Harley Bassman’s Open Letter To The Fed (With A Preamble From Me)
[Editor's note: Below find, as attributed, an open letter to the Fed by Harley Bassman. But first, I'm going to deliver a lengthy preamble.]
As regular readers will doubtlessly note, Harley makes a few assertions that are incongruous with my own take on what is and isn't possible with regard to modern federal government finance in advanced economies with sufficient monetary sovereignty.
For example, Harley asks, "Why should there be poor people if it is possible to create wealth and offer it
Thanks for sharing this H! I largely agree with his suggestions, home values are bubbled and savers are basically being punished for their fiscal responsibility. Both of those need to be corrected. However, I’m still not a believer in this continuation of leverage we seem to be determined to leave with the TBTF banks. Again, these banks destroyed half of American’s wealth in the last collapse and paid exactly zero price for their misdeeds. Why in the world don’t we create a direct lending facility from the FED to small business? This would create competition that could force banks out of their predatory lending practices (Looking at you Wells Fargo), reduce the occurrence of red lining racist lending practices, and potentially demonstrate how eliminating the middle man (banks) could actually transfer wealth from the 1% to lower classes. I feel like this should have been priority #1 in 2009 and all we continue to see is the current model only benefiting banks no matter what happens in the economy.
Agreed Dameworth. What often gets lost in the conversation is that we actually have institutions that are TBTF. This moral hazard would cause ANY institution to take on more risk with the knowledge that Uncle Fed is there to fix things when that ‘can’t fail’ trade doesn’t work as planned.
Bassman’s take that these institutions need to be taken care of smacks of a man preaching to his own (top 1%) choir. When banks aren’t lending but use excess funds to increase dividends and buy back stock, the system is broken.
Elizabeth Warren, etc. are correct, bring back Glass-Steagal (or a modern equivalent) and when risk management isn’t employed by a company, let that entity fail. I am sure the depositor bank down the street will be just fine. Under the current situation, we have no such assurance.
Central Bank and their Apologists have finally shifted their discourse from “it was the only way” to “we had no clue what we were doing and we still don’t”. These bureaucrats with the “Maestro” Alan Greenspan at the helm, have now corrupted the financial system to a point were true price discovery is now seen as undesirable due to the short-term pain we’d all have to endure, perpetuating their position at the core of our system.
Principal-agent problem at its finest.
Bassman offers a reasonable transition but let’s not kid ourselves, Central Bankers have absolutely no incentive to apply ideas such as his. If they did, it would expose the caricature CB’s as institutions have become after Paul Volcker.
There was never (and can never) be “true price discovery.” There’s nothing to “discover.” Stocks, bonds, etc. have no “natural” prices. We made them up. Their prices are what we say they are. They cease to exist the moment humans disappear. Central banks, hedge funds, institutions, SWFs, retail investors and everyday people are ultimately playing the same game. We’re manipulating the price of things that aren’t real.
The vast majority of people who argue for a “grand reset” in which the system is allowed to purge all misallocated capital are prepared for no such thing. Here’s a handy rule of thumb: If you currently have a reliable internet connection, clean running water, electricity and the luxury of spending your days debating the merits of a “grand reset” scenario with other, similarly fortunate people from an expensive computer or smartphone, chances are you’d be among the first to starve in the very scenario you ostensibly want to see play out.
Don’t forget that.
Never in history has there ever been a non-price sensitive marginal buyer of financial assets as current CB’s.
Financial assets prices are a function of the price of money, which was also part of the price discovery paradigm. Once this process is corrupted, everything else in markets becomes infected.
Prices are real as they define a line were agents can or cannot participate in a market. IE an olive producer takes the price as a signal to keep producing or not and impacts his capital allocation decisions, as limited in options as they might be.
As I pointed out, I’m not calling for an Austrian reset and neither is Bassman since I’m sure we’re both aware of the consequences. The fact is CBs have created this problem and have no incentives to solve it.
“The fact is CBs have created this problem and have no incentives to solve it.” In fact, just the opposite is true; they have important reasons not to solve the problem.
“Never in history has there ever been a non-price sensitive marginal buyer of financial assets”
Yes, there has.
You caveat that with “as current CB’s” so that you have plausible deniability. And that’s fine. I’d do that too.
But the fact is, virtually every comment you’ve ever posted here is either a criticism of central banks or else some pseudo-prediction about the deleterious side effects of anything besides a kind of classical, orthodox, straight-out-of-a-textbook view of government finances and markets. That’s no longer a viable lens.
The most interesting point is near the end which links the price of convexity to yield/volatility levels. You might throw in the idea that its all a big carry trade linked to yields and low volatility. It works until it does not. But the key point is you have maximum exposure toward the end of the cycle when volatility is low, convexity is highest, and positioning is most over its skis. I am not here to tell you where we are on that timeline, but it is not the beginning.
I think the question you have to ask is basically… exposure to what? I mean yes the easy quick answer is losses… but what realistically happens then? Do we all the sudden enter an era where the fed doesn’t monetize those losses to bail out institutions? Do people continue to panic sell when they realizes the carry trade is enforced at the point of a printing press? I mean look at the Pandemic… what worse event overcomes the CB capability to print?
I think the bigger risks are not so much the financial as the actual physical capabilities of the system. Supply chain is going to struggle as pricing and availability of raw and value add materials becomes unstable.
What if the risk is not that the spring snaps shut like a trap but that it becomes a straight piece of steel bar incapable of dampening oscillations? What if your 401k says you’re a millionaire but you can’t get critical supplies when you need them because the economy no longer cares about engaging in meaningful value production. You could call it inflation but in that scenario the higher prices would encourage investment. When things are too transient there’s no capability to build new capacity before prices fall again due to demand contraction as people give up on consumption. If Inflation is trying to drive up a hill and burning more fuel than usual and deflation is going down a hill burning less fuel then our injectors and air filter are clogged and our timing chain has slipped, put more gas in the tank or try to accelerate harder and it isn’t going to fix the problem, we need to do some major policy maintenance instead of just raising or lowering rates or running QE or tapering.
Thanks for this perspective!
“You might throw in the idea that it’s all a big carry trade linked to yields and low volatility”
That is most assuredly true.
Yellen had the best take when she was running the FOMC. She stated and I am approximating something like this, “we are shrinking the balance sheet but it will be so slow it will be like watching paint dry”. The FOMC needs to do the same thing with Q/E. So a statement like, “we are going to begin to step away from buying government and agency debt in 3 months-it will be a gradual adjustment and so slow that you will hardly notice it”. I also do not think it is necessary to skew stepping away from agency debt. In fact if my reading is correct, the market has already factored that partially in and spreads have started to widen vs. comparable UST bonds. It may take them 12-18 months once it starts to unwind balance sheet growth. It may take another 6 months after that to raise short term borrowing rates. The more boring the better. We should be far more concerned about fiscal policy, particularly how and where funds are directed to- and how our tax rates and rules are changed. There is a crying need for a better safety net for our citizens, and there is a lot of infrastructure to make the economy more efficient and resilient that needs to be spent. The FOMC is a bit of a side show compared to that.
I learn so much from this site — i.e., H. and the many smart commenters who contribute on a regular basis. Like: Vlad’s allusion to Minsky’s work (“It works until it does not”), calh0025’s suggestion that the macro economy is not the same as a music engineer’s board where faders can be moved up and down at a whim to produce the desired effect, and Ria’s always sensible (to me) prescriptions for getting us out of this mess.
H-Man, it would seem that Harley is simply suggesting that it is time for “Last Call” and see what happens when the bar reopens the next day. By postponing “Last Call” everyone drinks into the wee hours turning a bad headache into a nasty pounder.
At least here we appreciate the great observations and then we must form our own conclusions. In markets something can be true but not all the time. It’s okay to observe deviation from the mean, but that doesn’t guarantee reversion. Early on, I was told today’s price is tomorrow’s headline. I keep repeating that on this site because I I think it’s true and important. I admire people who strive to fly the plan, but are quick to admit they are wrong. I think this stuff is addicting, and if you don’t feel that way, perhaps a longer Buffett type of time horizon is in order….Let;s not forget the Fidelity study where the best long tem performance was where the client had died, and no action was taken for a long time….