Everything Old Is New Again

People like the macro narrative distilled down to a few words and wrapped up in a simple box. The problem is the US economy, financial system and market participant behaviour is far more complex. Toss in international economies and regional problems and you can see why tags like "New Normal" and "New Neutral" catch on. Sound bite macro for the short attention span practitioner.

In Paul McCulley's new note from his re-ascended perch at PIMCO he gives us a good history lesson into the financial crisis. link

I've spent some quality time with Paul and I've found him to be an impressive thinker and engaging personality. I have 2 take-aways from the post:

1) He's right about Taylor being wrong.

2) He's wrong about a Liquidity trap and thus wrong about the "new neutral."

Here's a Bloomberg article capturing the "Get Used To It" zeitgeist-

The concept of the equilibrium policy rate is important beyond TED conferences, Davos plutocrat dance parties, and Jackson Hole pocket protector con-fabs. Some idea of neutral/equilibrium is needed to calibrate the present into context. That so many have clung to Taylor's insipid model for so long is sad and shocking. Kudos to Paul for calling him out, we've been doing it for years.

Long time masochists, I mean readers, know I calculate the equilibrium policy rate in a different way. Here's a chart of 12 month LIBOR:

12 mo click to make big like

As can be seen, even in the throws of last year's Taper Tantrum, our model still advocated a ZIRP-y level for neutral policy, and thus additional help from LSAPs. The steep slide since has come with "others" hard recognition of this fact. (refresher- equilibrium policy rate should be 60bp under 12 month LIBOR). If your eyes are good you can see the recent uptick from "since existence" lows. There's alot of ground between here and a change but no reason to believe a new paradigm has replaced the old.

Vince Foster and I have done what we could to bore people with our belief that we have been in a Robert Dugger described Structural Trap.

Structural conditions pose a challenge to monetary policy, as the example
of Japan shows. In this paper we develop the concept of structural trap,
where the interplay of long-term economic development incentives,
politics, and demographics results in economies being unable to efficiently
reallocate capital from low- to high-return uses. The resulting
macroeconomic picture looks like a liquidity trap – low GDP growth and
deflation despite extreme monetary easing. But the optimal policy
responses are very different and mistaking them could lead to perverse
results. The key difference between a liquidity trap and a structural one is
the role of politics. We show how, in the Japanese case, longstanding
economic incentives and protections and demographic trends have
resulted in a political leadership that resists capital reallocation from
older protected low-return sectors to higher-return newer ones - Dugger and Ubide Tudor Inv. 2004

Our advice is for policy makers, both in Congress and at the Fed, to head the words of Dylan Thomas and rage against the "dying of the light" that is the New Neutral. We should not accept the idea of "less" as inevitable. The recognition, both at the FOMC and The BOJ, that bloated balance sheets will be around for some time is a step in the right direction. Participants should take advantage of it.

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