World’s Biggest Hedge-Fund
To Taper or not to Taper?
Couple of month ago (exactly before the fuss about tapering started) I heard an idea that FED has become the true shadow-bank by employing unseen accommodating monetary policy. The biggest concern being that unregulated shadow banks (financial intermediaries providing for liquidity to the financial market — but not regulated despite the fact their business is maturity and liquidity transformation) had greatly added to the destruction of the current financial crisis and caused shoveling of taxpayer money so what will happen in the next crisis, when FED is on the other side — the side of shadow banks? FED indeed is responsible for most of the present liquidity in financial markets (which is causing instabilities by blowing price bubbles in unexplored nooks and crannies of financial markets). Should there be another immediate and robust shock to financial markets imploding asset prices and making asset holders pose huge losses with FED being on the shadow-banking side at its peak money printing capacity — we will be in entirely unexplored waters. The only option left might be (and I’m citing here): “to build economy based on nuts and hope that guys on Wall-Street are not squirrels”.
These concerns were smoothed by FED showing that tapering is very much on their agenda and that tapering is going to be sequenced. This gave at least a short relief and sense of everything being under control. However, talks about tapering raised even more concerns and brought the issue of FED being a shadow-bank to the very front of every monetary policy agenda. So what is worse? Tapering causing turmoil in financial markets and making world’s economy collapse? Or no tapering leaving FED with inflated balance-sheet and possible huge losses when the next turmoil hits. Leaving economy without a savior?
However, recent developments showed us that FED is backing down from its own commitment to ease its treasuries buying program. It might be because of economy not showing as strong recovery as expected, it might be because of panic in the markets (capital fleeing china) that indicate unpreparedness of financial markets to get off drugs of unlimited liquidity. It may as well have something to do with Mr. Bernanke’s time at FED coming to an end. Not the best time to make your biggest career mistake!
This morning I heard the first attempt to address this problem from a Central Banker. And want to share it with you (in this case it was ECB official talking explicitly about ECB).
“With all due respect to Mr. W. Buffet ECB is nowhere near being a hedge-fund, which is dealing in many different asset classes to match risk profiles and profit from fluctuations. ECB deals with very specific assets with a very much different goal” the ECB official started.
He was further asked — what about possible losses on ECB’s balance sheet (or other CB’s balance-sheet as such losses for ECB are not that plausible). Answer to such concerns was in itself concerning. He admitted that some central banks are forming reserves for such outcomes and for that reason trying to use profits they are earning at the moment. Moreover, he used comparison of a Bundesbank situation after the WWI when hyperinflation struck Germany. Bundesbank decided to open an account with a negative balance (losses causing it) which could be off-set with future profits when the mess is gone. And this seemed to work.
So all in all: (i) Should we be worried of CB’s stepping in and staying in untested territories and serving as shadow banks? (ii) Is retreat from unlimited liquidity more harmful then the risks arising from employing untested tools of monetary policy? (iii) Is it maybe only the question of transition from accommodating to conventional monetary policy (if this will actually happen at all)?
