Former Fed economist and current Morgan Stanley Asia Chairman Stephen Roach Sees ‘Great Risk’ in Fed Exit Strategy.



The Federal Reserve may cause another crisis by botching the withdrawal of liquidity from the U.S. economy, Morgan Stanley Asia Chairman Stephen Roach said.



The Fed is the “weak link” among central banks and may fail to tighten monetary policy in time to stop asset bubbles from forming, Roach said at a conference in Berlin today. The Fed helped trigger the boom and then bust of the subprime mortgage market by being “quick to slash, slow to normalize” interest rates, he said.



“There is a great risk in the coming exit strategy,” said Roach, a former Fed economist. “They are lacking primarily a political will to execute the exit in a timely and expeditious fashion that will avoid the mistakes of the last crisis.” The traditional view of central bankers that asset bubbles are hard to spot and deflate with rates is “ludicrous,” he said.



“This is a failed flaw in the intellectual construction of modern central banking that must be addressed,” said Roach. “If we don’t fix this problem we’re doomed to repeat the failed asymmetric policies of the past and set ourselves up” for another crisis.



Roach recommended the Fed be required to “hardwire” the goal of preserving financial stability into its mandate, alongside the pursuit of full employment and low inflation. Central banks should not be “allowed to outsource their responsibilities” to regulatory bodies, he said.

Fed Is Fatally Flawed

Fed Uncertainty Principle

The Observer Affects The Observed



The Fed, in conjunction with all the players watching the Fed, distorts the economic picture. I liken this to Heisenberg's Uncertainty Principle where observation of a subatomic particle changes the ability to measure it accurately.



To measure the position and velocity of any particle, you would first shine a light on it, then detect the reflection. On a macroscopic scale, the effect of photons on an object is insignificant. Unfortunately, on subatomic scales, the photons that hit the subatomic particle will cause it to move significantly, so although the position has been measured accurately, the velocity of the particle will have been altered. By learning the position, you have rendered any information you previously had on the velocity useless. In other words, the observer affects the observed.



The Fed, by its very existence, alters the economic horizon. Compounding the problem are all the eyes on the Fed attempting to game the system.



Fed Uncertainty Principle:

The fed, by its very existence, has completely distorted the market via self reinforcing observer/participant feedback loops. Thus, it is fatally flawed logic to suggest the Fed is simply following the market, therefore the market is to blame for the Fed's actions. There would not be a Fed in a free market, and by implication there would not be observer/participant feedback loops either.



Corollary Number One :

The Fed has no idea where interest rates should be. Only a free market does. The Fed will be disingenuous about what it knows (nothing of use) and doesn't know (much more than it wants to admit), particularly in times of economic stress.



Corollary Number Two : The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates, the more power it will attempt to grab. Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing.



Corollary Number Three :

Don't expect the Fed to learn from past mistakes. Instead, expect the Fed to repeat them with bigger and bigger doses of exactly what created the initial problem.



Corollary Number Four :

The Fed simply does not care whether its actions are illegal or not. The Fed is operating under the principle that it's easier to get forgiveness than permission. And forgiveness is just another means to the desired power grab it is seeking.

Fixing The Fed

fixed

Can the Fed Be Improved?

improving

Dual Mandate Issues





Roach recommended the Fed be required to “hardwire” the goal of preserving financial stability into its mandate, alongside the pursuit of full employment and low inflation.

What Is The Proper Supply Of Money?

Why Should The Fed Control Money Supply?

Lack of Political Will vs. Plain Incompetence



Roach states “They are lacking primarily a political will to execute the exit in a timely and expeditious fashion that will avoid the mistakes of the last crisis.” The traditional view of central bankers that asset bubbles are hard to spot and deflate with rates is “ludicrous”.

Bernanke: Why are we still listening to this guy?

Measuring Consumer Prices

Case-Shiller CPI is formulated by substituting the Case-Shiller housing index for Owner's Equivalent Rent in the CPI. For a complete description of the reasons and methodology, please see What's the Real CPI?



CS-CPI continues to fall albeit at a less rapid pace and measures -5.1% YOY. Meanwhile the government’s CPI-U also continues to fall at a slower pace and measures -1.5% YOY. The divergence is to due to the government’s housing metric of Owners’ Equivalent Rent (OER) continuing to show price increases (+1.7% YOY) vs. Case-Shiller data showing price decreases (-13.3% YOY).







click on chart for sharper image



Since the Case Shiller housing market peak in June 2006, OER is up +7.7%, while the Case-Shiller index is down -30.9% - an amazing 3860 basis point divergence!



CS-CPI YOY has now fallen for 11 consecutive months and 14 of the past 18. Meanwhile the government's CPI-U YOY has fallen for 6 consecutive months.

The Only Exit Strategy That Will Work

The Fed is the 'weak link' among central banks.

They are lacking primarily a political will to execute the exit in a timely and expeditious fashion that will avoid the mistakes of the last crisis.”

Call For Action