To be honest, I saw the term TLRTO being discussed and I couldn’t remember the meaning. So I looked it up and found it spelled out here.

The blog page by Axel Merk of Merk Investments, has a few paragraphs about monetary policy and some other things about the investment environment that seem worth of analysis in addition to reminding me what TLRTO stands for.

Here’s what he says about the general investment environment:

Investors have a tendency to ignore the hidden risks in their investments, even if those risks may be hiding in plain sight. You may recall the references to a “goldilocks” economy in the run-up to the 2008 credit crisis. Similarly, in the 1990s, what could possibly go wrong investing in tech stocks? What these episodes have in common is that the downside volatility of asset prices was unusually low. The pessimists warn of pending collapse, yet are ignored.

As an optimist, I agree with the pessimists. Not because I think the world will come to an end, but because the path from euphoric to normal is a rough one. When low asset price volatility lulls investors into believing the markets have become safer than they really are, folks take risks that they are bound to regret. Those that pile into the equity markets on the backdrop of ever shorter corrections, of ever higher asset prices, of historically low volatility, may be running for the exit fast when they realize they had no business being over-exposed to the equity markets in the first place.

So it’s low volatility that makes him nervous. That’s fair, I suppose. Of course markets should go up and down to a certain degree given the totality of circumstances. But what if the volatility is being caused by monetary policy not responding to circumstances like perhaps an inflow of dollar demand from capital fleeing places like Russia and the EU to some extent? There hasn’t been any policy statement from the Fed that the extra demand will be accommodated. It might be that I am jumping the gun and a week of market volatility doesn’t make a serious problem. But given market pricing adjustments from it already, if it continues, there will need to be some response or the 2% target that is low enough that the margin of error is condensed doesn’t really mean anything at all. There is always the possibility that the Fed has its eyes wide shut to create the reality of Obama wissing into the wind on Russia policy. We try to damage the Russian economy and end up hurting ourselves instead because of central bank incompetence. So, to some extent, we should fear the Fed.

Liquidity is dead

The low volatility environment has been accompanied by what is historically low volume. When liquidity in the market is low, it provides fertile ground for more abrupt price moves. One reason why liquidity may be low is due to the Dodd–Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). Dodd-Frank, with its good intentions, has banished a lot of risk taking by financial institutions. That may be a good thing in some ways, but it has also curtailed major liquidity providers. The next sharp correction in the markets may well be an indication of whether the dearth of market participants is a problem.

I wouldn’t be so sure to blame liquidity issues on Dodd-Frank. I don’t really have much more to say about this, except Mr. Merk sees the symptoms of tight monetary policy (that in all likelihood has become tighter in the last week) but in all of his analysis, he attributes them to a variety of causes without considering ongoing lack of accommodation of dollar demand. There would be more going on in the markets if people weren’t so fearful of the bottom inexplicably falling out – which will happen when the Fed is focused on last month’s inflation reports, having little wherewithal to get out in front of the volatility. Wouldn’t it be better to have an ounce of prevention instead of a pound of cure?

And here’s the punch line:

Policy makers concerned

Folks at the Fed have started to talk about complacency, with New York Fed President Dudley saying, “Volatility in the markets is unusually low.” At a dinner of the Hoover Institution I attended, Kansas City Fed President George mentioned in a speech: “The incentives to reach for yield extend to smaller financial institutions as well… If longer-term interest rates were to suddenly move higher, these institutions could face heavy losses.”

The irony here is amazing. Policymakers have an irrational policy of being behind the curve, being concerned only about the price of goods last month, and they are concerned that investors could face “heavy losses” from unexplained movements in long-term interest rates. We do not need to fix investors, we need to fix the policy (and probably officials like Ms. George too).

Last, but certainly not least, here is what Mr. Merk has to say about monetary policy:


The U.S. dollar has not been acting as a safe haven currency. Part of it may be because of a lack of leadership. We are not referring to Mr. Obama, but Ms. Yellen. And it’s not personal. The Fed has, in our interpretation, communicated that monetary policy shall be increasingly ad hoc. In fact, the best indicator of where rates will go may be whether the convicted felons that the head of the Federal Reserve profiled in her first public speech have a job by now. I wish this were a joke, but I’m rather serious about it: Yellen has indicated she wants to keep rates low as long as necessary to boost employment as long as inflation does not cause too much of a problem.

Curiously, when inflation numbers come out higher than expected, a currency often appreciates versus its peers, as investors anticipate the central bank will do “the right thing” and raise rates. It’s then, over time, that the currency reflects whether the central bank walks the talk. In the case of the Fed, we don’t think the Fed is likely to walk the talk. As such, we continue our overall negative view with regard to the dollar.

At least he gives me another possible view as to why the dollar has been appreciating with markets reflecting the new reality, investors placing bets that interest rates will rise sooner rather than later. The recent market volatility may be a combination of capital flight and anticipation that the Fed will tighten prematurely, which it has already done passively. But these two paragraphs are sort of incoherent because obviously, if the markets tighten policy on their own, interest rates need not rise to have the same effect in the short run. The Fed has to say more than it has to undo it.

And I am glad he still has his negative view of the dollar. It goes to show the EMH has merit. He has a negative view on the dollar, but is still heading for the exit in other areas.

About the dollar being a safe haven currency, I don’t believe it should be intended as an investment utility. And I’m rather put off by the criticism of Yellen, as she supposedly waits for convicts to become employed before deciding to do the “right thing.” If I considered the kinds of people who have been gravely damaged by the Great Recession, mostly hard working people, I would think of Mr. Merk as a man with a sense of importance much too large for his very small mind that cannot grasp the holistic view of what the “right things” may be. Surely he can’t be implying that the “right thing” is to permanently reduce living standards of others so he can increase his. Is that what we’re about as a society? I certainly hope not.