Quantity over quality

Zero Hedge has a piece on Fed policy that is worthy of being shared.

No, all of these are secondary items. Here is what is of absolutely critical importance in the just released Goldman letter, nested deep in Hatzius’ final paragraph, where it would otherwise be missed by most:

…we have found some evidence that at the very long end of the yield curve, where Operation Twist is concentrated, it may be not just the stock of securities held by the Fed but also the ongoing flow of purchases that matters for yields

For those who are aware of the Fed’s sentiment vis-a-vis the debate of stock vs flow of money effect, this will be a stunning revelation. Especially since it vindicates what we have been saying since day one, namely that when it comes to securities price formation in a centrally-planned regime, it is flow not stock that matters. And as those who follow the Fed’s thinking know too well, the Fed is convinced it is stock, not flow that serves as a consistent catalyst for subjective risk valuation. The above quote is just the first crack in the Fed’s thinking, because if Goldman now believes this, so will Bill Dudley, following his next meeting with Jan Hatzius at the Pound and Pence, and shortly thereafter, it will become canon at the Fed.

One way of visualizing what this means is to think of a shark which has to be constantly in motion in order to survive. Well, the allegory of Jaws can be applied to liquidity addicted capital markets. Translated simply, it means that it is irrelevant if the Fed’s balance sheet is $1 million, $1 trillion or $1,000 quadrillion. A primacy of flow over stock means that UNLESS THE FED IS ACTIVELY ENGAGING IN MONETIZATION AT EVERY GIVEN MOMENT, THE IMPACT FROM EASING DIMINISHES PROGRESSIVELY, ULTIMATELY APPROACHING ZERO AND SUBSEQUENTLY BECOMING NEGATIVE!

You should read the entire article, but I wanted to highlight this part as it reinforces something I am often criticized for. Clearly, Fed policy is directed by style over substance as appearances are everything. Liquidity is paramount as money on the sidelines detracts from the shell game. The Fed needs the money to keep flowing. This is why they get involved with their stealth stock purchases to keep the illusion alive.

I get knocked because I note the importance of consumer confidence. Austrian economists dismiss it as myth, but in Fed world it is very much a part of the show. It directly feeds into consumer spending which is central to the Keynesian business cycle theory. Consumers need to ‘feel’ that illusion of recovery so they will keep spending money. It’s not about whether or not this is a successful model to operate under. It is what it is. We can point out what we should be doing all day long but the fact is the Fed requires consumer confidence leading to consumer spending leading to liquidity spending. As the article said, it’s about “flow”. So never fear, the “crash” is still on schedule coming to a neighborhood near you.

5 thoughts on “Quantity over quality”

  1. I am constantly amazed that the crash has not already happened. Credit was a powerful tool for the advancement of civilization. Ironically it will be the misuse of credit that will destroy civilization.

  2. I used to be amazed just like you Jim. But now I think that absent an unforeseen trigger event, they can extend this charade for several more years. That was what I was after in the post. The consumer is the key. Lose confidence, stop spending regardless of the Fed props and at that point there is nothing anyone can do to stop it. Just makes it that much worse in the end.

  3. I get knocked because I note the importance of consumer confidence.

    After clicking over to read the whole convulted piece and then thinking about it, I’m still left in want of a simple answer. Because there isn’t one.

    I say convulted because I think he tried to explain too much in too little space while typing too fast. Also, he’s talking about the stock market, not the economy as a whole. After all, it’s blatantly obvious the stock market is riding free Ben Benranke dollars. This will not last. While indeed this “is what it is,” it does matter “whether or not this is a successful model.” Why? Flawed systems don’t work.

    Think all the way back to 2008 when the banking system collapsed. It had nothing to do with consumers losing confidence and abruptly ceasing spending, the banks model of lending money they didn’t have simply met its logical conclusion. The house of cards collapsed. So, even though they’re playing Keynesian and MMT games, they still can’t provide answers.

    On velocity … Let’s say you, me and Jim are sitting around a table. I owe you a dollar, you owe Jim a dollar, and Jim owes me a dollar. So I give you a dollar which in turn you give to Jim who in turn gives it to me. We’re all paid in full because the dollar I pulled out of my pocket “did the work of three” (velocity or “flow”). But, did the velocity of that dollar really mean anything? Did it add capital to, or subtract from the economy? Obviously not.

    Valuations are always subjective, so yes, one can say there’s a psychological aspect to the market. But psychology can’t overcome reality. I was a banker in 2008, rest assured there was a great deal of confidence in the housing market. Did it continue to rise? Nope. The reality of the banking system gave confidence a brutally cold shower. Reality wins every time. Look at the Treasury market. The reason the Fed is the single largest buyer of governent bonds is because individuals and private instutions don’t want them (psychological). But is it purely psychological (“animal spirits”), or is it more likely that fedgov debt isn’t worth the risk (rational subjectivity)?

    One last thought … The high inflation and miserable economic conditions of the 1970’s were abruptly brought to a halt when Volcker radically reversed the Fed’s easy money policies by incentivizing savings and reducing the money stock. Yeah, the exact 2 things we’re continuosly told will bring the economy to its knees.

    Just because that’s what they think, doesn’t mean it’s going to play out according to their theory.

  4. Just because that’s what they think, doesn’t mean it’s going to play out according to their theory

    No argument here. But that was my point, not that any of his logic makes sense, only that he relies upon it. In Bernanke world, he puts value on consumer confidence.

Comments are closed.