in his master’s eyes.
But what if times are really rather normal? And what if Summers really weren’t so brilliant, after all?
Reason Without Limits
Let us deal with the second question first…
We set aside the fact that Summers managed to turn almost the entire Harvard faculty against him…and that he cost the Harvard endowment a billion dollars, thanks to his wrongheaded interest rate speculations.
Let us look at a larger and more obvious failing.
In 2005, in Jackson Hole, Raghuram Rajan (who this week was appointed to take over at the Reserve Bank of India) laid out the contours of the financial bubble to an audience that included Larry Summers.
Rajan warned it would pop. No special analysis or deep thinking was required from Summers. He didn’t have to figure it out for himself. He just had to pay attention.
In the event, he did pay attention. And, as is his habit, he misunderstood. ‘The basic, slightly Luddite, premise of this paper,’ he commented, ‘is largely misguided.’
Get it? Summers thinks that any mention of cycles or limits is anti-progress.
We read Summers’ commentaries regularly in the Financial Times. We don’t recall a single insight worth repeating or a single proposal that merits further discussion.
Like Tom Friedman at The New York Times, he sees problems everywhere and finds solutions for them readily. And every solution he comes up with would be neat, logical and disastrous.
Unintended consequences? Has he ever heard of the concept?
For Summers, reason has no limits…intervention has no risks…and the world has no Black Swans.
Whatever It Takes
Which brings us to the second question: How abnormal is this situation?
The US switched to a fully fiat-based monetary system in 1971. With this new paper money Americans could borrow a lot more money than before.
Was it not normal that they did so? Total debt went from about 150% of GDP to 350%.
Then, in 2007, when even unemployed household pets had mortgages on houses at inflated prices, was it really surprising that lenders panicked? Every credit bubble is followed by a credit bust.
What’s not normal?
The feds panicked too. Rather than let a correction do its work, they stepped in.
First, a $700 billion program under President George W. Bush (with $23 trillion of additional guarantees). Then another $700 billion under President Obama. Then the Fed went to work with ZIRP, QE I, QE II, Operation Twist…and QE III. Isn’t that just what you’d expect?
The Fed will do ‘whatever it takes’ to keep the money flowing.
A Better Candidate…
But adding more credit to an economy that already suffers from too much doesn’t really help. Nothing unnatural about that, either. The economy didn’t revive. These policies just pushed up prices for rich peoples’ assets.
Most people got nothing from this monetary and fiscal hullabaloo. There were 116 million Americans employed in 2008. There are only 113 million today. And the population has grown by 8 million people in the meantime. What’s more, many more of today’s jobs are in the low-paying service sector.
What’s not normal? And what brilliant innovations will Larry Summers come up with to mask the fact that the Fed’s activism doesn’t work?
What’s needed is not brilliance at all, but dull forbearance. We need normal policies for a normal period of de-leveraging.
So far, only one candidate for the Fed chairmanship has demonstrated the lack of brilliance required. He alone understood what was happening in 2005–2007 and he now appreciates the limits of central bank activism. You know who that candidate is: yours truly.
Repeatedly, he warned, in sober economic terms, that ‘this Vesuvius of debt’ was ‘going to blow sky-high’ (or words to that effect).
Then, when the lava flowed in 2008–2009, he foresaw the Fed response and predicted that it wouldn’t do ‘a damned bit of good.’
And now he knows what to do. The Fed should back off. Sit tight. And let markets do their work.
It’s time for a change.
Mr. Obama, we’re standing by the phone.
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