Tag Archives: William Dudley

He Said That? 12/3/14

From William C. Dudley, president of the New York Federal Reserve, at a speech at Bernard M. Baruch College:

Let me be clear, there is no Fed equity market put. The expectation of such a put is dangerous because if investors believe it exists they will view the equity market as less risky.


The “equity market put” refers to the Fed’s practice of giving speculators and investors a “put” option on the equity market. In other words the Fed protects them from losses, like a put option would. This whopper far exceeds: “If you like your health care plan, you can keep it,” as an out and out lie. Since Alan Greenspan opened the liquidity sluice gates after the 1987 stock market crash, the Fed has repeatedly propped up the equity market. That was the response to the savings and loan crisis in the early 1990s, the 1997 Asian currency crisis, the 1998 Russian debt crisis, the 2000 tech wreck, the 9/11 attack, and the 2008-2009 financial crisis. The Fed even pumped liquidity beforehand for a crisis that never happened. Remember Y2K? Does Mr. Dudley think the Fed’s almost fourfold expansion of its balance sheet and microscopic interest rates since the last financial crisis have had nothing to do with the stock market’s ascent from its 2009 low? Does he think that St. Louis Fed President James Bullard’s hint that the Fed should consider delaying the end of quantitative easing on October 16 had nothing to do with reversing a S & P downdraft over the previous few weeks and its subsequent straight up rally? (see Fed Cries Uncle, SLL, 10/16/14) Has he not noticed that equity markets rally anytime any central bank official, anywhere on the planet, hints of additional monetary easing? Mr. Dudley is either monstrously mendacious or dangerously deranged or both (the betting favorite here at SLL) if he can publicly deny the Fed’s equity market put. He is, however, correct that the put is dangerous because it encourages speculators, and what’s left of investors, to view the equity market as less risky.

Oil Economics, Part 2, by Robert Gore

Monday’s post, “Oil Ushers in the Depression,” was one of the most read, commented on, and controversial posts on SLL. Here is an amplification, and a doubling down on the prediction in that piece:

The sharp drop in oil will support U.S. growth by boosting spending, two top Federal Reserve officials said, playing down the risk that plunging energy costs could push inflation further below the Fed’s goal.

Fed Vice Chairman Stanley Fischer and New York Fed President William C. Dudley, speaking at separate events today in New York, both stressed the positive impact on the U.S. economy from the steepest decline in oil prices for five years.(Bloomberg, “Fed’s Dudley Says Oil Price Decline Will Strengthen U.S. Economic Recovery,” 12/1/14)

If that sounds eerily like Benjamin Bernanke’s infamous assurance that “…the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained,” it should (testimony before the Joint Economic Committee, U.S. Congress, 3/28/07). However, Fischer and Dudley go Bernanke one better. Bernanke at least acknowledged a problem, although he woefully underestimated its impact. The dynamic duo sees nothing but blue skies after oil’s precipitous fall. Their Panglossian visions reveal the rotten-to-the-core premise of Keynesian economics and complete ignorance of the towering debt skyscraper of cards their policies have helped erect.

In their Keynesian world, demand and consumption are the center of the solar system around which all other economic factors revolve. Reality, on the other hand, dictates that something must be produced before it is consumed, so we’ll stick with reality-based economics. Fischer and Dudley don’t even acknowledge that the falling price of oil might harm producers.

The Saudis are the world’s low cost producer. It is much cheaper to pump oil out of the desert than it is to frack it, extract it from tar sands or shale, or pump it from under the ocean, which is how oil is produced in much of the rest of the world. The Saudis amortized the costs of their petroleum industry long ago; the relevant cost to them is their marginal cost.They have decided to pump sufficient oil to drive its price low enough to make it uneconomic for many higher-cost producers to produce.

Their decision has political and economic motivations. The Saudis have been mightily displeased by the course of events in Syria. The Sunni Saudis don’t like Shiite Bashar Assad, Syria’s despot. They thought President Obama would fight their war for them when Assad crossed his red line. They were furious when Vladimir Putin gave Obama a face-saving out, not just because of Obama’s inconstancy, but also because Putin had thwarted a potential US attack against his ally, Assad. The U.S.’s half-hearted response to the Islamic State—its reluctance to put those all important boots on the ground—has further inflamed the Saudis, who view the campaign against the Islamic State as the perfect pretext for getting rid of Assad.

What better way to punish both the US and Russia (and perpetual enemy Shiite Iran), and reestablish dominance in oil, than by glutting the market? As a business plan, taking on debt at junk bond rates to fund oil production, as many US and Canadian producers have done, or basing government budgets and economic projections on a high price of oil, as Russia and many other oil-producing nations’ governments have done, leaves something to be desired when the lowest-cost producer can lay waste to your plan at any time.

The subprime fiasco offers the perfect analogy. Just as everything “worked” as long as house prices kept going up, the dreams in the oil patch seemed plausible when its price was high. As soon as oil’s price headed in the undesired direction in this highly leveraged market, the dreams evaporated, just as they did in the highly leveraged housing market. The debt of the most indebted producers, now losing money, is worth less than face value. Their creditors will eventually recognize losses. As previously noted, the one wrinkle is that so many producers are governments. They have not, in most cases, explicitly backed their debt with oil revenues, but they had assumed those revenues and based their future spending plans on them. Call it “soft” debt.

The dilemma is the same for both private and government producers. They can go on producing at an economic loss, for the cash flow, adding to the glut and the downward pressure on prices, or they can curtail production and their own revenues. The former is a short-term palliative only; the latter means immediate pain. Either way, total revenues accruing to uneconomic oil producers decline. Those producers will consume less—just as homeowners significantly curtailed their spending when house prices crashed, which is contractive and deflationary.

As the oil price drop leads to losses for producers, their suppliers, and creditors, assets will be sold, production curtailed, orders cancelled, and workers laid off. Eventually the price of oil will stabilize, but producers, especially government producers, may well continue to add to the glut due to short-term cash flow needs—it’s better than people taking to the streets. Even the House of Saud has committed much of its huge revenues to bribing their disaffected off the streets and keeping itself on the most kleptocratic and lucrative throne on the planet.

Dudley and Fischer refuse to acknowledge the debt daisy chain for which they and their fellow central bankers around the world are largely responsible, just as Greenspan and Bernanke have never fessed up to their mortgage-debt-and-securitization daisy chains. When oil-based debt implodes, it will stay as “contained” as the subprime implosion; daisy chains are daisy chains. However, given the much higher level of world debt now, the fallout from this conflagration compared to last time will be akin to the difference in fallout between hydrogen and atomic bombs.


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