Monthly Archives: January 2014

Ben Bernanke’s tenure as Federal Reserve chairman ends this week. Financial Times markets and investment columnist John Authers speaks to Gavyn Davies, principal of Fulcrum Asset Management, who analyses the massive expansion of the Fed’s balance sheet under Mr Bernanke, and the course he has set for his successor, Janet Yellen

The generally optimistic tone at Davos last week was rudely interrupted by a melt-down in emerging markets, triggered by concerns that the major central banks in the developed economies are contemplating an exit from easy money sooner than previously expected.

The Fed will probably take its second step towards tapering next Wednesday and now seems to be on auto-pilot for the rest of the year. More surprisingly, the Bank of Japan sounded some cautious notes about the likelihood of further quantitative easing when fiscal policy tightens in April. Finally, the UK authorities, in the shape of “aides of the Chancellor”, hinted that a rise in short rates may be no bad thing this year.

A significant shift towards tighter monetary policy in the developed world as a whole still seems extremely unlikely, given the deflation risks highlighted by the IMF last week.

But the British case is now very intriguing and, after contradictory messages at Davos, also somewhat confused.

Because of low productivity, the level of UK GDP continues to lag well behind the recovery from the Great Recession achieved in many other economies. But the remarkable recent surge in UK growth rates, along with a sharp fall in unemployment, means that the Bank of England now has to reconsider its entire monetary stance. With forward guidance now in murky waters, the markets will want greater clarity in the next Inflation Report in February. 

The first ATM machine dispensing Bitcoins is apparently opening this month in Asia. So what exactly is the Bitcoin phenomenon? Variously described as a digital Gold Standard, an internet miracle, a means of conducting illegal transactions, a tulip bubble and much else besides, it is a subject that is irresistibly attractive to the blogosphere.

However, when you add the fact that the founder of the digital currency is known only under the pseudonym Satoshi Nakamoto, the mystery surrounding the whole activity has been enough to dissuade most sensible and honest investors from taking it seriously.

Until now, I have therefore largely ignored it. But John Authers and Tim Harford, after explaining the phenomenon very clearly, conclude that it is time to pay attention. Furthermore, the major private banks and regulatory agencies have started to express serious interest in it.

The Chicago Fed has said that, warts and all, “it represents a remarkable conceptual and technical achievement, which may well be used by existing financial institutions or even by governments themselves”. And even the conservative ECB argues that, if it is not Bitcoin, then another virtual currency may soon start to grow extremely rapidly.

In recent weeks, the authorities in Germany, France, China, India and Malaysia have all taken steps to discourage speculation in Bitcoins. So it is time to ask whether we should be worried about the economic consequences of virtual currencies. 

The FT’s “year in a word” series suggested that the spirit of 2013 could be captured in words like “taper”, “sequestration”, “Abenomics”, “selfie” and, of course, “twerking”. I would like to suggest another over-used word from last year: “bubble”. In fact, there was a bubble in the use of the word bubble, especially relating to the S&P 500 index.

It is not very helpful simply to throw the term bubble at any situation in which market prices are deemed to be rising too fast. We should try to do better than that. Many investors would like to be able to distinguish bubbles, which happen relatively infrequently, and tend to reverse extremely abruptly, from a regular bull market.

Accordingly, this blog presents a new research paper released yesterday by my Fulcrum colleagues Ziad Daoud and Juan Antolin Diaz (available here) that attempts to define and measure a market bubble more precisely. It uses new econometric techniques developed by Peter Phillips and others, and updates their results to the present.

One important conclusion is that the probability that the S&P 500 index is currently in a bubble is only 20-33 per cent. But that could change fairly quickly during 2014 if the recent pace of advance in equity prices continues. And, just to be clear, this conclusion does not mean that normal market corrections, or a regular bear market, cannot happen this year. Bubble detection may be one metric to aid market forecasting, but it is far from the whole story. 

Among the bedrock assumptions for 2014 among macro-economists, two are central: first, that the real GDP growth rate in the US will accelerate as the fiscal squeeze abates, and, second, that the Federal Reserve is now on “auto pilot”, and will taper its asset purchases by about $10bn per meeting until they disappear entirely before year end. Last week, the December jobs data challenged the comfortable assumption of accelerating GDP growth, and the publication of the latest FOMC minutes provided some interesting new insight into divisions within the Fed.

Most analysts have responded to these events by concluding that nothing much has really changed. That is probably right, for now. Although the employment report was something of a nightmare, involving both a very weak gain of only 74,000 in nonfarm payroll employment and another disconcerting drop of 0.2 per cent in the participation rate, it is only a single month’s reading, amid a snap of very cold weather. It will be brushed aside.

Longer term, the combination of only moderate employment growth with a shrinking labour supply is a persistent phenomenon that is likely to challenge the FOMC increasingly as 2014 progresses. The Committee seems fairly united for now around the announced path for tapering, but there are significant divisions in members’ underlying economic analysis that are likely to be laid bare before too long. 

Janet Yellen is likely to be confirmed by the Senate as the next Fed Chair on Monday, and Ben Bernanke delivered an initial version of his own personal history in an address to the American Economic Association on Friday.

Typically objective and analytic, it won him a standing ovation (watch it here [1]) that accurately reflects what the majority of the academic economics profession thinks of the man and the public servant. Despite the highly controversial nature of his actions, they view him as one of their own. He has risen to greater importance in public office than any previous member of the academic economics profession, including John Maynard Keynes.

The history books will no doubt focus on the Fed’s role in the great upheavals of the age. The outline verdict is already clear for some of this.

The Fed clearly underestimated the impact of the housing bubble on the economy, and failed in its regulatory duties from 2006-08; its reaction to the financial panic in 2008-09 was exemplary; its role in cleaning up the US banking system in 2009 was important and far-sighted; and its balance sheet expansion from 2010-13 was more aggressive than most other central banks, with both good and also some not-so-good effects. (See this blog for a lengthy assessment of QE.)

According to the “great person” view of history, Mr Bernanke will be the individual who gets most of the blame and plaudits for all these developments. The buck stopped on his desk. Yet he was only one actor among dozens in Washington. As a believer in the “great events” view of history, I have been trying to identify the areas in which Ben Bernanke personally made a difference that others might not have made.