(By Ed Pawelec) Famed LSD advocate and Harvard Professor Dr. Timothy Leary passed away on May 31, 1996, but the practitioners of his philosophy, "The only hope is dope
," live on at the Federal Reserve.
The market's response to Wednesday's Fed policy statement and subsequent press conference by Bennie "The Bong Master" Bernanke suggests that confidence in the Central Bank is waning.
Bennie freely admitted that the Central Bank, after the completion of the $267 billion Twist 2 at the end of this year, would be out of ammunition as far as maturities extensions go. Quoting from the New York Fed, who will be implementing the sale of short maturities and purchase of longer dated treasuries:
"Once the maturity extension program is completed, the Federal reserve will hold almost no securities maturing through January 2016."
So that's one less form of monetary dope that Bennie will be peddling. Frighteningly for investors, Bernanke thinks he has other weapons at his disposal that can save the economy, but I believe he is completely out of touch, and cash may be the best play available if you can't short the market.I Think I'm Turning Japanese
During the press conference, which is always the most entertaining part of the circus, a Japanese reporter, whose name I did not catch, questioned the chairman as to whether or not he felt he was essentially creating a liquidity trap. That's a situation where Central Bank monetary injections fail to have the desired effect of stimulating the economy. Bennie replied:
"The U.S. economy is in a situation where short term interest rates are close to zero. So what that means is that the Federal Reserve cannot add monetary accommodation by cutting short term interest rates, the usual approach. It's been one of the themes of my own work for a long time, including the work I did on the Bank of Japan, that central banks are not out of tools once the short term interest rate hits zero. There are other additional steps that can be taken and we have demonstrated through both communications techniques, guidance about future policy, which is something the Japanese have done as well, and through asset purchases, also something the Bank of Japan has done, that central banks do have some ability to provide financial accommodation to support the recovery even when short term interest rates are close to zero ... But I do think it can be effective in helping the economy."
Apparently, the work he did for the Bank of Japan did not include the evaluation of the effectiveness of such measures. Over the last decade and change, Japan's central bank has not only purchased its own treasuries, but expanded the accommodative policies to include purchases of ETFs on the Japanese stock market as well as real estate investment trusts (REITs). The results have mired the country in a no-growth, deflationary spiral, and few would argue with that.
I'm not sure how anyone could possibly characterize that as effective policy, unless they are completely inebriated. The Money is Where?
A few minutes later, another reporter gave Bernanke the opportunity to confirm the fact that his over reliance on monetary theory has clouded his vision. The question related to whether or not Operation Twist and other forms of quantitative easing will have a continued negative impact on bank earnings and, as a result, impede the ability of consumers to get credit from said banks. At first, he even seemed a little confused by the question...
"Credit to consumers? No I don't think so. I've heard the argument that when you lower interest rates you make it unattractive to lend. I don't think that is quite right. What we are lowering is the safe interest rate, the treasury rate. That should make it even more attractive for banks, rather than to hold securities, to look for borrowers and to earn the spread between the safe rate and what they can earn by lending to households and businesses. So I think macro (sic) policy and fiscal policy can support lending. Now the question arises in some contexts whether there are other barriers to lending, as exists for example in some parts of the mortgage market. But lower interest rates on securities and other types of assets, all else being equal, would induce banks to look for higher yielding returns, higher yielding assets in the form of loans to households and businesses."
There are so many things wrong with this answer, but I will try and keep it brief. According to the St. Louis Federal Reserve, since the announcement of the first round of quantitative easing was announced in August of 2008, commercial and industrial loans are down 10%. Now it is true that this is up from the lows set in October of 2010 when business lending was off 21% from the announcement of QE, but banks are clearly not actively searching to make new loans.
Banks make risky bets with excess cash. Jamie Dimon said as much during his recent testimony on Capitol Hill. Banks are looking for higher returns, but they are not looking for the measly few percentage points they can get by putting the money to work in the economy by making loans. They are swinging for the fences and double-digit returns through speculation in obscure derivatives.Pack Another One, Bennie!
Wednesday's press conference was, in my opinion, a stark confirmation of two big negatives for the economy and the markets:
1) The Fed is out of ammo unless it resorts to Japanese style asset purchases and no, Mr. Chairman, that will not stimulate the economy.
2) Bernanke is completely lost in monetary theory and does not understand what is really going on in the banking system he is supposed to oversee.
Both of these issues mean that, if you can't short the market, cash is a great play until central bankers step away from the dope. Sadly, much more damage could be done before that happens.