Friday, June 28, 2013

Moodys is Right On

Moodys released a report on state pension funds today that implied that such funds currently hold only 48 cents out of every dollar needed to properly fund their obligations.  Three cheers for Moodys!

For decades, state and local pension funds have released grossly misleading and inaccurate figures suggesting that they are better funded than is merited by the facts.  Politicians have acquiesced in this charade since it was inconvenient, to use Al Gore's phrase, to speak the truth.

The chief method of disguising the truth is to make over-optimistic assumptions about future asset returns and unrealistic assumptions about the contributions that will be forthcoming in the future.

Based upon false information, state and local governments have touted reforms that hardly make a dent in the real problems.  Virginia is a great example.  The so-called pension fund reforms enacted by the Virginia General Assembly and backed by Governor McDonnell were misleadingly hailed as a 'major' improvement in funding.  Nothing could be further from the truth.  By maintaining mostly a defined benefit system supported by optimistic and unrealistic assumptions, the Virginia reforms simply locked in concrete a failing system without any serious reform.

The only properly funded pension systems are defined contribution systems.  Period.  If you are a participant in a defined benefit system (social security is a good example), the best advice for you is to start saving as much as you can.  Your pension system is most likely in deep, deep trouble.

Thursday, June 27, 2013

GDP Revised Downward

Instead of 2.4 percent as originally advertised, the US GDP grew at a revised 1.8 percent during the first quarter of 2013.  Consumption spending fell off the cliff, which was unexpected.

So, the stock market rallied...big time.  Why?  Because the bad economic news suggested that the Fed might continue its bond purchases indefinitely.  "Long live QE3" was the rallying cry.

Meanwhile the President and his cronies were busily designing more strategies to lengthen unemployment lines: increase minimum wage, bury the coal industry, continue down the road on Obamacare, push for higher taxes, and stall the Keystone pipeline.

Nothing discourages this White House.  They will not likely be satisfied until unemployment gets back into double digit territory (so they can match their heroes in Europe) or until millions more Americans give up on working and move into disability or off into the black market.

On the ObamaCare front, the Administration is now recruiting Hollywood types and NFL superstars to begin a campaign to get young folks to sign up for ObamaCare health insurance, which will cost  the 18-25 set roughly twenty times the penalty for not signing up.  The premiums for young people are more then ten times what free market insurance would cost them.

There is some justice here, since young folks backed Obama's candidacy in overwhelming numbers.  Now, the young will find first hand what it is like to pay to subsidize others.  Don't expect the young to buy in.  Coffee house conversation is one thing; actually paying for ObamaCare is another.  They will not buy in.

Without the youth 'buy-in,' the ObamaCare numbers don't work.  But that's okay one supposes, since the so-called insurance exchanges mandated by the law are not in existence anyway.  ObamaCare is mostly an idea -- a terrible idea.  No one knows what the reality will be because no one in the Obama administration is doing anything significant toward implementation.  All of this will slam into the economy as the year progresses.

Between the coming of ObamaCare, higher taxes, the war on the coal industry, and the push for higher minimum wages, don't expect much improvement in the economy.  Even housing is going to struggle with the new regulatory environment which makes it border-line criminal for a bank to make a mortgage loan to someone who needs a mortgage loan.  Not to mention higher mortgage rates, which zoomed up from 3.7 percent to over 4.5 percent just in the last thirty days.

Meanwhile the stock market moves higher.

Wednesday, June 26, 2013

Unilateral Energy Disarmament

As the rest of the world gears up to massively increase their carbon footprint, Obama is moving to put the US out of the coal business.  That won't keep worldwide coal production from soaring.  It just takes the US out of the coal business.  Obama has made no effort at all to get global partners to sign on board.  Instead, the US is walking this plank all alone.

This is in keeping with the Obama strategy of strangling the US economy to gain accolades from the Harvard coffee houses.

Once again, American workers will bear the brunt of the Obama agenda.  It is not enough to have the worst economic recovery on historical record (at least since 1850).  Now, with Obamacare on the horizon, Obama provides one more nail to the coffin of American prosperity with his arbitrary EPA war on the American worker and energy user.

The route to third world status is paved with good intentions and truckloads of hubris.

Tuesday, June 25, 2013

Why Employment Problems Aren't Going Away

Suppose you had a business that would improve revenues by $ 60,000 per year if only you could add one additional employee.  Should you add that employee?

That depends upon what the employee costs.  It does not depend upon what you pay that employee.  Is there a disconnect here?

Yes.  What an employee costs in modern America is a far, far greater number that what an employer might pay that employee.

If you hire an employee these days, the costs, beyond salary, are enormous.  In some states these extra costs can make the overall costs nearly double the wage or salary that the employee is paid (before tax).  Why?

You can begin with social security taxes, medicare taxes and workmen's compensation.  If the company offers a health care insurance plan, you can add that in.  Under ObamaCare, you must add something in for health care insurance. 

What about complying with various federal rules?  OSHA?  Disability Laws?

What about potential lawsuits for "protected" employees?  If you hire females, minorities or anyone over the age of 50, you must reserve or insure against lawsuits (regardless of whether you are likely to win or lose such lawsuits).  Just defending yourself is expensive.  Often the litigation involves activities that take place between employees away from work and during non-work hours.  That is how absurd the "protections" are for employees.  But, the point is, they are costly to the employer.

Imagine that the employee who can help you increase your revenues by $ 60,000 per year requires a salary of $ 45,000 per year.  Whether you hire that employee will depend upon all of these other costs that whittle away the $ 15,000 margin of profit.  If your business is located in California or New York, the "extra costs" typically exceed $ 25,000 per employee.  At $ 25,000 in extra costs, the total costs to an employer become $ 70,000.

Would you pay $ 70,000 to add an employee that could increase your revenues by $ 60,000?

It's worth noting that the "extra costs" are relatively less for highly paid and highly skilled employees, which explains what so many high income Americans don't care if low income employees are priced out of the market by these extra costs.  Greenwich, Connecticut votes left.  For good reason,  Practically no one who resides in Greenwich is priced out of the labor market by these "extra costs."

The losers in this story are the lower skilled employees, the minorities, the single moms and older workers.  These policies that encourage lawsuits and saddle employers with health care costs, retirement costs, unemployment costs and the like dramatically reduce the employment prospects of "protected" employees.

No wonder employment is growing at the slowest rate in American history during a period of economic recovery.  Don't expect things to get much better.  This is a micro problem, not a macro problem.

Monday, June 24, 2013

Elizabeth Warren and the Minimum Wage

The newest Senator from Massachusetts is Harvard faculty member -- a native American according to her resume (as opposed to her true heritage) -- Elizabeth Warren.  Her main claim to fame is villifying Wall Streeters for lining their pockets, a practice she seems especially adept at.  No wonder she notices it in others.

Senator Warren was singing the praises of the minimum wage last week during Senate hearings.  According to Senator Warren, increasing the minimum wage actually increases jobs.  Employers, I presume, get excited, knowing that employees now cost more than before and therefore expand their hiring.  I guess that's Senator Warren's logic, since she didn't offer any logic during the hearing.

Using Senator Warren's logic, I propose we cut to the chase.  Increase the minimum wage to $ 1,000 per hour.  That way, it will impact fat cats like Senator Warren, not just minorities and high school graduates. 

People like Senator Warren have a noblesse oblige approach to the unemployed.  Let them eat cake (or better yet, raise the minimum wage).

Employers really are a silly lot if the they behave as Senator Warren thinks they behave.  Wonder why they didn't think of raising wages themselves so that they can then offer more jobs?

Warren's absurd statements should be good fodder for a comedy show not a Senate hearing.

Sunday, June 23, 2013

Stopping Bank Crises Before They Start

This is a Wall Street Journal Oped 6/24/2013

Regulating the riskiness of bank assets is a dead end. Instead, fix the run-prone nature of bank liabilities.

In recent months the realization has sunk in across the country that the 2010 Dodd-Frank financial-reform legislation is a colossal mess. Yet we obviously can't go back to the status quo that produced a financial catastrophe in 2007-08. Fortunately, there is an alternative.

At its core, the recent financial crisis was a run. The run was concentrated in the "shadow banking system" of overnight repurchase agreements, asset-backed securities, broker-dealers and investment banks, but it was a classic run nonetheless.

The run made the crisis. In the 2000 tech bust, people lost a lot of money, but there was no crisis. Why not? Because tech firms were funded by stock. When stock values fall you can't run to get your money out first, and you can't take a company to bankruptcy court.

This is a vital and liberating insight: To stop future crises, the financial system needs to be reformed so that it is not prone to runs. Americans do not have to trust newly wise regulators to fix Fannie Mae and Freddie Mac, end rating-agency shenanigans, clairvoyantly spot and prick "bubbles," and address every other real or perceived shortcoming of our financial system.

Runs are a pathology of financial contracts, such as bank deposits, that promise investors a fixed amount of money and the right to withdraw that amount at any time. A run also requires that the issuing institution can't raise cash by selling assets, borrowing or issuing equity. If I see you taking your money out, then I have an incentive to take my money out too. When a run at one institution causes people to question the finances of others, the run becomes "systemic," which is practically the definition of a crisis.

By the time they failed in 2008, Lehman Brothers and Bear Stearns were funding portfolios of mortgage-backed securities with overnight debt leveraged 30 to 1. For each $1 of equity capital, the banks borrowed $30. Then, every single day, they had to borrow 30 new dollars to pay off the previous day's loans.

When investors sniffed trouble, they refused to roll over the loans. The bank's broker-dealer customers and derivatives counterparties also pulled their money out, each also having the right to money immediately, but each contract also serving as a source of short-term funding for the banks. When this short-term funding evaporated, the banks instantly failed.

Clearly, overnight debt is the problem. The solution is just as clear: Don't let financial institutions issue run-prone liabilities. Run-prone contracts generate an externality, like pollution, and merit severe regulation on that basis.

Institutions that want to take deposits, borrow overnight, issue fixed-value money-market shares or any similar runnable contract must back those liabilities 100% by short-term Treasurys or reserves at the Fed. Institutions that want to invest in risky or illiquid assets, like loans or mortgage-backed securities, have to fund those investments with equity and long-term debt. Then they can invest as they please, as their problems cannot start a crisis.

Money-market funds that want to offer better returns by investing in riskier securities must let their values float, rather than promise a fixed value of $1 per share. Mortgage-backed securities also belong in floating-value funds, like equity mutual funds or exchange-traded funds. The run-prone nature of broker-dealer and derivatives contracts can also be reformed at small cost by fixing the terms of those contracts and their treatment in bankruptcy.

The bottom line: People who want better returns must transparently shoulder additional risk.

Some people will argue: Don't we need banks to "transform maturity" and provide abundant "safe and liquid" assets for people to invest in? Not anymore.

First, $16 trillion of government debt is enough to back any conceivable demand for fixed-value liquid assets. Money-market funds that hold Treasurys can expand to enormous size. The Federal Reserve should continue to provide abundant reserves to banks, paying market interest. The Treasury could offer reserves to the rest of us—floating-rate, fixed-value, electronically-transferable debt. There is no reason that the Fed and Treasury should artificially starve the economy of completely safe, interest-paying cash.

Second, financial and technical innovations can deliver the liquidity that once only banks could provide. Today, you can pay your monthly credit-card bill from your exchange-traded stock fund. Tomorrow, your ATM could sell $100 of that fund if you want cash, or you could bump your smartphone on a cash register to buy coffee with that fund. Liquidity no longer requires that anyone hold risk-free or fixed-value assets.

Others will object: Won't eliminating short-term funding for long-term investments drive up rates for borrowers? Not much. Floating-value investments such as equity and long-term debt that go unlevered into loans are very safe and need to pay correspondingly low returns. If borrowers pay a bit more than now, it is only because banks lose their government guarantees and subsidies.

In the 19th century, private banks issued currency. A few crises later, we stopped that and gave the federal government a monopoly on currency issue. Now that short-term debt is our money, we should treat it the same way, and for exactly the same reasons.

In the wake of Great Depression bank runs, the U.S. government chose to guarantee bank deposits, so that people no longer had the incentive to get out first. But guaranteeing a bank's deposits gives bank managers a huge incentive to take risks.

So we tried to regulate the banks from taking risks. The banks got around the regulations, and "shadow banks" grew around the regulated system. Since then we have been on a treadmill of ever-larger bailouts, ever-expanding government guarantees, ever-expanding attempts to regulate risks, ever-more powerful regulators and ever-larger crises.

This approach will never work. Rather than try to regulate the riskiness of bank assets, we should fix the run-prone nature of their liabilities. Fortunately, modern financial technology surmounts the economic obstacles that impeded this approach in the 1930s. Now we only have to surmount the obstacle of entrenched interests that profit from the current dysfunctional system.

Wednesday, June 19, 2013

"Our Work Is Not Yet Done"

So said President Obama speaking in Berlin earlier today.  The president referenced unemployment and poverty as items left undone.

What the president meant, of course, is there is more for big government to do.

It was appropriate that the president's venue was Europe.  Europe, by policy, has ruled out any hope of full employment or prosperity.  Creating 'justice' and 'fairness' in the labor market has meant that, for European youth, there is no economic future.

Unemployment is above 12 percent, on average, across the Eurozone and over 25 percent in the hardest hit areas.  Youth employment (18-25) is rarely below 25 percent even in the best of times in Europe.  This is the new European reality.  The Eurozone GDP has been mired in recession for more than two years and there is little prospect for the European recession to end.

America is learning the European way.  The unemployment rate in the US is kept below double digits only by the fact that millions of Americans now consider their own job prospects so hopeless that they have given up looking for a job.  That means that millions of Americans are no longer counted in the unemployment data. 

US GDP is growing almost imperceptibly.  That is not likely to continue with the Fed finally reversing course on bond purchases and the looming implementation of Obamacare.

So, what is left for government to do?

If markets were free, Europe would have an unemployment rate below 5 percent, as would the US.  Economic growth would exceed four percent in both Europe and the US.  But free markets are frowned on by policy makers and their admiring press.

But, Obama sees more to do.  Not a good omen for those looking to the future.

Tuesday, June 18, 2013

Mankiw on the 1%

Greg Mankiw has an intereting new article draft, titled "Defending the 1%"  It's mistitled really, as the main point I got out of it is the more interesting question, "Can transfers really help the bottom 50%?"

It's a very well written (as one would expect) and survey of economic issues surrounding the idea of greatly expanded taxation of upper income people to fund transfers. Go read it, I won't do it justice in a summary.

As Greg notes, much of the success of the 1% is not rent-seeking, nor inherited wealth, but entrepreneurs who innovated and got spectacularly wealthy in the process.

It's not clear how Steve Jobs getting hugely rich hurts the rest of us. (Greg makes a few jabs at financial profits, but readers of this blog know that's a more nuanced issue.) It's not clear how any of us even know if Jobs had $100 million, $1 billion, or $1 Gazillion when he died, though it makes a huge difference to measured inequality.  And I like Greg's emphasis that it doesn't make much philosophical or moral sense to draw national borders around income-transfer moral philosophy.  Look for the kidney story too.

Greg chose not to argue with the very tricky measurement issues, instead just quoting Pikkety and Saez' numbers.  That's a good issue for another day -- other measures give very different results.

One of Greg's main points is that our inequality is the result of an interplay between supply and demand for talented skilled people.
I am more persuaded [than by Stiglitz] by the thesis advanced by Claudia Goldin and Lawrence Katz (2008) in their book The Race between Education and Technology. Goldin and Katz argue that skill biased technological change continually increases the demand for skilled labor. By itself, this force tends to increase the earnings gap between skilled and unskilled workers, thereby increasing inequality. Society can offset the effect of this demand shift by increasing the supply of skilled labor at an even faster pace, as it did in the 1950s and 1960s. In this case, the earnings gap need not rise and, indeed, can even decline, as in fact occurred. But when the pace of educational advance slows down, as it did in the 1970s, the increasing demand for skilled labor will naturally cause inequality to rise. The story of rising inequality, therefore, is not primarily about politics and rent-seeking but rather about supply and demand.
Having stated it this way, I'm disappointed Greg didn't explore supply more. Why is it that America has not responded this time by increasing the supply of skilled workers? The obvious suspects are easy to name, and do not bode well for the left's suggestion that permaent confiscatory taxation plus transfers are the answer to the "problem."

Greg does a good job of painting the standard incentive problem with tax and transfer redistribution. However, he states it in its classic, static form. More transfers means less work effort. In reality, hours of work don't really respond that much, as there are only so many hours in a day and income and substitution effects offset. To make this come alive, we need to think harder about the margin of working vs. not working.

And investing. Here the two points come together, and I don't think Greg's article nor the literature put the pieces in one place. We need a dynamic perspective. If inequality comes from a mismatch between supply and demand for skill, then keeping the incentives in place to acquire skill is vital. If there is a strong income-based transfer scheme in place, yes, there  is less incentive to work overtime. And yes, there is less incentive to work at all at least legally. But most of all, there is less incentive to go to school, to pick hard courses (face it, art history is a lot more fun than python and Java 101), pursue expensive advanced graduate education or innovate. One can imagine a spiral, or inequality laffer curve: Demand for skill outpaces supply, inequality rises, we put in place an income based transfer scheme, less people acquire skils, inequality rises...

Greg has a great section, "listening to the left" which I will now invite as well. Forget about the 1%. Pretend wealth grows on trees. Let's just think of the fortunes of the bottom 50%. Can we actually help them? Is there any historical precednent of a successful society that pays large means-tested amounts to young and working-age men and women, without destroying their incentives to gain skills and become middle class, to say nothing of the next Steve Jobs?

Social security doesn't count; the question is sending checks to young, healthy, but low-skilled working age people.  Short-term doesn't count. I want to know of an instance in which, maintained over a generation or two, such a system did anything more than perpetuate an unskilled largely dysfuncitonal underclass, which achieved much more than reliably voting for politicians who endorse its transfers. (The model "send money to Democratic voters" does explain the proposed policies pretty well!) The reputed wonders of living in Sweden or other welfare states don't count: their benefits are in kind, and not means tested.

It's easy to come up with incentive-destruction horror stories, American welfare, European dole, and so on.  Small cash transfers coupled with restricted educational opportunities and large labor market wedges, as faced by refugees and many European immigrants, seem particularly destructive. Tom Sowell writes whole books of examples.  But it's too easy to listen to the choir. To those of you advocating large cash transfers, when has this ever worked?   I'm curious to hear a clear historical precedent for the policies you advocate for the US. 

Two seconds

The weekend wall street journal had an interesting article about high speed trading, Traders Pay for an Early Peek at Key Data. Through Thompson-Reuters, traders can get the University of Michigan consumer confidence survey results two seconds ahead of everyone else. They then trade S&P500 ETFs on the information.

Source: Wall Street Journal

Naturally, the article was about whether this is fair and ethical, with a pretty strong sense of no (and surely pressure on the University of Michigan not to offer the service.)
It didn't ask the obvious question: Traders need willing counterparties. Knowing that this is going on, who in their right mind is leaving limit orders on the books in the two seconds before the confidence surveys come out?

OK, you say, mom and pop are too unsophisticated to know what's going on. But even mom and pop place their orders through institutions which use trading algorithms to minimize price impact. It takes one line of code to add "do not leave limit orders in place during the two seconds before the consumer confidence surveys come out."

In short, the article leaves this impression that investors are getting taken. But it's so easy to avoid being taken, so it seems a bit of a puzzle that anyone can make money at this game. 

I hope readers with more market experience than I can answer the puzzle: Who is it out there that is dumb enough to leave limit orders for S&P500 ETFs outstanding in the 2 seconds before the consumer confidence surveys come out?

Thursday, June 13, 2013

Job market doldrums

Three recent views on the dismal labor market pose an interesting contrast.

Alan Blinder wrote a provocative WSJ piece on 6/11, Fiscal Fixes for the Jobless Recovery. A week prviously, 6/5, Ed Lazear wrote about The Hidden Jobless Disaster. And John Taylor has a good short blog post Job Growth–Barely Keeping Pace with Population

All three authors emphasize that the unemployment rate is a poor measure of the labor market. Unemployment counts people who don't have a job but are actively looking for one. People who give up and leave the labor force don't count. Employment is a more interesting number, and the employment-population ratio a better summary statistic than the unemployment rate. After all, if unemployment falls because everyone who is looking for a job gives up, I don't think we'd see that as a good sign.

Source: Wall Street Journal
Ed Lazear made this interesting chart. As he explains,

Every time the unemployment rate changes, analysts and reporters try to determine whether unemployment changed because more people were actually working or because people simply dropped out of the labor market entirely... The employment rate—that is, the employment-to-population ratio—eliminates this issue by going straight to the bottom line, measuring the proportion of potential workers who are actually working.

While the unemployment rate has fallen over the past 3½ years, the employment-to-population ratio has stayed almost constant at about 58.5%, well below the prerecession peak. Jobs are always being created and destroyed, and the net number of jobs over the last 3½ years has increased. But so too has the size of the working-age population. Job growth has been just slightly better than what it takes to keep the employed proportion of the working-age population constant. That's why jobs still seem so scarce.

The U.S. is not getting back many of the jobs that were lost during the recession. At the present slow pace of job growth, it will require more than a decade to get back to full employment defined by prerecession standards....

Why have so many workers dropped out of the labor force and stopped actively seeking work? Partly this is due to sluggish economic growth. But research by the University of Chicago's Casey Mulligan has suggested that because government benefits are lost when income rises, some people forgo poor jobs in lieu of government benefits—unemployment insurance, food stamps and disability benefits among the most obvious. The disability rolls have grown by 13% and the number receiving food stamps by 39% since 2009.
John Taylor makes the point nicely with another graph, which contrasts the labor force participation rate to the BLS' forecast of what should have happened from demographic effects.

The graph comes from a recent paper Chris Erceg and Andrew Levin.

I part company a bit with Lazear on his conclusions
... the various programs of quantitative easing (and other fiscal and monetary policies) have not been particularly effective at stimulating job growth. Consequently, the Fed may want to reconsider its decision to maintain a loose-money policy until the unemployment rate dips to 6.5%.
If low employment is "structural," resulting from the worker-side disincentives as well as employer-side disincentives -- policy uncertainty, regulatory threats, NLRB, Obamacare, Dodd-Frank, EPA, and so on -- then the problem isn't lack of "demand" in the first place. If the problem has nothing to do with the Fed, and if $2 trillion of QE didn't do anything to help it, why does the solution have anything to do with the Fed?

The greater surprise is to hear so much agreement from Alan Blinder:
The Brookings Institution's Hamilton Project, with which I am associated, estimates each month what it calls the "jobs gap," defined as the number of jobs needed to return employment to its prerecession levels and also absorb new entrants to the labor force. The project's latest jobs-gap estimate is 9.9 million jobs. At a rate of 194,000 a month, it would take almost eight more years to eliminate that gap.

.... policy makers should be running around like their hair is on fire.
Lazear said "a decade."  More suprising agreement on the impotence of monetary policy:
The Federal Reserve has worked overtime to spur job creation, and there is not much more it can do.
As you might imagine, I'm not such a fan of Blinder's suggested fixes. He starts with traditional simple Keynesian recommendations that  the government should hire people and "spend" more. No need to refight that here. The more interesting recommendations follow as he warms up to his latest clever scheme.
... the basic idea is straightforward: Offer tax breaks to firms that boost their payrolls.

For example, companies might be offered a tax credit equal to 10% of the increase in their wage bills over the previous year. ...

Another sort of business tax cut may hold more political promise....Suppose Congress enacted a partial tax holiday that allowed companies to repatriate profits held abroad at some bargain-basement tax rate like 10%. The catch: The maximum amount each company could bring home at that low tax rate would equal the increase in its wage payments as measured by Social Security records.

For example, if XYZ Corporation paid wages covered by Social Security of $1 billion in 2012 and $1.1 billion in 2013, it would be allowed to repatriate $100 million at the superlow tax rate. The reward for boosting its payroll by $100 million would thus be a $25 million tax saving. That looks like a powerful incentive.

...companies could claim the tax benefit only for individual earnings below the Social Security maximum ($113,700 in 2013). No subsidies for raising executive pay.
I find this most interesting at the level of basic philosophy; how we think about economic policy.

There are huge, longstanding, tax and regulatory disincentives to hiring people. Income tax, payroll taxes, health care and other mandates, and NLRB, OSHA, and so on. There are the high marginal taxes to labor implied by social insurance programs, as Mulligan points out.  If we want to increase the incentive for companies to hire people and people to take the jobs, why add another tax break to an obscenely complex tax code, rather than fix some of the existing disincentives? 

Is this really the right way to run a country? When "policy makers" want more employment, they slap on a complex, tax break on top of a mountain of disncentives. Presumably they then will remove this tax break, and pages 536,721 to 621,843 of the tax code describing it, despite the lobbying by large corporations who have figured out how to exploit it for billions of dollars, once the Brookings Institution decides that there is "enough" employment (!), and "policy-makers" no longer need to encourage it? 

How are the existing hundreds of bits of social engineering in the tax code working out? Do we really need more of this?  Isn't it time to return to a tax code that raises money for the government at minimal distortion?

The contrast between the benevolent "policy-maker" (no dictator ever had such power) and the reality of how the tax code in this country is actually enacted is pretty striking.

I have to say, I'm a bit disappointed in the end by both. They agree that the US economy is about 10 million jobs short. Something big is in the way. Lazear at least mentions some candidates, though many are long-standing. But the stirring conclusion from Lazear is only to continue a loose monetary policy that he says has been ineffective so far, and the conclusion from Blinder is the sort of clever scheme that economists cook up in late-night cocktail parties piling one more quickly-exploitable bit of social engineering on top of a tax code rife with them. Neither recommendation comes close to 10 million jobs, or addressing any sort of clear story why those jobs have vanished.

Wednesday, June 12, 2013

S&P 500 vs. gold stocks: 3-year performance chart

S&P 500 (SPX) versus gold stocks (HUI), June 2010 - June 2013. 

This relative performance chart shows SPX decoupling from the HUI Gold Index (aka the NYSE Arca Gold BUGS index) in 2011 and greatly outperforming the gold stocks up to mid-2013. Since June 2010, SPX is up around 51 percent while the HUI is down 41 percent for the same period. 

Whether you're a "gold bug" or not, it pays to take note of the price action in gold stocks, which may run in tandem with the gold price or take their own separate course at times. 

Although we did see a nice bounce in the gold mining shares (see HUI, XAU indices and the leading ETF, GDX) recently, it remains to be seen if the longer-term trend is changing. It may simply be an oversold bounce within a downtrend that started in the fall of 2011.

Over the past 3 years, the major US stock indices have shown continued strength (helped along by QE) and various leading stocks and industry groups have emerged, and rotated or fallen off, within that time. 

However, even at this late date, I find there are still people riding out the continued weakness in precious metals mining shares (some may have added to losing positions in an effort to "average down"). You've probably seen this type of behavior before. Instead of taking a loss and regrouping or focusing on stronger long candidates, investors stay anchored to a weak sector or weak stock, tying up their capital (and drawing on their emotional capital) to support a losing trade or investment.

From a trend trading approach, you want to be long the strongest stocks in the strong groups and short the weakest names in weak groups. A reminder: trade what you see, not what you hope to see.

Sunday, June 9, 2013

Thank You!

Life of Finance Blogger can be tough.
People have different time frame for trading and we all expect instant and positive results for all our trading. That is simply not possible and many times Trolls send abusive emails.
However, once in a while, someone send encouraging emails as well.
The following is an email from one of my long term subscriber:

Hello BB.
Thank you so much for a the many good calls you have come up with.
This has been quite a experience for me.

I would like to thank you for the newsletter and the many blog entries
you took the time to author.
I would also like to share a bit of my trading history, and the
reasons for me to sign up for the newsletter. You see I have been
trading for 7-8 years. It all started with the many daily discussions
about media, politics and financial bubbles of the danish housing
market (I live in Denmark), almost needles to say my views was/is
contrasting to the media painted views -  most the discussions back
then was ending the same way, with my friends telling me "if you are
that smart, go make some money". Well, I opened an account and so it

After the beginning of my trading there was big wins and big losses,
my trading style was about macro and stats, I thought, but I was so
wrong. For me it was mostly about emotions. I became emotionally
exhausted and the timing of the swings was my bad. I saw ETF 3X move
up and run away with gains up to 100% ending with losses in the double
digits. What agony.

So I left the "minute chekking" - checking accounts on hourly basis -
emotional stress and returned to where my successes were (looking from
my trading history). It took half a year before I did any trade again
- and quit levered ETF as a whole (up till now). I never thought I
would be subject to this level of stress because I am a very clam guy.
After my pause I got some checks and balances in place which could
counter some of my bad trading habits (for instance if a trade goes
against you the counter trade is not the right one either, it not
about being IN - its about capital preservation).

I started following you on the blog and it was a easy choice signing
up for subscription to the newsletter and that was the first time ever
I paid for trading advise. But I knew I needed some guidance to grow
with. Partly so I would not revert to my old trading patterns of wild
swings (happened before) a sane voice so to speak, and to get my
emotional toolbox in order.

And now I am more confident than I have ever been and hoping to
continue the journey with you on ward and finally this week concludes
some of the best winning 9 months for me.
My deepest thanks for the advise and being the sane voice I needed so much.

With the best regards.

I was both humbled and touched with this email.
Thank you my friend.

Coming back to market, our exit time was very good and so far our new trade has played well. I was not able to scale in the 2nd part because it ran away from us on Friday but I decided not to chase it. I think the trade will come back to us on Monday to a certain extent when I will add the balance position.

I see a long term top forming on Housing and would think that with the coming bounce we should exit housing if we are long housing. Also with the sentiment negative on gold, I see a long term bottom forming but I still think we will have to wait somewhat more before we can go long.

Thank you and wish you all great trading.

Friday, June 7, 2013

Crummy Numbers - Big Rally

As expected, the economy continues to limp along.  The jobs report this morning showed 175,000 new jobs.  With net downward revisions for the prior months, the number was barely above the 150 K mark.  The result -- 7.6 percent unemployment unchanged.  Five years after the bottom, still a pitiful recovery.  But, that's good news for Wall Street because it suggests that expansive liqudity provision by the Federal Reserve will remain the policy.

For a while, higher stock prices will paper over the continued stagnation of the American economy.  But those looking for jobs and wage gains have all but given up hope in this tepid recovery.  The economy figures to soon be body slammed by Obamacare, so don't expect a healthy economy for quite a while.

Hoping for Bad Economic Numbers

World stock markets appear to be hoping for a bad employment number this morning.  Why?  They want Bernanke to continue QE3.  That's why.  Global markets reflect the new wave:  hope for bad economic news and expect a bailout.  This mentality encourages homeowners to borrow more than they could ever afford to pay back.  Student borrowers are encouraged to do the same.  Gaming the system by behaving economically foolish pays off because of the expectation that the government will step in.  At the end of the day, that is what Obamacare is all about as well.

In the bad old days, we expected free markets and incentives to fuel economic growth to raise living standards.  That is no longer the plan.  Now, it is all about slicing up the pie, while the pie no longer grows.  The taxpayer is assumed to have endless resources.  A bad assumption.

The 'entitlement mentality' has permeated every level of society and has infected global equity markets as well. 

Those who are hoping for bad economic numbers will likely get their wish.

Thursday, June 6, 2013

First Meaningful Pull Back.

It has been a while since my last post. It is simply a function of lack of time. In the mean time, I have somehow managed to send the Weekly newsletters to the subscribers.
I was hoping for a market TOP around 1st week of May and accordingly we went long VIX (UVXY) and short Emerging markets and other sectors including Finance.
However, there was an over-shot and the markets kept going up till May 22nd. Obviously, there were some doubts amongst the subscribers. I kept stressing that the correct has simply been delayed not cancelled. And we kept hanging on to the long VIX and short everything else trade.
Yesterday and today we closed our positions. We made a tidy little sum on UVXY and peanuts on others. But at least there was no big red anywhere.
Now we are taking a new position for a short term trade.

I think we are in the process of a giant TOP forming which will take us till the end of summer before we see any major correction.
For now, I think the short term correction is over and we will see another bounce soon. How far it will go is a question of time. But if it fails to make a new high, we have problem. Big problem or little problem, I am not sure at this time.

We stayed away from Gold and Silver because I think the cycles did not bottom. Nor for that matter the cycle for Apple and we will see more downside for Apple as well.  We are waiting for more favourable time to go long PM sector.

We play the game by the seat of the pants. And we always correct the course of action as we go along. We cannot be correct 100% of time. For e.g. I am holding grain ETFs for few months now and I am under water, although not by much. But I am holding onto those positions for longer term. And that is where I find most folks have problem. Committing to a position for long term. May be we got brain washed by leveraged option trade, when we start expecting instant results. We get impatient and when a trade initially goes against us, we get scared. The cycle of fear and greed plays on.

Hope you guys are doing great.
Trade safe.

Two on financial reform

I recently read two interesting items in the long-running financial regulation saga.

First, a very thoughtful, clear, and succinct speech by Philadelphia Fed President Charles Plosser titled "Reducing Financial Fragility by Ending Too Big to Fail." It's interesting to see a (another?) Fed President basically say that the whole Dodd-Frank / Basel structure is wrong-headed. Two little gems:
 There is probably no better example of rule writing that violates the basic principles of simple, robust regulation than risk-weighted capital calculations.
Remember that Title II resolution is available only when there are concerns about systemic risk. Just imagine the highly political issue of determining whether a firm is systemically important, especially if it has not been designated so by the Financial Stability Oversight Committee beforehand....

...Creditors will perceive that their payoffs will be determined through a regulatory resolution process, which could be influenced through political pressure rather than subject to the rule of law
No surprise, I agree.

Second, Anat Admati and Martin Hellwig have an addition to their "Banker's new clothes" book (my review),  23 Flawed Claims Debunked.  Don't miss the fun footnotes.  Anat and Martin get some sort of medal for patience in wading through dreck.

Bipartisan Mercantilism

From the press release here and here
Wednesday, June 5, 2013 WASHINGTON, D.C. — Following new figures that show a 34 percent jump over last month’s [my emphasis] U.S.-China trade deficit, U.S. Sens. Sherrod Brown (D-OH), Jeff Sessions (R-AL), Chuck Schumer (D-NY), Lindsey Graham (R-SC), Debbie Stabenow (D-MI), Richard Burr (R-NC), Susan Collins (R-ME), and Robert Casey (D-PA), today introduced the Currency Exchange Rate Oversight Reform Act of 2013... 
 ...the bill would use U.S. trade law to counter the economic harm to U.S. manufacturers caused by currency manipulation, and provide consequences for countries that fail to adopt appropriate policies to eliminate currency misalignment. The senators’ introduction comes in advance of upcoming talks between President Obama and Chinese President Xi.
Obviously, this is a political shot across the bow to the Obama Administration to press mercantilist trade restrictions in the upcoming discussions with China. Still, why cloak it in such nonsense as
“It is universally accepted that China and other major countries intentionally manipulate their currency to create an advantage for themselves in the marketplace” [Senator] Graham said.
Well, not "universally."

The "complete summary" continues,
"the bill specifies the applicable investigation initiation standard, which will require Commerce to investigate whether currency undervaluation by a government provides a countervailable subsidy if a U.S. industry requests investigation... 
I'm glad to see that industries which don't like to compete with Chinese manufacturers will become experts in monetary policy.
The legislation requires Treasury to develop a biannual report to Congress that identifies... "fundamentally misaligned currencies" based on observed objective criteria...
I cannot find what those "objective criteria are." Let us know, guys and gals, a Nobel Prize in economics awaits you.

If they don't like the Chinese peg, maybe next they can target Texas for its 1-1 peg to the Ohio dollar, which is obviously sucking business to Texas.

When they're done with "currency manipulation" perhaps they can get to the serious business of impeaching the Easter Bunny.

(Thanks to Alex Walsh at the Birmingham News for pointing me to the link.)


I wrote a short essay on immigration for Hoover's "Advancing A Free Society" series. It's here, and reproduced below.  The whole set of essays in Hoover's Immigration Reform series is worth perusing.

Since writing it, and also reading Steve Chapman's good editorial on the subject (Chicago Tribune, Townhall) the e-verify system seems like an even bigger nightmare. Every employer in the country must check that every applicant has the Federal Government's permission to work before employing him or her.

Beyond the points raised in the essay below, it's an interesting coincidence that this e-verify is in the news at the same time as the IRS scandal. Congressional Republicans get the cognitive-dissonance award of the year for this one.

Surely, it will never happen that e-verify agents target selected groups for more careful scrutiny or slow processing, because they might want to vote one way or another, or because they have expressed unpopular opinions? Surely employers with unpopular political opinions have nothing to fear here?

Surely, with the technology in place, Congress will never expand the power to dictate who has the right to work and who doesn't? It won't try to deny work or work in certain industries to people convicted of crimes?  Especially people convicted of vague white collar crimes like say "consipracy?" Surely, it will never happen that people's right to work is blocked for getting in trouble with other federal agencies like the NLRB, EPA, EEOC, etc? Surely, this system won't be used to ensure that the victim of the latest SEC witch hunt can never work in the securities industry again?

Surely, Congress will never expand the system to make sure anyone who gets a job has paid up their health insurance, paid their taxes, and changed their lightbulbs to the new low-energy mandates? Surely, Congress and the agency will never use the system to deny the right to work to people accused of "hate speech" or other unpopular exercises of first-amendment privileges?

Surely. Your papers, please?

The Hoover essay:

Immigration Policy: Purpose and Unintended Consequences

The immigration policy discussion and legislative proposals suffer from a huge gaping problem: nobody can articulate what the point is. What are the objectives? People want to come to the United States, work, pay taxes, start businesses, buy houses, and join our society. Why are we keeping them out?

Well, obviously, people who don’t work and want to come only to receive government checks and other benefits are a drain. But our immigration policies and proposals are not crafted to solve that problem. And it’s easy to solve: require a payment at the border, or post a large bond, say $10,000, which is refunded after five years or so of paying taxes, having a job and health insurance, and staying out of jail. Obviously, we don’t want criminals and terrorists, but that desire hardly explains our laws or the proposals on the table.

The vague charge that immigrants will “take jobs” and lower American’s wages is not established at all in economics, and it doesn’t make much sense anyway. It surely doesn’t explain why we keep out people who want to start businesses. Our ancestors didn’t steal Native Americans’ jobs to get rich; they created new businesses and opportunities. Land and capital are plentiful in the United States, so why would we expect new immigrants to be any different?

Furthermore, whether an immigrant works in a US factory and produces a good which undercuts that good produced by a US worker, or whether the immigrant works at a factory in Mexico and produces the same good–probably cheaper–the effect on US wages is the same. By keeping the immigrant out, the factory just moves to Mexico.

Finally, even if keeping foreigners out boosted Americans’ wages, such a policy is a pure transfer. Would the US government send marines to Mexico, to steal a prospective migrant’s cow, or take his wages and send the cow or the wages as a subsidy to US workers? And then charge a sales tax on both the Mexican and the US product, raising its price and sending that as a subsidy to American workers as well? That’s exactly what restricting immigration to prop up wages accomplishes, as it is exactly what trade restrictions accomplish. We send foreign aid and development assistance to lots of countries (well, to their governments, but the intent is to help people). We then try to impoverish them to our benefit.

Political and social arguments carry a little more weight. Face it, many Republicans are anxious about immigrants because they fear they will vote Democratic. A thirteen-year disenfranchisement seems well crafted to exploit that worry. Stories of extremists who immigrate who live off welfare, and commit acts of terrorism stoke fears that the melting pot is broken. But if that were the genuine concern, our immigration laws should favor hardworking, entrepreneurial immigrants likely to adopt our culture. If we have so little faith in the power of our ideas, perhaps we should reexamine them.

If we worry about culture wars, and voting citizens who do not have the basic command of US history, political philosophy, legal and social traditions, that battle was lost, and should be won, in the disastrous public schools, not by keeping entrepreneurs on the doorstep.

Rudderless policies are even more prone to unintended consequences. Under the proposed e-verify system, all employers are supposed to verify the work eligibility status of all employees, including domestic works, in a gargantuan national database.

The result is fairly predictable. The only way to get around the e-verify system would be to make the worker fully illegal. So, rather than have a worker with illegal immigration status, but in the social security system and withholding taxes, we would move to an under-the-table cash economy. And once the company moved to accommodate some illegal workers, why not avoid taxes, regulations, health insurance penalties, and all the rest of it by paying the Americans in cash as well? The immigration law has a huge hole in it: How do people who want to come to work in the United States in the future come here legally? Even if the current illegal immigrants are allowed to stay, if we keep denying entry, new ones will keep coming, and we will be back in the same mess all too soon. You can tell that this must be the plan, because otherwise we wouldn’t need to talk about e-verify. If everyone who wants to come and work can, you don’t need to do fancy verification. You only need that if you conceive of a new, large stock of people in the country trying to work and being barred from doing so.

Immigration law should be like drivers’ licensed law or passport applications: setting out the procedure by which anyone who wants to move to the United States can go about doing so.

Wednesday, June 5, 2013

The Equity Risk Premium Puzzle

One of the more interesting, yet to be explained, facts in finance is the fact that common stocks perform so well, as compared to less risky assets.  Treasury bills are earning almost nothing these days, but stocks are on a tear.  Why?

The same pattern has held historically.  The gap between what stocks earn and what much safer assets earn has been much, much bigger than could possibly be explained by aversion to risk.  Something more is afoot.

The question is front and center today.  Usually the question is posed as: "why are short term rates near zero, but other assets -- stocks, housing, e.g. -- doing so well.  Why don't people simply shift from treasuries to stocks and housing?"  Apparently folks are doing just that, but not by enough to narrow the return gap.

You could argue that there is not enough investment by ordinary folks in stocks.  That means that stock prices never get quite high enough to deflate their long run return prospects.  But, what about housing?  It is hard to believe that a similar argument would apply to housing.

I'm no fan of the equity market these days (I became bearish at 1391 in the S&P and the market is 15 percent higher than that today).  But, long run, you can't beat equities.  You just have to somehow ride through the rough patches, which may lie just ahead.

Tuesday, June 4, 2013

Monetary Policy Puzzle

Might raising interest rates, but not paying interest on reserves, actually be "stimulative," inducing banks to lend out reserves?

Last week, I gave a talk on monetary policy at a forum organized by the Becker-Friedman institute.  I explained my view, that as long as reserves pay the same interest rate as very short-term Treasuries, and as long as banks are holding huge amounts of excess reserves, that monetary policy and pure quantitative easing -- buy short-term treasuries, give the banks more reserves -- has absolutely no effect on anything. Interest-paying excess reserves are exactly the same thing as short-term treasuries.

When the time comes to tighten, I said, I hope dearly that the Fed continues to pay a market interest rate on reserves and allow huge amounts of excess reserves to continue. (I had lots of financial-stability reasons, which will wait for another day here.)   But that means that conventional open market operations and quantitative easing -- more reserves, less Treasuries -- will continue to have no effect whatsoever.

An audience member asked a very sharp question: Suppose the Fed raises interest rates but does not raise the rate on reserves? Now, banks do have an incentive to lend them out instead of sitting on them. Wouldn't velocity pick up, MV=PY start to work again, and the Fed get all the "stimulus" it wants and then some?

It's a particularly sharp question, because it gives sensible-sounding mechanism why the conventional sign might be wrong: why raising rates now might give monetary "stimulus" that is otherwise so conspicuously lacking. There are a few other of these stories wandering around. One: Low rates are said to discourage retirees and other savers, who now "can't afford to spend."  (Quotes around things that don't make much economic sense.)   John Taylor, wrote a very provocative WSJ oped, (too subtle to summarize in one sentence here) and also came close to saying the sign is wrong and higher rates would be more stimulative.

But is the suggestion right? I sort of stammered, and needed the weekend to think it through. (Giving talks like this is a great way to clarify one's ideas. Or maybe this just reveals my shocking ignorance. In any case, it makes a good exam question.) Think about it, and then click the "read more."

The answer is no, I think, but revealing about what the Fed can and cannot do.

How exactly would the Fed raise interest rates?

In the new interest-on-reserves regime (the one I hope will continue) the Fed simply announces, "we borrow and lend reserves at 3%." Interest rates go up to 3%. But so do interest rates on reserves.

The standard mechanism, which allows reserves not to pay interest,  would be for the open-market desk to sell securities in exchange for reserves, in order to drive down the supply of reserves until interest rates rise on the inter-bank (federal funds) market. Banks who need reserves then are willing to pay interest to borrow non-interest-paying reserves overnight to satisfy reserve requirements on their checking accounts.

You see the trouble. Rather than "get banks to lend out the reserves,"  the Fed has to soak up all those reserves in order to raise interest rates in the first place.

Like other central banks, the Fed could offer prices rather than control quantities. Other central banks set rates in the interbank market, by simply saying "we borrow and lend at 3%. Come and get it." (They may leave a window, borrow at 2.9%, lend at 3%, to keep a private market going.)

If the Fed were to do this, banks would simply take all the reserves --  money lent to the Fed overnight -- and... lend it to the Fed overnight at the higher interest rate. This is interest on reserves by another name, no more no less. To the extent that the Fed ties up the money -- borrows at term, or otherwise makes its offer more "bond" like -- this action just synthesizes the huge open market operation that drains reserves from the system. (It's not a bad idea, though, if the Fed wants to shrink reserves without selling assets!) Again, the desired incentive to get banks to "lend out" the reserves vanishes.

What if the Fed offers a price target for Treasuries, and also refuses to pay interest on reserves? Could the Fed offer to buy and sell 3 month Treasuries at 3%, but insist on no interest on reserves and no open market operations to soak up reserves? No, because offering to buy and sell Treasuries means offer to take reserves and give out treasuries, which ipso facto soaks up the reserves again.

The Treasury could (and arguably should) take over interest-rate policy. After all, in the interest-on-reserves regime, when the Fed says "3%, come and get it," short-term Treasury rates will also jump to 3%. (Banks dump Treasuries and give the proceeds to the Fed, driving up Treasury rates.)  It is exactly as if the Treasury said, "Rather than auction 3 month debt, we'll set the rate at 3%, and the market sets the quantity." If you think the quantity reaction might be large, you've figured out some usually unspoken limits on the Fed's interest-rate setting abilities.

But reserves are our numeraire. Pegging interest rates at 3% means the Treasury rather than the Fed takes in reserves in exchange for debt, and parks it in the Treasury account rather than bank's accounts at the Fed. The banks will  again drain reserves rather than "lend them out."

The Treasury could commit to immediately spend the money... But now we're in the land of fiscal, not monetary stimulus, and a reminder that the two always come together.

I'll be interested to hear comments on this one.  The standard stories by which interest rate increases are contractionary are very weak and full of holes. The idea that perhaps raising interest rates is "stimulative" is fun to think about. And a number of schemes around to get banks to "lend out the reserves" are also fun to think about. I don't think this one works, but maybe one of you can get it to work.

Bad News is Good News

Stock markets rallied yesterday upon learning that US factory activity plunged to new lows.  The factory activity index reached a low of 49, where anything below 50 is considered a sign of economic contraction.  Three cheers!  Weak economic news means the Fed will continue its QE3 purchases of more than $ 80 billion of debt each month.

Stock market mavens no longer hope for good economic news.  That seems an unlikely prospect.  Instead weakness suggests more aggressive Fed activity, so market prognosticators stay tuned in to see how bad it can get.  The more the economy worsens the better.

Maybe the Obama Administration is long the stock market.  If so, that might explain policies that seem designed to prevent the economy from what should have been a strong economic recovery.

So, instead of jobs and economic growth, we get higher stock prices.  At least for a while.

Sunday, June 2, 2013

Forward Guidance vs. Commitment

He: "Honey, I'm getting tickets for Sunday's football game. Do you want to come?"

Forward guidance.  She: "As things look now, I think I'll feel like coming when Sunday rolls around. Of course that might change. If my mother calls and wants to go shopping I might well feel differently."

Commitment. She: "Sure, honey, that sounds like fun. Get the tickets. I know my mom might call, and I'll regret it later, but we have to get the tickets now, so count me in."

 Commitment means declaring a plan, even a contingent plan, that you will follow, even if you will regret it later. Forward guidance means announcing now what you think you will feel like doing in the future, but not giving up any discretion to change your mind later. Obviously, to someone who has to plunk down money for tickets, commitment is useful.

These issues came up in the last year's fascinating discussions about monetary policy, and brought to the forefront again by Fed Chairman  Ben Bernanke's testimony on May 22, the subsequent question and answers, the FOMC meeting, and market gyrations and controversy surrounding these events.

The words that roiled the markets were, most briefly, "in considering whether a recalibration of the pace of its purchases is warranted, the Committee will continue to assess the degree of progress made toward its objectives in light of incoming information."  Recalibration? Says the  market.

Perceptions matter as much or more than actual statements here (this is the "managing expectations" game). The Wall street journal wrote
Wednesday's flurry of new information jostled markets, which moved up when Mr. Bernanke's congressional testimony was released in the morning, then pared triple-digit gains when he began taking questions and turned negative when the minutes were released in the afternoon....Taken together, the chairman's testimony before the Joint Economic Committee and the minutes suggested that Fed officials aren't yet near consensus on when to begin to wind down the bond buying but that a decision appears to be approaching in the months ahead. ...
"Rather we would be looking beyond that to seeing how the economy evolves and we could either raise or lower our pace of purchases going forward. Again that is dependent on the data," he [Mr. Bernanke] said.
The minutes of the most recent policy meeting said "a number of participants expressed willingness to adjust the flow of purchases downward as early as the June meeting if the economic information received by that time showed evidence of sufficiently strong and sustained growth."

But, the minutes added, "many [officials] indicated that continued progress, more confidence in the outlook, or diminished downside risks would be required before slowing the pace of purchases would become appropriate." 
The Economist wrote (my emphasis)  
One of the main points Mr Bernanke tried to make was that if QE slows, it will "not be an automatic mechanistic process." For example, if it drops from $85 billion to $65 billion, it need not drop to $45 billion at the next meeting. It could stay at $65 billion or if the data worsen, go back to $85 billion. This isn’t that surprising; the Fed always reserves the freedom to respond to the data and hates feeling boxed in by market expectations.
This all scores somewhere between total discretion (we'll do whatever we think is right given the data at the time) to a degree of forward guidance (here is an outline of what we think now we'll feel like doing, but of course we might change our minds.)

Why does this matter? It's an interesting denoument to a big discussion in academia, the Fed, and the broader evolution of central banking doctrine (I hate to say "theory" as it's all pretty loosey-goosey).

The idea was that the Fed can stimulate the economy by committing now to keep policy expansionary for longer than it will want to do ex-post.  I last wrote about this in "managing a liquidity trap." For the previous year, highlighted by a stellar speech by Mike Woodford at Jackson hole (see previous post), this idea was all the rage.

In the standard new-Keynesian model, consumption is low today because its future level is anchored, and a too-high path of real interest rates makes consumption grow too fast. Hence the current level of consumption is too low. That level can be raised by lowering expected future interest rates and hence expected future consumption growth just as effectively as by lowering today's interest rates and today's consumption growth. (If this all seems insane, read here.) So, goes the story, the key to stimulus when interest rates are zero is for the Fed to commit to keeping interest rates low, lower than than we and the Fed know it will want them to be when the time comes. 

 I expressed some doubts that the Fed would ever make such a commitment, or that people would believe it if it tried to do so. (I also expressed some doubts at the whole modeling approach, but that's not important now.)  These events seem to prove that conjecture in spades.

The vast market gyrations, and the Economist's trenchant quote are especially interesting. If the Fed had been committed to a path, or even to a rule (no change until unemployment falls below 6.5%), and most of all if people thought it had such a commitment,  then Mr. Bernanke's answers to questions from congressmen should have no effect.

If only commitment now to do things you will regret later were so easy as it is in our models. This is not a criticism of the Fed. Imagine the Fed chair explaining to Congress that he is keeping rates lower than everybody thinks they should be, with unemployment down to 5% and inflation heating up at 4%, because he made that commitment in order to stimulate the economy back in 2012. Commitments need more than words. It's easy in a model to write "the Fed commits to x," like a new inflation target or interest rate path. It's easy to write opeds that "the Fed should commit to x." Generating such a commitment -- which means, by definition, something that constrains your actions in the future -- is not so easy.

Benn Steil has a nice blog post and more media links.