Dr.Mishkin or How I Learned to Stop Worrying and Love the Bubble

Former Fed governor Fred Mishkin distinguishes between bad bubbles, that hurt banks, and good bubbles like the tech bubble, that just hurt investors and distort the economy.

Is the Fed creating a bubble in equities now? Probably.

Do they care, are they concerned? No, not according to ex Fed governor Fred Mishkin.

We find that there is an odd framing of the question, which seems rather binary. Either there is a bubble, or no recovery, because the Fed must tighten and risk a new recession.

There are other things the Fed and the Treasury might do to ecourage banks to lend, rather than to engage in market speculation in imitation of Goldman Sachs, the trading bank with no depositors or borrowers.

Here is why Fred Mishkin has learned to stop worrying and love irrational exuberance fueled by reckless monetary expansion and financial engineering.

There is also the little detail, by the way, of the kinship between the credit bubble, created by the Fed, in response to the collapse of the tech bubble, which was also created by the Fed. Fred seems to think the credit bubble had a virgin birth.

So, preserve your precious bodily fluids while you read this, and be on the lookout for economic preverts and their quantitative preversions.

Financial Times
Not all bubbles present a risk to the economy
By Frederic Mishkin
November 9 2009 20:08

There is increasing concern that we may be experiencing another round of asset-price bubbles that could pose great danger to the economy. Does this danger provide a case for the US Federal Reserve to exit from its zero-interest-rate policy sooner rather than later, as many commentators have suggested? The answer is no.

Are potential asset-price bubbles always dangerous? Asset-price bubbles can be separated into two categories. The first and dangerous category is one I call “a credit boom bubble”, in which exuberant expectations about economic prospects or structural changes in financial markets lead to a credit boom. The resulting increased demand for some assets raises their price and, in turn, encourages further lending against these assets, increasing demand, and hence their prices, even more, creating a positive feedback loop. This feedback loop involves increasing leverage, further easing of credit standards, then even higher leverage, and the cycle continues.

Eventually, the bubble bursts and asset prices collapse, leading to a reversal of the feedback loop. Loans go sour, the deleveraging begins, demand for the assets declines further and prices drop even more. The resulting loan losses and declines in asset prices erode the balance sheets at financial institutions, further diminishing credit and investment across a broad range of assets. The resulting deleveraging depresses business and household spending, which weakens economic activity and increases macroeconomic risk in credit markets. Indeed, this is what the recent crisis has been all about.

The second category of bubble, what I call the “pure irrational exuberance bubble”, is far less dangerous because it does not involve the cycle of leveraging against higher asset values. Without a credit boom, the bursting of the bubble does not cause the financial system to seize up and so does much less damage. For example, the bubble in technology stocks in the late 1990s was not fuelled by a feedback loop between bank lending and rising equity values; indeed, the bursting of the tech-stock bubble was not accompanied by a marked deterioration in bank balance sheets. This is one of the key reasons that the bursting of the bubble was followed by a relatively mild recession. Similarly, the bubble that burst in the stock market in 1987 did not put the financial system under great stress and the economy fared well in its aftermath.

Because the second category of bubble does not present the same dangers to the economy as a credit boom bubble, the case for tightening monetary policy to restrain a pure irrational exuberance bubble is much weaker. Asset-price bubbles of this type are hard to identify: after the fact is easy, but beforehand is not. (If policymakers were that smart, why aren’t they rich?) Tightening monetary policy to restrain a bubble that does not materialise will lead to much weaker economic growth than is warranted. Monetary policymakers, just like doctors, need to take a Hippocratic Oath to “do no harm”.

Nonetheless, if a bubble poses a sufficient danger to the economy as credit boom bubbles do, there might be a case for monetary policy to step in. However, there are also strong arguments against doing so, which is why there are active debates in academia and central banks about whether monetary policy should be used to restrain asset-price bubbles.

But if bubbles are a possibility now, does it look like they are of the dangerous, credit boom variety? At least in the US and Europe, the answer is clearly no. Our problem is not a credit boom, but that the deleveraging process has not fully ended. Credit markets are still tight and are presenting a serious drag on the economy.

Tightening monetary policy in the US or Europe to restrain a possible bubble makes no sense at the current juncture. The Fed decision to retain the language that the funds rate will be kept “exceptionally low” for an “extended period” makes sense given the tentativeness of the recovery, the enormous slack in the economy, current low inflation rates and stable inflation expectations. At this critical juncture, the Fed must not take its eye off the ball by focusing on possible asset-price bubbles that are not of the dangerous, credit boom variety.

Peak Oil: WhistleBlower at IEA Claims Oil Production Statistics Are Manipulated

Here's one for the peak oil crowd, and those who suspect that the US and others have been manipulating certain market information for their own purposes, to promote a hidden agenda, to manage public perception.

Skeptical as always for now, but let's see what happens with this story.

Guardian UK
Key oil figures were distorted by US pressure, says whistleblower
Terry Macalister
9 November 2009 21.30 GMT

Exclusive: Watchdog's estimates of reserves inflated says top official

The world is much closer to running out of oil than official estimates admit, according to a whistleblower at the International Energy Agency who claims it has been deliberately underplaying a looming shortage for fear of triggering panic buying.

The senior official claims the US has played an influential role in encouraging the watchdog to underplay the rate of decline from existing oil fields while overplaying the chances of finding new reserves.

The allegations raise serious questions about the accuracy of the organisation's latest World Energy Outlook on oil demand and supply to be published tomorrow – which is used by the British and many other governments to help guide their wider energy and climate change policies.

In particular they question the prediction in the last World Economic Outlook, believed to be repeated again this year, that oil production can be raised from its current level of 83m barrels a day to 105m barrels. External critics have frequently argued that this cannot be substantiated by firm evidence and say the world has already passed its peak in oil production.

Now the "peak oil" theory is gaining support at the heart of the global energy establishment. "The IEA in 2005 was predicting oil supplies could rise as high as 120m barrels a day by 2030 although it was forced to reduce this gradually to 116m and then 105m last year," said the IEA source, who was unwilling to be identified for fear of reprisals inside the industry. "The 120m figure always was nonsense but even today's number is much higher than can be justified and the IEA knows this.

"Many inside the organisation believe that maintaining oil supplies at even 90m to 95m barrels a day would be impossible but there are fears that panic could spread on the financial markets if the figures were brought down further. And the Americans fear the end of oil supremacy because it would threaten their power over access to oil resources," he added.

A second senior IEA source, who has now left but was also unwilling to give his name, said a key rule at the organisation was that it was "imperative not to anger the Americans" but the fact was that there was not as much oil in the world as had been admitted. "We have [already] entered the 'peak oil' zone. I think that the situation is really bad," he added.

The IEA acknowledges the importance of its own figures, boasting on its website: "The IEA governments and industry from all across the globe have come to rely on the World Energy Outlook to provide a consistent basis on which they can formulate policies and design business plans."

The British government, among others, always uses the IEA statistics rather than any of its own to argue that there is little threat to long-term oil supplies...

SP Futures Daily Chart and the Triumph of the Swill

It looks like the bulls want to take this squeeze up to the 1105 trendline, with six bull days under their belt since the tag on the lower trend line last week.

This rally is being accomplished on thin volumes, thick liquidity, and weak regulations dominated by trading programs, with obviously fabricated and highly overstated fundamental underpinnings.

As Lloyd Blankfein would characterize it, the Wall Street banks are just "doing God's work," or at least the work of some power and principality with a favorable inclination to greed, pride, and deception, if these masters of the universe were to acknowledge any power greater than themselves.

No doubt there are some good intentions in the government behind a desire to manage the markets higher. After all, a rising stock market is a sign of wealth and prosperity to the superficial elite based on their own personal portfolios. Especially if one ignores all the jobless, homeless, and suffering people being victimized in their highly exclusive empire of the ego.

But who can stop a people determined to be rich without productive labor, with a self-obsession capable of subordinating even heaven to their personal greed and vanity? This will end in an ocean of tears.

The banks must be restrained, and the financial system reformed, and balance restored to the economy, before there can be any sustained recovery.

Outlook for US Natural Gas Supplies and Demand

For now natural gas supplies in the US are above average, and the Energy Information Administration is forecasting a slightly warmer winter than last year in the US Midwest, and slightly colder in the West. The Midwest is the primary consuming region for natural gas and propane, with heating oil in the northeast.

There is some speculation this week that Hurricane Ida may enter the Gulf of Mexico, the first to do so for this remarkably light storm season, and speculators have been given some cheer in the oil and nat gas markets because of this.

Oil may be justified, but barring a selectively devastating storm, natural gas looks to be well supplied. This is the time of year in which we will typically look to place bull positions in the natural gas markets. So far that does not seem to be justified, but perhaps later, just on seasonal variance.

The energy bulls should hope for an abnormally cold winter in the US midwest. Their government does not think that they will get it.

"EIA projects average household expenditures for space-heating fuels to be $960 this winter (October 1 to March 31), a decrease of $84, or 8 percent, from last winter. This forecast principally reflects lower fuel prices, although expected slightly milder weather than last winter will also contribute to lower fuel use in many areas. The largest expenditure decreases are in households using natural gas and propane, projected at 12 and 14 percent, respectively. Projected electricity and heating oil expenditures decline by 2 percent (see EIA Short Term and Winter Fuels Outlook slideshow).

According to the National Oceanic and Atmospheric Administration’s (NOAA) most recent projection of heating degree-days, the Lower-48 States are forecast to be 1 percent warmer this winter compared with last winter and 1 percent milder than the 30-year average (1971-2000). However, heating degree-day projections vary widely between regions. For example, the Midwest, a major market for propane and natural gas, is projected to be about 4 percent warmer than last winter, while the West is projected to be about 4 percent colder.

EIA expects the price of West Texas Intermediate (WTI) crude oil to average about $70 per barrel this winter (October-March), a $19 increase over last winter. The forecast for average WTI prices rises gradually to about $75 per barrel by December 2010 as U.S. and world economic conditions improve. EIA’s forecast assumes U.S. GDP grows by 1.8 percent in 2010 and world oil-consumption-weighted GDP grows by 2.6 percent.

Energy prices remain volatile, reflecting uncertainty, or risk, in the market. To measure this uncertainty, EIA is tracking futures prices and the market’s assessment of the range in which those futures prices might trade (see STEO Supplement: Energy Price Volatility and Forecast Uncertainty). The Outlook will now report confidence intervals around the New York Mercantile Exchange (NYMEX) crude oil and natural gas futures prices using a measure of risk derived from the NYMEX options markets known as “implied volatility.”

Natural gas inventories are expected to set a new record high at the end of this year’s injection season (October 31), reaching more than 3.8 trillion cubic feet (Tcf). The projected Henry Hub annual average spot price increases from $3.85 per thousand cubic feet (Mcf) in 2009 to $5.02 in 2010."

Source: US Energy Information Administration

This chart shows the divergence between the Natural Gas ETF and the Crude Oil ETF in the US. The reason for this is founded in the fundamentals.



This is merely a linear version of the first chart shown above, the annual build and depletion of natural gas inventories over time. This tends to illustrate the big swings that are possible, and over a longer timeframe.

Krugman Declares "Mission Accomplished," Maginot Line Completed

The triumph of financial engineering based on an analysis of the past.

Conscience of a Liberal
The story so far, in one picture
By Paul Krugman
November 3, 2009

World industrial production in the Great Depression and now:

Jesse here. This chart is a bit deceptive because it compares two periods of time based on the start of the crisis. It would be interesting to compare the two crises from the start of the Fed's expansion of the monetary base. As I recall, the early 20th century Fed did not react this way until 1931 and did so in two stages. Ok, Ben was quick out of the starting gate with a massive quantitative easing. Score one for the Fed. They are quick on the draw when it comes to monetization.

And there is little hazard that Ben will tighten prematurely out of fear of inflationary forces, having learned at least that lesson from what might prove to be a simplistic historical comparison.

It would be unjust not to note that the 1930's Fed struggled a bit with the difficulties of an entirely different type of commercial banking structure and regulatory structure, and the restraints of a gold standard.

But at the heart of it, the comparison may be irrelevant. The genuine challenge in this era of fiat currency will be to avoid the 'zombification' of the economy, the appearance of vitality with none of the self-sustaining growth.

It may be discovered that the key to coming out of a crisis permanently is not how quickly and dramatically one inflates the money supply, or even how long one maintains it, and how many stimulus programs one can create, but rather how quickly and capably a country can reform, can change the underlying structures that caused the problem in the first place.

Japan has been doing it slowly because of its embedded kereitsu structure and government bureaucracy supported by a de facto one party system under the LDP. In the 1930's the impetus for reform was overturned by a strict constructionist Supreme Court and an obstructionist Republican Congress. The story of our time might be the perils of regulatory and political capture.
Before this Administration declares "Mission Accomplished" and high fives its victorious recovery, they may wish to consider that they have done the obvious quickly in one dimension, but have done very little to change the dynamics which created the crisis in the first place, choosing instead to support the status quo to a fault, partly out of ignorance and to some extent because of a pervasive and endemic corruption of the political process.

There are three traits that make a nominal bounce in production fueled by a record expansion in the monetary base a success: sustainable growth without subsidy, sustainable growth without subsidy, and sustainable growth without subsidy. And this can only be achieved by changing the game, reforming what was wrong with the system in the first place, if this is what caused the crisis.

Our forecast is that Ben and Team Obama are failing badly because they are fighting the last war, in the almost classic style of incompetent generals who lost the early stages of the Second World War because they were using the game plan from the First. And plans for a Vichy-style government establishing l'état financière seem to be well underway, in a general surrender of the goverance of the nation to the econorati.

For all its flaws, at least the Clinton Administration used to conduct polls to see which way the public was leaning, and took its cues from that. The Obama Administration blatantly ignores public outrage, and takes its calls from Wall Street, literally, and forms its policy and laws around what they want, or at most, will grudgingly accept.

A Reader Asks "How Did 558,000 People Lose Their Jobs When Only 190,000 Jobs Were Lost?"

Here is an excerpt from today's Bureau of Labor Statistics Non-farm Payrolls report.

"The unemployment rate rose from 9.8 to 10.2 percent in October, and nonfarm
payroll employment continued to decline (-190,000), the U.S. Bureau of Labor
Statistics reported today. The largest job losses over the month were in con-
struction, manufacturing, and retail trade.

Household Survey Data

In October, the number of unemployed persons increased by 558,000 to 15.7
million. The unemployment rate rose by 0.4 percentage point to 10.2 percent,
the highest rate since April 1983. Since the start of the recession in
December 2007, the number of unemployed persons has risen by 8.2 million,
and the unemployment rate has grown by 5.3 percentage points...

The civilian labor force participation rate was little changed over the month
at 65.1 percent. The employment-population ratio continued to decline in
October, falling to 58.5 percent."

An astute reader noticed that the BLS press release says that 190,000 jobs were lost from payroll employment, but the number of unemployed persons increased by 558,000. What's up with that?

The BLS report consists of two independent data samples. BLS has two monthly surveys that measure employment levels and trends: the Current Population Survey (CPS), also known as the household survey, and the Current Employment Statistics (CES) survey, also known as the payroll or establishment survey.

There is the "Establishment Survey" which is based on responses from a sample of about 400,000 business establishments, about one-third of total nonfarm payroll employment. The headline payroll number, the job loss of 190,000, is based on this data.

Then there is the "Household Survey" which is a statistical survey of more than 50,000 households with regard to the employment circumstances of their members, which is then applied to the estimates of the US population to obtain the unemployment number. This survey was started in the 1950's and is conducted by the Census Bureau with the data being provided to BLS. It is from the household survey that more detailed information is obtained about employment statistics within population groups like gender and age, wages, and hours worked. It is this study that is responsible for the unemployment rate of 10.2%.



So which survey is correct? Neither. The truth is somewhere in between.

The most obvious reason for the discrepancy is that job creation in the US seems to be centered in the smaller business and the self-employed areas in recent years. These sectors are not polled by the BLS and their impact would only be obtained by the Household Survey's interviews.

The BLS does have a way to account for this called the "Birth Death Model" which is supposed to estimate jobs created by smaller businesses. That model is a bit of a joke actually since it almost always follows the same pattern of adding jobs, with two big corrections in January and July of each year when it will do the least damage to the headline number. Any model that does not reflect the job declines that started in 2007 can most certainly be called a statistical joke. Small business is not immune to business cycles.



The payroll survey for October will be revised several times in the short term, with each release of monthly data, and even larger revisions will be done periodically, every year or so, to correct the whole series and sometimes dramatically.

The household survey is not revised per se, but the data against which it is statistically evaluated, the census data of the population, will be revised and this will change the representation of the monthly samples. Let's hope that lowering of the population is only done by revision of the numbers, and not the more draconian things practiced throughout the earlier part of the 20th century.

There was a famous joke that the Household Survey and the Establishment Survey were synchronized under George W. Bush by getting rid of people, by lowering the estimates of the population that is, which is something his pappy did when he was the president. In the states there will be a new Census conducted in 2010 as you yanks may already know, so we will have to see if the census bureau's population estimates are lowball or highball.

So what are we to conclude from this?

First, that Wall Street and the government use the monthly jobs data as tools to achieve their particular ends, to justify programs, to buy and sell, to promote certain ideas and behaviours in the public. Secondly, people will believe what they wish to believe to suit their biases if they are not fact-based in their thinking.

The truth is more clearly demonstrated in the long term trends, the averaging of the data over time. It does not seem that the long term data is as manipulated as the Consumer Price Index information which has become a statistical disgrace with its hedonic adjustments.

So what do we do, the average person with too little time and too many other priorities, at times seemingly held captive by the flows of information from the mainstream media? As always, we must sift what the government and business tell us, with a keen eye for deception which is an unfortunate part of human nature especially when things are not going well and it is easy to rationalize many things, and do what seems to be the right thing based on our own judgement and a broader analysis of all the news.

Perspective: SP 500 Rally From the First Bottom of the Financial Crisis

Here is a longer term chart of the SP 500 showing the decline with the unfolding financial crisis, and the rally from the first major market bottom in equities. The rally has been a nearly perfect 50 percent retracement.



Here is the same view of the SP 500 but deflated by the Euro. This puts the rally into a slightly different perspective, which is not nearly so dramatic, about a 38.2% retracement which is a decent bounce.



Again the same chart of the SP 500, this time deflated by gold. The rally is stripped of the monetary inflation supplied by the Fed, and appears to more accurately reflect the 'jobless recovery.'

Warren Pollock: Game Change for Zombie Banks

Gasparino on "The Sellout"

RealClearMarkets has an interesting interview with Charlie Gasparino regarding his new book "The Sellout." There seems to be a consensus forming that something has gone seriously wrong with the US republic, and that the Obama administration is failing to address it, failing badly.

One has to wonder what it will take to give Washington a wakeup call. It seems that, when confronted by white collar crime, people lose all the perspective which they have when it comes to fighting crime and injustice. "It won't work, it can't be done, they will just come back and do it again."

Well, duh. If you make it worth their while, administer wristslap justice at worst, and let all the top dogs openly flout the law, of course they will be back. What the US needs is the reincarnation of Melvin Purvis with a minor in finance. I would put Eliot Spitzer in charge of the SEC with the right resources and let him rip through Wall Street like the wrath of God, and make the bankers howl.

But that probably won't happen, because there is too much dirt, too many scandals on both sides of the aisle for this crew to administer its oath to uphold the Constitution.

Here is an excerpt from the interview:

"I don't know when it's going to happen, but if history is any guide, it has to happen again--the "it" being another financial crash. Of course, it won't happen tomorrow or next week, or maybe not even two years from now. But when the memory of 2008 wears off, and mark my words it will wear off, excessive risk taking will be back in a form that evades all these alleged regulatory controls that have been established. Regulation can never cure the disease of excessive risk.

The only thing that can cure it is tough love--allowing firms to fail. That doesn't mean I wanted the Fed and the Treasury to walk away last year. That would have meant Armageddon. But they should have walked away before that, when the systemic risk was smaller and the damage would have been limited. 1998 would have been a great place to start. Let Long Term Capital Management fail; let Lehman, and as I show in my book, possibly Merrill to fail, because the trades were the most vulnerable to LTCM's bad bond market bets.

Instead, by arranging a bailout, and by using free money to juice up the markets, policy makers emboldened Wall Street to take even more risk. That's what they did then, and that's what I fear is happening all over again...

Now I'm not in the Goldman is the center of all evil camp. But I know a lot of really smart people who believe that Goldman's bankers and traders virtually control the federal government in order to advance their own notorious agenda.

In fact, as I show in The Sellout, there were far worse players whose risk taking led to last year's meltdown, starting with Merrill Lynch and Citigroup. They were equally powerful from a policy making standpoint.

Remember, after Robert Rubin fought to end Glass-Steagall's separation of investment and commercial banking, he didn't go back to his old firm, Goldman Sachs, he went to work for the firm that benefited the most from the law's demise, Citigroup.

But Goldman in many ways crystallizes all that is wrong with the financial bailout, started by the Bush Administration, but carried on and expanded by Obama's. Goldman has been declared a bank, not much different than the old Bailey Building and Loan, and yet they don't take deposits or offer checking accounts. So what do they do? They trade, and they are trading as a federally protected bank, meaning they get to borrow at cheaper rates and they are Too Big To Fail."

Read the full interview here.