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5 CREDIT BUBBLE
BULLETIN Not so benign
neglect By Doug Noland
COMMENTARY Federal Reserve Bank of St.
Louis President William Poole spoke Tuesday before
the Industrial Asset Management Council. In the
Q&A session, a member of the audience posed
the follow question:
“Dr. Poole, on M3 - I
believe it is a number the government doesn’t now
publish - what effect do you think the amount of
money we’re printing and
putting into the economy - what effect does it
have as far as devaluing the dollar in the world
markets?”
Dr. Poole’s response:
“The Federal Reserve stopped publication
of M3 a year or so ago … It was after extensive
exploration of whether anybody actually used the
measure. We didn’t use it internally and we
decided that very few people actually used it… Now
that is not in anyway directly related to the
other question you asked about the depreciation of
the dollar.
The depreciation of the dollar
is something that is not explicable. And the way I
like to phrase this – I like to put my academic
hat back on. If you look at academic studies of
forecasts of the exchange rates across the major
currencies, you find that the forecasts are simply
not worth a damn. Your best forecast of where the
dollar is going to be a year from now is where it
is now. There is no model that will beat that
simple model. And people have dug into this over
and over again. Obviously, you can make a ton of
money if you were able to have accurate forecasts.
No one has been able to come up with a forecasting
methodology that will make you a lot of money. And
you can’t make money under the forecast that the
dollar is the same as it is right now a year from
now. I can go a step beyond that though – and this
is what I think is really interesting.
"The academic literature is also full of
papers trying to explain exchange rate
fluctuations after the fact – after you have all
the data that you can put your hands on – data
that you can’t accurately forecast, but data that
after you get your hands on it might logically
explain the fluctuations of currency values. And
those models aren’t worth a damn either. We cannot
explain the fluctuations of currencies after they
have occurred even with all the data that we can
dig out. And therefore, to me, it’s completely
unsupported idle speculation not only to make the
forecast but to talk about why the dollar has
behaved as it has. I know the financial pages and
the traders love to talk about that, but I would
challenge any of them to construct a model that
would stand up to a peer review journal in
economics or finance. The models just aren’t that
good.”
A post-event question from a
Bloomberg reporter: “I was hoping you could
elaborate a little bit on the implications of the
weakness in the dollar right now… whether
implications on inflation or just the economy in
general.”
Dr. Poole: “I don’t see any
implications for inflation, at least with the
magnitude of the depreciation that we’ve seen so
far. The evidence is that – there’s a literature
that looks at what’s called “pass through” – pass
through of changes in domestic prices. And the
evidence is that the pass through coefficient has
gotten small and smaller.”
Dr. Poole and
the Federal Reserve more generally are at this
point succumbing to Not So Benign Neglect of our
nation’s currency. For a top U.S. central banker
to claim today that the dollar’s ongoing five-year
devaluation is “inexplicable” is simply hard to
swallow. And to seemingly dismiss analyses of the
predictably deleterious currency effects stemming
from unprecedented Credit excess and resulting
Current Account Deficits (as “completely
unsupported idle speculation”) is barren central
banking. I would also suggest to Dr. Poole that
there surely won’t be a single hedge fund manager
or Wall Street proprietary trader interested in
submitting an academic paper on the issue of
forecasting the dollar: they have been and remain
far too busy making enormous and easy speculative
profits from dollar debasement.
The nature
of Dr. Poole’s dismissal of currency-induced
inflationary ramifications is further indicative
of what are increasingly evident deficiencies in
our “academic” Fed. September’s 4.4% y-o-y
increase in the Producer Price Index follows
yesterday’s report of a 5.2% y-o-y jump in the
Import Price Index (monthly imports running almost
$200bn!). And with crude trading today above $84
for the first time – and commodities indices
recently breaking out to new record highs – this
is not the time for inflation complacency. Surging
energy costs have already spread to the food
complex and beyond. The nature of Inflation
Dynamics will now ensure more pronounced
“knock-on” effects throughout. It is also worth
noting that the Baltic Dry Freight cost index this
week increased y-t-d gains to 140% (up “fivefold
since 2003”). Especially with China, India and
greater Asia’s heightened inflationary backdrop,
to not expect a meaningfully higher “pass through”
from foreign manufactures is wishful thinking,
suspect analysis, and regrettably poor central
banking.
While on the subject of
less-than-exemplary central banking, this week’s
improved Trade Deficit is deserving of a brief
comment. It has been the Greenspan/Bernanke
doctrine to view the weakening dollar as an
integral facet of an expected long-term gradual
adjustment in global imbalances - including our
Current Account position. As such, August’s
better-than-expected $57.6bn trade shortfall (vs.
year ago $67.6bn) – with Goods Exports up 13.2%
y-o-y compared to a 2.4% gain in Goods Imports –
might be viewed as confirming the merits of the
gradualist approach.
Not surprisingly, the
dollar barely budged from multi-decade lows
despite the positive trade news. At this point,
any marginal beneficial improvement in
trade-related financial flows is inconsequential
when compared to the massive scope of speculative
finance these days seeking to profit from further
dollar depreciation. The fact of the matter is
that the “gradualist” approach completely failed
to anticipate that multi-year dollar debasement
would stoke powerful Inflationary Biases
throughout "Un-dollar" asset classes (certainly
including currencies, commodities, international
real estate, global equity and debt securities,
and art/collectables). And once Bubbles take hold…
The fateful flaw in U.S. central banking
has been to focus on a depreciating dollar as the
key mechanism for rectifying excesses and
imbalances, while completely disregarding Credit
and financial excesses. It was an easy – seemingly
painless – expedient that had no chance of
success. The pressing need to commence the process
of financial and economic adjustment (“pressing”
in respect to the nature of escalating distortions
and structural impairment) required policies that
would directly alter financial developments and
restrain excess.
Instead, a declining
dollar within the backdrop of Federal Reserve
accommodation worked only to further bolster
distortions and imbalances both at home and
abroad. It can be viewed as the worst of all
policy courses – virtually condoning a system of
escalating Credit and speculative abuses, while
ensuring a major additional element (our weak
currency) supportive of global excesses. To be
sure, Destabilizing Monetary Processes and
Monetary Disorder sprang from the confluence of
booming Wall Street finance, the burgeoning
leveraged speculator community, and rapidly
escalating Inflationary Biases and Bubble Dynamics
throughout global Credit and economic systems.
Weak dollar policies could not have been more
Bubble friendly.
Confronted abruptly this
summer with Acute Financial Fragility, the Fed in
both words and deeds again aggressively
accommodated Bubble perpetuation. It is important
to compare and contrast the current
“reliquefication”/“reflation” with the previous
episode. First, and foremost, when the Fed began
aggressive post-tech Bubble “mopping-up”
accommodation in early 2001, the dollar index
traded near 120 (today 78.22). Approaching $6.0
TN, international reserves assets have inflated
about three-fold since 2001. Chinese reserves have
ballooned from about $170bn to $1.434 TN. The
price of oil is up almost three-fold; gold almost
the same. The price of copper has inflated from
about $80 to $350, lagging some of the other
industrial metals. The price of wheat is up more
than three-fold. The Goldman Sachs Commodities
index rallied from 250 to 550. Brazil’s Bovespa
equities index has inflated from about 15,000 to
62,500; the Mexican Bolsa 5,000 to 32,500;
Russia’s RTS 130 to 2,100; the Shanghai Composite
from about 2,000 to 6,000; and India’s Sensex
4,000 to 18,000.
The median price of a
home in California began 2001 at about $244,000,
before topping out this April at $597,640.
Contrarily, after spiking to 4,816 in March of
2000, the NASDAQ100 did not
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