Committees vs Markets

A new paper from the IMF investigates the optimal structure for monetary policy committees, which are described as a "major evolution" over decision making by individual policy makers. The researcher then reviews the literature on how preferences and beliefs are aggregated in committee structures. Our immediate reaction was to jump to a radical but seemingly obvious conclusion — if committees are preferred to individuals thanks to their aggregating functions, then it only follows that deep markets of diverse and heterogenous agents should provide even more effective information pooling, collective accuracy, and dispersed social influence. Said markets already exist and could be invaluable guides to monetary policymakers. A framework for such a design is outlined by Manuel Johnson and Robert Keleher in their book Monetary Policy, A Market Price Approach (1996). Evolution, anyone?

More on the Political Landscape

Here’s an interesting piece from Bruce Bartlett that ties in with our recent ‘Idle Speculator’ piece on potential shifts in the U.S. political landscape. Bartlett offers a historical narrative that reminds us that, prior to stagflation and the withdrawal from Vietnam in the 1970s, libertarian activists were typically associated with the political left.  

As interesting as these speculations are however, they assume that libertarian minded voters swung the recent election, and there is no such agreement among Democrats. In fact, there is major disagreement over the reasons for their success, and ‘old left’ elements like the AFL-CIO have been very vocal in claiming the electoral mandate over more centrist and conservative members. For example, it was reported by the WSJ recently that Robert Rubin, one of the primary architects of President Clinton’s (relatively) centrist economics, received an intense grilling from some incoming members of Congress, especially on trade policy and globalization.

We expect to see these divisions laid bare in the upcoming Congressional session, and we also expect them to play a key role in determining which Democratic presidential candidates survive the early primary season for 2008. In fact, the presidential nomination will provide something of an ideological referendum for Democrats.

We Thought Sarbox Was Harsh is carrying an Associated Press report about an ex-China Construction Bank accountant convicted of nine figure fraud. He recently exhausted his appeals, and his execution can now be scheduled. No ‘white collar country clubs’ in Chungwa, apparently. 

Looking Under the Hood

The bull versus bear debate continues to rage on and off Wall Street, with the bears prominently pointing to faltering housing and auto industries and to an inverted Treasury yield curve that, according to one widely watched Federal Reserve model, estimates over a 50% chance of a recession in coming quarters. Clearly, there are enough negative indicators at work for the bear case to merit close attention, and we have been carefully analyzing how various indicators are lining up in the current business cycle compared to prior ones.

One of our more interesting findings argues against the bear case, and by extension, against the bet that a Fed rate cut is in the immediate offing. Using the most recent Corporate Profits After Tax (CPATAX) data released by the Commerce Department’s Bureau of Economic Analysis, we compared the trajectory of corporate profits over the current period (2001-2006) and most recent period (1996-2001) to contrast the underlying business performance in each. We distinguish between these periods on the basis of U.S. monetary policy: from 1996 to 2001, the federal government pursued an explicit “strong dollar” policy, the Federal Reserve publicly fretted about “irrational exuberance” in asset prices, and USD money and credit conditions were tight globally; the 2001-2006 period began with the Federal Reserve gnashing its teeth over the threat of deflation and lowering its overnight target rate to historic lows, and since that time the U.S. dollar has lost significant value against other currencies, industrial and other commodity prices have reached historic levels, and core inflation has been printing slowly but steadily higher.

When comparing corporate profits between these two periods, we find that they differ starkly — year-to-year growth in profits from 1996 to 2001 averaged only ten basis points, while from 2001 to 2006, it has averaged just under 15%. Importantly, the preliminary estimates for 3Q06 CPATAX do not show any sign of rolling over, increasing 4.5% sequentially and 31% year over year:



Despite the current soft patch, we continue to stand by our assessment that the domestic and global economies are still performing well, and that capital markets should remain relatively healthy as long as no significant new externalities come into play in the coming year. With that in mind, and given that price level stability is (or at least should be) the primary aim of monetary policy, we’re standing by our expectation that the Fed will hold its position until enough indicators point to a levelling off of inflation somewhere around its unofficial comfort zone of 2%. Should inflation surprise to the upside, we may even see additional tightening in 2007, which could cause a significant spike in volatility as markets are forced to reassess their expectations, as happened in June of 2006: