Monday, August 07, 2006

Bernanke Tells Beckner: Too Soon To Flip The Game

Today's missive from Chairman Bernanke, via Beckner (look for Ip in the AM), had one major intent. It was to let everyone know that if they skip Augy don't get worked up into a lather handicapping the first ease. Stick with the current game -- setting odds on the next tightening. Don't flip the game, an Augy skip means wait and see not wait and ease.

Seems a shame that this missive came out before the Street could go full tilt into its data mining mode to forecast the ease based on average time span from stopping to dropping. Undaunted, most economists are out there raising their odds of a recession next year. My initial reaction to all this is to recognize how little impact economists have. When I first began working, in 1977 at Manufacturers Hanover Trust, there was a huge reluctance for bank economists to officially call a recession -- believing that it would become a self-fulfilling prophecy.

Today, these pronouncements seem more self-filling than not (kinda like a blog!). My second response to all this is that they are wrong. The economy is transitioning from housing to capex, where neutral rates (fed funds slightly less than nominal GDP growth) and a weaker but not plummeting dollar (central banks hate plummets) will help keep capex going. Even higher energy prices help since, as we all remember, when an important price shifts our budget line there is an income effect (where the economists are stuck today) and the substitution effect (cap spending, anyone?).

Lastly, this is an economy that, through financial innovation, floats on both side of the balance sheet. Further, the Fed moves have been so well telegraphed everyone has been adjusting accordingly. Obviously some housing stock cannot be sold at these rates, but then they probably shouldn't have been built in the first place. Yes, a reason to raise rates is to get a more efficient allocation of capital rather than too much flowing to a sector that is being subsidized (long term, an economy constructed on home building is not stable).

Back to Beckner, er Bernanke, the article touches on another theme that I have been touting, the Mishkin argument (see previous blogs) that a little less transparency will make the Fed more effective. The Chairman has taken it to heart, hence all the uncertainty regarding August 8 and what it means longer term.

I still believe the Fed skips, at some stage Bernanke needs to trust his forecast for moderating growth based on the lagged impact of past Fed hikes and higher energy costs -- and this is the best time. More interesting than the skip is what the Fed is saying going forward, their decisions will effectively be a roll of the dice. So those of you who own 2yr Treasurys understand the risks, you are betting that there will be eases next year. If there aren't, you lose. Are you being paid enough?

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