Tag: James Grant

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.

 

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.

 

James Grant Transcript 09-28-12 #914

September 28, 2012

WEALTHTRACK Transcript 

#914- 9/28/12

 

CONSUELO MACK:  This week on WEALTHTRACK, financial historian and thought leader, James Grant, attacks the Fed’s policies of zero interest rates and massive purchases of treasury and mortgage bonds as dangerous to the economy and damaging to savers. Grant’s Interest Rate Observer’s James Grant is next on Consuelo Mack WEALTHTRACK.

 

Hello and welcome to this edition of WEALTHTRACK. I’m Consuelo Mack. Federal Reserve Chairman Ben Bernanke has been widely credited with playing a key role in saving the global financial system from spiraling into a deeper recession. As a recent Financial Times headline read, “Central Bank Action Lifts Gloom”; “Bold Fed and ECB Moves Cheer Investors- Confidence Increases in U.S. and Europe.” There is no question that the Fed and to a lesser degree the ECB, the European Central Bank, are pulling out all stops to boost economic growth, investor confidence, and stock returns, going far beyond what their critics maintain is their proper role. As this week’s guest, financial journalist and historian James Grant told me, “Central bankers have morphed into central planners.”

 

The Fed, unlike other central banks around the world, has a dual mandate. Starting in 1977, Congress stipulated that, similar to other banks, it is supposed to ensure price stability, i.e. keep inflation in check. More recently, the Fed has focused on preventing deflation and has said its targeted inflation rate is 2%. Its second and unique mandate is to “promote effectively the goals of maximum employment.” With unemployment at more than 8% and long term unemployment near 15%, the Fed is a long way from meeting that goal; which is why the Fed recently pledged to keep short term interest rates near zero until mid-2015, an unprecedented seven year stretch, continue buying U.S. treasury bonds to keep interest rates low, and purchase $40 billion dollars a month of mortgage backed securities until the labor market “improves substantially”; in other words, it’s an open ended commitment.

 

Perhaps the most stunning statement by the Federal Reserve Chairman came in a recent speech in Jackson Hole, Wyoming. We will have the full text on our website, wealthtrack.com. In describing all the unusual policy actions taken he said: “Central bankers in the United States, and those in other advanced economies facing similar problems, have been in the process of learning by doing.”

 

This week’s guest is appalled by the Fed’s expansionist policies and worried about its known and unknown consequences. He is Financial Thought Leader James Grant, editor of Grant’s Interest Rate Observer, a twice monthly, self-described “independent, value oriented and contrary minded journal of the financial markets.” It also happens to be a must read among top professional investors. Jim is also an historian and author. His most recent book is Mr. Speaker! The Life and Times of Thomas B. Reed. I began the interview by asking Jim if the Fed wasn’t just doing its job: promoting maximum employment and price stability.

 

JIM GRANT: That is a good legal question. I think the subsequent financial question is whether there is any reason, either in theory or in common sense, to suppose that suppression of interest rates- and really let us call a spade a spade- price control is going to improve the prospects for working Americans. It seems to me that everything argues against that. The Fed, again to use plain talk, is suppressing interest rates. It is muscling around the structure of interest rates known in the trade as the yield curve. It is virtually allocating credit with its exertions, and it’s in the business of price control. Now, that has never worked. Chairman Ben Bernanke in remarks at Jackson Hole, Wyoming now a week or two weeks ago said that… he said, “We are learning by doing.” Learning by doing. Now, we have thousands…

 

CONSUELO MACK:  And he’s a financial historian as well.

 

JIM GRANT: No, he’s not.

 

CONSUELO MACK:  Well, that’s what he supposedly he is. Supposedly, he’s a student of the Great Depression.

 

JIM GRANT: He’s the kind of financial historian, if I may say so, who neither reads history nor writes much of it. That’s the kind of financial historian he is.

 

CONSUELO MACK:  All right.

 

JIM GRANT: There is a record of monetary history going back thousands of years, yet he says we are learning by doing. This, to me, is not the utterance of an historian.

 

CONSUELO MACK:  So when you said what we’re having in this interest rate suppression, which means that basically by buying Treasury securities and mortgage-backed securities, they are sopping up supply and, therefore, they’re keeping interest rates low.

 

JIM GRANT: And they are planting an idea in the mind of the market that interest rates will remain low and, that if they do move up, the Fed will be there to tamp them down again. So they kind of bring the marketplace into partnership. People are happy to play along with the Fed. It’s an easy way to make some money.

 

CONSUELO MACK:  People being Wall Street, institutional investors.

 

JIM GRANT: Yes, professional investors. Right, and today the chairman of the Federal Reserve Board talked about how the stock market’s going to go up which is nice for those who deal in common stocks or who own them, but for those about whom he’s supposedly is most worried, namely the victims of this most miserable and protracted of labor market slumps- not most miserable, certainly among the more protracted labor market slumps- to these people, rising stock prices…

 

CONSUELO MACK:  Savers.

 

JIM GRANT: Yeah, savers and people looking for work.

 

CONSUELO MACK:  But it’s interesting in that when you look at what the Federal Reserve has done, is that we have had a very positive response in the stock market to the expectations and the actuality of the Fed’s actions.

 

JIM GRANT: Sure, it’s free money. It’s free money, and it’s no competition from the bond market. I don’t mean to say that every single company listed on the New York Stock Exchange or NASDAQ is unworthy as an investment. On the contrary, there are, I think, some things to do in the stock market- there perhaps always are some things to do in the stock market- but the Fed has got it into its head that if it succeeds in levitating the average level of stock prices, that good things happen from that. Now, shouldn’t it be that the stock market goes up because good things are happening to the companies that issue the common stocks? I mean, in his rhetoric, in his language of technical eco terms, in these bouquets of calculus and algebra that fill the footnotes and the technical sections of these papers, they seem not to focus on two and two.

 

CONSUELO MACK:  So let’s talk about the law of intended or unintended consequences in this point. So what are you seeing? I mean, what kind of distortions are you seeing?

 

JIM GRANT: Well, the distortions are all around us and in his speech in Wyoming, Chairman Bernanke enumerated four there the tritest and perhaps the least interesting and meaningful to Americans of the many that are possible. For example, he neglected to mention the fact that if you save… there must six or eight people in America who do save. Right? Many of them watch you.

 

CONSUELO MACK:  WEALTHTRACK. Absolutely.

 

JIM GRANT: He neglected to mention … he might have said,” Sorry the absence of interest rates is starving you, but we don’t mean that to happen.” He didn’t even mention that. He might have mentioned that zero percent interest rates makes hash and nonsense out of credit analysis. The money markets are full of instruments like commercial paper, certificates of deposit that yield just about nothing before tax, after tax even worse, worse than nothing, and people spend time still analyzing the credit worthiness of these claims. But why? If they yield nothing, why bother? So the suppression, the manipulation of interest rates distorts and makes a mockery of credit analysis and, furthermore…

 

CONSUELO MACK:  Well, you know, most of us don’t care about credit analysis. You do.

 

JIM GRANT:  Oh, yes you do.

 

CONSUELO MACK:  Do we?

 

JIM GRANT:  We cared about it in 2008 when we discovered no one was doing it, and another thing, Consuelo…

 

CONSUELO MACK:  Put me in my place.

 

JIM GRANT:  No, no. Another thing that the Fed has not thought about apparently is that all of us who invest, either part time or full time, are kind of doing it in this hall of mirrors. Right? We don’t know exactly what values are, because values to a degree derive their value from some calculated stream of discounted future income; but if interest rates are zero, how do you do the arithmetic? Right? So investment values are distorted, and they’re distorted furthermore because they go up because the Fed says they should, not because companies are doing better. The whole thing is kind of nuts when you think about it.

 

CONSUELO MACK:  So isn’t there some method to Ben Bernanke’s madness? If he’s keeping interest low, that means that the people who are loaning us, I should say, who are loaning us money, the Chinese and the Russians, for instance, and the Japanese, then in fact the value of their Treasury holdings will be stable at least.

 

JIM GRANT:  Well, if I were a creditor to this government and running affairs in China or Russia or some place or Japan, I would like some interest income just to make me feel as if they cared. I think that by suppressing interest rates and by creating hundreds of billions of dollars, new dollars a year, the chairman is not, after all, reassuring our creditors, but he ought to be alarming them. He ought to be alarming our thoughtful creditors. Now, some of our creditors don’t care so much about the market value of their obligations, of American obligations. What they care about is manipulating or suppressing or managing their own exchange rate so they can export more to this country. So they’re not so concerned with interest income as they are with keeping the factory’s chimney smoking.

 

CONSUELO MACK:  Well, just one more point, I mean, along these lines is the fact that the Fed has been pretty consistent since 2008 in that they have pulled out all stops. They have done whatever they can do. I mean, they’ve done it kind of incrementally, but now…

 

JIM GRANT:  Yeah, but from time to time you never knew exactly what was going to happen next.

 

CONSUELO MACK:  True. You didn’t know who was going to be bailed out, who was going to be financed, right.

 

JIM GRANT:  And so, again, what this amounts to, Consuelo, in my opinion, is a full-scale federal war on Adam Smith’s invisible hand. This is a campaign against what the economists call the price mechanism. It’s this miraculous human contrivance that allows Wal-Mart to stock its shelves because at a price merchandise moves or it doesn’t move. That’s the way a complex economy is coordinated. It’s so simple, we scarcely pay attention to it, but this miraculous contrivance is exactly what the Federales are trying to stamp out. They put their thumb on the scale. They don’t want prices to be cleared in the marketplace. They want to dictate them in the interest of macro-economic stability. How the heck do they know what’s going to be stable?

 

You know, there was an episode in our not-so-distant past. There was a depression in 1920, ’21. It’s the depression Chairman Bernanke never mentions. It lasted 18 months peak to trough, and to meet this cataclysm, this disaster… you know, wholesale prices were down 40%. Unemployment went from three percent to twelve percent.

 

CONSUELO MACK:  That’s a depression.

 

JIM GRANT:  Real activity declined by nine or ten percent. To meet this, the Feds: A, balanced the federal budget and, B, raised interest rates. And guess what? The thing ended. Markets cleared. Assets got cheap. People bought them because they were bargains, and it was off to the races. That was a kind of free market depression. What they’re doing in the past five years or whatever it’s been, one loses track, is everything except that; and the consequences in no small part are the 23-year-olds at home in their bedrooms of their childhood wondering when somebody’s going to respond to their e-mail looking for work. In the interest or with the best of motives of making a capitalist system more humane, they have made it hugely inhumane. Let markets work.

 

CONSUELO MACK:  So Jim, one of the things that you do in Grant’s Interest Rate Observer aside from analyzing this kind of behavior and telling us in plain language what’s going on, is that you also give investment advice as well, and so how do we invest in a period like this?

 

JIM GRANT:  Well, with an eye always to a margin of safety, but it seems to me that from time to time Mr. Market does present one with what seems like a bargain. For example, we have recently waxed bullish on, of all companies, General Motors. I spent the last two hours…

 

CONSUELO MACK:  Right. I almost fell off my chair when you told me that.

 

JIM GRANT:  …sermonizing against federal intrusion into our commercial and financial affairs. Government Motors has emerged from bankruptcy with the cleanest of balance sheets, with a new and, I think, rather energized management structure. It means to do better. The American odometer has put on a lot of miles. We have the oldest, I think, oldest car fleet on the road right now.

 

CONSUELO MACK:  So there will be demand for new cars.

 

JIM GRANT:  Yeah, people are going to want that new car smell. GM, I think, is in a good way. Now, no good value story is complete without the object of one’s affections having a lot of hair on it. Right? Something has to be wrong with it to put people off. In the case of GM, it’s the government’s important equity holding. So the bearish case on GM is, why buy this thing? It might be cheap, but it is cheap like six times the estimate for next year of earnings. But why buy it if the government’s going to come out and dump its stock? Well, GM, we think, may very well be the buyer of that stock itself. It has the balance sheet to do it. So for all those reasons, for operational reasons, for financial reasons and for strategic reasons, perhaps we think that GM is a bargain.

 

CONSUELO MACK:  So let me ask you.

 

JIM GRANT:  And we add this. And because it’s well-financed, because the balance sheet is clean, the chances of permanent impairment of one’s capital, which is always a consideration, we think are low. So that’s our story on GM.

 

CONSUELO MACK:  As far as the investment environment and what’s going to do well in the market and what’s not going to do well, given the backdrop of what the Fed has been doing, so what do you… what are the opportunities that are being created? What are the biggest risks that are being created?

 

JIM GRANT:  I think that the biggest risk… and I’ve been so wrong about this. I preface it with my own assurances that my judgment is just as infallible as the chairman’s, although what I don’t do is impose it on others, but in my opinion, the so-called safe assets are the unsafe assets, and the so-called risky assets paradoxically will turn out to be the remunerative assets. Today we live in this land of risk on and risk off. This is what you hear on cable television with Wall Street, this kind of yak-yak you hear on Wall Street, and conveniently the brokers define these categories for us. We have to think safe or risk off… let’s see, risk off. Right. Safe assets.

 

CONSUELO MACK:  Right, treasuries.

 

JIM GRANT:  Right, sovereign. Yes, U.S. Treasuries and, of course, let us not forget European sovereign credit yielding less than zero, so-called, the dramatic on northern European …

 

CONSUELO MACK:  Swiss bonds.

 

JIM GRANT:  Yeah, Swiss and Danish and German yielding less than zero. So you pay them to keep your money. Doesn’t that sound wonderful? Safe, safe. Well, as we learned in the ‘60s, ‘70s and early ‘80s, and have learned subsequently in different settings, safety is a defined term. Bonds are not intrinsically safe, nor are stocks intrinsically risky. There ain’t no intrinsic in investing; it’s all a matter of price and value. If bonds yield nothing, are they really intrinsically anything except risky? No, to answer my question. They are risky. So in my opinion, the years to come will see a great shifting in our perceptions of risk.

 

So if you have a good company, and there are many good companies that have the capacity to adapt, that can deal with inflation when it comes, that can deal with deflation, that can adapt their products to a changing marketplace and that are priced at, say, 13 or 14 times earnings that are yielding two and a half percent, to me those are, relatively speaking, pretty good investments over time compared to Treasuries and other sovereign emissions yielding zip. So if I had to pick, and I do, between stocks and bonds, I pick stocks, and if I had to pick between risk on, so-called, and risk off, give me risk on. I want what they regard as risky, and I would sell what they regard as safe.

 

CONSUELO MACK:  And as far as the stocks are concerned, are there some stocks that represent the best, again, you know, best investments as far as price, value, yield?

 

JIM GRANT:  I mean, Google, for example, we wrote about. It was a little bit lower, but we wrote about it this summer, and it had a market multiple. It was like 13 or 14 times the estimate, and this is one of the great collections of American and, indeed, of world intellects, and they sit around all day thinking stuff up, and they have a good profitable business, a fabulous balance sheet. They seem to have the future in sight. They have demonstrated that they know something about technology beyond the fax machine.

 

And I’m thinking that, as compared with a Treasury that yields little or a Treasury inflation-protected security that yields less than nothing, that Google in a market multiple is a pretty good warrant or option on human progress.

 

CONSUELO MACK:  So where do we go for yield?

 

JIM GRANT:  Well, there ain’t none. There is very little natural yield. However, there are what used to be called business man’s risks. We now call them business people’s risks on Wall Street that will deliver you some yield at a reasonable risk. One of these opportunities is called prime rate or floating rate funds, and they are funds of bank loans. Now, the loans are to leveraged or indebted companies, but you as a lender to them in the bank level get a senior claim, and the senior claim is, I think, a safe claim, and these leveraged loan funds as they’re called, or prime rate funds, deliver interest income that will go up if interest rates go up, and over the past 12 months or so, they’ve delivered seven or eight percent over that time in interest income, and I think they will likely continue to do that. They have been much less popular than speculative grade or junk bond funds. Junk bond funds have had huge inflows. These prime rate funds have had very little in way of investment inflow. So we like those. They’re a decent business person’s risk for interest income.

 

CONSUELO MACK:  So are there any particular prime rate funds that… ?

 

JIM GRANT:  Well, Eaton Vance has one that we have spoken well of, for example. All the big mutual fund companies have them. Another set of interest spinning entities in this world of no-interest income are the mortgage real estate investment trusts. Annaly, NLY, is one. American Capital Agency, AGNC, is one. Hatteras, HTS, is another. MFA, same ticker, MFA, is a fourth. We’ve written about them. We followed them for years and years. They are leveraged, meaning they do business with borrowed money. They borrow short and lend long. There are risks, and there are risks that, for example, that the Fed might succeed so well that it crushes all interest spread in our world of mortgages, but these things yield 12 and 13%. They are trading at book value or slightly above or slightly below it. Each of the four I mentioned has some particular merit and, in some cases, some characteristic frailty, but taken as a portfolio, these four, it seems to me, again, in the context of taking some reasonable risk for income, these are not a bad way to proceed.

 

CONSUELO MACK:  And I know that Annaly has been a past one investment recommendation of yours, and we’ve had the CEO, Mike Farrell, on WEALTHTRACK a couple of times in the past. As far as, you know, we’ve got an election coming up, so what do you think the impact of the election is going to be on the markets? Is it going to make a big difference?

 

JIM GRANT:  Well, we can talk about religion next, now that we’re talking about politics, and this is– I’m not sure what my political views are worth, but I’ll give you them. It seems to me that this issue that the election is really about from the financial point of view, the election is about the price mechanism. It’s about the invisible hand. It’s about supply and demand. Do we prefer that to the government? That’s the question. I mean, everything else is being discussed, but the essential financial issue in this, to me, is shall we give, at long last, shall we restore capitalism to Wall Street? Shall we restore the price mechanism to its proper place in our money and capital markets? Shall we get out of the business of suppression and manipulation?

 

Now, Mitt Romney is a most imperfect champion of these ideas, but he is infinitely better than our incumbent in my opinion. Therefore, I mean, Grant’s Interest Rate Observer has only endorsed one political candidate in all of 30 years in business, and that was Grover Cleveland, and he was dead and we endorsed him. And I’m not going to endorse Mitt Romney, but I am going to vote for him.

 

CONSUELO MACK:  That is great. Jim Grant from Grant’s Interest Rate Observer, thank you so much for joining us on WEALTHTRACK.

 

JIM GRANT:  Well Consuelo, it has been my pleasure. I thank you.

 

CONSUELO MACK:  At the end of every WEALTHTRACK, we try to leave you with one suggestion to help you build and protect your wealth over the long term. This week we are taking the lead from our guest, Jim Grant, who mentioned a portfolio of mortgage backed REITs as one way to feed our widespread yield starvation. This week’s Action Point is: consider investing in REITs through a traditional real estate investment trust index fund. Morningstar’s favorite is the Vanguard REIT ETF, symbol VNQ, the largest in the category with low fees and less volatility than the competition. Incidentally, Morningstar recommends holding REITs in a tax-deferred account, such as a 401k, because their dividends are taxed as regular income.

 

I hope you can join us next week. We are going to interview Great Investor David Winters of the five-star rated Wintergreen Fund who is going to challenge three big investor misconceptions. Don’t forget, if you are interested in seeing this week’s program again, you can go to our website wealthtrack.com. It will be available as a podcast or streaming video. And while you are there, you can also see additional interviews with WEALTHTRACK guests answering some unusual questions in our new and improved WEALTHTRACK Extra feature. And that concludes this edition of WEALTHTRACK. Thank you for watching! Have a great weekend and make the week ahead a profitable and a productive one.

James Grant: The Federal Reserve’s Most Outspoken Critic

September 28, 2012

Federal Reserve Chairman Ben Bernanke has been widely credited with playing a key role in saving the global financial system from spiraling into a deeper recession. As a recent Financial Times headline read, “Central Bank Action Lifts Gloom”; “Bold Fed and ECB Moves Cheer Investors- Confidence Increases in U.S. and Europe.” There is no question that the Fed and to a lesser degree the ECB, the European Central Bank, are pulling out all stops to boost economic growth, investor confidence, and stock returns, going far beyond what their critics maintain is their proper role. As this week’s guest, financial journalist and historian James Grant told me, “Central bankers have morphed into central planners.” Continue Reading »

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