A Fed Governor speaks honestly to us about the costs and risks of our monetary policy

Summary: Fed officials see as tools their ability to manage our confidence and expectations. This means a constant policy of exaggeration and distortion in their speeches, as truth and plain-speaking are secondary considerations. But there are exceptions. Perhaps the most famous is Bernanke’s 2002 “the U.S. government has a technology called a printing press” speech. This week as another, an even more impressive and rare example of honesty by a high government official. He warns us that the extreme monetary policy of today has costs, and might prove difficult to unwind. Let’s pay attention to his words.

Note: We tend to get our news and insights through intermediaries, who inevitably filter and distort the content. On the FM website we try to avoid this, instead giving excerpts with links to the full text.  Governor Fisher — like the IPCC, and the famous leaders of our past — speaks to us, and needs no interpreters.

Magic Hat Money

Beer Goggles, Monetary Camels, the Eye of the Needle and the First Law of Holes
With Reference to Peter Boockvar, the Book of Matthew, Sherlock Holmes, ‘The Wolf of Wall Street’ & Denis Healey

Richard Fisher, President of the Federal Reserve Bank of Dallas
Remarks before the National Association of Corporate Directors
14 January 2014

Excerpt #1:  Beer Goggles …

Two comments I recently read have been buzzing around my mind as I think about the many issues that will condition my actions as a voter.

The first was by Peter Boockvar, who is among the plethora of analysts offering different viewpoints that I regularly read to get a sense of how we are being viewed in the marketplace. Here is a rather pungent quote from a note he sent out on Jan. 2:

“… QE [quantitative easing] puts beer goggles on investors by creating a line of sight where everything looks good …”

For those of you unfamiliar with the term “beer goggles,” the Urban Dictionary defines it as “the effect that alcohol … has in rendering a person who one would ordinarily regard as unattractive as … alluring.” This audience might substitute “wine” or “martini” or “margarita” for “beer” to make it more age-appropriate, but the effect is the same: Things often look better when one is under the influence of free-flowing liquidity. This is one reason why William McChesney Martin, the longest-serving Fed chairman in our institution’s 100-year history, famously said that the Fed’s job is to take away the punchbowl just as the party gets going. {1955 speech}

Peter Boockvar is Chief Market Analyst of The Lindsey Group (bio here). Here is an early statement of his “beer goggles” theory.

Excerpt #2: Free and Abundant Money Changes Perspective, the first explicit mention I’ve seen by a Fed official of QE’s possible ill effects.


But I have found myself making arguments similar to his and to those of other skeptics at recent FOMC meetings, pointing to some developments that signal we have made for an intoxicating brew as we have continued pouring liquidity down the economy’s throat.

Among them:

  • Share buybacks financed by debt issuance that after tax treatment and inflation incur minimal, and in some cases negative, cost; this has a most pleasant effect on earnings per share apart from top-line revenue growth.
  • Dividend payouts financed by cheap debt that bolster share prices.
  • The “bull/bear spread” for equities now being higher than in October 2007.
  • Stock market metrics such as price-to-sales ratios and market capitalization as a percentage of gross domestic product at eye-popping levels not seen since the dot-com boom of the late 1990s.
  • Margin debt that is pushing up against all-time records {data here, graph here}.
  • In the bond market, investment-grade yield spreads over “risk free” government bonds becoming abnormally tight.
  • “Covenant lite” lending becoming robust and the spread between CCC credit and investment-grade credit or the risk-free rate historically narrow. I will note here that I am all for helping businesses get back on their feet so that they can expand employment and America’s prosperity: This is the root desire of the FOMC. But I worry when “junk” companies that should borrow at a premium reflecting their risk of failure are able to borrow (or have their shares priced) at rates that defy the odds of that risk.

… And then there are the knock-on effects of all of the above. Market operators are once again spending money freely outside of their day jobs. An example: For almost 40 years, I have spent a not insignificant portion of my savings collecting rare, first-edition books. Like any patient investor in any market, I have learned through several market cycles that you buy when nobody wants something and sell when everyone clamors for more.

During the financial debacle of 2007 – 2009, I was able to buy for a song volumes I have long coveted (including a mint-condition first printing from 1841 of Mackay’s Memoirs of Extraordinary Popular Delusions, which every one of you should read and re-read, certainly if you are contemplating seeing the movie The Wolf of Wall Street). Today, I could not afford them. First editions, like paintings, sculptures, fine wines, Bugattis and homes in Highland Park or River Oaks, have become the by-product of what I am sure Bill Martin would consider a party well underway.

I want to make clear that I am not among those who think we are presently in a “bubble” mode for stocks or bonds or most other assets.

Excerpt #3: How Large Is the Camel? How narrow the eye of the needle?

A Monetary Black Hole
Perhaps this is The Singularity!

Let’s turn to the camel, by which I mean the size of the Fed’s balance sheet. …

Here is the rub. We have accomplished the last $2 trillion of balance-sheet expansion by purchasing unprecedented amounts of longer-maturity assets: As of January 8, 2014, 75% of Federal Reserve-held loans and securities had remaining maturities in excess of 5 years.

The brow begins to furrow. To be sure, Treasury and MBS markets are liquid markets. But the old market operator in me is conscious that we hold nearly 40% of outstanding eligible MBS and of Treasuries with more than 5 years to maturity. Selling that concentrated an amount of even the most presumably liquid assets would be a heck of lot more complicated than accumulating it.

Currently, this is not an issue. But as the economy grows, the massive amount of money sitting on the sidelines will be activated; the “velocity” of money will accelerate. If it does so too quickly, we might create inflation or financial market instability or both.

The 12 Federal Reserve Banks house the excess reserves of the depository institutions of America: If loan demand fails to grow at the same rate as banks accumulate reserves due to our hyperaccommodative monetary policy, the resultant excess reserves are deposited with us at a rate of return of 25 basis points (1/4 of 1% per annum).

Here is some math confronting policymakers: Excess reserves are currently 65% of the monetary base and rising. The only other time excess reserves as a percentage of the base have come anywhere close to this level was at the close of the 1930s, when the ratio hit 41%. We are in uncharted territory.

… In the parlance of central banking, the “exit” challenge we now face is somewhat daunting: How do we pass a camel fattened by trillions of dollars of longer-term, less-liquid purchases through the eye of the needle of getting back to a “normalized” balance sheet so as to keep inflation under wraps and yet provide the right amount of monetary impetus for the economy to keep growing and expanding?

For more about the danger Fisher warns of:

For More Information

(a)  Poss about our great monetary experiment:

  1. Bernanke leads us down the hole to wonderland! (more about QE2), 5 November 2010
  2. The World of Wonders: Monetary Magic applied to cure America’s economic ills, 20 February 2013
  3. The World of Wonders: Everybody Goes Nuts Together, 21 February 2013
  4. The greatest monetary experiment, ever, 20 June 2013
  5. Government economic stimulus is powerful medicine. Just as heroin was once used as a powerful medicine., 19 September 2013
  6. Different answers to your questions about the momentous Fed decision to delay tapering, 20 September 2013
  7. Do you look at our economy and see a world of wonders? If not, look here for a clearer picture…, 21 September 2013
  8. Two warnings about quantitative easing, the taper, and what comes next, 27 September 2013

(b)  Posts about monetary stimulus:

  1. A solution to our financial crisis, 25 September 2008 — Among other things, large monetary action
  2. Important things to know about QE2 (forewarned is forearmed), 21 October 2010
  3. Bernanke leads us down the hole to wonderland! (more about QE2), 5 November 2010

(c)  Posts about hyperinflation:

  1. Can Obama turn America into something like Zimbabwe?, 22 February 2010
  2. The Fed is not wildly printing money, as yet no hyperinflation, we’re not becoming Zimbabwe, 2 March 2010
  3. Explaining the gold standard, the Euro, Default, Deflation, and Hyperinflation, 17 December 2011
  4. What are the limitations of the Fed’s power? It’s neither impotent nor omnipotent!, 17 February 2012

(d)  Posts about Inflation:

  1. Inflation is coming! Inflation is coming!, 7 February 2011
  2. Inciting fear of inflation in our minds for political gain (we are easily led), 28 February 2011
  3. Update on the inflation hysteria, the invisible monster about to devour us!. 15 April 2011
  4. What every American needs to know about the Federal Reserve System, 31 March 2012
  5. The lost history of money, an antidote to the myths, 1 December 2012
  6. Lessons from the failed forecasts of inflation since the crash, 5 October 2013

Perhaps a glorious future lies ahead of us

Camel walking through the Eye of the Needle



12 thoughts on “A Fed Governor speaks honestly to us about the costs and risks of our monetary policy”

  1. Although I agree with Fischer, I will note that he does not hold the majority view on the Fed.

    Interesting times lie before us, although we’ve known that for some time.

  2. Yet more highly educated people screaming “Fire!” in the midst of a flood. Keynes-Wicksell models of the economy predicted low inflation despite “unprecedented” liquidity for central banks, and those predictions have uniformly come true. Meanwhile, Chicago school economists warned of runaway inflation, and those predictions have uniformly been falsified by observed reality.

    The reality of the U.S. economy remains that inflation hovers near zero and deflation threatens to break out. At the same time, forward indicators for the U.S. economy look poor, with preliminary signs of a slowdown — following, for obvious reasons, the slowdown in China’s economy.

    Paul Krugman said it best:

    What remains notable, however, is just what all Republicans are obliged to say: Ron Paul monetary theory has become obligatory:

    Vice Chair Yellen will continue the destructive and inflationary policy of pouring billions of newly printed money every month into our economy, and artificially holding interest rates to near zero. This policy has been in place far too long.

    So, the Fed began rapidly expanding its balance sheet when Lehman fell — more than five years ago. [What’s been] the result of that “destructive and inflationary” policy so far[?] It’s not often that you see an economic theory fail so utterly and completely. Yet that theory’s grip on the GOP has only strengthened as its failure becomes ever more undeniable….

    I can, in a way, understand refusing to believe in global warming–that’s a noisy process, with lots of local variation, and the overall measures are devised by pointy-headed intellectuals who probably vote Democratic. I can even more easily understand refusing to believe in evolution. But the failure of predicted inflation to materialize is happening in real time, right in front of our eyes; people who kept believing in inflation just around the corner lost a lot of money. Yet the denial remains total.

    I guess it’s a matter of who you’re gonna believe — Ayn Rand or your own lying eyes.

    Source: “Free-Floating Inflation Hysteria,” Paul Krugman, The New York Times, 5 November 2013.

    Fed Governor Richard Fisher utterly ignores the example of Japan, which has held interest rates near zero going on twenty years now. Where is the runaway inflation in Japan? Where is the skyrocketing Japanese stock market creating a gigantic bubble that threatens their economy? Where are the zooming land prices propelled by uncontrolled inflation?


    Look at this chart of Japan’s year-over-year GDP growth and then look at this chart of Japan’s core inflation rate since 1990. What do you see? Are these rates going up? Or are they going down?

    The US–economy has not experienced sustained deflation since the Great Depression of the 1930’s, when consumer prices fell 10% between 1929 and 1933. But Japan has been battling falling prices since 1995, – triggered by the bursting of the Nikkei–225 equity bubble, and a unrelenting slide in land prices. Central bankers and macro–economists from all corners of the earth have been studying Japan’s descent from its giddy economic prosperity in the 1980’s, and into the deflation trap in the 1990’s, that Tokyo’s financial warlords have still been unable to remedy.

    Nowadays, central bankers must be watchful, not only against the traditional worry of inflation, but also to defend against the devil of deflation, well before inflation dwindles to zero–percent. That’s because deflation is more debilitating to economies – and harder to overcome – than inflation. In Australia, Brazil, China, Chile, Israel, India, and Peru, central bankers have tightened their monetary policies this year to control inflation. However, in England, Japan, and the United States, and to a lesser degree in the Euro–zone, central bankers are engaging in the radical scheme of “Quantitative Easing,” (QE), in order to fend–off the threat of deflation.

    Recently, several Federal Reserve officials have been openly expressing their fears that the US–economy could stumble into a Japanese style deflation trap. And as Japan’s experience suggests, deflation can increase the financial pain of a traditional recession. When deflation strikes, lower sales prices cut into business profits and in turn, prompts companies to trim payrolls. That undermines consumers’ buying power, leading to a vicious cycle of more pressure on profits, jobs, and wages, – and cutbacks in purchases of new equipment.

    Source: “Japanese-style deflation spreads to global bond markets,” 18 January 2014.

    America looks to be following the path of Japan. Take a look at this chart comparing U.S. and Japanese core inflation rates since 1990. What do you see? Are the two charts similar? Or is America’s inflation going up while Japan’s inflation rate goes down?

    But the really devastating coup de grace comes from the history of the Fed’s declining U.S. economic predictions since 2009. Take a look at this chart of U.S. GDP growth rates predicted by the Federal Reserve since 2009. Notice anything? How about the trend?

    Do you notice that the predicted year-over-year GDP growth starts out at 4.5% in 2009 and steadily declines all the way down to 2% per annum in September 2013?

    What is the trend of that series of projections?

    Now take a look at the actual U.S. GDP growth. Last quarter’s 1.8% GDP growth was just revised down to 0.9%. So real U.S. GDP growth is actually lower than even the Federal Reserve’s continually declining projections.

    Do the people at the Federal Reserve even bother to look at charts of their own GDP projections? Do the people at the Fed ever mark their views to market? Apparently some do — some Federal reserve governors have been openly warning about looming deflation in the U.S. economy.

    A subtle but significant shift appears to be occurring within the Federal Reserve over the course of monetary policy as the economic recovery is weakening.

    On Thursday, James Bullard, president of the Federal Reserve Bank of St. Louis, warned that the Fed’s policies were putting the economy at risk of becoming “enmeshed in a Japanese-style deflationary outcome within the next several years.”

    Source: “Within the Fed, Worries of Deflation,” The New York Times, 29 July, 2010.

    So why is FM force-feeding us this twaddle about nonexistent inflation? We should seeing the charts I’ve posted here in an FM post about the U.S. economy. Instead, we get fools and cranks like this Fed governor Richard Fisher who continue to scream “Fire!” even as the flood waters rise above their chins.

    Take a look at this chart of inflation-indexed government bond yields from 2000 to 2013, worldwide, across all the OECD countries (source: Ben Bernanke’s speech at a macroeconomics conference in San Francisco, 1 March 2013): the chart starts at 4% and plummets into negative territory, ending up at -0.1%.

    Don’t these people even bother to look at the FRED data on the U.S. economy? If inflation represents such a serious problem, where is the evidence for it?

    Of course FM will claim that describing Fed Governor Fisher as a “a fool” and a “crank” is extreme and outlandish. Oh? Really? When Nobel laureate Paul Krugman has warned that the U.S. is heading for Japanese-style stagnation and deflation given the dismal performance of our economy since 2009?

    “We are in a very Japanese scenario in the United States,” said Krugman during a conference at the annual convention of the Argentine Chamber of Construction in Buenos Aires.

    Source: “US on the path of Japan’s stagflation of 18 years ago, says Nobel Prize winner: Economics 2008 Nobel Prize Paul Krugman said the United States is heading along a path of stagnation and deflation similar to that of Japan 18 years ago given the critical economic situation and the uncertain political scenario following the recent mid term elections that brought to Congress diehard Republicans,” South Atlantic News Agency, 24 November 2010.

    Lastly, take a look at this chart of quarterly changes in U.S. GDP since 2009.

    Does this look like an economy that’s recovering? Or an economy with 0.9% GDP growth (flopping around like a dying fish between 0.5% and 1.8% annual GDP growth) with depressed housing prices and persistently high unemployment…an economy like Bulgaria in disguise?

    FM usually provides solid information and analysis on economic issues, but this post by FM represents a severe misstep.

    1. Thomas,

      (1). ” At the same time, forward indicators for the U.S. economy look poor, with preliminary signs of a slowdown

      Every economist I know disagrees with you. Fed economists. Wall Street economists. The major econometric firms.

      (2). “following for obvious reasons, the slowdown in China’s economy.”

      The correlation of the US and Chinese economies is quite low.

      The possible Chinese cyclical slowing is of the sort common in US from after WW2 until 2000 — induced by government restrictions on credit.

      The larger slowdown in a China is a common downshift in growth from the low teens of nations breaking out from the emerging state into the middle income trap.

    2. Thomas,

      “So why is FM force-feeding us this twaddle about nonexistent inflation?”

      Whenever you find yourself writing such things about writings of major figure (Fisher has a distinguished 38-year career), you should consider that you’re missing the point. As your comment does, quite radically.

      Economists are upgrading their forecasts for 2014 GDP, becoming more confident in their expectation for the US to return to trend growth. Bank of America expects “Red, White, and Boom” for the US. Barclays on Friday wrote “Macro economic reports and markets this week were consistent with our view that the US has reached escape velocity.”

      You determined focus on the past ignores that the low inflation in the developed world — like that of Japan since the mid-1990s — resulted from slow growth.

      Fisher notes that a return to normal growth will quickly bring the US back to high utilization of both labor and capacity. Capacity utilization is 79.2%, vs the 1971-2012 average of 80.2%. Labor is more complex, but many experts believe the decline in labor participation is structural, so that there might not be as much excess labor as commonly believed.

      Hence the possibility that we will soon be back in the normal world, where massive excess bank reserves quickly induce inflation.

      From another perspective, low inflation despite a large money supply results from low velocity. But history shows that velocity can spike up FAST, with little warning. The Fed’s tools work best when they’re applied to keep inflation under control. They dont work as well to restrain out-of-control inflation.

      1. Thomas,

        Actual data, from J.P. Morgan’s Economics team, 17 January 2013:

        There is little doubt that the global economy gathered considerable momen-tum over the course of the last quarter. The question is how much of that momentum owes to one-off adjustments and how much is signaling a more meaningful pickup in economic activity heading into the new year.

        … The lift in recent economic releases is impressive because of its intensity and breadth.
        * Global industrial production is ramping up, with manufacturing out-put having jumped 5.4% annualized in the three months through November.
        * The latest business surveys are pointing to an equally strong increase in December, an outcome supported by this week’s strong gain in US factory output last month. A portion of this production is flowing into inventories and so one should be cautious about extrapolating forward too much of this strength.
        * However, final demand is also accelerating. Growth in global retail sales volumes jumped a robust 5.4% annualized in the three months through November, and global auto sales expanded to an all-time high in December.
        * Meanwhile, our proxy for global capital expenditures (G-3 capital goods shipments) advanced 13% annualized over the same period. Signs of a stirring in global equipment spending after a year-long slumber are particularly encouraging.

    3. “Yet more highly educated people screaming “Fire!” in the midst of a flood.”

      It is possible for the upper stories of a building to catch fire while the streets and basements are flooding.

      The thought that the analogous thing could happen to an economy seems to be ignored simply because the standard tools and theories provide no clear way to deal with it.

    4. “Every economist I know disagrees with you. Fed economists. Wall Street economists. The major econometric firms.”

      If I understand the argument of Thomas More correctly, those institutions are exactly those whom he accuses of having a very poor track record at economic forecasting, hence their new predictions cannot be considered to be credible.

      I must say he has a point. The real issue is then to figure out which set of economic forecasters — not necessarily the prominent ones like FMI or FED — have had a consistently fair to good performance in the past.

      1. guest,

        “having a very poor track record at economic forecasting, ”

        (1) In fact that is quite wrong. Their forecasts are fairly accurate. They don’t catch downward inflection points well, for a simple reason: almost all recessions result from external shocks (including behavioral changes by public or corporate leaders), which are difficult to predict.

        (2) They have a better record than Thomas More — which is the relevant point (More: “At the same time, forward indicators for the U.S. economy look poor, with preliminary signs of a slowdown.” And they have the advantage, unlike More and the legion of casual critics of economists, of supporting their case with a large body of data coherently arranged.

        ==> To repeat, comments here show people tend to criticize scientists (broadly defined) much like fans criticize professional athletes. “I could do better! Put me in the front line of the Raiders and I’ll show them!” (exaggeration for effect. Few people are that suicidal. They imagine themselves as batters or coaches.) I find this quite daft.

        To take the example at hand — economists working as Chief Economists at major institutions usually (not always) get there over strong competition, to a large extent (not exclusively) on the basis of their proven skilful analysis. Laypeople believing they can do better in this complex & difficult field are imo quite delusional.

        (3) “which set of economic forecasters … have had a consistently fair to good performance in the past.”

        Do you really imagine that economists’ performance is not closely tracked? They are all working with the same body of theory and data. So it should not surprise that there is no long-term record of outperformance by individuals or institutions. There are “hot hands” (to use a sports analogy), where economists see a trend earlier or clearer than their peers (often due to the suitability of their methodology to current conditions). But trends change, and outperformance tends to return to the mean.

        See the current agony of the Economic Cycle Research Institute (ECRI), who are liquidating their excellent record by sticking to their recession forecast — originally made in September 2011 (see these posts for details).

  3. I think we should be less concerned with the Feds problems unwinding QE than with the world wide total Debt. When the debt service on that exceeds the ability to pay the feces will hit the blades. At some point that will happen. The US economy and perhaps the whole world is based on consumption financed by debt, as FM pointed out in a recent post. The Feds balance sheet is a very small part of this.

    I found this paper interesting in researching another issue. “The Road to Debt Deflation, Debt Peonage, and Neofeudalism“, Michael Hudson, Levy Institute, February 2012

    1. Doug,

      “I think we should be less concerned with the Feds problems unwinding QE than with the world wide total Debt.”

      Yes. and No. Problems exist on various time horizons. I might have serious cancer, but an open vein demands immediate attention. We get to deal with long-range problems by also handling more immediate problems.

      That being said, I agree about debt. This is imo one of the great issues of our age. The next economic regime will be, IMO, very different in this respect.

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