The Magical World of Charles Evans

August 28, 2012
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Consider this article a plea for assistance. Would someone with a PhD in economics, or better yet, deep-level training in Fed Speak, step forward and help this simple caveman trader solve a true “conundrum” of Alan Greenspan caliber?

It has to do with Charles Evans, President of the Federal Reserve Bank of Chicago. On Monday, Reuters ran a headline story, Fed’s Evans: Buy Bonds Until Jobless Rate Falls.

Here is the gist:

The Federal Reserve should launch a fresh round of monetary stimulus immediately, buying bonds for as long as it takes to produce a steady decline in the jobless rate, a top Fed official said on Monday.

Without a change in policy, the unemployment rate, now at 8.3 percent, was unlikely to fall below 7 percent before 2015 at the earliest, Chicago Federal Reserve Bank President Charles Evans told reporters in Hong Kong.

“I don’t think we should be in a mode where we are waiting to see what the next few data releases bring,” Evans told a seminar at the Hong Kong Bankers Club. “We are well past the threshold for additional action; we should take that action now.”

And here are the burning questions we have:

Why would a Federal Reserve official assume any direct connection between buying bonds and lowering the jobless rate? 

Is there any sort of logic or rationale whatsoever behind this view? Can someone, anyone, make a credible case for the chain of logic that Evans assumes – the if / then assertion that “if” the Fed buys more bonds, “then” unemployment will fall? 

We suggest Charles Evans is either a genius or a buffoon: A genius if he sees some powerful connection that no one else does – a buffoon if he is pounding the table for a solution that makes no sense.

Could someone please explain the “genius” case to us? Why, why, why, would the Fed buying bonds make sense at this juncture? 

In unemployment terms, prior attempts of Federal Reserve stimulus have been a failure. As far as stimulus goes, the Fed has been failing for years. Gargantuan sums have succeeded in pushing paper assets to new heights and creating stagnant liquidity pools in bank vaults. But that’s about it.

Oh, wait, we forgot: Federal Reserve stimulus has also created some pretty sweet borrowing deals for massive Fortune 500 corporations with fortress balance sheets – i.e. exactly the type of entities that don’t need to borrow, but can do so anyway, at rock bottom rates.

We have an acquaintance who is more or less a billionaire. This individual built his fortune founding a private company, some three decades ago, that would easily be worth billions in a public flotation today. (It will never go public – there is no need for the cash – but such is mentioned for comparison purposes.)

At any rate, this individual is excited about borrowing, as are his wealthy friends and colleagues. Via keeping interest rates low, the Federal Reserve has created an excellent arbitrage opportunity for wealthy individuals: Borrow at ridiculously low rates… invest in long-term real estate deals… keep the sweet terms locked in for as long as you can.

Again, all well and good. For some, but not nearly for all. Consider the following, also from Reuters, Small business borrowing woes hurt jobs:

A majority of U.S. small businesses are having a tough time accessing funding, holding back job growth and stunting economic growth, Duncan Niederauer, chief executive of NYSE Euronext, said in an interview.

New York Stock Exchange parent NYSE released the results of an annual survey on Monday on the economy, business and job creation. It included 340 CEOs from companies listed on NYSE Euronext markets from 26 countries, and 285 U.S. small business owners.

It was the first time in the survey’s eight years that Main Street business owners were included, and 47 percent of them said their capital needs were being met marginally or not at all. Just 21 percent said they have sufficient capital.

The wealthy, both individual and corporate, have access to lenders via ample collateral and credit. The rest of America does not. How will pushing down treasury yields by a few more basis points change that?

Evans says the Fed should “buy bonds for as long as it takes to produce a steady decline in the jobless rate.”

But what if it takes forever, because buying bonds has no impact on the jobless rate at all?

Worse yet, what if buying bonds — continuing various forms of stimulus indefinitely — turns out to be counter-productive, actually perpetuating America’s slow unemployment crisis?

It is not hard to see how this could happen. Near-zero interest rates benefit wealthy corporations and wealthy individuals. But they are very bad news for seniors and other fixed income savers.

Perpetually easy monetary policy means that return on savings stays low, even as food and energy costs go up (vis a vis a debased currency). Furthermore, the Fed’s rationale of “pushing people out on the risk curve” has little impact on savers with limited assets and a healthy fear of the volatile stock market.

So, what you could very easily get by way of a “buy bonds ad infinitum” plan, is a situation where the following occurs:

  • Seniors and savers spend less (because their accounts earn less).
  • Cost of living expenditures (via food and energy) go up.
  • Small businesses are hurt as seniors and savers pull back.
  • Unemployment perpetuates via poor business climate.
  • The rich get richer as the poor get poorer.
  • In this case, the “poor” representing the bottom 70%.

It seems clear that buying more bonds to make the jobless rate go down is a very unhelpful idea.

It is unhelpful for another reason too: Long-dated treasurys are already within reasonable distance of multi-century lows. So far, this little factoid has not helped matters much at all. So if bond yields are already not far above historic lows, why would pushing them down further (through Fed bond buying) do any good?

Oh and by the way… how has perpetual ZIRP worked out for Japan?

Let us put forth a hypothesis, in the form of another question: Is it possible that Mr. Evans and other Fed doves are guilty of magical thinking? Per Wikipedia:

Magical thinking is a type of causal reasoning or causal fallacy that looks for meaningful relationships of grouped phenomena between acts and events. In religion, folk religion, and superstition, the correlation posited is between religious ritual, such as prayer, sacrifice, or the observance of a taboo, and an expected benefit or recompense. In clinical psychology, magical thinking is a condition that causes the patient to experience irrational fear of performing certain acts or having certain thoughts because they assume a correlation with their acts and threatening calamities.

“Quasi-magical thinking” describes “cases in which people act as if they erroneously believe that their action influences the outcome, even though they do not really hold that belief.”

Perhaps Mr. Evans is only guilty of “quasi-magical thinking,” as opposed to the real thing. But if that is the case, it makes him a charlatan instead of a fool.

Again, please. This is a call to anyone who is rational, logical and intelligent… preferably with a soft spot for defending the actions of the Fed. Your contributions via comments, and expanded discussion, are eagerly sought.

What is missing here? How is it rational, logical or even credible to believe that buying bonds will make the jobless rate go down?

And if such views are not rational, logical or credible, why do we allow such irrationality to stand?

Men like Evans are not elected. But can’t they be shamed? Can’t they be forced to either defend their viewpoints – especially as relating to very important matters of monetary policy – or else be loudly advised to, shall we say, “STFU” as the impolitic acronym goes?

One advantage of an active and intelligent financial blogosphere, with many sharp individuals participating, is that ideas can be vetted and rigorously examined to determine their true worth.

A great example of this was the response to the Bill Gross “death of equities” assertion via Pimco Investment Outlook (which you can read here).

We like what happened with the Bill Gross feedback on the death of equities. Many smart responses came about in reply; our favorite was the lengthy rebuttal from Ben Inker of GMO, a most excellent and worthy read. (You can find that one here.)

So why can’t we have the same sort of process when Fed Governors say very stupid things? It would seem to yours truly that Charles Evans is a magical thinker, or worse yet a quasi-magical thinker… which, given the stakes at hand, and the potential costs inflicted from bad policy, makes the man worse than a Witch Doctor, a Voodoo Shaman, or a Medical Quack who deserves to be sued for financial malpractice.

We could be wrong, of course. It could be, at least hypothetically speaking, logical to believe that “buying bonds to make the jobless rate go down” has technical merits as a causal course of action, and is not just blathering from a man with a hammer (to whom everything looks like a nail).

But if this is the case, can someone please, please explain to us why? Pro-Evans rebuttals both welcomed and encouraged…

JS (jack@mercenarytrader.com)

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