Tag: inflation

JAMES GRANT & RICHARD SYLLA: THE GREAT FED DEBATE! – Transcript 3/14/2014 #1038

March 14, 2014

CONSUELO MACK: This week on WealthTrack as the Federal Reserve celebrates its 100th birthday, is it a cause for rejoicing or despair? Two financial historians, NYU’s Richard Sylla and Grant’s Interest Rate Observer’s James Grant debate the case for lighting candles or snuffing them out- next on Consuelo Mack WealthTrack.

Hello and welcome to this special edition of WealthTrack, I’m Consuelo Mack. What is the proper role of a central bank? Can any institution prevent or control the booms or busts that dynamic market-based economies produce? Can they control interest rates and inflation, or insure robust employment? Should they try to?

Those are questions being raised anew as the Federal Reserve officially marks its one hundredth anniversary. On December 23rd, 1913, President Woodrow Wilson signed the Federal Reserve Act into law. As the current Federal Reserve describes it: “the Federal Reserve Act stood as a classic example of compromise- a decentralized central bank that balanced the competing interests of private banks and populist sentiment.” That rivalry and tension between private financial interests and populist sentiment is alive and well today and has been with us since earliest days of the republic.

Prior to 1913, populist forces killed two attempts to establish a permanent central bank. The nation’s business was financed by state banks, but it was also disrupted by a series of financial crisis and bank runs. Financier and banker JP Morgan had to come to the rescue twice- first in the banking panic and depression of 1893 and again in the banking crisis of 1907.

Calls for reform of the banking system became widespread. It took years of debate before the Federal Reserve Act of 1913 was signed by President Wilson, creating a decentralized system of 12 reserve banks with branches around the country and independent decision-making powers.

It wasn’t until the 1920s that the buying and selling of Treasury securities was coordinated as a monetary tool to influence the availability of credit.  Even so, the new Federal Reserve system didn’t seem to have much effect on the market crash of 1929 or the Great Depression that followed. Thousands of banks and businesses failed and one in four Americans was out of work.

In response, President Franklin Delano Roosevelt’s New Deal brought big changes to the financial system and the Federal Reserve. One of the biggest, the Glass-Steagall Act of 1933 separated commercial banking and investment banking and gave the Fed authority to supervise multi-bank holding companies.

The Banking Act of 1935 changed the Fed’s structure by establishing the Federal Open Market Committee as a separate legal entity and removing the Treasury Secretary and the Comptroller of the Currency from the Fed’s governing board. But it wasn’t until the 1951 Treasury-Fed Accord that the Fed gained the independence to pursue monetary policy on its own.

Meanwhile the Fed’s duties continued to expand. The 1977 Community Reinvestment Act required the Fed to ensure banks lent to low and moderate-income individuals. And the Federal Reserve Act of 1977 codified the Fed’s dual mandate of stable prices and maximum employment.

The Fed has been widely blamed for the double-digit inflation of the 1970s. But starting in 1979, the new Fed Chairman, Paul Volcker, took on the role of the nation’s number one inflation fighter, hiking interest rates to restrict credit and cut off inflation. His painful, recession-inducing strategy succeeded in killing inflation. His successor, Alan Greenspan, continued to use monetary policy to “serve as a source of liquidity to support the economic and financial system” from the market crash of 1987, the bursting of the tech bubble and the terrorist attacks of 9/11.

But it wasn’t 9/11 that revolutionized the Fed’s role. It was the subprime mortgage bubble, which morphed into a global financial crisis in 2008. Under Fed Chairman Ben Bernanke, the Fed invoked emergency authority to launch a series of new programs and assistance packages to rescue global financial markets and economies. The Fed also slashed short term interest rates to record lows in 2008 and have kept them there ever since. Nearly four trillion dollars of stimulus later, the Fed continues its activist role. In the words of Ben Bernanke, the Fed has “come full circle back to the original goal of preventing financial panics.”

Should that be the Fed’s goal and can it really succeed in doing it? Joining us are two WealthTrack favorites, each a respected financial historian and author.

James Grant is the Editor of Grant’s Interest Rate Observer, a twice monthly, self-described “independent, value-oriented and contrary minded journal of the financial markets” that is considered to be a must read by many institutional investors. He is a vocal critic of current Fed policy.

Richard Sylla is the Henry Kaufman Professor of the History of Financial Institutions and Markets and Professor of Economics, Entrepreneurship, and Innovation at the New York University Stern School of Business.

I began the interview by asking them to go back to basics: what is the role of a central bank?

JAMES GRANT: Well, one might start with the role that was assigned in legislation 100 years ago. It was to lend against sound collateral. It was to create a market in commercial paper, meaning business loans. It was to furnish so-called elastic currency and it has to be a lender of last resort, and that was it. Oh, yes. They added “and for other purposes” and we have all too many of the other purposes, but my suggestion is the Fed think more about the roles for which it was created rather than the ones it has arrogated to itself.

CONSUELO MACK: Dick?

DICK SYLLA: Since the 1970s, the Federal Reserve has had the obligation to stabilize the price level. That was there for a long time, but an added obligation was to generate high levels of employment, and so this is called the dual mandate. The Fed had a dual mandate. We talked for the last 30 years about the dual mandate of the Fed. The Dodd-Frank Act of 2010, I think, added another item. The Fed is not only supposed to stabilize the price level and give us the maximum amount of employment, but it’s also to foster financial stability. So the Fed now has those three things to do.

CONSUELO MACK: So my question, though, is what do you think the role should be?  We know there’s this long litany of ever-expansive roles that it has, so…

JAMES GRANT: Well, Dick has just told us what it can’t do.

CONSUELO MACK: …would you say that was one of the original goals?

DICK SYLLA: Yeah, I think traditionally a central bank was responsible for stable prices, and that happens to be what they might be pretty good at. Most economists, I’m one, think that the Federal Reserve actually has the power, the tools to stabilize the price level. There’s a lot of evidence in favor of that. It’s much less certain that they can do much to change the unemployment rate, reduce the unemployment rate.

JAMES GRANT: See, the Fed has got into its head that it can improve the future before it comes to pass. The Fed has morphed from central banking into kind of a seat of the pants central planning. It has these models don’t you know, very, very complex, a lot of differential equations. They don’t work, but they do give the Fed the seeming intellectual authority to do so many things that common sense would tell you that simply the Fed cannot do.

For example, the Fed now is in the business of manipulating the structure of interest rates. It is in the business of suppressing some interest rates, and new thing, it is in the business of talking up the stock market. In other words, Dick mentioned stabilizing prices. The Fed is manipulating prices, especially on Wall Street. It’s a very new thing.

CONSUELO MACK: Has it been an effective price stabilizer? And stabilizing prices I’m assuming means that they don’t go up or down too much.

DICK SYLLA: I would say in the long run the Fed has not really been all that effective, because the 20th century was a three percent inflation century. You know, there was some low inflation, some very high inflation, but you can compare it with the previous period of the 19th century when prices in 1914 were not very different from what they were in 1815 according to pricing. So the 19th century was a zero inflation century without the Federal Reserve. When the Fed came in, we had basically a three percent inflation trend ever since then, but I don’t think we can entirely blame that on the Fed. There was something called World War I. There was something called World War II, and…

CONSUELO MACK: The Korean War, The Great Society Program.

DICK SYLLA: Yeah, and if you look back at those periods, it turns out the Federal Reserve was sort of conscripted to be part of the government’s financing machine, and the Secretary of the Treasury told the Fed what to do. In World War I, it was to lend a lot of money to banks so they could buy first liberty bonds and then victory bonds.  In World War II, the Secretary of the Treasury commanded the Fed to keep the interest rates no higher than two and a half percent on long-term bonds and three eighths of one percent on a Treasury bill, and so the Fed was told what to do.  We did not have an independent central bank. So I’m saying there’s…

CONSUELO MACK: Until 1951. Right.

DICK SYLLA: 1951. Then the Fed was freed from the control of the Treasury but, of course, the worst inflation we had was from 1965 or ’66 through 1981, which ended up with double-digit inflation in ’79 to ’81, and the Fed had a lot to do with that inflation. It was using the wrong models. Jim talked about the Fed uses the wrong models. I think they were definitely using the wrong models in the 1970s. Then Paul Volcker came in. He knew what to do, and he’s become sort of an American hero since that time, and 30 years after he whipped inflation, now he has his Volcker Rule passed.

CONSUELO MACK: So Jim, would you give the Fed the role of stabilizing prices?  Is that a fair role to give?

JAMES GRANT: No, no. Prices ought to be determined, it seems to me, through what they call future price discovery; that is to say, the unplanned and unmanipulated dynamics of free people making choices in the marketplace. You know, the time of terrific technological progress one would expect the general price level to kind of dwindle, because every day lower and lower prices is how Wal-Mart’s made a pretty good business about that. Prices dwindled a percent or so a year, one and a half percent or so a year in the last quarter of the 19th century. People kind of liked that. They regarded it as a sign not of deflation but of progress.

Now we have a Fed that wants us to know that prices must not go down. Well, in order to assure the prices don’t go down, the Fed creates lots and lots of credit that creates lots and lots of distortions, some of which end up from time to time in crises. This price stability is a very glib thing to say. It sounds very, very… it sounds commonsensical off of the tongue but it is, in fact, not so.

CONSUELO MACK: So I guess the issue is, can any institution really in an economy such as ours and in a world that we live in which is so dynamic, really be chartered…?

JAMES GRANT: Well, no.  If it could, the Soviet Union would still be in business. The idea of the humble but wonderful institution of the price mechanism, the price system, is it is what makes free economies work. It’s how work is measured and how goods are allocated. It’s a pretty cool system, and the Fed without an explanation really why is interposing itself between that system and us.

CONSUELO MACK: If you talk to most people on Wall Street and in the country, they feel that without the Fed, we would have had financial Armageddon. So Dick, I mean, does the Fed have a role in what Bernanke is saying, is to prevent financial panics?

DICK SYLLA: Well, Jim mentioned that one of the obligations of the Fed traditionally… and this is not just the Fed but central banking history going back to an Englishman named Bagehot, I would even say back to Alexander Hamilton… the central bank should come to the aid of the market in a crisis. Crisis is typically when almost nobody wants to lend to anyone else, so a central bank, when nobody wants to lend to anyone else, the central bank is supposed to keep lending on good collateral at a high rate of interest. You know, recently the Fed lent on dodgy collateral at a low rate of interest, so that’s a corollary I guess to the old rule.

JAMES GRANT: Also to solvent institutions.

DICK SYLLA: To solvent institutions, right.

JAMES GRANT: Violated their own…

DICK SYLLA: …but if you bring in collateral, whether you’re solvent or not, at least the Fed … if the collateral is good, then you can make the loan. So I think the Fed, you know, I think we do need it. Most people say we need a central bank to act as a lender of last resort. That’s the term, end of crisis.

CONSUELO MACK: So would you give the central bank that, Jim, that we do need a central bank that is the lender of last resort?

JAMES GRANT: We don’t need one. We can have one that will do less harm if it sticks to that kind of business, but the trouble is the Fed- this is a trend that’s been in operation over the decades- the Fed has presided over the decay of finance, and it has presided over the degradation of the dollar. By decay of…

CONSUELO MACK: And how so?

JAMES GRANT: By decay of finance, I mean by the integrity of private financial institutions. An example, before 1935, say, the stockholders of a bank were responsible for the solvency of that institution. If the capital was impaired, if the bank went broke, the courts came after the stockholders for a capital call to restore the bank to working order. Now we have, of course, the FDIC. We have the socialization of credit. We have the sidewalk superintending of almost every detail of our financial lives, but notice that in 2008 almost every major financial institution, certainly in the city of New York, was functionally insolvent. Now, how did that happen?

I submit to you that finance and central banking are different than almost any other set of phenomena in modern life. Most things we see progress. We see cars work better. We don’t shave with a cutthroat razor anymore. We don’t use sextants at sea. Progress. Right? In banking, what we see is the cyclical insolvency, virtual or actual, of things like Citicorp. Right? We see retrogression in finance rather than progress, and I say that the retrogression can be laid at the feet of the Fed and of the regime behind it.

CONSUELO MACK: But how so? I mean, why is the Fed to blame basically for the problems that the banking industry had?

JAMES GRANT: Well, the Fed is the creation of a system of paper money and of socialized and subsidized credit. Now, Dick mentioned that the Fed was dragooned into financing the First and Second World War. Nobody ever quits from the Fed in protest or the outrage of being seconded or being dragooned by the government. Right? They just go along with it. Let the record show that Dick is laughing sympathetically at this.

CONSUELO MACK: So is the Fed responsible do you think, as Jim says it is, for the degradation of our currency, for the problems that we have with the mismanagement of the financial institutions and basically for the financial crisis? Was it a contributing factor to this global financial crisis that we’ve just experienced?

DICK SYLLA: Well, I think it was a contributing factor. I wouldn’t be quite so…

CONSUELO MACK: And how did it contribute, Dick? What’s your take on the problems that the Fed has created?

DICK SYLLA: Look over the economic financial history of the last 10 to 15 years. You know, we had a late 1990s dot-com bubble which sort of burst in 2000, and by 2001 the U.S. economy emerged into a recession. The Federal Reserve then pushed interest rates to very low levels and held them there for a couple of years, and that’s when the housing bubble began.

CONSUELO MACK: Right, and this was under Alan Greenspan.

DICK SYLLA: It was under Alan Greenspan, but Ben Bernanke was on the Federal Reserve Board then, and so we got this housing bubble going, and I think the problem isn’t the Fed’s monetary policy so much as its regulatory policy. I mean, it was not… the Fed is one of our regulators. Maybe one of our problems is we have too many regulators. We have the Commodity Futures Trading Commission, the FDIC …

JAMES GRANT: Six of them.

DICK SYLLA: … the Comptroller of the Currency, the Federal Reserve, and they sometimes…

CONSUELO MACK: And they’re all doing different things and ..

DICK SYLLA: Yeah.

JAMES GRANT: Or worse, the same thing.

DICK SYLLA: Or maybe somebody thinks, well, you know, this other person will regulate. This other agency will regulate, so I don’t have to, but in the end maybe none of them regulate as much as they should.

JAMES GRANT: But the city of London flourished for decades and decades without a bank failure and without a regulator. I mean, you can walk into Goldman Sachs and look around, and you’re never sure if the person you’re looking at, except by, I don’t know, maybe the color of his socks or something, is a federal employee or one of the paid help. These regulators swarm over these institutions, and still there’s “too big to fail” anxieties.  These anxieties are well founded. These institutions are leveraged, and they operate under the supposition that the government will be there in time of stress. So the apparently innocuous and indeed necessary idea of lender of last resort I say has become distorted such that the government is now guaranteeing underwriting risk that individuals ought to be bearing for themselves.

CONSUELO MACK: So another interesting development is that when the Fed in the Community Reinvestment Act, for instance, was given the job of making sure that banks lent more to low-income individuals and low-income communities, I mean, again it just seems that… but this is Congress, Dick. Right? The Fed’s roles are ever expanding. It’s given more and more oversight to do more and more, I mean, political things, in fact.

DICK SYLLA: Yes, well, we have to remember that the Federal Reserve is a creature of Congress. Congress created the Federal Reserve. Congress oversees the Federal Reserve. Congress asked the Federal Reserve to do all these things such as the Community Reinvestment Act. You know, you go out and make sure that banks lend to people who aren’t such good risks.

JAMES GRANT: You know, Consuelo, what…

CONSUELO MACK: So it’s not the Fed’s fault, Jim. It’s Congress’ fault. Right?

JAMES GRANT: Congress ought to pay more attention to its, as Dick said, creature. We have not really talked about the nature of the dollar of which the Fed is a steward. The dollar from Alexander Hamilton’s time until about Richard Nixon’s time was to find as a weight of something, that something being gold …

CONSUELO MACK: Gold.

JAMES GRANT: … mostly something silver, sometimes both. Since 1971, the dollar has been kind of faith-based. It has been a piece of paper. It’s been a concept to a degree, and now increasingly it is pixels, computer pixels. The Fed materializes these on computer screens, but in the absence of a definition of the dollar, the Fed can create as many of these things as it deems expedient, and its definition of expediency comes from its mathematical models which I attempted to lampoon into, smirk at earlier in the session.

CONSUELO MACK: But can you lay the blame for going off the gold standard at the Fed’s feet?

JAMES GRANT: No, no. The Fed was the agent of this, but still, we can still hate it for other reasons, Consuelo.

CONSUELO MACK: So if you had your druthers, Jim Grant, and you were in charge of Congress…

JAMES GRANT: Now we’re talking.

CONSUELO MACK: Yeah, so now we’re talking. So what would you do with the Fed?

JAMES GRANT: Well, I would recall the founding legislation. I would go back to that.  I’d read the founding legislation and let us reinvent this institution.

CONSUELO MACK: You mean the 1913 Federal Reserve Act? You wouldn’t go back to Alexander Hamilton and…

JAMES GRANT: I would at least go back to the founding legislation and ask whether we have made progress over these past 100 years. Now, every institution must adapt. Right? The United States Navy has missiles that John Paul Jones did not anticipate. The difference with money is that it is not physics. Right? Money is about human behavior, and we have let the would-be physicists, namely these mathematical economists, into running this institution behind their formula, behind their models, and Congress has let this happen. Congress ought to take this institution by the scruff of its neck and ask it, “What for Pete’s sake are you doing?” You materialize $2 trillion in the past like six or eight weeks. Are we sure that’s what we ought to be doing? You’re doing $85 billion a month, and the financial markets shudder at the prospect of them doing $84.5 billion a month. Is this the right way forward? At least let us ask some common sense questions.

CONSUELO MACK: Dick, what would you do if you were in charge of Congress?

JAMES GRANT: I’m in charge of Congress.

CONSUELO MACK: I just reappointed.

DICK SYLLA: I know that if Ron Paul had become President, Jim Grant was going to be his candidate to be head of the Federal Reserve.

CONSUELO MACK: So I understand, unbeknownst to Jim, he found that out later that he was going to be the Fed Chairman under Ron Paul.

JAMES GRANT: Well, it apparently didn’t happen.

CONSUELO MACK: No, I guess it didn’t.

DICK SYLLA: I think the Fed, you know, it defines price stability as the consumer price index basically.

CONSUELO MACK: Which gets changed all the time.

DICK SYLLA: It gets changes all the time, and there hasn’t been a whole lot of inflation in the consumer price index in recent years. The Fed, by what it’s trying to do, it could say that it did a very good job, but Jim mentioned there are some other prices in the economy, like Wall Street’s prices, like the stock market and interest rates. The Fed seems to have, I think almost deliberately trying to push the stock market up. I mean, I’ve watched this stuff for 40, 50 years now, and this is the first time in my memory when it seemed to be official U.S. government policy that the stock market goes up, and the Fed likes this because it thinks that when the stock market goes up, people who own stocks feel richer. They’ll go out and spend more money, and the unemployment rate will come down.

JAMES GRANT: The portfolio of balance channel, I think, Dick, is the phrase you’re looking for.

DICK SYLLA: That’s right.

CONSUELO MACK: Well, so a former Fed official said that he calls quantitative easing the biggest backdoor bailout of Wall Street of all time. Would you agree with that?

DICK SYLLA: Well, there’s some truth in it, because whenever last…

CONSUELO MACK: You don’t agree.

JAMES GRANT: It’s front door.

CONSUELO MACK: We’re going to have to leave it there, but thank you so much and, if I had the power, I would appoint both of you, a committee to be in charge of Congress to redefine and perhaps recharter the Fed but, Dick Sylla, it’s so great to have you here from NYU Stern School of Business and Jim Grant from Grant’s Interest Rate Observer. Thanks so much for joining us.

JAMES GRANT: Thank you, Consuelo.

DICK SYLLA: Thanks.

CONSUELO MACK: At the close of every WealthTrack, we try to give you one suggestion to help you build and protect your wealth over the long term. This week’s Action Point is: Whether you agree with them or not, pay attention to what the Federal Reserve is saying.

Ever since 1978, when the Humphrey-Hawkins Act required the Chairman of the Fed to testify in front of Congress twice a year about its objectives and plans for monetary policy, the Fed has become increasingly more forthcoming. The Bernanke Fed has made a point of being more transparent as has Fed Chair nominee Janet Yellen. The Fed is arguably the world’s most powerful financial institution. It influences the economy and it moves markets. Understanding their thinking has never been easier. Just go to their website, federalreserve.gov and click on News & Events for their latest meeting minutes and commentary.

I hope you can join us next week. We will sit down for a rare interview with Great Investor Brian Rogers, long time portfolio manager of the T. Rowe Price Equity Income Fund, a consistent Morningstar favorite. In the meantime, to see more WealthTrack interviews and previous programs, just go to our website, wealthtrack.com. And for those of you on Facebook and Twitter, we look forward to connecting with you. In the meantime, have a Merry Christmas and make the week ahead a joyous, profitable and productive one.

 

ED HYMAN & BILL MILLER – PART I – INVESTMENT LEGENDS’ PREDICTIONS FOR 2014 – Transcript 1/10/2014 #1029

January 27, 2014

CONSUELO MACK:  This week on WealthTrack: Two financial champions were firing on all cylinders in 2013. What’s their plan to finish in the winners’ circle again this year? Wall Street’s reigning king of economists Ed Hyman joins investment legend Bill Miller next on Consuelo Mack WealthTrack.

Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack. What kind of a year will 2014 turn out to be? Which economies will thrive and which will falter? Where will money be made and lost?  We have two financial superstars with us to answer those questions and they will be with us for the next two editions of WealthTrack.

One has been an exclusive television guest here every year since our launch nine years ago. He is Ed Hyman, Chairman of independent institutional research firm, ISI Group. Inc. Ed has been ranked Wall Street’s number one economist by institutional investors for an unprecedented 34 years in a row. Continue Reading »

BRIAN ROGERS – NOTHING IS CHEAP – Transcript 12/27/2013 #1027

January 27, 2014

CONSUELO MACK:   This week on WealthTrack while the weather outside is frosty this week’s Great Investor guest says the market is frothy! T. Rowe Price’s Brian Rogers warns the Bitcoin, IPO and social media crazes are possible signs of market storms ahead, next on Consuelo Mack WealthTrack.    

 

Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack. One of my favorite images of 2013 comes to us courtesy of last week’s guest, Jim Grant of Grant’s Interest Rate Observer and his art director artist, John McCarthy. Instead of Uncle Sam commanding citizens to enlist in the army in World War One and Two this cartoon portrays Uncle Ben Bernanke directing us to invest in the U.S. stock market.  The Fed’s unprecedented stimulus policies including buying hundreds of billions of dollars of bonds, even with the start of tapering, and keeping short term interest rates near zero for five years  have certainly helped boost the appeal of stocks compared to bonds and other interest bearing investments.

 

All financial things considered, the year has been a good one for most investors. The U.S. stock market has been strong, small company stocks in particular have been outstanding performers. The economy is recovering, resuming its leadership role as an engine of world growth. As the independent research firm, Cornerstone Macro, told clients recently: The energy and manufacturing renaissance is continuing.  U.S. industrial production is at record highs. Unemployment has dropped to a five-year low and inflation remains contained. Even Washington has gotten its act together in a couple of  areas- for the first time in years Congress and the Senate reached and passed a budget deal, avoiding a shutdown and scaling back mandated sequester cuts. And the budget deficit is shrinking to 4%. All proving once again that miracles can happen!

 

This week’s guest wears many hats that give him both a global macro view and a micro one. He is Great Investor Brian Rogers, Chairman of the highly respected investment and asset management firm T. Rowe Price as well as its Chief Investment Officer and the longtime manager of the T. Rowe Price Equity Income Fund which he has shepherded since its 1985 launch.. A Morningstar favorite, the fund has delivered consistent category beating returns over the years with less volatility than the market. I began the interview by asking Rogers why he is more confident about the state of the world than he has been since the financial crisis.

BRIAN ROGERS:  I think it’s primarily because the world is a safer place financially today than it was four or five years ago. When you think of what’s transpired over the last four or five years, how global economies have slowly recovered from the ’08, ’09 downturn, how the global financial system is in such stronger position today than it was, markets have rebounded strongly since 2009 obviously. That can be a good or a bad thing for investors, by the way. It’s been a good thing.  It begs the question what it will be prospectively, but I think economic growth, I think the whole financial crisis is well behind us, and I think investors and the global financial system are both in better places.

 

CONSUELO MACK:   So let’s talk about what you said. It could be a good thing and a bad thing. It certainly has been a great thing that the markets have rebounded as much as they have since the lows of 2009. However, looking at what you’ve been telling clients, I’m going to quote T. Rowe Price. “Risk reward is more balanced, and we should be risk aware.” What do you mean by risk aware? What are the risks that we should be aware of?

 

BRIAN ROGERS:   Well, Consuelo, I think what that all means is that prices are up a lot since the bottom, and so it’s not uncommon to find stock market indices up 150, 160 percent since 2009, ditto on the bond market. So if you’re a high-yield bond investor, you’ve made almost as much money as you have in equities, and what risk aware really means is be sensitive to risk after prices have appreciated. Be aware of the risk you’re taking when you make a new investment, because valuations are higher. The global financial backdrop is much better as we briefly mentioned, but with higher prices come higher risk, and so that’s what we’re saying when we say be a little bit more risk aware than you’ve been over the last five years.

 

CONSUELO MACK:   Okay, because I think certainly most of us have been, you know, frightened over the last five years, because there seemed to be so many risks. So there’s kind of a more complacency now in the market, and that’s a risk in and of itself. Right?

 

BRIAN ROGERS: Oh, without doubt.  I think you always make more money when you’re terrified, and to the extent we were all terrified back in 2008 and 2009, we had a great subsequent five-year period. Now the backdrop is better. Financial conditions are more appealing. Investors, I think without doubt, are a little bit more complacent today, and I think that’s something that you have to be wary of.

 

CONSUELO MACK:  So another thing that T. Rowe Price has said in a recent presentation to clients was that investors are finally, U.S. investors especially, are finally rotating back into stocks after fleeing them, but they may too late is what T. Rowe Price said.

 

BRIAN ROGERS: Well, yeah.

 

CONSUELO MACK: Is it too late to get into the market?

 

BRIAN ROGERS: No, I don’t think so. I think it depends on what you invest in and what you buy. I think the great rotation has been a mild rotation. To me it hasn’t been a great rotation thus far, so the money moving from fixed income funds to equity funds has been a slow but steady pattern, and I think that’s probably a good thing for the long term. I think when you think about prices being higher, it just puts a burden on the investor to make better decisions. So a company that in 2009 might have been selling at 10 times earnings, in today’s world might be selling at 15 times earnings.  Now, that doesn’t mean buying a company at 15 times earnings or, for that matter, 18 or 20 times earnings will be a bad investment, but it simply means that your return expectations have to be tempered, and you might not be making 15 or 20% a year in an investment prospectively. You might be making five to ten percent a year, and so you have to really temper your expectations and have more realistic assessment when you’re buying stocks at higher valuation levels.

 

CONSUELO MACK:  One of the themes that you’ve been talking to clients about is… And I love this. This title is what if nothing is cheap. So my first question to you, is nothing cheap right now, kind of looking at all of your investment choices and the different asset classes that you oversee as a Chief Investment Officer at T. Rowe Price. Is nothing cheap?

BRIAN ROGERS: Well, very few things are cheap. Consuelo, when you look around the world, I always start with the fixed income markets, because there is a predictability of returns in fixed income. If you buy…

 

CONSUELO MACK: From the income.

 

BRIAN ROGERS: If you buy the 10-year Treasury, you know over 10 years you will make today 2.8 percent a year.

 

CONSUELO MACK: Right, and you’ll get your money back if you hold to maturity.

 

BRIAN ROGERS: And you get your money back. We won’t talk about reinvestment risk and all that, but you know your return will basically be 2.8%a year. When you think about equities, again equities at 15 or 16 times earnings in the U.S., after the type of rebound we’ve had since 2009, many studies would suggest that you might earn between five and ten percent, maybe six, seven, eight percent a year over the next few years.

 

CONSUELO MACK: Right, versus what you’ve been making which is definitely double-digits over last five years.

 

BRIAN ROGERS: Over the last five years, yeah, compared to the long-term average of nine or ten percent. When you look around the world, there are different markets, so lots going on at different parts of the world. The global fixed income markets, I would say the prospective returns are similar to those of the U.S. which means modest, and I think in different equity markets, I think there’s all sorts of exciting stuff going on in Japan. A big question about Europe’s recovery, how sustainable it is, and then you have investing in emerging markets which has been a tricky place for the last couple years and an area where I think there’s pretty good opportunity over the next few. So if you think about that 2.8% starting fixed income return, as an investor you have to ask yourself, are you willing to take the risk of investing in equities to try to earn that five to ten percent?  And if you take the midpoint of that five to ten and say your expected return from the equity market might be seven, seven and a half, is that enough to compensate you for the risk of volatility relative to that 2.8%?

 

CONSUELO MACK: So is it?

 

BRIAN ROGERS: I think the answer’s yes, but I think again you just have to be a little bit more careful. You can’t indiscriminately throw money into the equity market and hope to make 15 or 20 percent a year. You just have to be more careful.

 

CONSUELO MACK: I don’t want to leave the fixed income market right away, because I guess 21 percent of T. Rowe Price’s assets under management are in U.S. bonds, I think fixed income. So how risky are bonds? I mean, what’s your advice to investors who want that certain return, and it’s kind of a non-correlated asset. It’s a balance in your portfolio. It gives you income. How risky are bonds?

 

BRIAN ROGERS:   I think bonds are fairly risky now, Consuelo, and you don’t think of bonds as being risky, but most people don’t anyway, but it feels as though from the starting yield levels and given how at some point the Fed is going to cut back on its asset purchases… And I don’t even worrying about tapering anymore. I mean, if I were the chair of the Fed, I would have begun to taper a long time ago, because I think we’re in a good economic recovery now, and the Fed doesn’t have to be acting quite the way it is, but when you get into duration math which is something I’m reluctant to do on your show, and you think of the risk in fixed income investment if rates increase, you could easily have very low single-digit returns or negative returns in the fixed income market over the next couple years.

 

CONSUELO MACK: So your advice there for a strategy, again, from the Chief Investment Officer of T. Rowe Price as far as bonds are is to what?  Shorten your maturities.

 

BRIAN ROGERS: Shorten your maturities, shorten your duration.

 

CONSUELO MACK: You’ve got about $30 billion in assets under management now at the T. Rowe Price Equity Income Fund. The yield is under two percent. You’ve had a really good year in 2013. Historically you look for undervalued dividend payers, so is there any such animal now as an undervalued dividend payer?

 

BRIAN ROGERS:  No, I think there are, but I think it’s so much harder. Every day when I look at my portfolio, I think there are so many more things to sell than to buy, and I think that often takes place at times after markets have appreciated. So I think there are interesting things to do, but I think they are much fewer in number. We’ve raised our cash a little bit over the last couple of quarters.

 

CONSUELO MACK: To?

 

BRIAN ROGERS: To almost seven percent which isn’t too high, but it’s the direction of the movement that’s important. There are very few signs of equity market stress where you can really capitalize on uncertainty and be a contrarian today, and so I think that’s the value investor’s challenge in today’s world.

 

CONSUELO MACK: So what’s your overall strategy? What kind of companies are you holding?  What kind of returns are you expecting?

 

BRIAN ROGERS: Consuelo, what we’re focused on right now are companies that have lagged the market over the last couple of years and consequently are inexpensive because of that.  So there aren’t many of those, by the way, so in today’s world, if a company is flat in 2013 and has a P/E of 10 or 11 or 12 and a dividend yield of three percent or something, you know, that’s a pretty interesting investment opportunity to us, and we can talked about some specifics if you’d like, but there aren’t many. There really aren’t many and, again, I come to work every day, and I look at some of the holdings we’ve had that have been really successful investments, and they’re great companies, but their valuations are less appealing, and their dividend yields have declined as prices have increased, and so these are really like benchmark blue chip American companies.

 

CONSUELO MACK: Such as…

 

BRIAN ROGERS: Such as like 3M, American Express, you know, fine companies, and we’re not selling because we don’t like the company. It’s because we’re less attracted to the stock price, and we always try to make that distinction between company quality, management performance, long-term return potential and today’s valuation, and we try to balance those couple of things out.

 

CONSUELO MACK: Is dividend growth a big part of the strategy? So you’re talking about total returns as opposed to what’s going on in the market, per se, or…?

 

BRIAN ROGERS: I think the perfect company for us, Consuelo, is a company that has a decent dividend yield today and can continue to grow that dividend over the long term.

 

CONSUELO MACK: Right, so give us some examples of companies that, if I were to look at the Equity Income Fund, you know, these are the kind of companies that you have always had for the last 18 years in the portfolio that represent the kind of companies that you want in the fund.

 

BRIAN ROGERS: Well, you know, over the last since ’85, we actually have a couple of the same companies in the portfolio for that whole period. One would be J. P. Morgan Chase and its predecessor companies. Another would be Exxon Mobil which way back when was just Exxon.   We’ve had an investment in Johnson & Johnson for many years. Those would be three that I would point to which have had a great track record of creating value for investors, have had really good dividend performance over the long term, and the stocks have done very well over the long term admittedly with big ups and downs in the short term.

 

CONSUELO MACK: Right. Talk about J. P. Morgan Chase, with what’s going on now with Dodd-Frank, with the Volcker Rule, the various governments around the world are arrayed against the banks. They want to rein them in, and J. P. Morgan Chase, Jamie Dimon seems to have a huge target on his chest. So what do you do in a situation like that where a company is really under tremendous regulatory pressure, and they’re being fined billions of dollars it seems like every other day?

 

BRIAN ROGERS:  Well, I think it’s probably a testimony to J. P. Morgan Chase’s strength that with all the fines and all the controversy, how well the stock’s done and how well the company’s done from an earnings and growth standpoint over the last one, three, five and ten years, and it’s done a fine job navigating its way through the crisis. I view what’s happened regulatoraly and politically as being grossly unfair to some of these companies and not just to J. P. Morgan Chase but to Bank of America and a number of financial services companies.

 

CONSUELO MACK:  So why?  Because the other side of… The critics of the banks would say, “Look, they got us into the mess of the financial crisis, and they made a ton of money and basically we can’t let them get in a situation where the taxpayers have to bail them out again.” That’s what the other side is saying.  So what’s your response to that?

 

BRIAN ROGERS:  Well, I think the blame for the financial crisis, Consuelo, can really be spread around to a number of people. I mean, there was bad lender behavior, appraiser behavior, mortgage originator behavior, Wall Street financial engineer behavior. There was a lot of bad behavior. There was bad political behavior, back to some of the incentives designed to spread home ownership to everybody and, in some cases, folks couldn’t afford it.  So I think there’s plenty of blame for the financial crisis. When I think specifically of J. P. Morgan Chase, and I view the role that they played in helping us get through the financial crisis in terms of the Bear Stearns transaction, the Washington Mutual transaction, those were major institutions that almost took us over the brink.

 

CONSUELO MACK: Right, and the government basically said you’ve got to take these things over.

 

BRIAN ROGERS: That’s why I view unjust as an applicable term here.

 

CONSUELO MACK: All right. So looking at the changes in the regulatory environment for a J. P. Morgan Chase, for instance, I mean, how different is the business model going to be, and how profitable is it going to be in the future?

 

BRIAN ROGERS:  Well, I think profitability will be impaired by some of the regulatory change. I think the basic business will not really be affected. I think all of these companies will have to hold more capital which is probably a good thing, and one of the reasons I think the global financial system is in much better condition today is because the leading financial institutions have much more liquidity and much more capital.  So if there is another market crisis in the next couple years, it probably won’t be because the residential mortgage sector took us over the brink. It will be something else, and so I think the companies have been healing. I mean, they’re good corporate actors. They care about their investors, and I think that’s an important thing to keep in mind.

 

CONSUELO MACK:  So a company that might surprise one if you’re looking at an equity income and the kind of track record that you have is Apple, and it was noted by Morningstar in a report I think that while the growth managers at T. Rowe Price were selling Apple, that the more value-oriented managers such as yourself were buying Apple. So talk to us a little bit about Apple.

 

BRIAN ROGERS:  Well, Apple was a company about a year ago under a lot of pressure, and Apple had been a great performer for many years, and really towards the end of 2012 into early 2013 the bloom really began to fall of the rose, and the stock weakened sharply over the course of the first half of 2013, and we looked at it in the springtime and thought, okay, the stock has gone from 700 to 400 roughly. The P/E multiple is now 10. They’re buying back stock at a frantic pace. They have a nice three percent dividend yield, and there’s a lot of investor controversy, and we love trying to identify controversy and to ascertain whether or not we can benefit  from really what’s a short-term panic, and so we looked at Apple in the springtime. I thought, you know, the stock’s way down. The valuation appeal is pretty high. It’s a yield stock which Apple had never really been, and so we made an investment in the springtime in Apple, and it’s rebounded since. So we’re always looking for companies like that that have struggled, where there’s uncertainty, where the investor concern creates a valuation opportunity, and there are a lot of things going on like that today. I think mean, even simple electric utilities now are very much out of favor.

 

CONSUELO MACK:  They are. I mean, it’s so funny because you had mentioned to me earlier that telecom and utilities were where you’re looking, and if I look at just about every major brokerage firm, they’re saying, you know, sell, underweight telecom and utilities, and you’re looking at them.

 

BRIAN ROGERS:  Well, the stocks are basically up a little bit to down over the last year, and because of that and because of the fact everything else is up 20 or 30%, all of a sudden in a relative sense they look pretty inexpensive. So whether it’s Entergy which is kind of an electric utility in the Gulf Coast region or even plain old-fashioned Ma Bell, AT&T with a five plus percent dividend yield, having lagged everything for the last 18 months price-wise. Both those look as relatively safe, risk-aware investments for the investor who wants exposure, who’s looking for dividend income but who does not want to take on too much risk.

 

CONSUELO MACK: You mentioned emerging markets earlier in the interview, so talk to us about what you’re seeing as opportunities in the emerging markets,

 

BRIAN ROGERS:  Well, as a sector, the emerging markets sell about 10 times earnings, so when you look at European valuations or U.S valuations, that’s probably a five multiple point difference.  The cash flows coming out of the sector have been large, so investors are moving in the opposite direction, perhaps not unlike investors selling Apple, and sentiment is pretty negative, and the fundamentals are, over the long term, ought to continue to be pretty good, and so many of the emerging market country governments are in better shape than some of the developed market governments.

 

CONSUELO MACK: Oh, absolutely. Their investment grade

.

BRIAN ROGERS:  Their investment grade, and population growth is high. The demographics are good, and I think over a five or ten-year period from here, they’ll present very interesting opportunities. So valuation is attractive. Sentiment is bad. Institutions have been moving out, and I think over a long-term period, I think it’s a very interesting area to explore.

 

CONSUELO MACK: So you’re talking about both stocks and bonds.

 

BRIAN ROGERS:  Oh, I think primarily equities.

CONSUELO MACK: Primarily equities.

 

BRIAN ROGERS:  Because from equities you will benefit from that long-term demographic growth case.

 

CONSUELO MACK: You also mentioned Japan.

 

BRIAN ROGERS:   Well, Japan is one of those markets and economies.Had I been a global strategist, I would have called for the turn in Japan 10 years ago. That would have been, what, 10 or 12 years into the big Japanese bear market.

 

CONSUELO MACK:  Right, exactly.

 

BRIAN ROGERS:  And so it took 20 years, not 10 years for Japan to really turn. And I just think there’s a lot of pent-up potential in Japan. It’s been a great market this year, and I think you can’t correct 20 years of underperformance and a 20-year bear market generally with one year of rebound, and I suspect over the next couple of years the Japanese market will be a very interesting and continuously rewarding place, and I think we’re probably in the second or third inning there, so I think it’s an area investors should focus on or pay attention to and try to capitalize on it if possible.

 

CONSUELO MACK: Talk about constant surprises in the financial markets. Who would have thunk that Japan would be a very interesting place, exciting place to invest.

 

CONSUELO MACK: One Investment for a long-term diversified portfolio, what would your choice be?

 

BRIAN ROGERS:  Consuelo, there are so many great ones.

 

CONSUELO MACK: I was going to say, how many companies do you have in your portfolio as it is?

 

BRIAN ROGERS:  Right now we have investments in roughly 115 companies.

 

CONSUELO MACK:  Right, and I’m asking you to choose your… Right.

 

BRIAN ROGERS:  I think one really interesting idea for the long-term is Deere.

 

CONSUELO MACK:  Really.

 

BRIAN ROGERS:  And Deere is a stock that, not unlike some of the utility stocks or telecommunication companies, is down this year. In response to that price weakness, they announced a buyback of about 25 percent of the company. Great dividend history, two and a half percent, maybe a little bit less than a two and a half percent dividend yield right now, and when you say long term, buy and hold, don’t worry about, I think in 10, 20, 30, 40, 50 years, Deere will still be making the equipment that feeds the world. And when you say one for the long term, I think the company will be… It’s been around for a long time. It’s going to be around for a long time. It’s under performed.  It’s inexpensive. It’s a really high-quality company, great source of income, great source of benefiting from capital allocation and a unique franchise globally.

 

CONSUELO MACK:   And I have one final question for you. You and I had talked earlier about that one of the things you’re watching are the pockets of craziness in the market and what’s that telling you. So talk about a couple of the pockets of craziness. Bitcoins, for instance, I know are one.

 

BRIAN ROGERS:   Yeah, Bitcoin is absolutely crazy, absolutely crazy. I think there is a little bit of froth in the IPO market.

 

CONSUELO MACK: Initial public offerings

BRIAN ROGERS:  A lot of things coming to market. I think the way certain what I will call new age or social network companies are being valued is I’d call it a yellow flashing warning as opposed to a red stoplight like we saw in 2000 at the height of the dot com bubble. I think there are warning signs there, and I think investors would be prudent to pay attention to. The whole Bitcoin thing, I mean, you have to have a currency that is geared to or based on something and not simply a Greater Fool, Tulip Mania kind of concept here, because the last time I checked there was no real economy or series of gold bars or central bank supporting a virtual electronic currency, and so if I were an investor, I would steer clear of that.  If I were a regulator, I would pay an awful lot of attention to what’s going on there.

 

CONSUELO MACK: And again, it’s telling you that those are flashing lights of frothiness that…

BRIAN ROGERS:  Yeah, I think the whole Bitcoin market is like a 10 or 12 billion dollar market I think, so it’s very small, but I think that type of behavior, that type of very aggressive investor behavior, speculative behavior never happens at the bottom.

 

CONSUELO MACK: So Brian Rogers, it’s such a treat to have you here on WealthTrack. We appreciate it so much, chairman, CIO and portfolio manager of T. Rowe Price. Thanks very much for being here.

 

BRIAN ROGERS:  Consuelo, great to be with you.

CONSUELO MACK:   At the close of every WealthTrack we try to give you one suggestion to help you build and protect your wealth over the long term. This week’s Action Point is: Consider rebalancing your portfolio.  The vast majority of the great investors we talk to, Brian Rogers included, periodically trim their winners when they become overvalued by their metrics and add to their laggards when undervalued. The practice applies to individual securities, as well as asset classes, mutual funds and ETFs. Since the market bottom in 2009 and more recently as well, U.S. stocks have been the global winners, small company stocks in particular, so consider trimming there.  Whereas emerging market stocks have lagged, time to potentially add there. In the bond universe consider trimming some top performing high yield bonds and shifting to some much shorter maturity treasury notes and T-bills for safety and stability, and tip toeing into high quality emerging market government and corporate bonds for long term appreciation and diversification.

 

I hope you can join us next week for a WealthTrack television first:  Two top value investors Wally Weitz and Tom Russo sit down together to talk about their very different portfolios and their mutual hero Warren Buffet. Also on our website Extra feature we will continue our conversation with Brian Rogers and ask him what worries him most in the markets. For those of you connecting with us on Facebook and Twitter keep communicating with us. In the meantime, have a great weekend and a very happy New Year celebration. We look forward to helping you make it a profitable and a productive 2014!

JAMES GRANT & RICHARD SYLLA: THE GREAT FED DEBATE! – Transcript 12/20/2013 #1026

January 27, 2014

CONSUELO MACK: This week on WealthTrack as the Federal Reserve celebrates its 100th birthday, is it a cause for rejoicing or despair? Two financial historians, NYU’s Richard Sylla and Grant’s Interest Rate Observer’s James Grant debate the case for lighting candles or snuffing them out- next on Consuelo Mack WealthTrack.

Hello and welcome to this special edition of WealthTrack, I’m Consuelo Mack. What is the proper role of a central bank? Can any institution prevent or control the booms or busts that dynamic market-based economies produce? Can they control interest rates and inflation, or insure robust employment? Should they try to?

Those are questions being raised anew as the Federal Reserve officially marks its one hundredth anniversary. On December 23rd, 1913, President Woodrow Wilson signed the Federal Reserve Act into law. As the current Federal Reserve describes it: “the Federal Reserve Act stood as a classic example of compromise- a decentralized central bank that balanced the competing interests of private banks and populist sentiment.” That rivalry and tension between private financial interests and populist sentiment is alive and well today and has been with us since earliest days of the republic.

Prior to 1913, populist forces killed two attempts to establish a permanent central bank. The nation’s business was financed by state banks, but it was also disrupted by a series of financial crisis and bank runs. Financier and banker JP Morgan had to come to the rescue twice- first in the banking panic and depression of 1893 and again in the banking crisis of 1907.

Calls for reform of the banking system became widespread. It took years of debate before the Federal Reserve Act of 1913 was signed by President Wilson, creating a decentralized system of 12 reserve banks with branches around the country and independent decision-making powers.

It wasn’t until the 1920s that the buying and selling of Treasury securities was coordinated as a monetary tool to influence the availability of credit.  Even so, the new Federal Reserve system didn’t seem to have much effect on the market crash of 1929 or the Great Depression that followed. Thousands of banks and businesses failed and one in four Americans was out of work.

In response, President Franklin Delano Roosevelt’s New Deal brought big changes to the financial system and the Federal Reserve. One of the biggest, the Glass-Steagall Act of 1933 separated commercial banking and investment banking and gave the Fed authority to supervise multi-bank holding companies.

The Banking Act of 1935 changed the Fed’s structure by establishing the Federal Open Market Committee as a separate legal entity and removing the Treasury Secretary and the Comptroller of the Currency from the Fed’s governing board. But it wasn’t until the 1951 Treasury-Fed Accord that the Fed gained the independence to pursue monetary policy on its own.

Meanwhile the Fed’s duties continued to expand. The 1977 Community Reinvestment Act required the Fed to ensure banks lent to low and moderate-income individuals. And the Federal Reserve Act of 1977 codified the Fed’s dual mandate of stable prices and maximum employment.

The Fed has been widely blamed for the double-digit inflation of the 1970s. But starting in 1979, the new Fed Chairman, Paul Volcker, took on the role of the nation’s number one inflation fighter, hiking interest rates to restrict credit and cut off inflation. His painful, recession-inducing strategy succeeded in killing inflation. His successor, Alan Greenspan, continued to use monetary policy to “serve as a source of liquidity to support the economic and financial system” from the market crash of 1987, the bursting of the tech bubble and the terrorist attacks of 9/11.

But it wasn’t 9/11 that revolutionized the Fed’s role. It was the subprime mortgage bubble, which morphed into a global financial crisis in 2008. Under Fed Chairman Ben Bernanke, the Fed invoked emergency authority to launch a series of new programs and assistance packages to rescue global financial markets and economies. The Fed also slashed short term interest rates to record lows in 2008 and have kept them there ever since. Nearly four trillion dollars of stimulus later, the Fed continues its activist role. In the words of Ben Bernanke, the Fed has “come full circle back to the original goal of preventing financial panics.”

Should that be the Fed’s goal and can it really succeed in doing it? Joining us are two WealthTrack favorites, each a respected financial historian and author.

James Grant is the Editor of Grant’s Interest Rate Observer, a twice monthly, self-described “independent, value-oriented and contrary minded journal of the financial markets” that is considered to be a must read by many institutional investors. He is a vocal critic of current Fed policy.

Richard Sylla is the Henry Kaufman Professor of the History of Financial Institutions and Markets and Professor of Economics, Entrepreneurship, and Innovation at the New York University Stern School of Business.

I began the interview by asking them to go back to basics: what is the role of a central bank?

JAMES GRANT: Well, one might start with the role that was assigned in legislation 100 years ago. It was to lend against sound collateral. It was to create a market in commercial paper, meaning business loans. It was to furnish so-called elastic currency and it has to be a lender of last resort, and that was it. Oh, yes. They added “and for other purposes” and we have all too many of the other purposes, but my suggestion is the Fed think more about the roles for which it was created rather than the ones it has arrogated to itself.

CONSUELO MACK: Dick?

DICK SYLLA: Since the 1970s, the Federal Reserve has had the obligation to stabilize the price level. That was there for a long time, but an added obligation was to generate high levels of employment, and so this is called the dual mandate. The Fed had a dual mandate. We talked for the last 30 years about the dual mandate of the Fed. The Dodd-Frank Act of 2010, I think, added another item. The Fed is not only supposed to stabilize the price level and give us the maximum amount of employment, but it’s also to foster financial stability. So the Fed now has those three things to do.

CONSUELO MACK: So my question, though, is what do you think the role should be?  We know there’s this long litany of ever-expansive roles that it has, so…

JAMES GRANT: Well, Dick has just told us what it can’t do.

CONSUELO MACK: …would you say that was one of the original goals?

DICK SYLLA: Yeah, I think traditionally a central bank was responsible for stable prices, and that happens to be what they might be pretty good at. Most economists, I’m one, think that the Federal Reserve actually has the power, the tools to stabilize the price level. There’s a lot of evidence in favor of that. It’s much less certain that they can do much to change the unemployment rate, reduce the unemployment rate.

JAMES GRANT: See, the Fed has got into its head that it can improve the future before it comes to pass. The Fed has morphed from central banking into kind of a seat of the pants central planning. It has these models don’t you know, very, very complex, a lot of differential equations. They don’t work, but they do give the Fed the seeming intellectual authority to do so many things that common sense would tell you that simply the Fed cannot do.

For example, the Fed now is in the business of manipulating the structure of interest rates. It is in the business of suppressing some interest rates, and new thing, it is in the business of talking up the stock market. In other words, Dick mentioned stabilizing prices. The Fed is manipulating prices, especially on Wall Street. It’s a very new thing.

CONSUELO MACK: Has it been an effective price stabilizer? And stabilizing prices I’m assuming means that they don’t go up or down too much.

DICK SYLLA: I would say in the long run the Fed has not really been all that effective, because the 20th century was a three percent inflation century. You know, there was some low inflation, some very high inflation, but you can compare it with the previous period of the 19th century when prices in 1914 were not very different from what they were in 1815 according to pricing. So the 19th century was a zero inflation century without the Federal Reserve. When the Fed came in, we had basically a three percent inflation trend ever since then, but I don’t think we can entirely blame that on the Fed. There was something called World War I. There was something called World War II, and…

CONSUELO MACK: The Korean War, The Great Society Program.

DICK SYLLA: Yeah, and if you look back at those periods, it turns out the Federal Reserve was sort of conscripted to be part of the government’s financing machine, and the Secretary of the Treasury told the Fed what to do. In World War I, it was to lend a lot of money to banks so they could buy first liberty bonds and then victory bonds.  In World War II, the Secretary of the Treasury commanded the Fed to keep the interest rates no higher than two and a half percent on long-term bonds and three eighths of one percent on a Treasury bill, and so the Fed was told what to do.  We did not have an independent central bank. So I’m saying there’s…

CONSUELO MACK: Until 1951. Right.

DICK SYLLA: 1951. Then the Fed was freed from the control of the Treasury but, of course, the worst inflation we had was from 1965 or ’66 through 1981, which ended up with double-digit inflation in ’79 to ’81, and the Fed had a lot to do with that inflation. It was using the wrong models. Jim talked about the Fed uses the wrong models. I think they were definitely using the wrong models in the 1970s. Then Paul Volcker came in. He knew what to do, and he’s become sort of an American hero since that time, and 30 years after he whipped inflation, now he has his Volcker Rule passed.

CONSUELO MACK: So Jim, would you give the Fed the role of stabilizing prices?  Is that a fair role to give?

JAMES GRANT: No, no. Prices ought to be determined, it seems to me, through what they call future price discovery; that is to say, the unplanned and unmanipulated dynamics of free people making choices in the marketplace. You know, the time of terrific technological progress one would expect the general price level to kind of dwindle, because every day lower and lower prices is how Wal-Mart’s made a pretty good business about that. Prices dwindled a percent or so a year, one and a half percent or so a year in the last quarter of the 19th century. People kind of liked that. They regarded it as a sign not of deflation but of progress.

Now we have a Fed that wants us to know that prices must not go down. Well, in order to assure the prices don’t go down, the Fed creates lots and lots of credit that creates lots and lots of distortions, some of which end up from time to time in crises. This price stability is a very glib thing to say. It sounds very, very… it sounds commonsensical off of the tongue but it is, in fact, not so.

CONSUELO MACK: So I guess the issue is, can any institution really in an economy such as ours and in a world that we live in which is so dynamic, really be chartered…?

JAMES GRANT: Well, no.  If it could, the Soviet Union would still be in business. The idea of the humble but wonderful institution of the price mechanism, the price system, is it is what makes free economies work. It’s how work is measured and how goods are allocated. It’s a pretty cool system, and the Fed without an explanation really why is interposing itself between that system and us.

CONSUELO MACK: If you talk to most people on Wall Street and in the country, they feel that without the Fed, we would have had financial Armageddon. So Dick, I mean, does the Fed have a role in what Bernanke is saying, is to prevent financial panics?

DICK SYLLA: Well, Jim mentioned that one of the obligations of the Fed traditionally… and this is not just the Fed but central banking history going back to an Englishman named Bagehot, I would even say back to Alexander Hamilton… the central bank should come to the aid of the market in a crisis. Crisis is typically when almost nobody wants to lend to anyone else, so a central bank, when nobody wants to lend to anyone else, the central bank is supposed to keep lending on good collateral at a high rate of interest. You know, recently the Fed lent on dodgy collateral at a low rate of interest, so that’s a corollary I guess to the old rule.

JAMES GRANT: Also to solvent institutions.

DICK SYLLA: To solvent institutions, right.

JAMES GRANT: Violated their own…

DICK SYLLA: …but if you bring in collateral, whether you’re solvent or not, at least the Fed … if the collateral is good, then you can make the loan. So I think the Fed, you know, I think we do need it. Most people say we need a central bank to act as a lender of last resort. That’s the term, end of crisis.

CONSUELO MACK: So would you give the central bank that, Jim, that we do need a central bank that is the lender of last resort?

JAMES GRANT: We don’t need one. We can have one that will do less harm if it sticks to that kind of business, but the trouble is the Fed- this is a trend that’s been in operation over the decades- the Fed has presided over the decay of finance, and it has presided over the degradation of the dollar. By decay of…

CONSUELO MACK: And how so?

JAMES GRANT: By decay of finance, I mean by the integrity of private financial institutions. An example, before 1935, say, the stockholders of a bank were responsible for the solvency of that institution. If the capital was impaired, if the bank went broke, the courts came after the stockholders for a capital call to restore the bank to working order. Now we have, of course, the FDIC. We have the socialization of credit. We have the sidewalk superintending of almost every detail of our financial lives, but notice that in 2008 almost every major financial institution, certainly in the city of New York, was functionally insolvent. Now, how did that happen?

I submit to you that finance and central banking are different than almost any other set of phenomena in modern life. Most things we see progress. We see cars work better. We don’t shave with a cutthroat razor anymore. We don’t use sextants at sea. Progress. Right? In banking, what we see is the cyclical insolvency, virtual or actual, of things like Citicorp. Right? We see retrogression in finance rather than progress, and I say that the retrogression can be laid at the feet of the Fed and of the regime behind it.

CONSUELO MACK: But how so? I mean, why is the Fed to blame basically for the problems that the banking industry had?

JAMES GRANT: Well, the Fed is the creation of a system of paper money and of socialized and subsidized credit. Now, Dick mentioned that the Fed was dragooned into financing the First and Second World War. Nobody ever quits from the Fed in protest or the outrage of being seconded or being dragooned by the government. Right? They just go along with it. Let the record show that Dick is laughing sympathetically at this.

CONSUELO MACK: So is the Fed responsible do you think, as Jim says it is, for the degradation of our currency, for the problems that we have with the mismanagement of the financial institutions and basically for the financial crisis? Was it a contributing factor to this global financial crisis that we’ve just experienced?

DICK SYLLA: Well, I think it was a contributing factor. I wouldn’t be quite so…

CONSUELO MACK: And how did it contribute, Dick? What’s your take on the problems that the Fed has created?

DICK SYLLA: Look over the economic financial history of the last 10 to 15 years. You know, we had a late 1990s dot-com bubble which sort of burst in 2000, and by 2001 the U.S. economy emerged into a recession. The Federal Reserve then pushed interest rates to very low levels and held them there for a couple of years, and that’s when the housing bubble began.

CONSUELO MACK: Right, and this was under Alan Greenspan.

DICK SYLLA: It was under Alan Greenspan, but Ben Bernanke was on the Federal Reserve Board then, and so we got this housing bubble going, and I think the problem isn’t the Fed’s monetary policy so much as its regulatory policy. I mean, it was not… the Fed is one of our regulators. Maybe one of our problems is we have too many regulators. We have the Commodity Futures Trading Commission, the FDIC …

JAMES GRANT: Six of them.

DICK SYLLA: … the Comptroller of the Currency, the Federal Reserve, and they sometimes…

CONSUELO MACK: And they’re all doing different things and ..

DICK SYLLA: Yeah.

JAMES GRANT: Or worse, the same thing.

DICK SYLLA: Or maybe somebody thinks, well, you know, this other person will regulate. This other agency will regulate, so I don’t have to, but in the end maybe none of them regulate as much as they should.

JAMES GRANT: But the city of London flourished for decades and decades without a bank failure and without a regulator. I mean, you can walk into Goldman Sachs and look around, and you’re never sure if the person you’re looking at, except by, I don’t know, maybe the color of his socks or something, is a federal employee or one of the paid help. These regulators swarm over these institutions, and still there’s “too big to fail” anxieties.  These anxieties are well founded. These institutions are leveraged, and they operate under the supposition that the government will be there in time of stress. So the apparently innocuous and indeed necessary idea of lender of last resort I say has become distorted such that the government is now guaranteeing underwriting risk that individuals ought to be bearing for themselves.

CONSUELO MACK: So another interesting development is that when the Fed in the Community Reinvestment Act, for instance, was given the job of making sure that banks lent more to low-income individuals and low-income communities, I mean, again it just seems that… but this is Congress, Dick. Right? The Fed’s roles are ever expanding. It’s given more and more oversight to do more and more, I mean, political things, in fact.

DICK SYLLA: Yes, well, we have to remember that the Federal Reserve is a creature of Congress. Congress created the Federal Reserve. Congress oversees the Federal Reserve. Congress asked the Federal Reserve to do all these things such as the Community Reinvestment Act. You know, you go out and make sure that banks lend to people who aren’t such good risks.

JAMES GRANT: You know, Consuelo, what…

CONSUELO MACK: So it’s not the Fed’s fault, Jim. It’s Congress’ fault. Right?

JAMES GRANT: Congress ought to pay more attention to its, as Dick said, creature. We have not really talked about the nature of the dollar of which the Fed is a steward. The dollar from Alexander Hamilton’s time until about Richard Nixon’s time was to find as a weight of something, that something being gold …

CONSUELO MACK: Gold.

JAMES GRANT: … mostly something silver, sometimes both. Since 1971, the dollar has been kind of faith-based. It has been a piece of paper. It’s been a concept to a degree, and now increasingly it is pixels, computer pixels. The Fed materializes these on computer screens, but in the absence of a definition of the dollar, the Fed can create as many of these things as it deems expedient, and its definition of expediency comes from its mathematical models which I attempted to lampoon into, smirk at earlier in the session.

CONSUELO MACK: But can you lay the blame for going off the gold standard at the Fed’s feet?

JAMES GRANT: No, no. The Fed was the agent of this, but still, we can still hate it for other reasons, Consuelo.

CONSUELO MACK: So if you had your druthers, Jim Grant, and you were in charge of Congress…

JAMES GRANT: Now we’re talking.

CONSUELO MACK: Yeah, so now we’re talking. So what would you do with the Fed?

JAMES GRANT: Well, I would recall the founding legislation. I would go back to that.  I’d read the founding legislation and let us reinvent this institution.

CONSUELO MACK: You mean the 1913 Federal Reserve Act? You wouldn’t go back to Alexander Hamilton and…

JAMES GRANT: I would at least go back to the founding legislation and ask whether we have made progress over these past 100 years. Now, every institution must adapt. Right? The United States Navy has missiles that John Paul Jones did not anticipate. The difference with money is that it is not physics. Right? Money is about human behavior, and we have let the would-be physicists, namely these mathematical economists, into running this institution behind their formula, behind their models, and Congress has let this happen. Congress ought to take this institution by the scruff of its neck and ask it, “What for Pete’s sake are you doing?” You materialize $2 trillion in the past like six or eight weeks. Are we sure that’s what we ought to be doing? You’re doing $85 billion a month, and the financial markets shudder at the prospect of them doing $84.5 billion a month. Is this the right way forward? At least let us ask some common sense questions.

CONSUELO MACK: Dick, what would you do if you were in charge of Congress?

JAMES GRANT: I’m in charge of Congress.

CONSUELO MACK: I just reappointed.

DICK SYLLA: I know that if Ron Paul had become President, Jim Grant was going to be his candidate to be head of the Federal Reserve.

CONSUELO MACK: So I understand, unbeknownst to Jim, he found that out later that he was going to be the Fed Chairman under Ron Paul.

JAMES GRANT: Well, it apparently didn’t happen.

CONSUELO MACK: No, I guess it didn’t.

DICK SYLLA: I think the Fed, you know, it defines price stability as the consumer price index basically.

CONSUELO MACK: Which gets changed all the time.

DICK SYLLA: It gets changes all the time, and there hasn’t been a whole lot of inflation in the consumer price index in recent years. The Fed, by what it’s trying to do, it could say that it did a very good job, but Jim mentioned there are some other prices in the economy, like Wall Street’s prices, like the stock market and interest rates. The Fed seems to have, I think almost deliberately trying to push the stock market up. I mean, I’ve watched this stuff for 40, 50 years now, and this is the first time in my memory when it seemed to be official U.S. government policy that the stock market goes up, and the Fed likes this because it thinks that when the stock market goes up, people who own stocks feel richer. They’ll go out and spend more money, and the unemployment rate will come down.

JAMES GRANT: The portfolio of balance channel, I think, Dick, is the phrase you’re looking for.

DICK SYLLA: That’s right.

CONSUELO MACK: Well, so a former Fed official said that he calls quantitative easing the biggest backdoor bailout of Wall Street of all time. Would you agree with that?

DICK SYLLA: Well, there’s some truth in it, because whenever last…

CONSUELO MACK: You don’t agree.

JAMES GRANT: It’s front door.

CONSUELO MACK: We’re going to have to leave it there, but thank you so much and, if I had the power, I would appoint both of you, a committee to be in charge of Congress to redefine and perhaps recharter the Fed but, Dick Sylla, it’s so great to have you here from NYU Stern School of Business and Jim Grant from Grant’s Interest Rate Observer. Thanks so much for joining us.

JAMES GRANT: Thank you, Consuelo.

DICK SYLLA: Thanks.

CONSUELO MACK: At the close of every WealthTrack, we try to give you one suggestion to help you build and protect your wealth over the long term. This week’s Action Point is: Whether you agree with them or not, pay attention to what the Federal Reserve is saying.

Ever since 1978, when the Humphrey-Hawkins Act required the Chairman of the Fed to testify in front of Congress twice a year about its objectives and plans for monetary policy, the Fed has become increasingly more forthcoming. The Bernanke Fed has made a point of being more transparent as has Fed Chair nominee Janet Yellen. The Fed is arguably the world’s most powerful financial institution. It influences the economy and it moves markets. Understanding their thinking has never been easier. Just go to their website, federalreserve.gov and click on News & Events for their latest meeting minutes and commentary.

I hope you can join us next week. We will sit down for a rare interview with Great Investor Brian Rogers, long time portfolio manager of the T. Rowe Price Equity Income Fund, a consistent Morningstar favorite. In the meantime, to see more WealthTrack interviews and previous programs, just go to our website, wealthtrack.com. And for those of you on Facebook and Twitter, we look forward to connecting with you. In the meantime, have a Merry Christmas and make the week ahead a joyous, profitable and productive one.

 

SEISMIC INVESTMENT SHIFT Transcript 10/11/2013 #1016

November 1, 2013

CONSUELO MACK: This week on WealthTrack, with the power of the Federal Reserve behind it, Gluskin Sheff’s influential economist, David Rosenberg predicts inflation is coming. What his big call means for investors is next on Consuelo Mack WealthTrack.

 

Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack. What has been one of the defining financial trends of the last three decades? We have covered it numerous times on WealthTrack, and no it’s not government shutdowns, although there have been 18 of them since 1977, including the most recent one. And it’s not the looming October 17th deadline for the federal debt ceiling limit. Congress has raised the debt limit 15 times in the last decade alone.  Probably the most significant economic development of the last 30 years has been the submission of inflation and the concomitant decline in interest rates.

Continue Reading »

Back to Top