Analyzing Fed Critics: Paul Kedrosky
It was a day when many questions would be raised, and a few were actually answered.
It was a time of financial crisis, with liquidity in doubt at several financial institutions. The Bear Stearns "bailout" is fresh in the minds of all, with many stories asking "Who is next?" The Fed rate decision was imminent and this time the answer was not known in advance. Before the opening the world would hear from Goldman Sachs and Lehman. Many expected big losses and further write-downs of financial assets.
Most of those in the financial community have turned very negative, particularly on the Fed. Since the ranks of blogging public policy analysts are so thin, we really have a minority viewpoint. Even our own loyal readers think that we are naive and clueless! (see yesterday’s comments).
We are trying to help investors make money. This is not via specific investment advice, which we would not offer en masse, but insights about how to use the available information. This frequently means some careful analysis of prevailing investor and pundit sentiment.
Readers can do their own tally of today’s Fed commentators and pundits. It would seem to be tough to criticize on a day when the market had a big rally, but most of that was the result of the Lehman and Goldman reports. Let us take a typical reaction from a leading voice, Paul Kedrosky. We choose this comment not because Kedrosky is a poor analyst. Quite the opposite. Like nearly everyone else, we read Infectious Greed, one of our featured sites, every day, enjoying both the breezy, wide-ranging commentary and the suggested weekend readings that highlight articles we would otherwise miss.
Having given this measure of well-deserved respect, we are going to disagree completely with his analysis and conclusions. Furthermore, we believe that Kedrosky’s thinking (Is the Fed Confused, or Just Being Confusing?) is quite typical of most trader and fund manager types. He starts by criticizing both the concept of compromise and academics by writing, "Ben Bernanke has compromised, like any good academic chair should."
He continues as follows:
…(T)his strikes me as somewhat confused. Is it inflation you’re
worried about? Is it the financial services industry bailout? What is
it? Why not get in front of the 2-year and call it a day? Why dodder
around fretting about inflation if you really think you’re facing a
credit market meltdown? And to have two dissenters is definitely
material, both citing inflation as a concern. When is the last time we
had two dissenters on a Fed rate cut/increase?
- The criticism of compromise makes sense only if one has a very simplistic view of government. Kedrosky, like most other critics, turns the FOMC into a unitary actor. He then expects the group consensus to reflect his personal viewpoint and to quash any dissent. Wow! Our government is pluralistic and participatory. Most institutions are structured to reflect a range of interests. The FOMC is actually much more insulated and narrow than most. Despite this, there are often genuine policy disagreements. When this happens, the resulting action reflects a compromise. In the case of the Fed, anything more than two dissents is a revolution, so there may have been serious compromising on the inflation language.
We wonder why Kedrosky finds this strange. He has been a member of various corporate committees and board. Our experience (on many boards including public companies, private companies, and non-profits) is that even when the votes are unanimous, there is often bargaining to achieve consensus. The world of government is not so different from the world of business in this respect.
Put another way, what is Kedrosky’s approach to the lack of a consensus on the FOMC? The Chair has no power to expel members. Should we not be seeking alternative viewpoints?
- Financial services bailout. The Fed has been clear — quite clear — that it is treating the reduction of interest rates and the efforts to direct liquidity as two different problems. This approach is much more insightful and sophisticated than that of the average trader and pundit. They dealt with the financial issue over the weekend.
- Why not get in front of the 2-year? This is simple. The majority of the committee does not agree with Kedrosky on the economic need. It is possible that none of them do. We watched many pundits today who thought that the Fed should cut only 50 bp’s. Whatever the FOMC does will be attacked by many if not most traders, pundits, columnists and managers.
- The vague objection about dissenters. We are not sure what Kedrosky thought should be done about this. These members have viewpoints that disagree with his personal notion of the best policy. The dissent is meaningful to anyone more interested in understanding and predicting Fed behavior than in commenting on what they should be doing.
We thought the two dissenting votes, from more hawkish regional bank Presidents who happen to be in the 2008 rotation of Presidents who are voting members of the FOMC, were important. Here was our comment, minutes after the decision, on RealMoney:
The FOMC meetings usually result in a consensus decision. This often
means a compromise, including aspects of the policy statement. Today’s
action had two dissents (favoring less easing). There have been two
dissents only twice in the last ten years. The last occasion was in
September of 2002.
Those interested in predicting future Fed moves should take note of
this. Some members probably believe that actions already taken will
begin to show effects. This would be the typical six to nine-month lag.
Here is part of Tony Crescenzi’s analysis from RealMoney (subscription required to get all of his worthwhile economic analysis):
While the Fed’s decision was not exactly a line
in the sand on inflation — the Fed did cut the funds rate by 75 basis
points, after all — it was strong enough, especially given the two
dissents, to put the U.S. dollar on
better footing and threaten speculators in the commodities markets.
I expect the dollar to be buoyed and commodities to fall in response to
today’s action and the Fed statement, if not immediately, then in hours
We agree with Crescenzi and expect the Fed to emphasize the difference between rate-cutting and directing liquidity. We continue to emphasize this fact:
Investors should focus not on pundits who opine on what the Fed should do. To profit, it is more important to understand the Fed and predict what they will do.