Category Archives: Financial Times

Plosser Speech

Posted on by

Plosser is perhaps the most hawkish Fed president.

Look for a dove to speak soon to soften this stance?

(intro remarks deleted)

The FOMC and Monetary Policy Objectives

In conducting monetary policy, the FOMC seeks to foster financial conditions, including growth of money and credit and a level of
short-term interest rates, consistent with achieving two goals: price stability and maximum sustainable economic growth.

Note this general policy statement:

I believe that the most important contribution the Fed can make to sustained economic growth and employment rests on credibly committing to and achieving long-run price stability. In fact, without a credible commitment to maintaining price stability, the Fed’s ability to promote sustainable growth would be seriously undermined. Moreover, price stability is not only an important element in achieving sustained economic growth, it is also critical in promoting financial stability.

That is the mainstream view, and the view the Fed has presented to Congress over the years regarding how it complies with its dual mandate: get price stability right and markets function to promote optimum long-term growth and employment.

The primary tool for implementing monetary policy is the federal funds rate,

(SNIP)

It is important to recognize that the influence of changes in the FOMC’s targeted funds rate on inflation and economic growth occurs with a lag, so by necessity the FOMC must be forward-looking in setting an appropriate funds rate target. It must forecast future economic growth and inflation based on available economic data and financial conditions, including a particular path for the fed funds rate.

(SNIP)

A change in the economic outlook is what was at work in the last two weeks when the FOMC decided to reduce its target fed funds rate in two steps to its current level of 3 percent.

Let me elaborate on recent economic and financial conditions and my current outlook for the economy and inflation.

The Outlook
Since last August, financial and economic conditions have deteriorated. As that occurred, policymakers revised downward their forecasts for 2008 economic growth. This took place in several steps as new data were released and, in turn, led the FOMC to lower the federal funds rate in a series of steps.

By last September, we had already seen a cumulative deterioration in the housing sector during the earlier part of 2007. In addition, the disruptions in financial markets in August caused by the problems in the subprime mortgage market raised the risk of potential adverse effects on the broader economy from a further tightening of credit conditions. As a result, I lowered my projection of economic growth for the fourth quarter of 2007 and the first half of 2008. In particular, the adjustment to my forecast involved pushing back the turnaround in residential construction, as low demand for homes meant it would take longer than expected for the economy to work off the inventories of new and existing homes for sale. The continuing high prices of oil and other commodities also suggested the potential for some slowing in the pace of economic activity, as well as hinting at increasing inflationary pressures — a point I will return to later. As the outlook changed, the FOMC lowered the fed funds rate target by 50 basis points in September, and then by another 25 basis points in both October and early December.

Since the Committee’s meeting in early December, the economic data have indicated that the deterioration in the housing market has continued unabated. Although that by itself was discouraging, other economic indicators also showed signs of an economy that was weakening. The renewed widening of some credit spreads in financial markets, along with weaker figures for retail sales, manufacturing activity, and job growth in December, led many forecasters in early January to further mark down their forecasts for 2008. The sharp rise in December’s unemployment rate, which was released in early January, also heightened many economists’ concerns about the economy’s health. What’s more, the Philadelphia Reserve Bank’s closely watched manufacturing survey recorded a surprisingly steep decline in industrial activity in January, to a level not seen since the last recession.

Although the economy’s resilience to past shocks makes me cautious about making changes to my outlook based on just one or two pieces of economic news, the string of weaker than anticipated numbers released in late December and in January had a cumulative effect on my own assessment of the 2008 outlook. While I would not be very surprised if the economy bounces back more quickly than many forecasters are now projecting, I am now, nevertheless, anticipating a weaker first half of 2008 than I did in October. This downward revision to the economic outlook is what led me to conclude that a substantially lower level of interest rates was needed to support the process of returning the economy to its trend rate of growth. Consequently, I believe the recent reductions in the federal funds rate were a necessary and appropriate recognition of this changed outlook.

The ongoing housing correction and the volatility and uncertainty in the credit markets are significant near-term drags on the economy and I expect growth in the first half of the year to be quite weak, around 1 percent. As conditions in the housing and financial markets begin to stabilize, I expect growth to improve in the second half of the year and to move back to trend, which I estimate is around 2.7 percent, in 2009. Overall, I am now anticipating economic growth in 2008 of near 2 percent.

Confirming ‘trend’ GDP at 2.7%.

Given the slowdown in economic growth this year, payroll employment will rise more slowly than last year and will remain below trend for much of the year before picking up in 2009. Slower job growth will also lead to an unemployment rate near 5-1/4 percent in 2008, after fluctuating between 4‑1/2 and 5 percent in 2007.

Two adjustments will continue to be needed to help work down the large number of unsold homes: further cuts in construction and declines in housing prices. I expect the decline in housing starts will bottom out in the middle of this year, but starts are likely to then be quite flat through the end of 2009 as the inventory of unsold homes is reduced gradually.

Interesting how long he thinks starts will stay around one million.

Of course, as was the case in 2007, how quickly housing bottoms out remains one of the main uncertainties surrounding any forecast in today’s environment. It seems that ever since last spring, the turnaround in housing was always six months away. Well, nine months later, it is still six months away. Simply having housing stop contracting will help economic growth. In 2007 the decline in residential construction took 1 percentage point off real GDP growth, which turned out to be 2.5 percent for the year (4th quarter to 4th quarter). Once residential construction stops declining, it will cease subtracting from overall growth. But housing is unlikely to make a positive contribution to economic growth until 2009.

Business investment should continue to increase this year, but at a slower pace than in 2007. Outside of autos and housing, there isn’t a large inventory overhang in the economy to be worked off. This is actually good news. Recessions are often preceded by periods of large inventory accumulation and much of the decline in production during recessions reflects a working off of an inventory imbalance. The absence of such an inventory overhang is encouraging.

The biggest component of GDP is consumer spending. With slower growth of employment and personal income in the first half of 2008, and as the decline in the value of homes and equities diminishes households’ net worth, consumer spending is likely to grow more slowly before picking up again in 2009.

One piece of good news has been the growth in exports. The trade sector supported economic growth last year as domestic demand weakened in the U.S. while foreign growth remained strong. The declining dollar also helped fuel a rebound in our exports. The net export component of GDP should continue to improve this year, although more slowly than it did in 2007 because we are likely to see somewhat slower growth among our major trading partners this year.

Inflation
Let me now turn to the outlook for inflation. Unfortunately, I expect little progress to be made in reducing core inflation this year or next, and I am skeptical that slower economic growth will help.

My understanding is the Fed was forecasting weakness that would bring down inflation.

All you have to do is recall the 1970s when we experienced both high unemployment and high inflation to appreciate that slow economic growth and lower inflation do not necessarily go hand in hand. I anticipate that core inflation (which excludes the prices of food and energy) is likely to remain in the 2 to 2‑1/2 percent range in 2008, which is above the range I consider to be consistent with price stability. If oil prices stabilize near their current levels, I expect headline, or total, inflation to decrease to around the 2 to 2‑1/2 percent range in 2008.

That is not a welcome forecast for the FOMC. They don’t want to conduct policy that lets core get that high.

(SNIP)

As the FOMC’s January 30 statement said, it will be necessary to continue to monitor inflation developments carefully. Most measures of inflation, including the core CPI and core PCE price measures, accelerated in the second half of 2007 compared to the first half. With inflation creeping up, we have to be particularly alert for rising inflation expectations. It is important that inflation expectations remain stable. If those expectations become unhinged, they could rapidly fuel inflation.

Again, that is the mainstream view. The expectations operator is key to a relative value story turning into an inflation story, as they say.

Moreover, as we learned from the experience of the 1970s, once the public loses confidence in the Fed’s commitment to price stability, it is very costly to the economy for the Fed to regain that confidence. The painful period of the early 1980s was the price the economy paid to restore the credibility of the Fed’s commitment — we certainly do not wish to go through that process again.

The mainstream often states it this way: ‘The real cost of bringing down inflation once expectations elevate is far higher than the cost of a near term recession.’

Fortunately, so far inflation expectations have not changed very much. But they bear watching because there are some signs that they, too, are edging higher. These may be early warning signs of a weakening of our credibility, and we must be very careful to avoid that.

The Fed is divided here. Most say that if expectations begin to elevate, it could be too late -the inflation cat is out of the bag- so, that much be avoided at all costs. Others say you can let them elevate a little bit, but must then act quickly to bring inflation down.

Monetary Policy Going Forward

(SNIP)

Over the course of the last five months, as forecasts for economic growth have been revised downward, the FOMC has lowered the fed funds rate by 225 basis points — from 5.25 percent to 3 percent. Taking expected inflation into account, the level of the federal funds rate in real terms — what economists call the real rate of interest — is now approaching zero. That is clearly an accommodative level of real interest rates. The last time the level of real interest rates was this low was in 2003-2004. But that was a different time with a different concern — deflation — and we were intentionally seeking to prevent prices from falling. Recently we have had reason to be worried about rising inflation, not declining prices.

This is a very strong statement – real interest rates are near zero, which was maybe appropriate given deflation fears in 2004, but he says not that is not the issue.

The FOMC’s reductions in the federal funds rate have been proactive in responding to evolving economic conditions that led to the deterioration in the outlook for economic growth. My inclination to alter monetary policy depends on whether the accumulation of evidence based on the data between now and our next meeting causes me to revise my forecast further. Weaker than expected data might lead to a downward revision, while stronger than expected data may lead to an upward revision to the forecast.

To make this point concrete, last Friday the Bureau of Labor Statistics reported that the economy lost 17,000 jobs in January. This was not an encouraging number. However, it was consistent with my forecast of weak employment growth in the first quarter of this year. Thus, by itself, it does not lead to a substantive revision to my forecast. We must look at the accumulation of data from a variety of sources to assess how the outlook may have changed relative to what was expected.

The payroll number did not change his forecast.

I also want to note that in early January there was much concern when the BLS reported only 18,000 jobs were created in December. Yet in the employment report last Friday that preliminary number was revised up to 82,000. Thus, we have to realize that economic data are subject to revision, and we have to be very careful not to rely on any one statistic or data series in assessing current economic conditions or our outlook.

Looks like he recognized January may be also revised up as December and August were.

There are those who have expressed the view that in times of economic weakness, the Fed must not worry about inflation and should focus its entire effort on restoring economic growth by dramatically driving interest rates down as far and as rapidly as possible. To borrow a line attributed to that famous, or perhaps infamous, Union Admiral David Farragut at the Battle of Mobile Bay, it is sort of a “damn the torpedoes, full speed ahead” approach to policy. But the Fed has a dual mandate for a reason. Price stability is a necessary component for achieving sustained economic growth. Ignoring price stability during times of economic weakness risks undermining our ability to achieve economic growth over the long run. It fuels higher inflation down the road and risks inappropriate risk taking and recurring boom/bust cycles. This would be counterproductive.

Again, this is the mainstream view.

Although it might be tempting to think that monetary policy is the solution to most, if not all, economic ills, this is not the case. I think it is particularly important, for example, to recognize that monetary policy cannot solve all the problems the economy and financial system now face. It cannot solve the bad debt problems in the mortgage market. It cannot re-price the risks of securities backed by subprime loans. It cannot solve the problems faced by those financial firms at risk of being given lower ratings by rating agencies because some of their assets are now worth much less than previously thought. The markets will have to solve these problems, as indeed they will. But it will take some time. However, the Fed can and should help by offsetting some of the restraint created by tightening credit conditions and the sharp reduction in housing investment. The Fed can and should also promote the orderly functioning of financial markets.

Going forward, then, my approach to making monetary policy decisions will be to look at incoming information and ask whether it is consistent with my outlook and the achievement of the Fed’s dual mandate. My outlook for 2008 already incorporates the fact that we will be receiving quite a few weak economic numbers in the first half of the year. However, to the extent that economic conditions evolve differently than expected, we will need to be prepared to incorporate those changing conditions into our policy decisions in a manner that is consistent with our dual mandate.

He uses the term ‘dual mandate’ to stress the importance of price stability.

Conclusion
In conclusion, my own forecast for economic activity has been revised downward since last October as economic conditions have evolved. I believe the recent reductions in the level of the federal funds rate target will be supportive of the economic adjustment process and a return to trend growth near the end of this year and on into 2009. The Fed has been aggressive in making this adjustment in rates, which will mitigate some, but not all, of the problems the economy and financial markets are facing. Some problems will simply take time for the financial markets to work out.

Seems his opinion is that unless the economy weakens more than currently forecast, the Fed is done.

In taking aggressive action in supporting the economy’s eventual return to its trend growth rate, I continue to believe we must not lose sight of the other part of the Fed’s dual mandate – which is price stability. We cannot be confident that a slow-growing economy in early 2008 will by itself reduce inflation.

The FOMC has been banking on this happening, Plosser is not so sure.

I am also convinced that we need to keep our eye on both headline as well as core inflation in assessing how well we are doing in achieving our goal of price stability.

Going forward, monetary policy decisions will depend on how the economy unfolds and whether further changes in the economic outlook are necessary.

Again, let me thank Philip Jackson and the Rotary Club for inviting me to return to speak here in Birmingham.

♥

Share

ECB on inflation, again

Posted on by

Trichet expresses the mainstream view of monetary policy:

“The financial market correction — it’s a very significant correction with turbulent episodes — that we are observing provides a reminder of how a disturbance in a particular market segment can propagate across many markets and many countries, Trichet said in a debate at the European Parliament economic and monetary affairs committee.

But at times of financial turbulence it is the duty of the ECB and other central banks to anchor inflation expectations, he said.

“In all circumstances, but even more particularly in demanding times of significant market correction and turbulences, it is the
responsibility of the central bank to solidly anchor inflation expectations to avoid additional volatility in already highly volatile markets,” he said.

♥

Share

Re: media influence

Posted on by

On Jan 21, 2008 6:45 PM, Bobby wrote:
> Hi
>
> Don’t you think the Media has something to do with this.

Hi, yes definitely, and it’s always that way- goes with the territory. adds to volatility.

Every time you turn on the TV, open a newspaper, read the web, it says we are in a recession or we are about to be in one etc etc. ? Or more negative things. We are bombarded with this, as are others around the world, 24/7. Like now the NY Times online feature story says Stocks Worldwide Plunge on US Recession Fears. All it does is scare the people that aren’t as smart as you or see things as you do for what they are.

True, and worse. Look at this story from earlier today:

U.S. consumers pull back on spending, worry more about debt as economy weakens

Note the title. Then, look for any evidence of a pullback on spending.

NEW YORK – Joi Freemont, a dentist in suburban Atlanta, doesn’t have to look further than her appointment book to tell that people are worried about money.

Patients who used to get their teeth whitened all the time “now want to think about it a bit,” she said. Braces? “People were getting them for the kids, for themselves, but now they’re waiting,” she added. And when people get cavities, they have their fillings done one a month, not five or six at a time, she said.

As a result, Freemont and her husband are worried their income could drop

Could drop – hasn’t dropped yet.

and are trying to be more prudent with their money. They’re monitoring spending more closely and continuing to whittle down their credit card balances and her dental school debt, she said.

Paying down debt from income – this is not typical, as consumer credit rose at the last report.

“We know how to put the brakes on if we have to,” said Freemont, 35.

‘If we have to’ – haven’t yet.

Across America, there are growing signs that consumers are worried about the weakening economy, which could slip into recession.

What growing signs?

While some say Americans are not famed for their belt-tightening tactics, there are signs that people are trying to improve their personal balance sheets so they’re ready for tougher times.

What signs?

Mark Zandi, chief economist at Moody’s Economy.com, said the economic signals “are flashing yellow,” suggesting that consumers need to take care.

What signals?

Jobs are getting harder to find,

Employment and income are still rising as of December and early January reports.

while the crisis in the mortgage industry has made it more difficult for homeowners to borrow against their houses, closing down what has been a major source of extra cash in recent years.

If that has been a factor, there’s little evidence of a material ‘wealth effect’ – it’s been going on for several months, and employment, income, and spending haven’t suffered yet.

Consumers’ budgets have been squeezed by rising food and fuel prices.

Yes, but exports have fill the gap and sustained GDP.

Credit card balances surged through the fall months, according to Federal Reserve figures.

Yes, consumer spending has been OK.

Now delinquency rates on consumer loans are rising, the American Bankers Association reported recently. Even companies that cater to higher-income families, such as American Express Inc., are feeling the pinch.

Delinquencies are rising, but not yet to problem levels. And that’s an overstatement of the announcement by AMEX, which was a statement regarding prospects for next year.

When the economy stumbles, “you have to begin living within your means, or you’ll be forced to do so,” Zandi said.

‘When’ means it hasn’t happened yet.

But Americans are much better spenders than savers, said Greg McBride, senior financial analyst with Bankrate.com, an online financial information service.

“Consumer spending isn’t something that gets turned on and off like a light switch,” he said. “People will say they need to cut back, but they often lack the willpower to do it.”

Still, it appears that people are starting to make an effort.

Starting to make an effort???

Denise Dorman, who runs an advertising and public relations agency in Geneva, Illinois, decided not to replace her 12-year-old vehicle, a Jeep Grand Cherokee with 125,000 miles (200,000 kilometers) on it, to avoid taking on a car payment.

She and her husband Dave, a commercial artist known for his Star Wars illustrations, also are “aggressively paying off credit card debt.” And Dorman is seeking new opportunities to expand her business, perhaps into growth areas such as video-gaming.

“I’ll feel a lot more comfortable when our debt is paid down and business has picked up,” she said.

Sounds like business is good for them – is this the best example the author can find for their recession claim?

The couple experienced the downturn in the housing market firsthand as it took them 18 months to sell their former home in Florida.

True hardship!

They’ve also become increasingly aware of the nation’s deepening economic malaise from news reports and the presidential election debates.

Yes, to your point, Bobby.

“Altogether, it made us rethink what we’re doing financially,” she said.

Frank Krystyniak, 65, director of public relations at Sam Houston State University in Huntsville, Texas, said the uncertain financial
environment and the effect of the upcoming presidential election has him worried that his savings could take a big hit.

So he recently moved his nest egg out of stock and bond funds and into a fixed-rate account that should yield about 4.75 percent a year, he said.

This is not evidence of recession; it’s evidence of the media scaring people into reallocating assets.

He’s also wary of rising gasoline prices, which could curtail his driving to Colorado to visit family and indulge in his hobby of trout fishing.

Could curtail – hasn’t cut back yet.

Some consumer retrenchment might not be a bad idea, said Sheryl Garrett, founder of The Garrett Planning Network of certified financial planners and author of the “Personal Finance Workbook for Dummies.”

High debt and low savings indicate that consumer budgets are out of kilter, she said.

“A mild recession would be a good opportunity _ or cause or excuse _for people to stop and take a deep breath,” Garrett said. “So many people have overextended themselves.

Apart from why this is in here, it also says there’s no recession yet. The article offers no support whatsoever for its headline – because there isn’t any evidence of a consumer pullback yet.

“If you’re living on the edge when times are good, just what are you going to do when they get bad?”

Should be even more intense tomorrow – might get a ‘capitulation’ day or might just keep going down. It’s technical at this point.

warren

>
> Bobby
>

♥

Share

Fed’s Fisher

Posted on by

Doesn’t get any more hawkish than this.

Well worth a quick read.

Richard W. Fisher
Challenges for Monetary Policy in a Globalized Economy
Remarks before the Global Interdependence Center
Philadelphia, Pennsylvania
January 17, 2008

Thank you, Charlie [Plosser]. I am grateful for the invitation to speak to the Global Interdependence Center.

(NON ECON INTRO SNIPPED)

You’d be hard pressed to find an economist or market operator in this city or anywhere else on the planet who is not concerned about waning U.S. economic growth. Some analysts and commentators sound like Chicken Littles. Others are less excitable, but are nevertheless assuming a defensive crouch. Most are mindful of recent developments in employment patterns, uneven retail sales and downward shifts in shipping, rail and trucking indexes, industrial activity, business capex plans, credit card payables, purchasing manager activity and other carefully watched indicators. These stresses follow on the severe housing downturn and the liquidity bind. There is an increasingly insistent drumbeat urging the Fed not only to not impose contractionary policy on a weakening economy, but indeed to get “ahead of the curve” through further monetary accommodation.

Chairman Bernanke spoke last week and made it clear that the FOMC stands “ready to take substantive action needed to support growth and provide insurance against downside risks,” adding that “additional policy easing may well be necessary.” In short, he made clear that the FOMC does not intend to just squat and wait should economic data and sound risk management signal that monetary accommodation is required.

It needs to be underscored that being proactive and not passive in doing our job does not mean that we will abandon prudent decisionmaking. We are the central bank of the United States, the bellwether economy of the world. Our job is not to bail out imprudent decisionmakers or errant bankers, nor is it to directly support the stock market or to somehow make whole those money managers, financial engineers and real estate speculators who got it wrong. And it most definitely is not to err on the side of Wall Street at the expense of Main Street.

In fact, to benefit Main Street, we have a duty to maintain a financial system that enables American capitalism to do its magic. To this end, we have recently taken steps designed to circumvent
bottlenecks in interbank lending—steps that include changing the operation of our discount window and opening a new term auction facility. This facility has provided $70 billion in funds in roughly a
month and will soon provide another $30 billion, and perhaps even more over time if needed.

In setting broader monetary policy and the fed funds target rate, the Fed operates under a dual mandate. We are charged by Congress with creating the monetary conditions for sustainable, noninflationary employment growth. Put more simply, our mandate is to grow employment and to contain inflation. Unstable prices are incompatible with sustainable job growth. Some critics worry that we have forgotten that axiom. We haven’t.

Let me give you my personal view.

In discharging our dual mandate, we must be mindful that short-term fixes often lead to long-term problems. The Fed occupies a unique place in the pantheon of government institutions. It was deliberately designed to be calm and steady, untainted by the passion of the moment and immune to political exigency and influence. Because monetary policy’s effects spread into the economy slowly and accumulate over time, having an itchy trigger finger with monetary policy risks shooting everyone in the foot. Our policy mandate must be discharged with careful and deliberate aim.

In the attention-deficit world of television and Internet commentary, where so-called “instant analysis”—an oxymoron if there ever was one—makes headlines, it is easy to understand why one might think that the effect of a change in the fed funds rate would immediately alter the dynamic of the economy. To be sure, movement in the fed funds rate, or even no movement at all, may have an immediate psychological effect and influence expectations for future monetary policy action. But the act of changing or not changing the fed funds target rate, in and of itself, has no immediate effect on the economy. Like a good single malt whiskey, the ameliorating or stimulating influence kicks in only with a lag.

The lag time necessary for inflation to respond to policy is especially long. As a policymaker discharging our dual mandate, I am always mindful that in providing the monetary conditions for employment growth, we must not also sow the seeds of inflation that will eventually choke off the very employment growth we seek to encourage. You do not have to be an inflation “hawk” to recognize that would be a Faustian bargain.

Those of you who follow my speeches—probably a very small number of you with way too much time on your hands—will recall that I like neither the term “hawk” nor “dove.” I like to think that all FOMC
members are best metaphorically described in ornithological terms as “owls”—wise women and men seeking to achieve the right balance in carrying out our dual mandate. To be owlish, and to avoid the
imbalance of emphasis that gave rise to needed harsh discipline imposed by the Volcker FOMC, one has to bear in mind that the seeds of inflation, once planted, can lie fallow for some time, then suddenly burst through the economic topsoil like kudzu, requiring a near-toxic dose of countermeasures to overcome.

In the pre-Volcker era, the Fed had a less-than-admirable record of keeping inflation at bay. But over the past few decades, we have done well enough to both contain inflation and engender growth that far outpaced other advanced economies for a sustained period with only a smattering of short recessions. In short, the Fed has delivered on its mandate.

To be sure, we have been profoundly impacted by the shifting economic dynamics that have complicated our efforts to continue delivering on our mandate. I need not try to convince members and supporters of the Global Interdependence Center that we are living in a globalized world. Increasingly, globalization is blurring economic boundaries. On the inflation front, for example, we have extensive economic playbooks that tell us how to treat the wage–price spiral or cost-push forces in a closed economy. In a closed environment, one would ordinarily expect that a weakening economy would lead, in turn, to a diminution in price pressures. But we have less experience with prescribing policy in an open economy where demand-pull forces come from beyond our borders—such as the burgeoning demand for commodities and food from rapidly growing and newly consequential economies like China, India, Latin America and the countries liberated from the oppression of Soviet communism. These faraway places play an ever-increasing role in determining prices here at home.

Writing in last Sunday’s New York Times, Ben Stein noted this and that the Fed does not have much power to influence the price of oil.[1] He is right. And for that matter, we can’t do much about the external demand impacting the price of food—which, by the way, carries twice the weight of energy in the consumer basket of personal consumption expenditures. But the dynamics of production and demand among the new participants in the global economy nonetheless impact us in different ways at different times. As these new participants joined the global economy, they provided significant tailwinds, helping us grow by providing cost savings, new sources of productivity enhancement and new sources of demand, helping fatten both the top line and bottom line of our businesses while also holding down inflation. Under such conditions, the Fed could operate with a more accommodative monetary policy than what might have been appropriate in a closed economy, without putting upward pressure on inflation. And that is what the Fed did, although some argue—with the benefit of hindsight—it did so for too long.

I think it is now clear that the winds have shifted. The growing appetite for raw inputs from the new participants in the global economy represents an inflationary headwind that is unlikely to soon abate. The so-called “income elasticity of demand” for energy is 1.2 across a wide range of countries, which is a fancy way of saying that economic theory should lead one to conclude that the demand for energy in, say, China, for example, would begin to grow faster than China’s income growth, which continues to increase at a rapid rate. Put more simply, income growth in China and India and elsewhere, even if it slows from its torrid pace, is likely to continue raising demand for food and energy. There is a risk that upward price pressures will continue to affect American producers and consumers of energy and food products and a continuing danger that overall inflation expectations will drift upward as a result.

If I am correct, then the situation today is the flip side of the 1990s and early 2000s: In delivering on our mandate to be monetary policy “owls,” we will have to err on the side of running tighter policy than would otherwise be justified if we wish to limit upward inflation pressures.

I mentioned single malt whiskey earlier to describe the effective time lags of monetary policy. I realize it is only lunchtime, but let’s return to the economics liquor cabinet for a moment. Inflation is like absinthe. The narcotic allure of inflation is a dangerous thing. It might seem like the remedy to bail out a government or a bad book of business and forget your troubles. Yet our experience in the past has taught us only too well that inflation is a dangerous elixir that ultimately proves debilitating for businesses, consumers, investors—including those foreign investors who have lately come to the aid of some large balance sheets here—and especially for the poor, the elderly and people on fixed incomes. It even inculcates bad financial behavioral patterns in the young by encouraging spending rather than investment and saving. Inflation is bad for Main Street and Wall Street and even for Sesame Street.

Yet we central bankers also traverse Lombard Street, and we know from Walter Bagehot that in times of crisis, liquidity is key. As a voter on the FOMC this year, I stand ready to take substantive action to support growth and provide insurance against downside risk, as long as inflation expectations remain contained.

You will note the operative qualifying words there were “as long as inflation expectations remain contained.” Each of us looks to different indicators for a sense of inflation’s direction. Some peruse markets for signs of shifting expectations, looking, say, to the yield on Treasury Inflation-Protected Securities, or TIPS, or to the spread between yields in the forward markets between TIPS and nominal Treasuries at different points of the yield curve or all along the entire curve. Personally, as a former market operator, I am wary of relying on Treasury spot or futures indicators during a flight to quality or at times when liquidity is at a premium, as investors may have other preoccupations that trump or distort conventional inflation concerns.

Others look to surveys of consumers and professional forecasters, like those conducted by the University of Michigan and the Philadelphia Fed. The latest, the University of Michigan survey, released in December, is forecasting headline Consumer Price Index (CPI) inflation of 3.4 percent, which is hardly comforting. The Philadelphia Fed survey, released last November, provides a more palatable forecast of 2.4 percent for the next four quarters; yet if you plot that survey against actual headline inflation obtained for the last four years, it has more often than not underestimated inflation’s true path.

The brow of a central banker considering further accommodation furrows further when looking at the inflation measures that form the basis for Main Street’s inflationary expectations—the CPI and the Personal Consumption Expenditures (PCE) deflator. On a 12-month basis, the most recent CPI, released yesterday, was running at a rate of 4.1 percent. The last PCE deflator, released in December, was 3.6 percent. The Trimmed Mean PCE Deflator, which the Dallas Fed tracks in an effort to eliminate “noise from signal” and as a basis for projecting inflation, is no longer trending downward. Even the so-called “Core PCE,” which I personally consider least useful because it eliminates food and energy prices, is rising rather than declining.

Of course, what matters most is the future direction of inflation, not the past. In the course of preparing for each FOMC meeting, I regularly consult directly with some 30-plus CEOs to develop a sense of future business activity, including cost and pricing developments. I have found this rigorous exercise to be extremely helpful in placing our staff’s econometric analysis in context as I have prepared for FOMC meetings in the past, and I will be listening especially carefully to these business operators’ reports on inflation-related developments as I prepare for upcoming FOMC meetings.

In my view, the degree of substantive action to support economic growth and insure against downside risk will be conditioned by what we see coming down the inflation pike. To deliver on its dual mandate, the Fed must keep one ear cocked toward signs that inflationary expectations are drifting upward as we execute additional monetary measures.

Let me bring this home to Philadelphia. In 1748, Benjamin Franklin wrote an “Advice to a Young Tradesman.” In it, he speaks in the language of the day of the concepts of opportunity cost and of the power of compound interest—pretty precocious stuff for those times. Of the money supply, he wrote that “the more there is of it, the more it produces [at] every turning, so that the profits rise quicker and quicker.” Yet he also warns in earthy terms of the dangers of being too prolific. “He that kills a breeding sow,” Franklin warned, “destroys all her offspring to the thousandth generation. He that murders a crown [the currency of the day], destroys all that it might have produced….”

The late Dame Mary Douglas was no Ben Franklin. Nor was she a Philadelphian. She was a brilliant British economic anthropologist who wrote a pathbreaking book titled Purity and Danger. In it, she wrote something that Franklin or Stephen Girard or any good central banker since the onset of time has understood implicitly: “Money can only perform its role of intensifying economic interaction if the public has faith in it. If that faith is shaken, the currency is useless.”

Like Charlie and my other colleagues, I have every desire to use monetary policy to intensify economic interaction, to keep breeding jobs and growing our economy, so that we might keep America strong to the thousandth generation. I have no intention of being party to any action that might shake faith in the dollar. The challenge to monetary policy, as I see it, is to achieve the growth part of our mandate in the short term and get “ahead of the curve” without shaking faith in the currency over the long term.

I know that the GIC has other things on its mind than just monetary policy. So let me stop there and answer any questions you might have.

About the Author

Richard W. Fisher is president and CEO of the Federal Reserve Bank of Dallas.

♥

Share

A very British bubble for Mr Brown

Posted on by

A very British bubble for Mr Brown

Leader
Sunday December 16 2007
The Observer

The buzz words in the world of finance these days are ‘moral hazard’. That is economist-speak for what happens when people who have engaged in risky business and fallen foul of market forces are let off the hook. It is the recognition that when you give dodgy lenders and borrowers an inch, they recklessly gamble for another mile.

When the City started to feel the ‘credit crunch’ over the summer, the Bank of England at first took a tough line on moral hazard. But it subsequently changed its mind. It rescued Northern Rock.

It rescued the depositors. Hardly a moral hazard issue. The shareholders still stand to lose if the assets don’t have the hoped for cash flows over time.

Last week it joined a coordinated action with US, Canadian and European central banks to provide easy credit to any institution that can’t borrow elsewhere.

Sort of, the CB’s job is to administer policy interest rates. And, again, there is nothing yet to indicate shareholders are getting baled out.

That was the right course of action. The banking sector may be in a mess of its own making – it over-exposed itself to US sub-prime mortgages – but the danger to the wider economy of a prolonged cash drought is too big to ignore.

What is a ‘cash drought’???

But even if last week’s intervention gets the wheels of global finance moving again,

Whatever that means. GDP seems to be muddling through as before.

the danger will not have receded. That is because high street lenders have no reason to pass central bank largesse onto their customers. Ordinary people will still find it hard to borrow and will still pay more than before to service their debts.

Haven’t seen any evidence of that, apart from would be subprime borrowers who perhaps never should have had access to funds anyway.

Since Britons are some of the most indebted people in the world, that puts us in a particularly vulnerable position. Per capita, Britons borrow more than twice as much as other Europeans. The average family pays 18 per cent of disposable income servicing debt. If the world economy slumps, the bailiffs will knock at British doors first.

More confused rhetoric. Aggregate demand is about spending. The risk to output and employment remains a slump in spending.

It might not come to that. The best case scenario envisages a mild downturn, consumers turning more prudent, demand dipping and inflation falling, which would free the Bank of England to cut interest rates and re-energise the economy for a prompt comeback.

No evidence cutting rates adds to demand in a meaningful way. It takes a strong dose of fiscal for that or for the non resident sector to start spending its hoard of pounds in the UK.

But in the worst case scenario, the credit crunch turns into a consumer recession.

If it results in a cut in aggregate demand, which it might, but somehow this discussion does not get into that connection.

House prices fall dramatically. People feel much poorer and stop spending.

OK, there is a possible channel, but it is a weak argument. Seems to take a cut in income for spending to fall.

Small businesses can’t get credit and fold.

Could happen, but if consumers spend at the remaining businesses that do not fold and employment and income stays constant, GDP stays pretty much the same.

But high fuel and commodity prices keep inflation high. Unemployment rises

When that happens, it is trouble for GDP, but he skirts around the channels that might lead to a loss of income, spending, and employment.

and millions of people default on their debts. Boom turns to bust.

Right, and the policy response can be an immediate fiscal measure that sustains demand and prevents that from happening.

The problem is with ‘high inflation’ and an inherent fear of government deficits; policy makers may not want to go that route.

The government can hope for the best, but it must prepare for the worst.

Fallout shelters?

That means talking to banks, regulators and debt relief charities to work out ways to help people at risk of insolvency.

Actually, bankruptcy is a means of sustaining demand. Past debts are gone and earned income goes toward spending and often spending beyond current income via new debt.

They must look first at reform of Individual Voluntary Arrangements. These are debt restructuring packages that fall short of personal bankruptcy declarations. In theory, they allow people to consolidate and write off some of their debt, paying the rest in installments.

This could hurt demand unless the installment payments get spend by the recipients.

There is no debtors prison over there anymore, last I heard?

But in practice they are sometimes scarcely more generous than credit card balance transfer deals, with large arrangement fees and tricky small print. There is emerging evidence they have been mis-sold to desperate debtors.

In theory, individuals can also negotiate debt relief directly with banks. But that requires the pairing of a financially literate, assertive consumer with a generous-hearted lender – not the most common combination. The government and banks should already be planning their strategy to make impartial brokering of such deals easier.

But the first hurdle on the way to easing a private debt crisis is political. Gordon Brown has constructed a mythology of himself as the alchemist Chancellor who eliminated the cycle of boom-and-bust from Britain’s economy. To stay consistent with that line, he has to pretend that Britain is well insulated from financial turbulence originating in the US.

Banning CNBC would help out a lot!

That simply isn’t true. The excessive level of consumer borrowing in recent years is a very British bubble and the government can deny it no longer. If the bubble bursts, we will face a kind of moral hazard very different from the one calculated by central banks when bailing out the City. It is the hazard of millions of people falling into penury.

Rising incomes can sustain rising debt indefinitely. It is up to the banks to make loans to people who can service them; otherwise, their shareholders lose. That is the market discipline, not short term bank funding issues.

♥

Share

Re: liquidity or insolvency–does it matter?

Posted on by

(email with Randall Wray)

On Dec 15, 2007 9:05 PM, Wray, Randall wrote:
> By ________
>
> This time the magic isn’t working.
>
> Why not? Because the problem with the markets isn’t just a lack of liquidity – there’s also a fundamental problem of solvency.
>
> Let me explain the difference with a hypothetical example.
>
> Suppose that there’s a nasty rumor about the First Bank of Pottersville: people say that the bank made a huge loan to the president’s brother-in-law, who squandered the money on a failed business venture.
>
> Even if the rumor is false, it can break the bank. If everyone, believing that the bank is about to go bust, demands their money out at the same time, the bank would have to raise cash by selling off assets at fire-sale prices – and it may indeed go bust even though it didn’t really make that bum loan.
>
> And because loss of confidence can be a self-fulfilling prophecy, even depositors who don’t believe the rumor would join in the bank run, trying to get their money out while they can.

If there wasn’t credible deposit insurance.

>
> But the Fed can come to the rescue. If the rumor is false, the bank has enough assets to cover its debts; all it lacks is liquidity – the ability to raise cash on short notice. And the Fed can solve that problem by giving the bank a temporary loan, tiding it over until things calm down.

Yes.

> Matters are very different, however, if the rumor is true: the bank really did make a big bad loan. Then the problem isn’t how to restore confidence; it’s how to deal with the fact that the bank is really, truly insolvent, that is, busted.

Fed closes the bank, declares it insolvent, ‘sells’ the assets, and transfers the liabilities to another bank, sometimes along with a check if shareholder’s equity wasn’t enough to cover the losses, and life goes on. Just like the S and L crisis.

>
> My story about a basically sound bank beset by a crisis of confidence, which can be rescued with a temporary loan from the Fed, is more or less what happened to the financial system as a whole in 1998. Russia’s default led to the collapse of the giant hedge fund Long Term Capital Management, and for a few weeks there was panic in the markets.
>
> But when all was said and done, not that much money had been lost; a temporary expansion of credit by the Fed gave everyone time to regain their nerve, and the crisis soon passed.

More was lost then than now, at least so far. 100 billion was lost immediately due to the Russian default and more subsequently. So far announced losses have been less than that, and ‘inflation adjusted’ losses would have to be at least 200 billion to begin to match the first day of the 1998 crisis (August 17).

>
> In August, the Fed tried again to do what it did in 1998, and at first it seemed to work. But then the crisis of confidence came back, worse than ever. And the reason is that this time the financial system – both banks and, probably even more important, nonbank financial institutions – made a lot of loans that are likely to go very, very bad.

Same in 1998. It ended only when it was announced Deutsche Bank was buying Banker’s Trust and seemed the next day it all started ‘flowing’ again.

>
> It’s easy to get lost in the details of subprime mortgages, resets, collateralized debt obligations, and so on. But there are two important facts that may give you a sense of just how big the problem is.
>
> First, we had an enormous housing bubble in the middle of this decade. To restore a historically normal ratio of housing prices to rents or incomes, average home prices would have to fall about 30 percent from their current levels.

Incomes are sufficient to support the current prices. That’s why they haven’t gone down that much yet and are still up year over year. Earnings from export industries are helping a lot so far.

>
> Second, there was a tremendous amount of borrowing into the bubble, as new home buyers purchased houses with little or no money down, and as people who already owned houses refinanced their mortgages as a way of converting rising home prices into cash.

Yes, there was a large drop in aggregate demand when borrowers could no longer buy homes, and that was over a year ago. That was a real effect, and if exports had not stepped in to carry the ball, GDP would not have been sustained at current levels.

>
> As home prices come back down to earth, many of these borrowers will find themselves with negative equity – owing more than their houses are worth. Negative equity, in turn, often leads to foreclosures and big losses for lenders.

‘Often’? There will be some losses, but so far they have not been sufficient to somehow reduce aggregate demand more than exports are adding to demand. Yes, that may change, but it hasn’t yet. Q4 GDP forecasts were just revised up 2% for example.

>
> And the numbers are huge. The financial blog Calculated Risk, using data from First American CoreLogic, estimates that if home prices fall 20 percent there will be 13.7 million homeowners with negative equity. If prices fall 30 percent, that number would rise to more than 20 million.

Not likely if income holds up. That’s why the fed said it was watching labor markets closely.

And government tax receipts seem OK through November, which is a pretty good coincident indicator incomes are holding up.

>
> That translates into a lot of losses, and explains why liquidity has dried up. What’s going on in the markets isn’t an irrational panic. It’s a wholly rational panic, because there’s a lot of bad debt out there, and you don’t know how much of that bad debt is held by the guy who wants to borrow your money.

Enough money funds in particular have decided to not get involved in anyting but treasury securities, driving those rates down. That will sort itself out as investors in those funds put their money directly in banks ans other investments paing more than the funds are now earning, but that will take a while.

>
> How will it all end?

This goes on forever – I’ve been watching it for 35 years – no end in sight!

> Markets won’t start functioning normally until investors are
> reasonably sure that they know where the bodies – I mean, the bad
> debts – are buried. And that probably won’t happen until house prices
> have finished falling and financial institutions have come clean about
> all their losses.

And by then it’s too late to invest and all assets prices returned to ‘normal’ – that’s how markets seem to work.

> All of this will probably take years.
>
> Meanwhile, anyone who expects the Fed or anyone else to come up with a plan that makes this financial crisis just go away will be sorely disappointed.

Right, only a fiscal response can restore aggregate demand, and no one is in favor of that at the moment. A baby step will be repealing the AMT and not ‘paying for it’ which may happen.

Meanwhile, given the inflationary bias due to food, crude, and import and export prices in genera, a fiscal boost will be higly controversial as well.

♥

Share

More detail on the liquidity facility

Posted on by

looks a lot like the recommendations Karim emailed to them:

An article in the Financial Times:

Fed officials have dusted down this proposal and adapted it to address the current credit market crisis.

Vincent Reinhart, a fellow at the American Enterprise Institute and former chief monetary economist at the Fed, says this kind of auction facility would allow the Fed to provide funds directly to a much larger group of banks than the limited number of primary dealers who participate in open market operations, against a wide range of collateral, without the stigma of the discount window.

“I think it would be very positive,” he says. Banks in need of liquidity could acquire funds relatively anonymously, while the large number of participants with direct access to Fed money would encourage arbitrage to exploit the gap between cheap Fed money and high interbank rates.

Moreover, the Fed could auction funds at whatever term it wanted to in order to target liquidity at particular term markets – for instance, the market for one-month loans. It would have the option of either auctioning a fixed amount of funds, or offering to supply whatever funds were needed at a target rate.

The intended interest rate spread over the Fed funds rate is not known. If the Fed decided to auction loans at or only slightly above the Federal funds rate, it would risk subsidising weaker banks, which normally pay a premium to borrow in the interbank market.

However, Mr Reinhart says this could be dealt with by varying the amount of collateral required in return for loans based on the creditworthiness of the bank seeking funds.

♥

Share

Bowling alley to run out of points!

Posted on by

National Debt Grows $1 Million a Minute

The Associated Press
Monday 03 December 2007

Washington – Like a ticking time bomb, the national debt is an explosion waiting to happen. It’s expanding by about $1.4 billion a day – or nearly $1 million a minute.

What’s that mean to you?

It means net financial assets are growing by only that much. 1.5% of GDP isn’t enough to support our credit structure needed to sustain aggregate demand over time.

It means almost $30,000 in debt for each man, woman, child and infant in the United States.

No, it means 30,000 in net financial assets for each.

Even if you’ve escaped the recent housing and credit crunches and are coping with rising fuel prices, you may still be headed for economic misery, along with the rest of the country.

Yes!

That’s because the government is fast straining resources needed to meet interest payments on the national debt, which stands at a mind-numbing $9.13 trillion.

No, it’s because the deficit is too small to supply the net financial assets we need to sustain demand, given the institutional structure that removes demand via tax advantage savings programs.

And like homeowners who took out adjustable-rate mortgages, the government faces the prospect of seeing this debt – now at relatively low interest rates – rolling over to higher rates, multiplying the financial pain.

Only if the fed hikes rates.

So long as somebody is willing to keep loaning the U.S. government money, the debt is largely out of sight, out of mind.

Government securities offer us interest bearing alternative to non interest bearing reserve accounts.

But the interest payments keep compounding, and could in time squeeze out most other government spending –

Operationally, spending is totally independent of revenues. The only constraints are self imposed.

leading to sharply higher taxes or a cut in basic services like Social Security and other government benefit programs. Or all of the above.

Only if congress votes that way..

A major economic slowdown, as some economists suggest may be looming, could hasten the day of reckoning.

The national debt – the total accumulation of annual budget deficits – is up from $5.7 trillion when President Bush took office in January 2001 and it will top $10 trillion sometime right before or right after he leaves in January 2009.

Too small as it is the equity behind our credit structure.

That’s $10,000,000,000,000.00, or one digit more than an odometer-style “national debt clock” near New York’s Times Square can handle. When the privately owned automated clock was activated in 1989, the national debt was $2.7 trillion.

It is also the national ‘savings’ clock as government deficit = non government accumulation of net financial dollar assets.

It only gets worse.

So does this article.

:(

Over the next 25 years, the number of Americans aged 65 and up is expected to almost double. The work population will shrink and more and more baby boomers will be drawing Social Security and Medicare benefits, putting new demands on the government’s resources.

The government spends by changing the number in someone’s bank account. Spending puts the same demands on government resources as running up the score at a football game puts strain on the stadium’s resources needed to post the score.

These guaranteed retirement and health benefit programs now make up the largest component of federal spending. Defense is next. And moving up fast in third place is interest on the national debt, which totaled $430 billion last year.

All interest expense is net income to the non government sectors.

Aggravating the debt picture: the wars in Iraq and Afghanistan, which the nonpartisan Congressional Budget Office estimates could cost $2.4 trillion over the next decade

That will be an aggregate demand add. What are the subtractions going to be? Increased pension funds assets, IRA’s, insurance reserves, and all of the other tax advantage ‘savings incentives’. To date, these have dwarfed government deficit spending and resulted in a chronic shortage of aggregate demand and massive economic under performance.

Despite vows in both parties to restrain federal spending, the national debt as a percentage of the U.S. Gross Domestic Product has grown from about 35 percent in 1975 to around 65 percent today.

Last I heard it was still 35%? But, as above, whatever it is, it is still not sufficient to support demand at ‘full employment’ levels. Our employment rate assumes large chunks of the population aren’t working because they don’t want to and wouldn’t work if desirable jobs were offered to them. The experience of the lat 90’s shows this isn’t true. With the right paid jobs available, employment could increase perhaps by 10%.

By historical standards, it’s not proportionately as high as during World War II – when it briefly rose to 120 percent of GDP, but it’s a big chunk of liability.

Didn’t seem to hurt war output!

“The problem is going forward,” said David Wyss, chief economist at Standard and Poors, a major credit-rating agency.

“Our estimate is that the national debt will hit 350 percent of the GDP by 2050 under unchanged policy. Something has to change, because if you look at what’s going to happen to expenditures for entitlement programs after us baby boomers start to retire, at the current tax rates, it doesn’t work,” Wyss said.

The only thing that ‘doesn’t work’ is the 10% of the work force that is kept on the sidelines by too tight fiscal policy.

With national elections approaching, candidates of both parties are talking about fiscal discipline and reducing the deficit and accusing the other of irresponsible spending.

Yes, and that is the biggest continuing systemic risk to the real economy – not a bunch of write downs in the financial sector.

But the national debt itself – a legacy of overspending dating back to the American Revolution – receives only occasional mention.

Who is loaning Washington all this money?

Who has all the money looking to buy government securities is the right question. And it’s the same funds that come from deficit spending. Deficit spending is best thought of as government first spending, then selling securities to provide those funds with a place to earn interest. The fed calls that process ‘offsetting operating factors’.

Ordinary investors who buy Treasury bills, notes and U.S. savings bonds, for one. Also it is banks, pension funds, mutual fund companies and state, local and increasingly foreign governments. This accounts for about $5.1 trillion of the total and is called the “publicly held” debt.

It’s also called the total net financial assets of non government sectors when you add cash in circulation and reserve balances kept at the fed.

The remaining $4 trillion is owed to Social Security and other government accounts, according to the Treasury Department, which keeps figures on the national debt down to the penny on its Web site.

Intergovernment transfers have no effect on the non government sectors’ aggregate demand.

Some economists liken the government’s plight to consumers who spent like there was no tomorrow – only to find themselves maxed out on credit cards and having a hard time keeping up with rising interest payments.

Those economist have it totally backwards and are a disgrace to the profession.

“The government is in the same predicament as the average homeowner who took out an adjustable mortgage,” said Stanley Collender, a former congressional budget analyst and now managing director at Qorvis Communications, a business consulting firm.

Wrong.

Much of the recent borrowing has been accomplished through the selling of shorter-term Treasury bills. If these loans roll over to higher rates, interest payments on the national debt could soar.

Wrong. The fed sets short term rates, not markets, and long term rates as well if it wants to.

Furthermore, the decline of the dollar against other major currencies is making Treasury securities less attractive to foreigners – even if they remain one of the world’s safest investments.

For now, large U.S. trade deficits with much of the rest of the world work in favor of continued foreign investment in Treasuries and dollar-denominated securities. After all, the vast sums Americans pay – in dollars – for imported goods has to go somewhere.

He’s getting warmer with that last bit!

But that dynamic could change.

“The first day the Chinese or the Japanese or the Saudis say, `we’ve bought enough of your paper,’ then the debt – whatever level it is at that point – becomes unmanageable,” said Collender.

Define ‘unmanageable’ please.

A recent comment by a Chinese lawmaker suggesting the country should buy more euros instead of dollars helped send the Dow Jones plunging more than 300 points.

Ok.

The dollar is down about 35 percent since the end of 2001 against a basket of major currencies.

Ok. Is that all there is to ‘unmanageable’? How about 10 year treasuries coming down below 4% as the dollar went down? How does he reconcile that?

Foreign governments and investors now hold some $2.23 trillion – or about 44 percent – of all publicly held U.S. debt. That’s up 9.5 percent from a year earlier.

Point?

Japan is first with $586 billion, followed by China ($400 billion) and Britain ($244 billion). Saudi Arabia and other oil-exporting countries account for $123 billion, according to the Treasury.

“Borrowing hundreds of billions of dollars from China and OPEC puts not only our future economy, but also our national security, at risk.

In what way? This is nonsense.

It is critical that we ensure that countries that control our debt do not control our future,” said Sen. George Voinovich of Ohio, a Republican budget hawk.

They already don’t. We control their future. Their accumulated funds are only worth what we want them to be. We control the price level. They are the ones at risk.

Of all federal budget categories, interest on the national debt is the one the president and Congress have the least control over. Cutting payments would amount to default, something Washington has never done.

Why would they? Functionally that’s a tax, and there are sufficient legal tax channels. So why use an illegal one?

Congress must from time to time raise the debt limit – sort of like a credit card maximum – or the government would be unable to borrow any further to keep it operating and to pay additional debt obligations.

Yes, that is a self-imposed constraint, not inherent in the monetary system that needs to go. If congress has approved the spending, that is sufficient.

The Democratic-led Congress recently did just that, raising the ceiling to $9.82 trillion as the former $8.97 trillion maximum was about to be exceeded. It was the fifth debt-ceiling increase since Bush became president in 2001.

Democrats are blaming the runup in deficit spending on Bush and his Republican allies who controlled Congress for the first six years of his presidency.

Not that I approve of the specifics of his tax cuts and spending increase, but good thing he did run up the deficit or we would be in the middle of a much worse economy.

They criticize him for resisting improvements in health care, education and other vital areas while seeking nearly $200 billion in new Iraq and Afghanistan war spending.

Different point.

“We pay in interest four times more than we spend on education and four times what it will cost to cover 10 million children with health insurance for five years,” said House Speaker Nancy Pelosi, D-Calif. “That’s fiscal irresponsibility.”

She is way out of paradigm. We can ‘afford’ both if the real excess capacity is there without raising taxes.

Republicans insist congressional Democrats are the irresponsible ones. Bush has reinforced his call for deficit reduction with vetoes and veto threats and cites a looming “train wreck” if entitlement programs are not reined in.

Both sides are pathetic.

Yet his efforts two years ago to overhaul Social Security had little support, even among fellow Republicans.

It was ridiculous. There is no solvency risk with social security or any other government spending requirement. Only a potential inflation risk. And the total lack of discussion regarding that is testimony to the total lack of understanding of public finance.

The deficit only reflects the gap between government spending and tax revenues for one year. Not exactly how a family or a business keeps its books.

Even during the four most recent years when there was a budget surplus, 1998-2001, the national debt ranged between $5.5 trillion and $5.8 trillion.

As in trying to pay off a large credit-card balance by only making minimum payments, the overall debt might be next to impossible to chisel down appreciably, regardless of who is in the White House or which party controls Congress, without major spending cuts, tax increases or both.

“The basic facts are a matter of arithmetic, not ideology,” said Robert L. Bixby, executive director of the Concord Coalition, a bipartisan group that advocates eliminating federal deficits.

Deficit terrorists.

There’s little dispute that current fiscal policies are unsustainable, he said.

Sad but true.

“Yet too few of our elected leaders in Washington are willing to acknowledge the seriousness of the long-term fiscal problem and even fewer are willing to put it on the political agenda.”

Fortunately!!!

Polls show people don’t like the idea of saddling future generations with debt, but proposing to pay down the national debt itself doesn’t move the needle much.

Our poor kids are going to have to send the real goods and services back in time to pay off the debt???? WRONG! Each generation gets to consume the output they produce. None gets sent back in time to pay off previous generations.

“People have a tendency to put some of these longer term problems out of their minds because they’re so pressed with more imminent worries, such as wages and jobs and income inequality,” said pollster Andrew Kohut of the nonpartisan Pew Research Center.

Good!

Texas billionaire Ross Perot made paying down the national debt a central element of his quixotic third-party presidential bid in 1992. The national debt then stood at $4 trillion and Perot displayed charts showing it would soar to $8 trillion by 2007 if left unchecked. He was about a trillion low.

Fortunately!

Not long ago, it actually looked like the national debt could be paid off – in full. In the late 1990s, the bipartisan Congressional Budget Office projected a surplus of a $5.6 trillion over ten years – and calculated the debt would be paid off as early as 2006.

That therefore projected net financial assets for the non government sectors would fall that much. Not possible!!! Causes recession long before that and the countercyclical tax structure fortunately builds up deficit spending (unfortunately via falling government revenue due to unemployment and lower profits) sufficiently to ‘automatically’ trigger a recovery.

Former Fed chairman Alan Greenspan recently wrote that he was “stunned” and even troubled by such a prospect. Among other things, he worried about where the government would park its surplus if Treasury bonds went out of existence because they were no longer needed.

Not to worry. That surplus quickly evaporated.

As above.

Mark Zandi, chief economist at Moody’s Economy.com, said he’s more concerned that interest on the national debt will become unsustainable than he is that foreign countries will dump their dollar holdings – something that would undermine the value of their own vast holdings. “We’re going to have to shell out a lot of resources to make those interest payments.

Interest payments do not involve government ‘shelling out resources’ but only changing numbers in bank accounts. ‘Unsustainable’ is not applicable.

There’s a very strong argument as to why it’s vital that we address our budget issues before they get measurably worse,” Zandi said.

“Of course, that’s not going to happen until after the next president is in the White House,” he added.

Might be longer than that.

♥

Share

Re: change of govt = change of practice

Posted on by

(Email)

On Dec 5, 2007 11:50 PM, Wray, Randall wrote:
> Bill: thanks. Yes I think the data are overwhelming for very serious problems, for deep recession, and for rate cuts.
the problems to the real economy aren’t showing up yet

  1. exports have been more than filling the housing gap- as long as foreigners continue the move to ‘spend their hoard’ of $US we can probably muddle through for quite a while.
  2. housing feels like it’s bottomed and won’t be subtracting from gdp. mtg rates are lower than in august and banks are pushing hard to loan directly without the securitization process and are keeping the (wider) spreads for themselves.
  3. none of the losses so far have been anything more than rearranging financial assets and have not resulted in business interruption in the real economy.
  4. unlike the 30’s, we are not on the gold standard. If we had been on it, instead of the run up in gold prices of recent years the same relative value changes would have instead been evidenced by a massive deflation (gold held constant), outflows of gold from the govt, and maybe higher rates to keep that from happening, eventual devaluation (1934), and more powerful motivation for trade wars- all like the 1930’s and other standard gold standard collapses. So comps with the 1930’s can be highly misleading. With today’s non convertible currency the ‘adjustments’ are very different and the financial stresses tend to be more removed from main street. Note the s and l crisis, the crash of 87, the 98 credit crisis had relatively minor effects on gdp. Loans create deposits unconstrained by the gold supply, and capital is likewise both endogenous and not constrained by gold. Instead, all is constrained by income, and govts are pretty good at sustaining that at least at modest levels during slowdown with countercyclical tax structures leading the way, and lots of ‘off balance sheet deficit spending’ leaking out all over the world. This includes massive state bank lending from China, to even the eurozone (though that may be catching up with them under current arrangements), and budget deficits around the world sufficient for the moment to keep things muddling through.

> there is a very large body of evidence to indicate this is the worst situation seen in the US since the 1930s. It is a good time for >pragmatism and for throwing out silly rules. Central bankers are doing what they can. Unfortunately, as we all know only too well, the importance of fiscal policy is not understood.

Right, while I would cut rates to 0, I would also offset the resulting fiscal drag but cutting social security taxes. Irony is current rate cuts in isolation tighten the fiscal balance.
(http://www.epicoalition.org/docs/Forstater_Mosler_article.pdf)

Also, I’m thinking a world wide cap on the $ price of imported crude and domestic gasoline prices might be a short term path to price stability and a long term path to using less of it as costs of production rise and it can’t be sold profitable.

Just in the beginning stage of this concept!

Meanwhile, I don’t think any slowdown will cut net demand for crude sufficiently to take away Saudi and Russian pricing power for at least the next 6 months. and if they simply spend their income here the higher prices won’t slow gdp, just hurt our real terms of trade and keep upward pressure on cpi which is starting to spill over to core, and which the Fed won’t ignore as it climbs past 4, 5 and 6%.

warren

>There isn’t too much reason to be optimistic. As they say, we live in
interesting times, that are making us long for boring. See you in
January.
>
> L. Randall Wray
> Research Director
> Center for Full Employment and Price Stability
> 211 Haag Hall, Department of Economics
> 5120 Rockhill Road
> Kansas City, MO 64110-2499
> and
> Senior Scholar
> Levy Economics Institute
> Blithewood
> Bard College
> Annandale-on-Hudson, NY 12504
>
> ________________________________
>
> From: Warren Mosler [mailto:warren.mosler@gmail.com]
> Sent: Wed 12/5/2007 8:13 PM
> To: Bill Mitchell
> Subject: Re: change of govt = change of practice
>
>
>
>
> Hi Bill, good info, thanks very much!
>
> warren
>
> On Dec 5, 2007 3:48 PM, Bill Mitchell wrote:
> > dear warren
> >
> > history was made yesterday – the RBA published the minutes of their
> > meeting
> > on Tuesday where they spell out their reasoning on rates (no change).
> > This
> > is the first time they have done that and it follows the election
> > campaign where
> > Rudd made a big point of returning honesty and transparency to his govt
> > after
> > the bad howard years of lying and covering up anything that moved.
> >
> > So you can see the minutes tell you that a further rate rise is now not
> > inevitable
> > despite inflation being above the magic upper bound of 3 and despite
> > them expecting
> > it to remain that way for at least 6 months more.
> >
> > They are now saying that world trends are for lower interest rates to
> > cope with the
> > worsening credit crisis.
> >
> > So: (a) their strict Inflation Targetting is being violated by “other
> > concerns”
> > (b) they think the US is heading for recession.
> >
> > local commentators last night said the Fed will lower by 0.5 next week
> > after BOC went
> > down this week and BOE is heading that way too.
> >
> > anyway, today the CofFEE conference starts – 2 days.
> >
> > see you
> > bill

♥

Share

FT.com – Oil – Rise in costs puts pressure on returns

Posted on by

Oil – Rise in costs puts pressure on returns RISE IN COSTS PUTS PRESSURE ON RETURNS By Javier Blas in Abu Dhabi
Published: December 4 2007 01:08

Exploration companies need oil prices of $70 a barrel to match the returns they made at $30 a barrel just two years ago because of the sharp increase in costs and higher government licence fees, according to analysis by a leading consultancy. The research, from Wood Mackenzie, the Edinburgh-based oil consultants, helps explain why non-Opec oil production is failing to accelerate its annual growth significantly in spite of record prices. Oil prices have been above $70 a barrel only since September.

This article can be found at: http://www.ft.com/cms/s/11ca6bb6-a1cd-11dc-a13b-0000779fd2ac,dwp_uuid=81

Share