So it could be that the creditors have agreed to swap their bonds for 30 year bonds with ‘half their face value’ but maybe also with about equal economic value, which can in theory be done if the coupon and quality of the new bonds is high enough.

But, again, seven months of negotiations shows it’s not all that easy to come to agreement, and also that for reasons probably not entirely disclosed the bond holders have substantial bargaining power.

Greece hopes for debt swap deal by end of week

Jan 26 (AP) — Greece is aiming to complete negotiations on its debt swap deal by the end of the week, the government’s spokesman said Wednesday, adding that the talks were at their “most delicate phase.” Charles Dallara, head of the Institute of International Finance will head back to Athens on Thursday for the negotiations on a bond swap, known as the Private Sector Involvement. Athens is trying to get its private creditors to swap their Greek government bonds for new ones with half their face value, thereby slicing some euro100 billion ($130 billion) off its debt. The new bonds would also push the repayment deadlines 20 to 30 years into the future.

The Fed is Starving Economy of Interest Income

By Warren Mosler

He left out the part about needing a fiscal adjustment to compensate but this is part one of a three part presentation of something I wrote.

Preface. I generally subscribe to the view that in free currencies, deficits are mostly self-funding, and ‘enormous’ deficits needn’t be accompanied by higher yields. Government builds a bridge, pays the bridgebuilder, who pays the grocer, who eventually either buys the Treasury or deposits in a bank whose reserves are fungible vs T-bills via the intermediating Fed. Government dissavings and private sector savings are equal and offsetting, as long as the Central Bank has a working spreadsheet and an interest rate target. Yields are just a function of duration needs of savers vs borrowers, but the AMOUNTS always match up. Likewise, I don’t believe that the creation of bank reserves is inflationary or hyper-inflationary; bank lending is capital – not reserve – constrained. Loan officers don’t check the vaults. There is always enough. I continue to marvel at the armies of deficit vigilantes who take aim at Treasuries and JGBs, armed with Gold Standard thinking or even the latest Reinhart/Rogoff, only to retreat 2-3 year later. It didn’t work shorting US Treasuries in 2009-2010 for the ‘money supply’ or ‘deficit spike,’ and that roadside is stacked with corpses. Even the Home Run deficit vigilante hitters who nailed Europe this year (and Europe is, for now, operating as a quasi-Gold standard and an entirely different set of risks) offset those gains with losses betting the other way on the US, UK, and Japan. It’s evident in the returns.

Wonder if the ‘New Bonds’ are Mosler bonds?

*DJ Greece, Creditors Close To Agreeing Step-Up Coupon Of Around 3.5%-4.6% -Source
*DJ Greece, Creditors’ Deal Would Have Average 4%-4.2% Coupon On New Bonds -Source
*DJ Greek Creditors’ Real Writedown Seen At 65%-70% Under Deal Terms -Source
*DJ Final Details On Greek Coupon Deal Still Under Discussion, May Change
*DJ Greece Creditors Deal Could Have Grace Period Of About 10 Yrs On Principal

>   
>   (email exchange)
>   
>   On Sat, Nov 12, 2011 at 2:19 PM, Stephanie wrote:
>   
>   John Carney loving on us again

Yes!

Paul Krugman Goes MMT on Italy

By John Carney

November 11 (CNBC) — It seems pretty clear that the school of thought known as Modern Monetary Theory has made a big impact on Paul Krugman’s thinking.

As Cullen Roche at Pragmatic Capitalism points out, just a few months ago the spread between bonds issued by Japan and Italy, which have similar debt and demographic issues, was perplexing Krugman.

“A question (to which I don’t have the full answer): why are the interest rates on Italian and Japanese debt so different? As of right now, 10-year Japanese bonds are yielding 1.09%; 10-year Italian bonds 5.76%.

…I actually don’t have a firm view. But it seems to be an important puzzle to resolve.”

But today’s column is basically right out of MMT.

“What has happened, it turns out, is that by going on the euro, Spain and Italy in effect reduced themselves to the status of Third World countries that have to borrow in someone else’s currency, with all the loss of flexibility that implies. In particular, since euro-area countries can’t print money even in an emergency, they’re subject to funding disruptions in a way that nations that kept their own currencies aren’t — and the result is what you see right now. America, which borrows in dollars, doesn’t have that problem.”

Lots of talk, particularly from Germany about the ECB not writing the check, due to (errant) inflation concerns.

But to no avail. In fact, with the Rubicon crossing decision to haircut Greek bonds 50% for the private sector’s holdings, expect the check writing to continue to intensify.

And expect economies to continue to slow under the pressure of continuing austerity demands that also work to make their deficits higher.

From today’s headlines:

Italian Bonds Advance as ECB Purchases Debt; French, Belgian Spreads Widen
A Successor, Picked by a Tainted Hand
EU Lowers Euro-Region Growth Forecasts
Italy’s Senate Speeds Austerity Vote
Merkel’s Party May Adopt Euro-Exit Clause in Platform, CDU’s Barthle Says
Greek President to Meet Party Leaders as Unity Aim in Disarray

Italian Bonds Advance as ECB Purchases Debt; French, Belgian Spreads Widen

By Paul Dobson

November 10 (Bloomberg) — Italian government bonds rose as the European Central Bank was said to purchase the securities and after the nation sold the maximum amount of one-year bills on offer at an auction.

The advance pushed the yield on 10-year securities below 7 percent. Italy’s senate is set to vote tomorrow on a package of austerity measures designed to clear the way for establishing a new government and restore confidence in Europe’s second-biggest debtor. The nation sold 5 billion euros ($6.8 billion) of bills at an average yield of 6.087 percent, up from 3.570 percent on similar-maturity securities sold last month.

“Together with reported ECB buying, this auction result should support further Italy outperformance,” said Luca Jellinek, head of European interest-rate strategy at Credit Agricole Corporate and Investment Bank in London.

The yield on two-year Italian government notes slid 55 basis points to 6.66 percent at 9:43 a.m. London time. The 2.25 percent securities due November 2013 rose 0.915, or 9.15 euros per 1,000-euro face amount, to 92.205.

The ECB bought Italian government bonds, according to five people familiar with the transactions, who declined to be identified because the deals are confidential. It also bought Spanish securities, two of the people added. The ECB was not immediately available for comment when contacted by telephone.

As previously discussed, it’s hard to see how anyone with fiduciary responsibility can buy Italian debt or any other member nation debt after EU officials announced the plan for 50% haircuts on Greek bonds held by the private sector.

Yes, all governments have the authority, one way or another, to confiscate an investors funds. But they don’t, and work to establish credibility that they won’t.

But now that the EU has actually announced they are going to do it, as a fiduciary you’d have to be a darn fool to support investing any client funds in any member nation debt.

The last buyer standing is and was always to be the ECB, which will now be buying most all new member nation debt as there is no alternative that includes survival of the union.

And when this happens there will be a massive relief response, as the solvency issue will be behind them, with the euro firming as well.

Then the reality of the state of their economy take over, as GDP continues to fade and unemployment continues to rise until they figure out austerity can’t work and instead they need to proactively increase their member nation’s budget deficits.

Hopefully this doesn’t take quite so long as it took to figure out the ECB has to write the check.

But this one might take even longer as it will be a function of blood in the streets rather than funding capacity.

   
>   (email exchange)
>   
>   On Wednesday, November 09, 2011 5:37 AM, Dave wrote:
>   
>    For BTPS & SPGBs all inter dealer screens have gone blank and there is no liquidity left.
>    There are really no quotes for even 10y BTPs for example and the last bids were hit
>    about 80BP wider for the day vs Bunds.
>   

The world’s poster child for losing decades looks to stay a step ahead:

(Nikkei)–Prime Minister Yoshihiko Noda vowed Thursday to gradually raise the nation’s consumption tax to 10% by mid the 2010s during a summit meeting of the Group of 20 leading economies in Cannes, France.

The announcement at the summit has effectively made the tax hike an international pledge, and is expected to be included in an action program due out Friday.

Noda stressed the importance of rebuilding debt-ridden Japanese finances and told G-20 leaders that fiscal consolidation is a must “for Japan to be put back on a sound economic growth path, regardless of the debt crisis in the euro zone.”

He also spoke to reporters that a Diet dissolution should be carried out before implementing the tax hike. “If we go to the people in a general election (to seek a mandate on the consumption tax hike), we should do so after passing related bills but before implementing them,” he said.

As to Japan’s participation in the Trans-Pacific Partnership free trade pact, Noda told reporters he will accelerate efforts to iron out differences within the Democratic Party of Japan, which he leads. “We have to close ranks and shouldn’t be split,” he said.

Noda showed his flexibility in making concessions to a controversial redemption period of reconstruction bonds aimed at funding rebuilding efforts of the March 11 disaster, in hopes of enlisting support from the Liberal Democratic Party and New Komeito, the main opposition parties.

“Our policy chief said that we envisage a 15-year period (for the redemption of reconstruction bonds), but there’s room for concessions,” he said.

By the end of QE2 the curve had adjusted to the Fed having taken out pretty much all of the new supply out to 10 years.

After QE2 the supply out to 10 years started to be replenished auction by auction.

This was quickly followed by twist which began working to remove supply from the long end and add it to the short end.

The net is an ongoing multi trillion shift taking supply out of the long end and adding it to the short end that will continue to be a major influence on spreads.

Additionally, the Fed is seeing no material evidence of any monetary derived inflation, credit expansion, escalating inflation expectations (not that they actually matter), etc. and they are also seeing the global economy gradually slowing, and the euro zone imploding. So higher rates from the Fed remain a highly unlikely scenario.

The obvious hasn’t been making the headlines:

A no vote means a lot more immediate austerity than a yes vote.

A no vote means Greece can’t borrow at all, and therefore govt. checks will only clear if Greece immediately cuts back to where it is only spending tax revenue.

A yes vote means Greece can continue to spend quite a bit more than tax revenues, to the tune of the check from the benefactors.

And with no one in government at any level having any kind of a plan to leave the euro, and no idea how to manage a new currency in any case, that option continues to have no political support.

So the choices are:
Yes, we accept a relatively modest deficit cut as per the EU proposal.
No, we prefer to go cold turkey to a balanced budget and a seriously draconian cut.

Meanwhile, tick, tick, tick, the entire euro economy continues to slow, and continuously nudge up the entire region’s budget deficit, as they all work their way towards the same fate as Greece.

And, tick, tick, tick, the US deficit reduction process moves forward, with multi trillion dollar reductions already proposed by both parties.

Greek Vote Threatens Bailout

By Alkman Granitsas, Marcus Walker, and Costas Paris

November 1 (WSJ) — ATHENS—Greek Prime Minister George Papandreou stunned Europe by announcing a referendum on his country’s latest bailout—a high-stakes gamble that could undermine the international effort to preserve the euro.

A “yes” vote in the referendum could deflate the massive street protests and strikes that threaten to paralyze Greece as it tries to enact a brutal austerity program to earn rescue loans from the euro zone and the International Monetary Fund.

Nice, they announce proposal to confiscate 50% of Greek bonds from investors right in front of an Italian auction. And we thought we had sorry politicians…

Now it all starts unraveling. It’s all talk- another ‘optical illusion’ with no operational reality I sight. The China participation isn’t a done deal. The 50% haircut isn’t a done deal either as they haven’t yet figured out how to actually do it without a default event. The EFSF contributions aren’t a done deal either.

What they have done is further frightened investors to the point where the ECB will find itself buying a lot more bonds to keep member nation funding in check, while ‘negotiations’ drag on with no resolution, meaning, as previously discussed, this is the resolution.

Hoping i’m wrong…

Euro Bailout Fund Chief Sees No Quick China Deal

By Reuters

October 28 (CNBC) — The head of Europe’s bailout fund said on Friday he does not expect to reach a conclusive deal with Chinese leaders during a visit to Beijing but expects the surplus-rich country to continue buying bonds issued by the fund.

The markets like the announcement. Of course they also liked QE2…

Unfortunately, as previously discussed, without the ECB the EFSF isn’t sustainable. It’s like trying to lift up the bucket by the handle when you are standing in it.

Nor is it cast in stone yet, but all subject to details.

Also, the positive market response, if it continues, only encourages the continuing austerity measures that are weakening the euro economy and forcing already unsustainable deficits higher.

And, again, it’s a case of ‘the food was terrible and the portions were small.’

Starting with the 50% private sector loss on Greek bonds-

Presumably that ‘works’ if it indeed brings Greek debt down to 120% of GDP from 160% by 2020. But that implies the austerity measures won’t continue to reduce GDP and cause the Greek deficit to increase, as continues to be the case.

It presumes the 50% haircut will be considered sufficiently voluntary to not be a credit event that triggers a variety of global default clauses.

The rest of the ‘package’ presumes markets won’t reduce the presumed credit worthiness of member nations who fund the EFSF.

It presumes private sector funds will recapitalize the banks that lost capital on the write downs.

It presumes the EFSF won’t be needed to fully fund Portugal, Spain, and Italy.

It presumes banks and other investors required to be prudent and financially responsible to shareholders will continue to buy other euro member nation debt even after seeing the euro zone members allow Greece to default on half of their obligations.

That is, how could any bank now buy, for example, Italian debt, in full knowledge that euro zone policy options include a forced write down of that debt. And not in extreme, unforeseen circumstances, but under current conditions.

And how can prudent investors invest in the banks when they’ve just seen euro zone remove some 100 billion euro in equity by decree?

The problem is, it takes a presumption of general improvement to presume additional losses will not be incurred by investors.

And it takes a presumption of general improvement to presume the EFSF will be successful.

And that requires the presumption that continued austerity measures will result in a general improvement.

Even as all evidence (and most theory) is showing the opposite.

Euro deal leaves much to do on rescue fund, Greek debt

By Luke baker and Julien Toyer

October 27 (Reuters) — Euro zone leaders struck a last-minute deal to limit the damage from the currency bloc’s debt crisis early on Thursday but are still far from finalizing plans to slash Greece’s debt burden and strengthen their rescue fund.

The modern day saga of the Trojan Horse continues.
as the euro debt crisis gives Japan the cover to do something
otherwise highly problematic.

Japan buying euro zone debt is a way to bolster the euro vs the yen
and thereby support Japan’s exporters.

Fujimura Says Japan May Boost Europe Bailout Bond Purchases

October 5 (Bloomberg) — Japan may increase its purchases of bonds to finance Europe’s debt crisis rescue fund, Chief Cabinet Secretary Osamu Fujimura said.

Fujimura told reporters today in Tokyo the government “would like to consider” buying more bonds from the European Financial Stability Facility to help stabilize the region. Japan bought more than 20 percent of the fund’s initial five-year, 5 billion euro ($6.6 billion) bonds in January, and purchased another 1.1 billion euros of 10-year EFSF bonds issued in June.

“Europe’s fiscal problem is also very important for Japan in terms of restoring market confidence, and the Europeans are grappling with this,” Fujimura said.

First, I see no public purpose in burning any crude oil to fly the Chairman and his entourage to make any speech.

He could just as easily deliver this one from the steps of the Fed in DC.
Congress should demand a statement of public purpose before endorsing any travel by its agents.

Next is what I expect from the speech.
The short answer is not much.

I don’t see more QE as the purpose of QE is to bring long rates down, and they are already down substantially. And the Fed now has sufficient evidence to confirm that long rates are mainly a function of expectations of future FOMC votes on rate settings.

To that point, when the Fed announced QE, and market participants believed it would spur growth, and therefore FOMC rate hikes somewhere down the road, long rates worked their way higher. And when the Fed ended QE, and market participants believed the economy would be slower to recover, long rates worked their way lower. Not to mention China hates QE and it still looks to me there’s an understanding in place where China allocates reserves to $US as long as the Fed doesn’t do any QE.

The Fed could cut it’s target Fed funds rate, the cost of funds for the banking system, down to 0 and lower that cost of funds by a few basis points. But those few basis points can hardly be expected to have much effect on anything.

It’s not the Fed has run out of bullets, it’s that the Fed has never had any bullets of any consequence.
And with the few it’s fired, it hasn’t realized the odds are the gun has been pointed backwards.
For example, it still looks to me lower rates, if anything, reduce aggregate demand via the interest income channels.

And QE isn’t much other than a tax on the economy, that also removes interest income.

So look for a forecast of modest GDP growth with downside risks, core inflation remaining reasonably firm even as unemployment remains far too high, all of which support continued Fed ‘accommodation’ at current levels.

First, the euro funding issue/crisis could vanish with a simple announcement, like:

The ECB hereby guarantees all the debt of the national governments.

But they won’t do that.
They are worried about their ability to subsequently enforce the Growth and Stability Pact, which has already proven unenforceable.

In fact, the only enforcement tool for austerity seems to rest with the ECB, which conditions its funding on austerity.

This is also the disciplinary principle behind my proposed ECB annual revenue distribution of maybe 10% of euro zone GDP to the national govts on a per capita basis-
The ECB would have the right to withhold future distributions to members who fail to comply with deficit rules. But this proposal isn’t even a consideration, so not likely to happen.

Mosler bonds (in the case of default they can be used for payment of taxes) for individual euro nations offer real hope, but time is short and the political process long.

That leaves the euro zone with what it’s been doing all along.
Muddle along anticipating, entertaining, debating, various funding proposals,
but ultimately,
when it gets bad enough,
relying on the ECB writing the check and buying national govt debt in the market place to facilitate ongoing funding.

All contingent with the member nation in question complying with terms and conditions of austerity set by the ECB.

It’s all highly deflationary, strong euro medicine, while it lasts.
It’s also operationally sustainable.
And phase 1- where austerity reduces deficits- has proven politically sustainable as well.

However we may now be entering phase 2,
where austerity results in falling GDP and higher deficits for all the euro members.
Yes, it’s operationally sustainable and continues to support the euro.

So the question is whether austerity measures intended to bring deficits down, that instead cause deficits to increase, are politically sustainable.

And, if not, what next?
And when?
How bad does it all have to get before they change policy?
And what change would that be?
The first step would probably be some ‘new’ form of QE,
and maybe even an interest rate cut,
which only make things worse,
as they wait for the appropriate lag before said policy ‘kicks in’.

And how long would it all continue to deteriorate before they stop waiting for it to ‘kick in’ and again change policy?

US deficit reduction round 2 coming soon as well.

To again quote that carpenter working on his piece of wood,
‘no matter how many times i cut it, it’s still too short’.

Is a misguided fuss over a reserve drain going to bring down global capitalism?

“The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics,” S&P said in a statement late yesterday after markets closed.

Credit ratings are based on ability to pay and willingness to pay.

David Beers of S&P knows this and has discussed this in the past.

Including direct discussion with me where he acknowledged a nation like the US always has the ability to make US dollar payments.

Therefore any downgrade would necessarily be based on willingness to pay.

In fact, I downgraded the US on willingness to pay several months ago on this website. And the debt ceiling debate more than demonstrated a willingness to default by far too many members of Congress for even consideration of a AAA rating.

So why then did David T. Beers decide to downgrade the US on ability to pay, and not explicitly on willingness to pay?

Sure looks like a case of intellectual dishonesty.
And I have no idea why.
So much for his legacy.

And, as previously discussed, markets probably won’t care, much like when Japan was even more severely downgraded.

A credit rating simply needn’t be applicable for the issuer of its own currency, as David should well know.

It doesn’t look to me like anything particularly bad has actually yet happened to the US economy.

The federal deficit is chugging along at maybe 9% of US GDP, supporting income and adding to savings by exactly that much, so a collapse in aggregate demand, while not impossible, is highly unlikely.

After recent downward revisions, that sent shock waves through the markets, so far this year GDP has grown by .4% in Q1 and 1.2% in Q2, with Q3 now revised down to maybe 2.0%. Looks to me like it’s been increasing, albeit very slowly. And today’s employment report shows much the same- modest improvement in an economy that’s growing enough to add a few jobs, but not enough to keep up with productivity growth and labor force growth, as labor participation rates fell to a new low for the cycle.

And, as previously discussed, looks to me like H1 demonstrated that corps can make decent returns with very little GDP growth, so even modestly better Q3 GDP can mean modestly better corp profits. Not to mention the high unemployment and decent productivity gains keeping unit labor costs low.

Lower crude oil and gasoline profits will hurt some corps, but should help others more than that, as consumers have more to spend on other things, and the corps with lower profits won’t cut their actual spending and so won’t reduce aggregate demand.

This is the reverse of what happened in the recent run up of gasoline prices.

Japan should be doing better as well as they recover from the shock of the earthquake.

Yes, there are risks, like the looming US govt spending cuts to be debated in November, but that’s too far in advance for today’s markets to discount.

A China hard landing will bring commodity prices down further, hurting some stocks but, again, helping consumers.

A euro zone meltdown would be an extreme negative, but, once again, the ECB has offered to write the check which, operationally, they can do without limit as needed. So markets will likely assume they will write the check and act accordingly.

A strong dollar is more a risk to valuations than to employment and output, and falling import prices are very dollar friendly, as is continuing a fiscal balance that constrains aggregate demand to the extent evidenced by the unemployment and labor force participation rates. And Japan’s dollar buying is a sign of the times. With US demand weakening, foreign nations are swayed by politically influential exporters who do not want to let their currency appreciate and risk losing market share.

The Fed’s reaction function includes unemployment and prices, but not corporate earnings per se. It’s failing on it’s unemployment mandate, and now with commodity prices coming down it’s undoubtedly reconcerned about failing on it’s price stability mandate as well, particularly with a Fed chairman who sees the risks as asymmetrical. That is, he believes they can deal with inflation, but that deflation is more problematic.

So with equity prices a function of earnings and not a function of GDP per se, as well as function of interest rates, current PE’s look a lot more attractive than they did before the sell off, and nothing bad has happened to Q3 earnings forecasts, where real GDP remains forecast higher than Q2.

So from here, seems to me both bonds and stocks could do ok, as a consequence of weak but positive GDP that’s enough to support corporate earnings growth, but not nearly enough to threaten Fed hikes.

Consumer borrowing up in June by most in 4 years

By Martin Crutsinger

May 25 (Bloomberg) — Americans borrowed more money in June than during any other month in nearly four years, relying on credit cards and loans to help get through a difficult economic stretch.

The Federal Reserve said Friday that consumers increased their borrowing by $15.5 billion in June. That’s the largest one-month gain since August 2007. And it is three times the amount that consumers borrowed in May.

The category that measures credit card use increased by $5.2 billion — the most for a single month since March 2008 and only the third gain since the financial crisis. A category that includes auto loans rose by $10.3 billion, the most since February.

Total consumer borrowing rose to a seasonally adjusted annual level of $2.45 trillion. That was 2.1 percent higher than the nearly four-year low of $2.39 trillion hit in September.

>   
>   (email exchange)
>   
>   On Thu, Jul 14, 2011 at 9:55 AM, wrote:
>   
>   I see Bernanke is speaking your language now…
>   

Yes, a bit, but but as corrected below:

“DUFFY: We had talked about the QE2 with Dr. Paul. When — when you buy assets, where does that money come from?

BERNANKE: We create reserves in the banking system which are just held with the Fed. It does not go out into the public.

Not exactly, as all govt spending is done by adding reserves to member bank reserve accounts. Reserve accounts are held by member banks as assets, and so these balances are as much ‘out into the public’ as any.

What doesn’t change is net financial assets, as QE debits securities accounts at the Fed and credits reserve accounts.

But yes, spending is in no case operationally constrained by revenues.

DUFFY: Does it come from tax dollars, though, to buy those assets?

BERNANKE: It does not.

Operationally he is correct, and in this case, to the extent QE does not add to aggregate demand, he is further correct. In fact, to the extent that QE removes interest income from the economy, it actually acts as a tax on the economy, and not as a govt expenditure.

However, and ironically, I submit he believes that QE adds to aggregate demand, and therefore ‘uses up’ some of the aggregate demand created by taxation, and therefore, in that sense, it would be taxpayer dollars that he’s spending.

DUFFY: Are you basically printing money to buy those assets?

BERNANKE: We’re not printing money. We’re creating reserves in the banking system.

Technically correct in that he’s not printing pieces of paper.

But he is adding net balances to private sector accounts, which, functionally, is what is creating new dollars which is generally referred to as ‘printing money’

All govt spending can be thought of as printing dollars, taxing unprinting dollars, and borrowing shifting dollars from reserve accounts to securities accounts.

DUFFY: In your testimony — I only have 20 seconds left — you talked about a potential additional stimulus. Can you assure us today that there is going to be no QE3? Or is that something that you’re considering?

BERNANKE: I think we have to keep all the options on the table. We don’t know where the economy is going to go. And if we get to a point where we’re like, you know, the economy — recovery is faltering and — and we’re looking at inflation dropping down toward zero or something, you know, where inflation issues are not relevant, then, you know, we have to look at all the options.

DUFFY: And QE3 is one of those?

BERNANKE: Yes.

Very hesitant, as it still looks to me like there’s an tacit understanding with China that there won’t be any more QE, as per China’s statement earlier today.

PAUL: I hate to interrupt, but my time is about up. I would like to suggest that you say it’s not spending money. Well, it’s money out of thin air. You put it into the market. You hold assets and assets aren’t — you know, they are diminishing in value when you buy up bad assets.

But very quickly, if you could answer another question because I’m curious about this. You know, the price of gold today is $1,580. The dollar during these last three years was devalued almost 50 percent. When you wake up in the morning, do you care about the price of gold?

BERNANKE: Well, I pay attention to the price of gold, but I think it reflects a lot of things. It reflects global uncertainties. I think people are — the reason people hold gold is as a protection against what we call “tail risk” — really, really bad outcomes. And to the extent that the last few years have made people more worried about the potential of a major crisis, then they have gold as a protection.

PAUL: Do you think gold is money?

BERNANKE: No. It’s not money.

(CROSSTALK)

PAUL: Even if it has been money for 6,000 years, somebody reversed that and eliminated that economic law?

BERNANKE: Well, you know, it’s an asset. I mean, it’s the same — would you say Treasury bills are money? I don’t think they’re money either, but they’re a financial asset.

Right answer would have been gold used to be demanded/accepted as payment of taxes, which caused it to circulate as money.

Today the US dollar is what’s demanded for payment of US taxes, so it circulates as money.

In fact, if you try to spend a gold coin today, in most parts of the world you have to accept a discount to spot market prices to get anyone to take it.

PAUL: Well, why do — why do central banks hold it?

BERNANKE: Well, it’s a form of reserves.

Yes, much like govt land, the strategic petroleum reserve, etc.

PAUL: Why don’t they hold diamonds?

Some probably do.

BERNANKE: Well, it’s tradition, long-term tradition.

PAUL: Well, some people still think it’s money.”

“CLAY: Has the Federal Reserve examined what may happen on another level on August 3rd if we do not lift the debt ceiling?

BERNANKE: Yes, we’ve — of course, we’ve looked at it and thought about making preparations and so on. The arithmetic is very simple. The revenue that we get in from taxes is both irregular and much less than the current rate of spending. That’s what it means to have a deficit.

So immediately, there would have to be something on the order of a 40 percent cut in outgo. The assumption is that as long as possible the Treasury would want to try to make payments on the principal and interest of the government debt because failure to do that would certainly throw the financial system into enormous disarray and have major impacts on the global economy.

So this is a matter of arithmetic. Fairly soon after that date, there would have to be significant cuts in Social Security, Medicare, military pay or some combination of those in order to avoid borrowing more money.

If in fact we ended up defaulting on the debt, or even if we didn’t, I think, you know, it’s possible that simply defaulting on our obligations to our citizens might be enough to create a downgrade in credit ratings and higher interest rates for us, which would be counterproductive, of course, since it makes the deficit worse.

But clearly, if we went so far as to default on the debt, it would be a major crisis because the Treasury security is viewed as the safest and most liquid security in the world. It’s the foundation for most of our financial — for much of our financial system. And the notion that it would become suddenly unreliable and illiquid would throw shock waves through the entire global financial system.

And higher interest rates would also impact the individual American consumer. Is that correct?

BERNANKE: Absolutely. The Treasury rates are the benchmark for mortgage rates, car loan rates and all other types of consumer rates.”

“BERNANKE: A second problem is the housing market. Clearly, that’s an area that should get some more attention because that’s been one of the major reasons why the economy has grown so slowly. And I think many of your colleagues would agree that the tax code needs a look to try to improve its efficiency and to promote economic growth as well.”

While housing isn’t growing as in the past, housing or anything else is only a source of drag if it’s shrinking.

It’s not that case that if housing were never to grow we could not be at levels of aggregate demand high enough to sustain full employment levels of sales and output.

We’d just be doing other things than in past cycles.

G. MILLER: Well, the problem I had with the Fannie-Freddie hybrid concept was the taxpayers were at risk and private sector made all the profits.

BERNANKE: That’s right.

That’s the same with banking in general with today’s insured deposits, a necessary condition for banking. Taxpayers are protected by regulation of assets. The liability side is not the place for market discipline, as has been learned the hard way over the course of history.

G. MILLER: That — that’s unacceptable. What do you see the barriers to private capital entering mortgage lending (inaudible) market for home loans would be?

BERNANKE: Well, currently, there’s not much private capital because of concerns about the housing market, concerns about still high default rates. I suspect, though, that, you know, when the housing market begins to show signs of life, that there will be expanded interest.

I think another reason — and go back what Mr. Hensarling was saying — is that the regulatory structure under which securitization, et cetera, will be taking place has not been tied down yet. So there’s a lot of things that have to happen. But I don’t see any reason why the private sector can’t play a big role in the housing market securitization, et cetera, going forward.”

As above, bank lending is still a public/private partnership, presumably operating for public purpose.

See my Proposals for the Banking System, Treasury, Fed, and FDIC (draft)

And there’s no reason securitization has to play any role. Housing starts peaked in 1972 at 2.6 million units with a population of only 200 million, with only simple savings and loans staffed by officers earning very reasonable salaries and no securitization.

“CARSON: However, banks are still not lending to the public and vital small businesses. How, sir, do you plan on, firstly, encouraging banks to lend to our nation’s small businesses and the American public in general?

And, secondly, as you know, more banks have indeed tightened their lending standards than have eased them. Does the Fed plan to keep interest rates low for an extended period of time. Are the Fed’s actions meaningless unless banks are willing to lend?

CARSON: And, lastly, what are your thoughts on requiring a 20 percent down for a payment? And do you believe that this will impact homeowners significantly or — or not at all?

BERNANKE: Well, banks — first of all, they have stopped tightening their lending standards, according to our surveys, and have begun to ease them, particularly for commercial and industrial loans and some other types of loans.

Small-business lending is still constrained, both because of bank reluctance but also because of lack of demand because they don’t have customers or inventories to finance or because they’re in weakened financial condition, which means they’re harder to qualify for the loan.

Right, sales drive most everything, including employment

“PETERS: Do you see some parallels between what happened in the late ’30s?

BERNANKE: Well, it’s true that most historians ascribe the ’37- ’38 recession to premature tightening of both fiscal and monetary policy, so that part is correct.

Also, Social Security was initiated, and accounted for ‘off budget’, and, with benefit payments initially near 0, the fica taxes far outstripped the benefits adding a sudden negative fiscal shock.

The accountants realized their mistake and Social Security was put on budget where it remains and belongs.

I think every episode is different. We have to look, you know, at what’s going on in the economy today. I think with 9.2 percent unemployment, the economy still requires a good deal of support. The Federal Reserve is doing what we can to provide monetary policy accommodation.

But as we go forward, we’re going to obviously want to make sure that as we support the recovery that we also keep an eye on inflation, make sure that stays well controlled.

Here’s my take:

A. They get a few trillion in long term cuts and maybe a few that kick in reasonably soon and extend the debt ceiling

This would help ensure aggregate demand stays low for long, which is bond friendly, and stocks muddle through in a range with slowing earnings growth but just enough top line growth to stay positive.

B. They don’t extend the debt ceiling

This would immediately and directly reduce aggregate demand, which is very bond friendly and very bad for stocks, as many top lines go negative until federal spending is restored.

And either way the economy remains vulnerable to looming external shocks, including a China slowdown, euro zone default and/or slowdown, UK slowdown, and a strong dollar.