In his book, The Signal and the Noise
, Nate Silver, the founder of the New York Times
political blog FiveThirtyEight.com offers:
The Finnish scientist Hanna Kokko likens building a statistical or predictive model to drawing a map. It needs to contain enough detail to be helpful and do an honest job of representing the underlying landscape – you don’t want to leave out large cities, prominent rivers and mountain ranges, or major highways. Too much detail, however, can be overwhelming to the traveler causing him to lose his way...
While some may cringe at the analogy, I’d offer that during the 2008 banking crisis, investors, regulators, and policymakers saw Dr. Kokko’s distinction unfold in real time. As confidence declined, all parties demanded more and more information from financial services firms to flesh-out their “maps.” While initially warmly received, as the crisis evolved, additional information, rather than soothing frayed nerves, added to the anxiety. Rather than offering answers, greater disclosure merely meant more things to worry about.
At the risk of oversimplicity, I’d offer that in hindsight the relationship between confidence and incremental information transparency in 2008 looked something like this:
While initially greater transparency boosts confidence, at some point it becomes TMI (Too Much Information). We become overwhelmed, and with heightened concern we begin to question our entire belief system.
If there is a group responsible for market cartography these days, though, it is central bankers. More than ever before, investors today scour every central banker statement for a sense of the road ahead. And not surprisingly, in response, central bankers themselves have gone to great lengths to be ever more transparent, with the Federal Reserve, for example, now offering a press conference following its regular meetings.
Recently, though, I have begun to wonder whether the same TMI phenomenon is beginning to unfold with regards to the market’s confidence in global central bankers as we saw in 2008 – where, rather than providing a clear road map for what may lie ahead, policymakers are instead offering too much confusing guidance.
Last July, ECB President Draghi stated simply that “the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough." Then in September, Fed Chairman Bernanke followed up announcing that the Fed would pursue additional policy actions until the outlook for the job market improves "substantially." Put simply, the ECB and the Fed would follow a Buzz Lightyear approach to monetary policy – “To Infinity and Beyond!” For investors, the map could not have been clearer. Whatever the Fed and the ECB would do, it would be enough to keep asset prices rising.
Since the fall of last year, however, it appears that central bankers have begun to complicate their maps in several ways.
First, since the election of Prime Minister Abe in Japan in the fall, it has become increasingly unclear who now holds the cartographer’s pen – a very small group of independent monetary policymakers or fiscal policymakers around the globe. If it was already a challenge to get inside the heads of roughly 25 key global monetary policymakers, it is an almost overwhelming task to understand the competing interests of executive and legislative fiscal policymakers. Who holds the map -- let alone the wheel of the car -- is now worrisome, especially with the national cars now seemingly aimed at one another.
Second, here in the United States, there was a striking contrast in the complexity of the Fed’s own message between the September and the December meetings last year. If September was "To Infinity and Beyond," December’s message was more akin to the following:
In an effort to explain the conditionality to the Federal Reserve’s ongoing monetary policy actions more fully, Chairman Bernanke all but went to the blackboard with a long piece of chalk. How, when, and if the Federal Reserve would alter its actions suddenly became a long complicated series of if/then statements. Clearly I was not alone in my reaction. It was very telling to me that on the same morning of the December meeting, Jon Hilsenrath and Brian Blackstone of the Wall Street Journal
offered a front-page story titled Inside the Risky Bets of Central Banks
in which they not only painted the group as academics, but added some rather striking adjectives to both the group and its actions. Call me crazy, but central bankers who “dreamed up mathematical models” while at MIT and are “among the most isolated people in government” and are now executing “high-stakes experiments,” which, if they fail, could “sow the seeds of another financial crisis,” are not what I think of when I think of Buzz Lightyear.
By trying to provide greater transparency, I am afraid that at the December meeting, the Federal Reserve raised more questions than it answered.
Finally, even among the most unified of central bank organizations today, there is mounting open division. Jens Weidmann, the president of the Bundesbank, has become increasingly vocal in his concerns regarding the ECB. And here at home, very recently Kansas City Fed President Ester George and Fed Governor Jeremy Stein both raised very public concerns about how today’s extreme monetary policy actions may be creating “collateral” bubbles in such assets as corporate bonds and farmland.
For investors, these concerns multiply the potential for if/then statements. Now not only must investors focus on what is happening on the main roads, but they must watch for trouble on the side streets, too.
Taken together, the current central bank environment forces investors to consider far more factors today than they did even as recently as six month ago. (And that was before the G7 weighed in this week, too!)
Why all this matters so much may best be conveyed by this recent thought from former Fed economist Vincent Reinhart, who offered in the Real Time Economics blog of the Wall Street Journal:
If monetary policy is a science, then we in the private sector are the little white lab mice upon which they experiment…However, as opposed to their counterparts in the hard sciences, the effectiveness of Fed officials in white lab coats depends in part on how well we white mice understand the plan.
As we move forward into 2013, investors would be wise think about the map being offered by global central bankers. Too many conflicting details from too many different cartographers add perceived uncertainty to the route ahead. Policymakers would be wise to consider this, given how many white mice are now on the road.
Peter Atwater's groundbreaking book "Moods and Markets" is now available on Amazon and Barnes & Noble.
“Peter Atwater brilliantly provides a framework for understanding both the socioeconomic hubris that led to the great credit bubble of the past decade and the dark social-psychological hangover that has resulted from its collapse. In so doing, he offers an invaluable guide to what promises to be a very difficult and turbulent period ahead as we experience what he calls the ‘me, here, and now’ behavioral tendencies of the post-crash world.” —Sherle R. Schwenninger, Director, Economic Growth Program, New America Foundation
Position in SH and JPM
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