Talking (Fed) Heads

Watch out, You might get what you’re after
Cool babies, Strange but not a stranger

Hold tight wait till the party’s over
Hold tight we’re in for nasty weather
There has got to be a way
Burning down the house

No visible means of support and you have not seen nuthin’ yet
Everything’s stuck together
I don’t know what you expect staring into the tv set
Fighting fire with fire

From The Talking Heads - Burning Down the House - 1983

It's hard to imagine the Talking Heads being so prescient regarding Fed policy.

***

As all the world's financial markets await Thursday's appearance by Alan Greenspan before the Joint Economic Committee to discuss the outlook for the economy, let's review some recent Fed Head talk.

Last Wednesday, Dallas Fed Head Richard Fisher likened the current state of the rate raising cycle to the eighth inning of a baseball game.

"We're clearly in the eighth inning of a tightening cycle ... We have the ninth inning coming up at the end of June. I think there's room to tighten a little bit further, and then we'll see. We may have to go into extra innings in the contest against inflation."

Another Fed Bubble?

Shortly thereafter, clear signs could be seen of a new bubble forming - another bubble inadvertently created by the Federal Reserve. Since the baseball analogy was first used to describe monetary policy, there is now a speculative fever sweeping across all of the financial media. A mania where writers have taken advantage of the easy terms offered by the Dallas Fed chief, only to overextend themselves in leveraging this analogy.

Of all the risky bets made, this may be the most tortured - let's hope this bubble bursts quickly ... but not immediately.

Gramlich Catches Fisher Foul Ball

On Friday, Fed Governor Edward Gramlich refuted conclusions that the Fed would stop tightening, saying:

"I don't know what inning we're in, period. "

The Fed governor, who may get even more testy and say even more interesting things before he retires in August, also said he felt the United States had won price stability and would work to keep it.

"To me, that is the ultimate test of price stability -- do you think that $10,000 goes farther this year than it did five years ago? I would argue in that sense we have achieved price stability."

Well, you can certainly buy lots more DVD players with that $10,000 (actually 345 DVD players at $29 each), but you'll be disappointed how much less $10,000 gets you in tuition, medical bills, gasoline, or housing.

Greenspan Still Baffled by the Knuckleball

In China yesterday, Alan Greenspan once again admitted to being baffled by the long term interest rate "conundrum".

"The pronounced decline in U.S. Treasury long-term interest rates over the past year despite a 200-basis-point increase in our federal funds rate is clearly without recent precedent. The yield on ten-year Treasury notes currently is at about 4 percent, 80 basis points less than its level of a year ago."

Unable to explain this unusual behavior, four possible causes of the conundrum were cited:

• Markets signaling economic weakness
• Pension fund buying
• Foreign purchase of U.S. Treasuries
• Excess global savings
  

Somehow, it doesn't seem that the low long term rates are really such a bad thing, at least for the next eight months, until Easy Al retires. Imagine what would happen to the real estate bubble if the ten-year note would have gone to over 6% instead of back down to 4%. With 30-year mortgages headed toward 8%, either home loans would have to get much more creative, or the entire economy would have a distinctly different feel right about now.

Before being praised, the nine thousand hedge funds currently competing for better return were identified as being susceptible to losses or worse:

"Consequently, after its recent very rapid advance, the hedge fund industry could temporarily shrink, and many wealthy fund managers and investors could become less wealthy. But so long as banks and other lenders to these ventures are managing their credit risks effectively, this necessary adjustment should not pose a threat to financial stability.

I trust such an episode would not induce us to lose sight of the very important contributions hedge funds and new financial products have made to financial stability by increasing market liquidity and spreading financial risk, and thereby enhancing economic flexibility and resilience."

Yes, all the spreading of risk and enhanced flexibility will work ... up to the point that it stops working. This offers little assurance:

"The economic and financial world is changing in ways that we still do not fully comprehend.

Policymakers need to be able to rely more on the markets' self-adjusting process and less on officials' uncertain forecasting capabilities. ... In this regard, the recent emergence of protectionism and the continued structural rigidities in many parts of the world are truly worrisome. In the end, I trust that we will all recognize our common interest in fostering global and domestic arrangements that promote the prosperity of our citizens."

So, if Asian currencies successfully unpeg from the dollar, and no trade wars break out, things should be OK. That is, the U.S. consumer and the rest of the world should be able to somehow handle the monstrous amount of U.S. dollar denominated debt that was created when the stock market went bust five years ago and a healthy recession was prevented from happening. When the biggest boom in history was followed by the shallowest recession in history, thanks to the creation of an even bigger boom based on more credit and debt ... and people’s homes.

Fighting fire with fire
Burning down the house