Moving the Bomb Line (The Fed)
Billmon - Whiskey Bar
August 10, 2004
"I really can't believe it," Clevinger exclaimed to Yossarian in a voice rising and falling in protest and wonder. "It's a complete reversion to primitive superstition. They're confusing cause and effect. It makes as much sense as knocking on wood or crossing your fingers. They really believe we wouldn't have to fly that mission tomorrow if someone would only tiptoe up to the map in the middle of night and move the bomb line over Bologna. Can you imagine? You and I must be the only rational ones left."
In the middle of the night Yossarian knocked on wood, crossed his fingers, and tiptoed out of his tent to move the bomb line up over Bologna.
Joseph Heller
Catch 22
If you've re-read Catch 22 as often as I have, you remember the scene: Terrified of being sent on a run over flak-infested Bologna, the men of Yossarian's bomb wing keep an anxious vigil over a map showing the progress of allied ground forces - praying the city will fall before the scheduled mission. But after Yossarian sneaks the line forward, wing informs group the city has been captured, group tells headquarters and headquarters cancels the mission.
This appears to be how the stock market thinks the world works, too. The Dow jumped 130 points today -100 of them after the Fed announced it was raising its target for a key short-term interest rate from 1.25% to 1.5%.
Now ordinarily, rising rates are not considered good for stocks, but the market chose to focus on the Fed's underlying message, which is that - a collapse in job creation notwithstanding - the economy has only hit a temporary soft patch, one that will soon pass, allowing the economy to climb into the broad, sunlight uplands of prosperity. Or, as the Fed's post-meeting statement put it:
In recent months, output growth has moderated and the pace of improvement in labor market conditions has slowed. This softness likely owes importantly to the substantial rise in energy prices. The economy nevertheless appears poised to resume a stronger pace of expansion going forward.
Displaying a touching faith in the godlike powers of Alan Greenspan, the market intepreted this as a promise, not a forecast:
Jeff Kleintop, Chief Investment Strategist at PNC Advisors, who called the decision "the right move," believes markets are happy to get past another uncertainty.
"I think the fed sent a very confident message that it feels that, despite the rise in energy prices, the economy is poised to resume a stronger pace of expansion," Kleintop said. "I think that's a bit of what the market wanted to hear and certainly acknowledges the softness in recent data but in a way brushes that aside as attributable to transitory affect like energy prices."
Like Yossarian and his comrades, Wall Street seems to have reversed cause and effect here. It's assuming the economy must be OK because the Fed says it is, when in fact the Fed is as much in the dark as the rest of us, and maybe more so.
By raising rates (i.e. moving the bomb line forward) the Fed is explicitly arguing that its version of reality is still correct, and implicitly conceding that to have admitted any doubt by leaving rates alone today would have seriously undermine investor confidence.
Judging from today's rally, the latter point would appear to be correct (wing tells group, group tells headquarters, etc.) But only primitive magic can transform that confirmation into proof of the Fed's first point. Only real events in the real economy can confirm or refute that.
Unless, of course, the market believes Alan Greenspan, like the Pope, is infallible - an argument which can only be sustained by ignoring the last two decades of economic history, with particular inattention to the fall of 1987, the winter of 1990, the fall of 1994 and the entire 1999-2000 period.
The truth is that the Fed may have just made a big mistake - almost as big as its decision to start raising rates at the end of June. Or, to be more charitable, it may have chosen what it thought was a lesser set of evils (slower growth, lower consumption) over greater ones (a touch of inflation, even more reckless debt expansion) - without understanding that those lesser evils are actually a good deal more dangerous than it thinks.
We'll find out soon enough which story is correct. But if I were the stock market, I wouldn't take too much comfort in the Fed's decision today. Greenspan has only raised the ante - it's still up to the economy to tell us who's holding the high cards.
The literary parallel isn't particularly encouraging, either: In Catch 22, headquarters finally realizes that Bologna has not been captured, and orders Yossarian's wing to bomb the city. To every one's enormous relief, the first mission turns out to be a milk run - hardly any flak, not a German fighter in the sky. So Col. Cathcart, Yossarian's amibitious but dimwitted commander, volunteers to send the wing back again - at which point they get the crap shot out of them.
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