201312.15
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Much Ado About Not Much

A few more pieces of the great taper justification puzzle fell into place last week. The politicians struck a budget deal that, as I said last week, changes little in the spending and taxes equation for the next two years, a period that pushes any real changes past the next election. And unless that election produces some pretty dramatic changes to the make up of Congress, significant changes won’t come then either. In the meantime, President Obama is cranking up the regulation machine to address the things he promised his base he would address that he can’t possibly get through Congress. Constitutionally suspect maybe but every President in my lifetime has pushed the executive power envelope and this one is certainly no exception. The point being that while the budget may be settled for the next couple of years, there are other ways to provide hurdles for the economy to overcome and this President seems intent on trying them all.

Also on the regulatory front, the Volcker rule finally achieved some definition. Or at least that’s what I read in the financial press which praised the new rules as if they had banished speculation and finally rendered the banking system safe for widows and orphans. The new rules will supposedly restrict banks from gambling with insured deposits – or proprietary trading as it is known on the street – but the hedging loophole is big enough to drive a Whale through and you can bet that Wall Street just discovered that they’ve been systematically under-hedging a slew of risks of which they and regulators were previously unaware. No word on when someone in DC will figure out that more rules will never accomplish what more equity capital undoubtedly would.

Last but not least was the rumor or trial balloon or whatever you want to call it that Stanley Fischer will be nominated for the position of Vice Chair of the Federal Reserve. Mr. Fischer is most famously known as Ben Bernanke’s PhD advisor but he has an impressive resume that checks off all the central banker requirements. First and foremost, he is a paid up member of the mainstream academic clique with an impressive list of mathematically complicated papers. He earned his monetarist stripes at the University of Chicago and his Keynesian badge at MIT. He also spent some time at the World Bank and the IMF where he gained what may turn out to be very valuable experience during the Asian crisis. Lastly, he ran the Bank of Israel from 2005 to this year so he has already run a central bank and quite successfully I might add. He was the first central banker to cut rates in 2008 and more importantly, the first to raise them after the crisis.

Mr. Fischer’s potential appointment is important for the simple reason that his time at the IMF and the Bank of Israel would seem to put him in opposition – to some degree – with the easy money, anti-austerity crowd headed by the new Fed Chair (I’m assuming she is confirmed) Janet Yellen. Fischer demanded free market changes, budget discipline and rational monetary policy as a condition for IMF help as a good banker should, and was criticized heavily by Joseph Stiglitz and Paul Krugman – among many others – for doing so. (By the way, after Fischer left the IMF, Stiglitz turned his ire toward Ken Rogoff who became Chief Economist at the IMF starting in 2001. Rogoff’s open letter to Stiglitz is without a doubt the best takedown of an arrogant Nobel prize winner ever published and well worth your time.) Fischer has been quoted as saying the Fed’s extraordinary policies were “dangerous but necessary” and has also panned forward guidance on the premise that the Fed can’t foretell the future any better than anyone else (and based on history probably quite a bit worse).

So it appears the stars are aligned for a taper of QE sometime in the near future, possibly as soon as this week. The budget is settled, the banks have a new set of rules to abide by, the economic statistics have been recently more bouyant and a new hawk is likely to join the flock scheduled to shift to voting status in January. Whether Bernanke will have the bal…er…guts to initiate the wind down next week or not is likely to prove academic. And I suspect, with no evidence whatsoever, that Janet Yellen will suddenly find an urgent desire to spend more time with her family sometime in the next 18 months and that Fischer will assume the role most acknowledge as his due. In fact, I think it is probably likely that Fischer was the President’s first choice but the historic nature of naming the first woman to head the Fed was too much to pass up.

The important question for investors is how the taper will affect the markets and on that front, I have no special insight. In fact, anyone who tells you they know what to expect from the end of QE is either lying or deluded. What we do know is the conventional wisdom – which usually proves anything but – holds that tapering means higher interest rates, lower stock prices and pain in emerging markets. As for the former I’d just point out that almost no one expects interest rates to fall right now and markets have a way of acting to frustrate the maximum number of participants. On the second, well, I’m not sure sentiment can get more bullish than it already is, but with everyone worried about tapering it may not be the bull killer everyone fears. I would also point out that the Fed was quite capable of blowing a bubble in housing with nothing more than low interest rates for a long time which is what we’ll be reduced to once QE is gone. As for the last, I’d just say that all emerging markets are not created equal and sentiment toward the group is hardly ebullient at the moment.

The budget deal and the news on the Volcker rule amount to much ado about not much but they do provide some cover for the Fed to move ahead with the tapering they so obviously want. The budget deal does nothing more than fiddle around the edges, cutting the 10 year deficit by a rounding error-like $22 billion. All that negotiating and all they got was a measly $2 billion per year in deficit reduction? I could have found that much in the Congressional couch cushion. The Volcker rule is just another exercise in Congressional log rolling with the financial industry no doubt getting exactly what they wanted. The big banks employ armies of lawyers who will direct them to the proper loopholes to justify whatever they want to do while their smaller competitors will find it that much more expensive to compete. All in all a win, win for TBTF.

I do hope the the Fischer appointment is more than just rumor. Personally I think the best central banker would do nothing more than stand ready to fill the lender of last resort role – and I do mean last resort – that is sometimes needed in times of crisis. Since that is unlikely in the extreme the next best thing would be a humble man who knows what he doesn’t know. Stanley Fischer would seem to fit that description better than anyone remotely qualified to do the job right now. Hopefully he’ll be appointed and confirmed and also move the Fed toward a more humble approach to monetary policy.

By the way, this will be my last commentary this year. My wife has convinced me to travel to Chicago to visit our daughter for the holidays and I have promised to take a break during our time in the Windy City. My daughter told me last week that it was 1 degree in Chicago – she said Chicago could only afford 1 right now – with a windchill of -20 so I’m pretty sure my wife has lost her mind but I’m packing my longjohns and doing what’s best for peace on earth or at least my house. So Happy Holidays and see you next year!

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For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, Joe Calhoun can be reached at: jyc3@alhambrapartners.com or   786-249-3773. You can also book an appointment using our contact form.