… Does it take to screw up banking systems? For those who may not remember, in July 2012 then-ECB President Mario Draghi said he would use any monetary policy tool in an effort to PRESERVE THE EURO.
During a testimony before EU Parliament on Monday, European Central Bank President Christine Lagarde boasted that the central bank and the EUROPEAN UNION had all the necessary tools to ensure against a banking situation similar to the US and the Swiss authorities. The problem for Lagarde is that EU banks were progenitors of the COCO bonds that caused so many Credit Suisse investors a great deal of financial pain. (Speaking of which, here is a post from 2013 in which we warned about the proliferation of COCO bonds.) The markets achieved a sense of calm in believing that the global authorities have things “under control” as equity markets rallied, precious metals stabilized and BOND prices fell as now the focus turns to the FOMC meeting that begins Tuesday. Many pundits such as Larry Summers and Mohamed El-Erian are advising Chair Powell to stay the course on the inflation fight and raise interest rates 25 basis points at this week’s meeting that concludes on Wednesday. The rationale for doing so is that the inflation fight is far from over and because the ECB boosted its benchmark rates by 50 basis points last Thursday some rate increase is warranted. We at NOTES FROM UNDERGROUND VEHEMENTLY DISAGREE. For at least the last four months central bank credibility has been an issue because the PRICE of GOLD was rising even as the central banks became more aggressive in their inflation fight. This has been MY MANTRA for 30 years about GOLD: It’s not an inflation hedge but a hedge against central bank credibility in a fiat currency world. If I were Chair Powell I would confront the PUNDITS with the following wisdom:
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The Committee decided to hold rates at 4.75% because of the rapid increase in the TIGHTENING OF FINANCIAL CONDITIONS. We are well aware that last week the ECB raised its overnight bank rate by 50 basis points and applaud their continued efforts to confront their inflation problem. But, the FED has already increased its RATE to 4.75% while our inflation levels have dropped well below those of the EU. It seems that energy and food prices have moderated while FINANCIAL CONDITIONS have tightened just as I postured at the last press conference. We are PAUSING because we believe LENDING CONDITIONS WILL BE TIGHTENING in response to the turmoil in the bank markets, both locally and globally. While the Committee has acted with the Treasury and FDIC to provide enough liquidity to restore calm we believe the present fragility of the banking system requires DISCRETION AND NOT BLIND ADHERENCE TO THEORETICAL MODEL OF FORWARD GUIDANCE. In closing, I would add this wisdom from former Chair Alan Greenspan in a speech he delivered at Jackson Hole in August 2003:
“Despite the extensive efforts to capture and quantify … these key macroeconomic relationships, our knowledge about many of the important linkages is far from complete and in all likelihood will always remain so. Every model, no matter how detailed or how well designed conceptually and empirically, is a vastly simplified representation of the world that we experience with all its intricacies on a day-to-day basis. Consequently, even with large advances in computational capabilities and greater comprehension of economic linkages, our knowledge base is barely able to keep pace with ever-increasing complexity of our global economy.”
We at NOTES FROM UNDERGROUND have been a consistent critic of the Fed — 13 years and counting — and endlessly warned that QE and all of its baggage was subverting central bank credibility. We have repeatedly cautioned that global leveraged risk in so many forms would result in financial instability as BANKS rushed to curb transitory inflation. STOP DEPENDING ON EQUITY MARKETS AS THE TELL IN FINANCIAL CONDITIONS it is a methodology promoted by the purveyors of asset peddling. PAUSE AND TAKE A MEASURE OF THE FINANCIAL UNCERTAINTY INFECTING THE GLOBAL FINANCIAL SYSTEM. The political backlash you will be facing from those warning about how workers will pay the price in unemployment while the RENTIERS GET BAILED OUT. It is FIRST REPUBLIC ON THE BOIL NOW BUT WITH LESS LENDING AND HIGHER RATES ON THE HORIZON THE COMMERCIAL REAL ESTATE LENDERS WILL BE NEXT. IS 25 BASIS POINTS WORTH IT? Where is your cost-benefit analysis?