Buttonwood Conference: Bubbles, TBTF, Japan, EM, CBs

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Buttonwood notes by Elliot Turner.

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I had the privilege of attending The Economist’s Buttonwood Gathering 2013 replete with a stacked lineup of speakers and panelists. At a conference such as Buttonwood, one of the most interesting elements is the opportunity to exchange ideas with attendees who are generally pretty brilliant in their own right. I had numerous conversations with other Gatherers on topics ranging including Mexico’s pro-market reforms, Canada’s housing bubble, the European banking environment, and much more. Measuring consensus on such topics at Buttonwood provides a great glimpse into what the “Smart Money” is thinking. Sure enough, smart money seems abundantly optimistic in Mexico’s steps toward and capacity to successfully implement said reforms, Canada’s housing bubble is very real, and the European banking environment will have to pivot from an arena of nationalistic-driven excess to centralized decency.


These are simply some topics I conversed about with fellow gatherers. The panels themselves covered a wide range of topics, from the global economy, to the emerging market landscape and today’s optimistic venture capital environment for technology. While it’s impossible to completely cover each topic and the panelists’ thoughts in this post, I want to share some of the points that were more striking and relevant to me personally in the themes and topics that I focus on.

The two-day event kicked off with a conversation on the “global economic outlook” between José Manuel González-Páramo, Robert Rubin and Nemat Shafik, moderated by Zanny Minton Beddoes. All the panelists echoed the theme that Europe was improving and a decent coefficient of global growth was moving from emerging back to developed markets. Robert Rubin took a strikingly pessimistic tone towards the US growth outlook, given his belief that the conventional narrative of a fiscal drag was overstated and the real problem remains lack of demand and therefore anemic consumption. Shafik explained how there is increasing decoupling and dispersion amongst the various emerging markets and how each unique country thought of in its own unique way. Gonzalez-Paramo mused that Europe had the greatest potential to outperform estimates in the coming months should the relevant parties continue on the path towards a formalized banking union.

The discussion on Europe offered a natural segue into the second panel covering “Europe’s Burden” with José Manuel Campa, Bruce Richards and Nicolas Veron. Véron explained how the stress tests in Europe would be completely different this time around. Rather than pure stress tests, the exercise would be an intensive Asset Quality Review (AQR) done by the ECB instead of the European Banking Authority. Richards seconded this sentiment, and noted that the EBA tests were “laughed at.” Richards further explained how Europe’s banks have $42 trillion in assets compared to a GDP of $13 trillion, far larger than the US, which has $15 trillion in assets on a GDP just shy of $17 trillion. While Europe’s economy “has bottomed” it will take time for the banks to grow out of their size problem, with the US Savings and Loan Resolution Trust Corporation wind-down offering the best analog. Richards called Europe today “the largest asset disposition in the history of the world” and said the opportunity is in the very early stages, with assets like Spanish Non-Performing Loans available for 3 cents on the dollar.

Next, Roger Altman and Thomas Horton spoke about the changing corporate landscape in the US. Altman insisted that “uncertainty” in the business community stemmed predominantly from a shortfall in demand in the economy and not from Washington. The biggest trend Altman has been watching is the rise in activism amongst shareholders, and the willingness of institutional shareholders to embrace activist proposals. Meanwhile, Horton opined that US tax policy’s limitations on repatriation offered a significant hurdle to prudent balance sheet management in corporate America and that regulatory uncertainty has been a particularly large obstacle for him personally in helping American Airlines emerge from bankruptcy.

Day two started with an interesting discussion on monetary policy between Mohamed El-Erian and Vincent Reinhart. Both gentlemen generally agreed that central bank policy cannot create supply, but that it can move demand. In this context, the risk/reward balance of further quantitative easing has shifted decisively towards the direction of risk, with little reward. While the Fed has emphasized the importance of forward guidance, they completely underestimated the market’s interpretation as to when tapering would begin. El-Erian worries that in this environment, people are being “pushed, not pulled into trades.” Reinhart stressed that in the future Yellen Fed, there will place a greater focus on the dual mandate. Further, she will take it as her responsibility to provide guidance that is both broader in scope and deeper in explanation.

Next, Jim Millstein and Mary Schapiro talked about the financial regulatory environment. Millstein highlighted how in Too Big To Fail, there is no market discipline happening in either the equity or debt markets for banks. As such, there is no natural free market check on these institutions considering debt is subsidized with the TBTF guarantee and equity is too large for an activist to impose changes. Ultimately, Millstein sees finance heading towards a more utility-like role in the economy. Schapiro expressed some concern that while a stronger regulatory regime has been constructed, it has effectively been rendered toothless by a lack of funding, but that ultimately she was optimistic regulators will find a middle ground and bridge some of the gaps present between political goals and regulatory reality.

Japan was next up in the Gathering’s coverage of global economies. Koichi Hamada and Paul Sheard both shared their belief that Abenomics so far is working, particularly on the monetary policy side. Hamada noted that excess capacity to GDP declined from 3% to 1.5% and inflation actually started moving in the right direction for once. The problem, both agreed, is that little light has been shed and little progress made on supply side reforms that are ultimately necessary for Abenomics to truly work. Both believe that in time this will happen, but for now, Abe will have to combat an entrenched and powerful bureaucracy to get his way. Sheard made the point that no central bank in world history has tried to dislodge deflation expectations knowing it will inevitably have to re-anchor inflation to a 2-2.5% target. Japan has plenty of room to do more when compared to the Fed, as the US central bank increased its balance sheet by 250% during the course of the crisis, in contrast to Japan’s 54% increase. Both explained how while many worry about Japan’s “demographic” challenges,” Japan does have an opportunity in that women make up a smaller percentage of the workforce than in most developed countries and there is considerable room to improve.

Robert Shiller and Lewis Alexander then held an interesting discussion about bubbles. Shiller started with a definition of a bubble: they are a price-mediated feedback between prices and market participants, with excessive enthusiasm, media participants, and regret from those who are not involved. The “psycho-economic phenomenon” is a defining characteristic that becomes ingrained in a culture and is related to long-term expectations that cannot be pinned down quantitatively. Alexander offered a distinction between those bubbles that are a systemic risk verse those that are not. Bubbles carry systemic risk only when they have a credit component. Thus, in the absence of a credit component, the risks of a bubble are not all that severe for society at large. The housing bubble was one such systemic risk event, though both emphasized this was clearly not the fault of the Federal Reserve Bank (as many skeptics proclaim). Home prices began their rise in 1997 and continued to rise even during periods within which the Fed was raising interest rates. Shiller explained that there simply was no correlation at all between the path of rates and home prices, and that the efficient market hypothesis was the real culprit for inducing a sense of complacency in market observers that all prices are rational. Further, right now, people are calling for bubbles everywhere and they can’t all be the Feds fault, as is evidenced by what Shiller said is “most likely” a bubble in Brazilian real estate. Though Alexander cautioned that the problem with monetary policy is how it is a “blunt tool” and influences all or nothing with regard to price, so some distortions can happen. These distortions are mainly in interest rate risk, not credit risk right now and he does not see accompanying systemic risk as a result.

The two Bagehot Lectures were given by Agustín Carstens and Alan Greenspan. Carstens discussed the role of emerging market central banks in a crisis environment. Central banks should continue to focus on keeping inflation under control, and could use some macroprudential policies to offer a countercyclical buffer, though such policy should be used “like tequilia–only in moderation.” EM central banks also should play a supervisory role to regulate the flows of currencies and help mitigate volatility, but monetary policy can’t do all this on its own. Many EMs need serious structural reforms and it’s unfortunate that these needs are only recognized on the down side of the cycle, not the up. This is equally true in other areas. For example, Mexico opened a permanent line of credit with the IMF when times were good, while now countries who would benefit from such a line don’t want to do so for fear of appearing to “need” it and in the process, looking vulnerable. Alan Greenspan then took to the stage. He explained how there is a significant bifurcation in our economy whereby capital investment of a less than 20 year duration is doing quite well and of greater than 20 years is in a deep slump. Greenspan believes this is the result of uncertainty in long-term planning and blames tax policy as the culprit. Right now in the US we are seeing one of the greatest spreads ever in term structure between 5 and 30 year Treasuries and this is a reflection of the gap between the short and long-term economies.

In the ensuing panel on fiscal priorities with Roger Ferguson, Laura D’Andrea Tyson and Carmen Reinhart, D’Andrea Tyson quickly launched into her rebuttal of Greenspan’s argument. She explained how the fiscal stimulus relative to GDP was rather small, and the premature austerity undertaken by the government since emerging from crisis has made the recovery slower than it needs to be. There is considerable excess capacity in our economy, and this is a far bigger culprit in weak long-term investing than anything else and this uncertainty is over demand, not politics. Carmen Reinhart agreed with most of these points and added that private sector deleveraging continues to be a headwind to growth. She also noted that the US has done particularly well relative to others around the globe, but worries about how the US will unwind it’s large fiscal deficit when all is said and done. Ferguson elaborated on how big the private sector short-fall was during the crisis and how much more the government could have stimulated the economy instead of leaving monetary policy as the “last man standing” to help. He complained that “politicians are acting Ricardian in a Keynesian world” and hurting, rather than helping our cause. He and D’Andrea Tyson remarked on how the negative real interest rates on Treasuries offer a serious opportunity for the government to borrow and invest in much-needed infrastructure projects, but unfortunately everyone in a position to do something is focused on discretionary spending as a problem when it’s really entitlements. If only discourse were more rational.

While this is hardly an exhaustive summary of the Buttonwood Gathering, these were some of the more relevant discussions on topics that I am concerned with. I took fairly extensive notes during the two days, and if anyone would like some more insight on any of the specific panels discussed here (or those that I didn’t mention), please feel free to leave a comment below or email me and I will be sure to answer.

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