Thursday, October 5, 2017

What, if anything, does Kevin Warsh understand?

I came across this article by Kevin Warsh that appeared in the Wall Street Journal last August, 2016. The article was re-posted by GATA.ORG.

As you may know, Warsh is the currently the favorite to take over as Fed Chair when Janet Yellen's term expires next February.

If you read the article you will find that Warsh sort of understands that Fed policy is confused and focused on either the wrong things or, things which the Fed has no set of tools to accomplish. On the other hand he seems to lack any ideas of his own on how to reform the Fed or, even what policies outside of monetary policy would be useful. In addition he appears to not understand the primary function of the Fed as rate setter.

First he says,

"Can't explain current inflation readings below their targets."

He might be alluding to himself here. That's because Warsh was spectacularly wrong back in 2008 and 2009 when, as a board member of hte Bernanke Fed, he predicted soaring inflation as a result of ZIRP and Quantitative Easing. It was almost as if Warsh was reading from one of Peter Schiff's scripts at the time. He's still really confused on this.

"A numeric change in the inflation target isn't real reform. It serves more as subterfuge to distract from monetary, regulatory, and fiscal errors. A robust reform agenda requires more rigorous review of recent policy choices and significant changes in the Fed's tools, strategies, communications, and governance."

Warsh gets this correct. Central banks seem to conflate inflation with growth. Inflation targets are not the same as growth targets. The Bank of Japan is a good example. It's been on a 25 year quest to bring inflation up. It's growth that they need in Japan, not inflation. Meanwhile all of the BOJ's policies are deflationary, such as negative rates and trillions upon trillions in asset purchases.

He makes this observation, which is a an obvious and good observation.

"Two major obstacles must be overcome: groupthink within the academic economics guild, and the reluctance of central bankers to cede their new power."

He its the nail on the head with the "groupthink" within the academic guild as he calls it. Unfortunately, he is a card carrying member of that guild.

"First, the economics guild pushed ill-considered new dogmas into the mainstream of monetary policy. The Fed's mantra of data-dependence causes erratic policy lurches in response to noisy data. Its medium-term policy objectives are at odds with its compulsion to keep asset prices elevated. Its inflation objectives are far more precise than the residual measurement error. Its output-gap economic models are troublingly unreliable."

He's correct here, too. The Fed looks at data, which is notoriously lagging. Furthermore, there's not much the Fed can do other than set prices via the interest rate channel and make loans. It needs to use those tools in a leading fashion to whatever extent they can help achieve its mandate. The "data" follows.

"The Fed seeks to fix interest rates and control foreign-exchange rates simultaneously -- an impossible task with the free flow of capital."

With this statement he appears completely ignorant of the Fed's rate setting role. He sounds like Jim Rogers or, Schiff, again. He thinks the market sets rates. Does he not understand that all the Fed has to do would be to set the fed funds rate at zero, permanently, and all rates along the term structure would converge there? It has nothing to do with capital flows. (Whatever that means.) Similarly, negative rates would strengthen the dollar while high interest rates would fuel inflation and erode the dollar's  exchange value.

"The Fed often treats financial markets as a beast to be tamed, a cub to be coddled, or a market to be manipulated. It appears in thrall to financial markets, and financial markets are in thrall to the Fed, but only one will get the last word."

For a Harvard trained lawyer his wording is quite colorful here. A bit flowery even. However, it's true that the Fed is a slave to the markets. Yellen won't do anything unless Fed fund futures tell her to do it. Bernanke would "poll"  market participants as to the size of QE the Fed should perform.

I come away with the sense that Warsh knows the Fed needs reform, but he doesn't know in what fashion, exactly. He also doesn't understand the Fed's power as a monopolist. He mentions "fiscal errors," but doesn't say what they are. He probably thinks too much debt and deficits.

Bottom line is, we can make a lot of money off this guy if he gets in.

1 comment:

Matt Franko said...

I think he is just signaling some general Fed skepticism to Trump so as Trump is somewhat skeptical of everything the govt does (at least before he was in charge) this should sit well with Trump...

I don't think we are at risk of Warsh (should he get in there) NOT raising rates in the face of whatever they believe is behind the metaphor "inflation!" which is the bottom line....

If things get going pretty well they will raise the rates... this is the main thing.... I dont think we are in any real risk of that not happening with Warsh...