Between explaining why the President of the United States seems intent on escalating his increasingly absurd Twitter feud with professional athletes, the White House was busy on Friday attempting to play defense after the Wall Street Journal basically suggested that Kevin Warsh is a shoo-in for Fed chair.
If you were paying attention to yields and the dollar when the Journal story hit, you probably noticed a spike in both and the reason was obvious: Warsh would likely try and steer the Fed in a more hawkish direction. Or at least until it becomes clear to Trump that doing so risks upending the equity rally he loves to point to as “evidence” of the incredible job he’s doing.
It’s still not entirely clear whether Trump understands the irony inherent in lambasting Yellen for “doing political things” that she “ought to be ashamed of” (which he did in September, 2016) and then live-tweeting S&P records just 12 months later. Even less clear is whether he actually “gets it” when it comes to the mechanics behind what then-candidate Trump called an “artificial stock market.”
But one person who does “get it” when it comes to how Fed policy has driven equities to record highs is Kevin Warsh. Consider these super-fun excerpts from a speech he delivered at the 15th BIS Annual Conference in Lucerne, Switzerland last year:
With high and rising global asset prices – aided and abetted by aggressive quantitative easing – we should subject the vaunted portfolio balance channel to stricter scrutiny. The guild is unwise to treat financial markets as some beast to be tamed, cub to be coddled, or market to be manipulated. Too many policymakers appear in thrall to financial markets, and financial markets are in thrall to policymakers, but only one of them will get the last word. Reconsidering the transmission mechanism of financial markets and the responsibility of policymakers is of a piece with a reform agenda.
The Fed directly purchased trillions of dollars of assets that would otherwise be held in private hands. And it took action with the ostensible purpose of managing financial asset prices, including bolstering the share prices of publicly held corporations.
It doesn’t get much clearer than that.
If that is any reflection of how he would run the Eccles cabal, well then anyone long risk assets might want to take a good hard look at their positions. There is a strong argument to be made that central banks underestimated the efficiency of the transmission channel between accommodative policies and financial markets while simultaneously overestimating the efficiency of the transmission channel between those same financial markets and the real economy. That mistake has led directly to this juxtaposition:
While policymakers might be forgiven for overestimating the extent to which inflating the value of 401ks would ultimately “trickle down” and usher in an economic renaissance, it’s not at all clear why they should be forgiven for underestimating the effect funnelling trillions in freshly-minted fiat money into financial markets would have in terms of blowing bubbles. Because you know: you bought tens of trillions in assets - what did you think was going to happen to the prices for those same assets?
Anyway, Warsh seems like he wants to break the communication loop between the Fed and markets. That communication loop has always been implicit, but as Deutsche Bank’s Aleksandar Kocic wrote in a 2015 note, the reflexive relationship has now become explicit. Kocic describes this in the theatrical context as “the removal of the fourth wall.” The audience (markets) is no longer a passive observer of a monetary policy play unfolding on the stage. The audience is now a part of the play, which by virtue of the two-way communication channel, is no longer a self-contained story with a preset course. As Kocic put it, “what you’re watching is not necessarily an inevitable self-contained narrative but rather, you are observing yourself from another angle as an observer of the observer of the observers.”
What the hell does all of that mean? Well, it means that the Fed is beholden to markets perhaps more than the market is beholden to the Fed and if Warsh is to be believed, he’d like to break that relationship.As you can probably imagine, that pleases the holy shit out of Albert Edwards, SocGen’s incorrigible but affable pessimist from whose cold, dead hand you will have to pry his enduring bear thesis.
On Monday, a note Edwards penned almost exactly a year ago is getting some spin, and it’s worth quoting because Albert is looking pretty prescient right now. Here’s a fun excerpt or three:
With global financial markets constantly agonizing over the timing of the Fed’s next rate hike, we are really missing the bigger picture. This far into the US economic cycle, the die is now cast. I see exactly what I saw before the 2008 Global Financial Crisis, but something is changed in me. I return from a recent trip to New York with excitement coursing through my veins for I have met a man named Kevin.
I was the first speaker and afterwards I enjoyed listening to every other speaker at the two-day event. Most notable of the outside economics speakers were Paul Volker, Larry Summers, and most significantly for me, ex Fed-Governor Kevin Warsh. Much to my own regret I had never familiarised myself with the views of Governor Warsh, who was at the Fed from 2006-11, and played a key role in navigating the Fed through the crisis. He got a rousing reception from the BCA audience as he talked a lot of sense – in particular on how the Yellen Fed has lost its way and current policy is deeply flawed. He explained that the Fed has been “captured” by a groupthink of academics led by the ‘Secular Stagnation’ ideas of his friend, Larry Summers. Rather than admitting they are wrong, this group, who failed to predict the current economic malaise, have constructed this theory to explain why ever more stimulus is required. In particular Warsh warned that the Fed had become the slave of the S&P. Warsh’s views were indeed a breath of fresh air for someone so close to policy.
I have recently seen his name mooted as a future Fed Chair, and should a vacancy (unexpectedly) arise, he would definitely be my choice.
There you go folks. Albert Edwards has seen the future and his name is Kevin (that’s actually the title of the note).
It remains to be seen whether Warsh will in fact get the job, but if he does and in the process turns one of Albert’s predictions into reality, then we all better pray that’s not the start of a trend.
Because if too many of Edwards’ predictions start coming true we’ll all be in a soup line before too long.
Catch more Heisenberg over at Heisenberg Report.