“There are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns – there are things we do not know we don’t know.”
— Donald Rumsfeld
I think of the former Defense Secretary’s line as I parse today’s statement by the Federal Reserve’s Federal Open Market Committee. It notes a modest recovery, unemployment easing but still high, all the stuff we know. The markets may be cheered by the lines that the FOMC “expects to maintain a highly accommodative stance for monetary policy” until 2014. We do not know.
The Fed is betting on several known unknowns, for example that inflation will remain low, with high gasoline prices being a temporary phenomenon. The central bank expanded the monetary base (“printed money”) significantly to battle the deflationary pressures of 2008-2009. Not to get all Ron Paul on you, but will all those dollars just magically fade away? Or will they roar back as hyperinflation? The latter is unlikely. But we do not know. Neither does the FOMC, except perhaps for dissenter Jeffrey Lacker, president of the Richmond Fed, who would tighten sooner.
We do not know if the central bank has a credible exit strategy from all the unorthodox policies it threw against the wall during the panic to avert a second great depression. They arguably worked. But what comes next, with that huge increase in dollars, not to mention all the toxic so-called assets the Fed took off the books of the banks to lock away in a financial swindles Yucca Mountain? Is this another Fed-brewed bubble waiting to ambush us? Years of slow growth might make all this work out fine, even as it penalizes average Americans with poor wages and job prospects. If inflation accelerates, Chairman Ben Bernanke can tighten credit quickly (and tank the economy). Would it succeed? We do not know.
We will also get a sense of “known unknowns” when the Fed reveals its “worst-case scenario” stress tests on the Too Big To Exist banks on Thursday (UPDATE: The results of the tests have come out today after JPMorgan Chase stated it had passed the test — Jamie Dimon is running the Fed’s timetable). This might be especially relevant given the burps and sighs of trouble coming from Bank of America. It would make for an interesting Democratic Convention in Charlotte if Tim, Ben and the gang are trying to do an “orderly” winding down of the hometown TBTE bank after, say, Europe really isn’t fixed.
Meanwhile, the rally lost a little of its mo’. Despite all the cheerleading, the markets remain risky. Mutual funds are lagging. By many measures, the rally is being oversold. But the party will continue until the next unknown unknown.
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Today’s Econ Haiku:
Playing by the rules
Rare with Beijing’s trade posture
As rare as rare earths