Before we get into this week’s outstanding Outside the Box, I want to comment on QE2 and the efforts by some Republican economists to urge legislators to get involved to stop it (see the front page of Monday’s Wall Street Journal). That pushes my comfort zone a little too much.
First, I am not a fan of QE2. Never have been. If it had been my call, I would have punted and told the guys in the Capital that the ball was in their court to get their fiscal house in order, because that is the main source of the problem. But Bernanke and the Fed felt they had to “do something,” to demonstrate they got the seriousness of the situation. If the only policy tool you have left is the hammer of printing money, then the world looks like a nail.
Second, I doubt it works. It might be interesting to see what would happen (theoretically) if they decided to print $3-4 trillion. Now that would have a (probably very negative) impact. But it would show up on the radar screen. I think $600 billion just gets soaked up in bank balance sheets, sloughed off to world emerging markets (that don’t want it) and other hot spots, with some drifting into the stock market. But does it increase real final demand, which is what the Keynesians are so seemingly desperate for? I doubt it. And I just don’t see the transmission mechanism for QE2 to produce new employment of any statistical significance.
Third, targeting the middle of the yield curve is about as benign a way as you can do it, as far as QE goes. It certainly is not bringing down mortgage rates (so far). This is not exactly shock and awe QE.
Now, if the real plan, which no one can mention in polite circles at G-20 meetings, is to weaken the dollar, then QE2 just might work at doing that. But do we want it to? Do we want our input prices to go higher? A weaker dollar cuts both ways. And Germany seems to be able to work with either a strong or a weak euro. Are they that much better than us? Really? I sincerely hope we can take Bernanke at his word that this policy is not meant to weaken the dollar. Currency manipulation is not what we need from the world’s reserve currency, nor will we hold that status much longer if we embark down that path.
Back to the Republican sortie against QE2. As long as it stays on a debate level, or even as a resolution, then fine. There is considerable room for debate, and some very serious economists on both sides of the issue. This is new territory and deserves to be debated vigorously. This is, after all, affecting the public. Fed policy is too important to be talked about only inside a conference room with a few appointed governors and economists.
But I do not want to see anything that would reduce the independence of the Fed from the political process (any more than it already has been reduced). I don’t want Republicans dictating Fed policy. Or Democrats. Or the President, beyond his power to appoint. That is the path to becoming a banana republic.
If We the People want to change Fed policy, then we need to realize it is important who we elect as president, because he appoints the chairman and the governors. Ideas matter and have consequences. How many times do presidential candidates get asked about their views on monetary policy in national debates? Are you a proponent of Keynes? Or Friedman? Fisher? von Mises? Which of these four dead white guys have you read and studied? These elections of ours are more than taxes and health care. The Senators who sit on the committees have the right to review appointees, though few understand the real issues regarding the Fed, I am afraid. (Wouldn’t it be fun to have Rand Paul on that committee? He could tag team with his dad in the House. Just a thought.)
Final thought. Maybe the reason for a less than shock and awe QE is that the Fed can get to the end of it and say, “Look, we tried. But the money just went back onto our balance sheet. Printing more doesn’t seem to be advisable.” (Especially if the public pushback gives them some cover.) Then they can back off and let Congress know that they have no intention of monetizing their fiscal profligacy and that Congress must get its house in order before the bond markets react negatively.
And then again I may be wrong. Maybe QE2 does do something. No one really knows because this is truly uncharted territory. We’ll find out in the coming months. And this Friday, in my weekly letter, we’ll look at the prospects for the economy going forward. I get back home tonight and will be home for two weeks. I am looking forward to catching up on my reading.
Now, for this week’s OTB I offer a review of Gary Shilling’s brand new book, The Age of Deleveraging: Investment strategies for a decade of slow growth and deflation.
Gary has long been a proponent of the idea that we are in for a period of deflation, and was writing as far back as the ’90s about the coming deflation. I am already into the book and am enjoying his wonderful prose, but must admit I skipped ahead to see his predictions, some of which are in the review below. You can buy the book at http://www.amazon.com/deleveraging.
Have a great week. And think about a few more fun things than QE2 every now and then.
Your loving the La Jolla weather analyst,
This week I am really delighted to be able to give you a condensed version of Gary Shilling's latest INSIGHT newsletter for your Outside the Box. Each month I really look forward to getting Gary's latest thoughts on the economy and investing. Last year in his forecast issue he suggested 13 investment ideas, all of which were profitable by the end of the year. It is not unusual for Gary to give us over 75 charts and tables in his monthly letters along with his commentary, which makes his thinking unusually clear and accessible. Gary was among the first to point out the problems with the subprime market and predict the housing and credit crises. You can learn more about his letter at http://www.agaryshilling.com. If you want to subscribe (for $275), you can call 888-346-7444. Tell them that you read about it in Outside the Box and you will get not only his recent 2009 forecast issue with the year's investment themes, but an extra issue with his 2010 forecast (of course, that one will not come out for a year. Gary is good but not that good!) I trust you are enjoying your week. And enjoy this week's Outside the Box....
And if you have cable and get Fox Business News, I will be on Happy Hour tomorrow Tuesday the 17th at 5 pm Eastern. Have a great week.
We are clearly not having as much fun taking off leverage as we had putting it on, or at least the vast majority are not. This week in Outside the Box we look at some very thought-provoking insights from my good friend Paul McCulley, who helps us think about how we got here and what will be the end point. From the letter:
"But what ailed Lehman was but a manifestation of what ailed, and ails the global financial intermediary system: the presumption that grossly levered positions in illiquid assets can always be funded, because those doing the funding will always assume the borrower is a going concern."
You need to read this when you have the time to think. The quotes from Keynes are important.
Paul is a managing director, generalist portfolio manager, and member of the investment committee in the Newport Beach office of PIMCO. In addition, he heads PIMCO's short-term bond desk. And is an avid fisherman
Can the credit crisis get any worse? In this week's Outside the Box my London partner Niels Jensen shows that it indeed can. Banks, and mainly European banks, have large exposure to emerging market debt of all types through both sovereign, corporate and individual loans. Just as banks have had to write down large losses from the subprime crisis and other related problems, next will come a wave of potential losses from yet another source. Niels then goes on to give us a look the size and problems with hedge fund deleveraging. Altogether, this is a very interesting letter and one that is written from a non-US point of view that I think you will find instructive.
I have often commented about the problem of personal savings. We worry about the lack of savings here in the US, but many do not understand that if everyone started to save 5% of there income immediately that it would seriously impact consumer spending, pushing the US into a recession. It is a paradox, as Paul McCulley points out, that what may be good for the individual may not be good for the collective country.
And in this week's Outside the Box, good friend and this week's Maine fishing buddy Paul McCulley writes about another paradox called the Paradox of Deleveraging. This Paradox is at the heart of the credit crisis. Many of you will not like his conclusions, as it calls for the government to step into the breach created by the problem he describes. But as I often point out, the purpose of Outside the Box is to make us think about ideas which may not be in our usual sources of information. Paul is the Managing Director at PIMCO, the world's largest bond manager. (www.pimco.com for more information.)