In last week's Outside the Box, which included a paper from the San Francisco Federal Reserve on the effectiveness of quantitative easing, I wrote, "What [authors] Cúrdia and Ferrero are really saying is that the latest round of QE, massive as it has been, has not had all that much effect on the economy, and that other factors should be taken into account. I'm sure this thesis is somewhat controversial, and I look forward to seeing what QE proponents like David Zervos over at Jefferies have to say about it."
And David thundered back with an answer the next day, more or less along the lines that I expected but with an interesting twist. He thinks the San Francisco paper is basically a fig leaf, intellectual covering for a policy the Fed must pursue no matter what. Quoting from his work, which is the lead story for this week's Outside the Box:
There is no doubt these folks are trying to delicately pop a fixed-income leverage bubble. They are deathly afraid of a souped-up version of the 1994 rout! They know that balance sheet expansion comes with the parasitic side effect of excessive private sector leverage. And as of now they feel the potential costs of further expansion are beginning to outweigh the benefits. The economy is recovering; QE has been working like a charm; but it's time to nip the side effects in the bud. That's the current Committee view!
As a consequence, there is a campaign underway by the FOMC to somehow convince us all that "soothing language" will be better than QE injections. That, of course, is like trying to tell Charlie Sheen that a warm cozy snuggle by the fireplace with a good book will be better than an eight ball. The market is not stupid, and neither is Charlie — both will freak out when u try to take their drugs away! And to be sure, we are 130bps into this freak-out session on 10yr rates. The bubble has been popped. And the question we should all be asking ourselves is, will the Fed lose control of the situation? My answer to that (for now) is NO! But I must say, there is quite a bit more room for a policy mistake than at any other time in the past few years."
We follow David's brief but pointed analysis with two related pieces, the first from Stephen Roach, who talks about the potential consequences for emerging markets when central banks have to reduce their easing. As we have all seen, even the run-up to tapering has not been pretty, and emerging-market central banks everywhere are complaining; but as James Bullard, president of the St. Louis Fed, noted in an interview with Bloomberg Radio, the domestic economy is the primary objective of Fed policy. "We're not going to make policy based on emerging-market volatility alone," he said. "They were complaining about us easing too much. Now when we start to talk about taper they're complaining about too tight of a policy. They have an independent monetary policy, and they have to use that to manage their own economies."
And so it goes without saying that, since we have an independent policy, too, what happens in foreign economic climates can't have much of an effect on us, can it? Au contraire, says the ever-colorful Joan McCullough. In our final piece, she rewinds the historical videotape to show that the US Treasury and Federal Reserve have ganged up more than once to bail out foreign countries before they could create big problems here.
But let's hear Joan say it:
So what's the difference if we send money to foreign shores to stop the hemorrhaging so that it doesn't reach us? Or if we acknowledge that having printed money and caused those foreign countries to be at the whim of fast, free do-re-mi ... we now put them in jeopardy by our withdrawing same? We did it in Mexico. We did it in Asia. We saw them nearly implode once the hot money started to leave big time and saw that this would cause us problems. So we took action to defend ourselves.
Why now, are they denying this reality? Just plain stupid? Or is there a method to the madness? Such as they see that they have created such a horrific, no exit mess as the result of QE Infinity and ZIRP, that they must now pretend that US policy has always been "every man for himself"? When we know that this is blatantly false?
As you read these three pieces, recognize that the problems described are all part of the same set of unintended consequences of massive central bank monetary easing and related unorthodox policies, and that the time is rapidly approaching when the world is simply going to have to live within its means.
"AND what is so rare as a day in June?
Then, if ever, come perfect days;
Then Heaven tries earth if it be in tune,
And over it softly her warm ear lays;
Whether we look, or whether we listen,
We hear life murmur, or see it glisten…"
― James Russell Lowell
With apologies to Mr. Lowell, far more rare is a pleasant day in Texas in August. But this year, while temperatures are still in the 90s during the day, the evenings cool down enough to allow one to comfortably sit outdoors at a restaurant or on the deck. I remember one span of two weeks in the 1980s when temperatures soared into the 110s every day. Generally, Texas is miserably hot in August, but this has been the best weather in August I can remember in my entire 63 years. I am sure that global warming is responsible somehow. This paean to the weather is occasioned by the wonderful evening I spent last night with my friend from the first grade Randy Scroggins, over chili rellenos and salsa at Gloria's, sharing life memories and updates on our kids. It is a special relationship that can survive youth, business successes and failures, and 13 kids between us. We've lived each other's ups and downs but have always been there for each other.
In two weeks I fly to Bismarck, where I will spend the day with Loren Kopseng, flying first to South Dakota and Mount Rushmore to play tourist (and to finally be able to say I have visited all 50 states) and then north to the Bakken for an update and tour of that fabulous oil play. Last year I flew around the block in a helicopter with Loren as he introduced me to the region. He asked me if I knew anything about oil, and I said I grew up in the oil patch but that my best friend (which would've been Randy) wouldn't let me invest in his oil company in 1981, when he was on one of his really big rolls.
"Wow!" said Loren. "He was a really good friend to you. 1981 was the first time I went bankrupt in the oil business." There's something special about oil wildcatters in general and Texas wildcatters in particular. I recognize that passion when I talk to Loren. Slightly mad, just about a half bubble off dead center, as my dad would say. But damn, you've got to love 'em.
Your wishing I had a few oil wells now analyst,
John Mauldin, Editor
Outside the Box
Guidance Schmidance ... Show Me the Money
By David Zervos, Jefferies & Co.
"Actions speak louder than words."
"Talk is cheap."
"Speak softly and carry a big stick."
These are common aphorisms which have been used historically to admonish those with loquacious tendencies to pipe down. They are words of wisdom — and something our central bankers should think about long and hard. The release of…