The Mystery of the Dots, Part II

A continuation from Part I

I returned to 221B Baker Street with an FT, an Economist, and a large bag of wine gums.  I recalled that while confronting a particularly vexing problem, Holmes had often taken to chewing the latter between puffs of his pipe.

"Anything else I can do for you, Holmes?" I asked as I handed over the items.

"Be a good chap and get me that copy of Who's Who in Finance, will you?" he replied, pointing his finger to the bookshelf behind me.  I retrieved the slim volume and wordlessly handed it over to him.  He placed it on the desk, then immediately bent over the two diagrams that Ms. Yellen had left him, immersing himself in their decryption.

While I struggled with the solution to the Times Su Doku and simple crossword, for the next several hours Holmes remained seated silently at his desk, stirring only to suck on his pipe or pop a wine gum in his mouth.

Finally, at dusk he yawned, stretched his arms to the ceiling, and stood up.   "Watson, we're making progress, my boy!" he said, with the slightest hint of a smile creasing his features.   "Still, there's more to be done. "

"What can I do to assist?"

"Run down to London Library and fetch a copy of the latest IMF World Economic Outlook, the proceedings from the 2003 Brookings Panel on Economic Activity, and every Federal Reserve Open Market Committee statement since February 1994." 

"With pleasure, Holmes."

"Watson, I've missed you, truly I have.   As an assistant and a foil you are peerless.  Oh, and while you're out, drop by the Yard and invite friend Lestrade round for an early lunch tomorrow."

Flushed by the praise from the world's preeminent detective, I caught a hansom cab to the library, where with the help of a consulting librarian I managed to procure the documents that Holmes required.   Carrying them in a large rucksack, I walked through St. James's Park to Scotland Yard.   Lestrade was out arresting a few LIBOR traders, so I left the message from Holmes and caught another cab back to Baker Street.

Holmes was in no mood to dine, and I was in no mood to go hungry, so after handing him the bag of documents  I went to the Royal China Club for a dinner of chili lobster and a rather decent bottle of Nuits-Saint-Georges.  I returned to his chambers to find him in almost a frenzy, a pile of documents strewn over his desk.   He consulted one sheaf of papers, and after making an annotation in a small, leather-bound notebook, tossed it aside to examine another.  It was clear that Holmes would be working for many hours to come, so I left the room as silently as possible, descended the stairs onto Baker Street and made my way back to my own quarters.

The next day dawned unusually warm for an early spring morning, with the sun making its first appearance in the London sky for what seemed like months.  It was therefore a pleasure to walk from my chambers to those of my friend, all the more so because of the sense of anticipation that gripped me.  Although I could not fathom the meaning of those bizarre diagrams, it was a comfort to know that if anyone in the world could unlock their secret, it was Mr. Sherlock Holmes.  

Mrs. Hudson extended her usual welcome when I arrived mid-morning, and allowed me to make my own way up to Holmes's sitting room.    Although it was just past ten, he was finishing up a plate of scrambled eggs and toast, topped up with appreciative sips of a large mug of tea.  Long experience told me that he had not slept; my friend's iron constitution and force of will allowed him to make demands of himself while working on a case that would overwhelm a lesser man.

"Good morning, Watson, a very good morning to you indeed!"  Holmes clapped me on the shoulder as I sat next to him at the table.

"You've found a solution, then, Holmes?  What do those dots signify?"

It was a frequent habit of my friend to wait for a particular moment of his own choosing to divulge the results of his inquiries.  Although he often chided me over the years for my sensational accounts of his adventures, he nevertheless had an uncanny knack for revealing his solutions in a manner that enhanced their dramatic impact.  Today, it appeared, would be no different.

"Now, now Watson!  "'Twould be rude of me to unlock the mystery of the dots before our guests are here, would it not?  Now, please allow me to freshen up before they arrive.   Please, make yourself comfortable, won't you?   No, try the seat by the door, and do keep your service revolver handy if you have brought it with you."

I picked up a copy of the Illustrated London Gazette and perused the sporting pages while Holmes readied himself.   He emerged from his dressing-room at five minutes to eleven, then went to his desk and opened a small dossier of papers as if double checking them.   Apparently satisfied, he closed the folder with a small, satisfied nod and sat upon the settee.   "Well, Watson," he said, rubbing his hands eagerly, "this promises to be very interesting indeed."

At the appointed hour the bell rang, and we could hear Mrs. Hudson usher our client up the stairs.   The door opened, and the elfin Ms. Yellen walked nervously into the room.  As we stood to greet her, Holmes gestured to the seat opposite me, saying, "Please sit, Ms. Yellen.  I believe you prefer the chair?"

"I do, thank you."   She walked over, made herself comfortable, and then looked at Holmes expectantly.   "Well, Mr. Holmes, have you got any answers for me?  Do you know what the dots mean?"

"I do, madam."    Our client exhaled deeply, as if a great weight had been lifted from her shoulders.  'However, before I share the results of my investigations, I must ask you a few questions."

Ms. Yellen nodded her assent.

"Tell me, madam, in your telegram to me you mentioned something about the case being 'vital to the world economy', yet when you were here yesterday there was no explanation of how or why?  Similarly, you referred to a big project that was winding down at your office, but refused to elaborate.   Why was that?"

Our client flushed.   "Well, Mr. Holmes, I...I...I just didn't think they were that important."

Holmes looked at her archly.  "Madam, might I suggest to you that your judgment of what is important or not leaves rather a great deal to be desired.   Facts are important, Ms. Yellen....such as the fact that you are the head of the US Federal Reserve."

Our client and I gasped simultaneously.   "But how did you kn-know..." she stammered.

"I know it all!" Holmes thundered.  "I know who you are, and I know what you've done!   Here, look at this!"  Holmes thrust a small piece of paper at our client's face.    "This was the very first Fed statement explicitly announcing interest rate policy!"


"It was short, concise, and to the point!   But look what you've done to it!" continued Holmes.   "Twisted it, stretched it, and pulled it all out of recognition.  You've destroyed it!"  He showed her another sheet of paper, upon which was printed dense blocks of text that required a font so small to fit on one page that it was illegible.  As our client squinted to read it, I heard a heavy footstep running up the stairs.

"Scotland Yard has wasted countless hours pursuing LIBOR setters and FX spot guys.  They are merely the unwitting foot soldiers of a campaign to distort and disrupt the financial system.  Ms. Yellen, the greatest manipulator of financial markets is....YOU!"

As Holmes stood and pointed at our client, Chief Inspector Lestrade appeared at the sitting room door.   Ms. Yellen appeared stunned for a moment, then a crafty glint appeared in her eye.    She feinted running behind the sofa, throwing Holmes off his guard, then charged past him and rushed at me.    As I fumbled with my revolver, she head-butted me on the hip, sending me sprawling.   Lestrade proved one obstacle too far, however, as he wrestled her to the ground and clapped restraining handcuffs upon her.

As Lestrade hauled Ms. Yellen to her feet, Holmes gazed at her with a look that almost resembled pity.  "There is a black thread of manipulation running through the colourless skein of the market, and our duty is to unravel it, and isolate it, and expose every inch of it."

"But what about the dots?" our erstwhile client screeched.  "I really was concerned about them."

"You can blame your friend the professor for that," replied Holmes.

"Faugh!" she said with visible disgust.   "And how long am I going to go down for?"

"Oh, I'd say for a considerable period," said Lestrade.  Ms. Janet Yellen blanched and gave an audible whimper as he led her down the stairs.

I sat down, shaking my head.  "For the life of me, Holmes, I cannot figure out what just happened, let alone the business with the dots.   And who is this professor?"   

My friend chuckled as he reclined on the sofa.  "These were deep waters, Watson, substantially deeper than I first supposed upon receiving the telegram.  It was obvious, of course, as I pointed out to you yesterday, that our Ms. Yellen held a senior position at the US Federal Reserve.   A quick check of the FT and Economist revealed that she had recently replaced a certain Ben Bernanke as chairman of the Open Market Committee.  Further research suggested that she had previously chaired the subcommittee on Communications.

"Her stated goal was 'transparency' of communications, but that was obviously a red herring.   Observe how poorly she was able to judge which information to emphasize in describing her case to us.  Note also how shifts in policy were communicated 20 years ago: short, succinct sentences.  Over the past few years, however, Fed policy has become a virtual Babel of messages, some of which conflict with each other.   Look at how long their last statement was, and how little it actually said.  Consider also that this statement and its guidance is just one plank of the policy platform.   Asset purchases and forecasting are also presented as policy tools.

"What I discovered is that the Federal Reserve, and indeed similar institutions like our very own Old Lady, are claiming to back efforts to enhance financial stability and do away with manipulation.   They support crackdowns in the LIBOR and FX scandals.   And yet these are the very same institutions that have suppressed volatility and risk premia more than a universe of bank traders could ever hope to do."

"But the dots, Holmes?"

"Ah yes, the dots.   In sifting through the literature, I found that that Ms. Yellen and her institution are not the mastermind of this nefarious campaign to manipulate markets.   The dots were placed there by the man at the centre of it all."

"And who is this?"

"In my study of global monetary policy over the last four years, Watson, I have become conscious of some sort of power over the manipulator, some agent who casts a veneer of academic credibility to the patently absurd.  Again and again in policies of the most varying sorts- qualitative guidance, state-contingent threshold guidance, target and policy forecasting- I have felt the presence of this force, and deduced its influence in other policies in which I have not personally been consulted.  In the end, my investigations led me to Professor Michael Woodford.

"He is the Napoleon of manipulation, Watson.   He is the organizer of half that is published and nearly all of what provides the intellectual underpinning of this trend in policy.   He is a genius, a philosopher, an abstract thinker.  He has a brain of the first order.  He sits, motionless, in the centre of a great web, but that web has a thousand radiations, and he knows very well the quiver of each of them.

"It was Woodford that convinced the FOMC that they could present explicit policy forecast guidance (for that, my dear Watson, is what those dots were), written qualitative guidance, and verbal guidance, all of which contradict each other, and still maintain the illusion of credibility."

"If it hadn't been for you, Holmes, it might have worked!"

"For a while longer, Watson.  But the agents of financial repression usually slip up in the end, and when they do, the market is there waiting for them.   Like Lestrade, the market is not always the quickest to catch on, but once it does it's like a bulldog with a bit between its teeth.  For now, we must keep a wary eye on our friend the Professor and catch him out whenever we can."

WATCH OUT WHEN HOLMES ENCOUNTERS PROFESSOR WOODFORD IN THE ADVENTURE OF THE VANISHING THRESHOLD  AND THE  QUALITATIVE QUANDARY!