The Fed and G7 central banking establishment has “learnt nothing from their empirical experience since 2008, which is simply extraordinary,” Christopher Wood at CLSA Research writes. The lessons that should have been learned during the financial crisis – when numerous warnings were given – is repeating itself. The US Fed is in a politically vulnerable position, he writes, as the Bank of Japan is already taking marching orders from Japanese Prime Minister Shinzo Abe. Watch out because missteps at this point, particularly if Donald Trump is elected, could be costly.
Why were warnings missed in 2008? Was the Fed focus only listening to a small academic group and avoiding market analysis techniques?
Not only was the US Federal Reserve documented to have been given a warning, but in the Bloomberg documentary “Hank” it is revealed that former US Treasury Secretary Hank Paulson gave his incoming counterpart a warning.
The question is: why were these warnings missed?
Wood didn’t go there, but one can say the Fed is looking at rather one-dimensional models and tends to listen to a select group of elite academics. There is very little diversity of opinion in the Fed circle, and truly challenging authority is not a path to remain included in the elite club.
In part the lack of challenging authority – questioning the consensus thesis – highlights both the current problems at the Fed and why they missed 2008.
Leading up to the financial crisis, bank establishment consensus thinking both at the Fed and among the academic elite was that the housing market wouldn’t fail. The Fed, for its part, wasn’t looking at the more practical issues. In part what hedge fund executives and market participants recognized that the Fed missed involves multi-dimensional analysis.
The Fed is wonderful at high level analysis. But the practical connect-the-dots analysis many hedge funds do — where challenging a thesis and poking holes in analysis is encouraged — is avoided at the Fed.
The Fed and its academic club were so focused on supercilious economic analysis that they either ignored or just plain missed the free-market experts that observed loan standards were being violated. It took an understanding of average people and how they were being given loans without proper documentation they could not afford.
Questioning the consensus thinking highlights a fundamental hedge fund view of the world. In unearthing consensus errors, tremendous profit can be garnered. The Fed and their academic elite followers appear to operate on the opposite principle: the only people they listen to are part of the elite and ever so polite private club, ignoring voices from the “free” market system. Because the warning did not come from within the hallowed grounds inside the banking system, it was not worthy of consideration.
CLSA says former Fed Governor Kevin Walsh was right
In part, this leads to an August 24 Op-Ed piece in The Wall Street Journal titled “The Federal Reserve Needs New Thinking.”
What was unique is that the article was penned by former Fed Governor Kevin Walsh, an insider who, after this article, isn’t likely to be well received inside the halls of conformity. Most material he wrote that Fed “models are unreliable, its policies erratic and its guidance confusing. It is also politically vulnerable.”
CSLA’s Wood “agrees with all of the above,” as do numerous market observers who are warning about the next 2008. What will be the trigger? A manipulated market structure can be very fragile and the slightest disruption or surprise can trigger it.
In the report Wood addresses Donald Trump and the risk to the Fed should he be elected. Trump, it is feared, may either revamp, reduce or eliminate the central bank if granted power. Even if Trump loses, the Fed needs to be wary of encroaching political control, with the Bank of Japan’s current subservience to the Japanese political establishment just one example of what could happen with missteps at this point.
The notion of eliminating the central bank is a deep affront to the established powers. In part this is hurting Trump because powerful if unseen forces are lining up against him. But the establishment also needs to be careful. There is a reasonable possibility that Trump has a path to victory despite the overwhelming establishment consensus thinking in the other direction.
“The email and Clinton foundation issues remain points of vulnerability for the Democratic campaign though the media establishment will try to play them down as old news,” Wood writes. “But for Trump to have a chance of winning he has to stay on message and avoid being provoked into gratuitous fights with people who do not matter. That, clearly, does not come easily!”