Category Archives: Financial Times

Fed Repo Facility

Posted on by


[Skip to the end]

It is something they want but seems there is no viable plan yet.

It is harder than it sounds and what they do come up with if short of a government guaranteed market will have similar risks.

The ‘answer’ is the repo markets add no value to the real economy and therefore there is no public purpose behind creating a ‘better one.’

I would just let the banks continue to price risk for secured lending as they are doing and let the interest spreads (and disintermediation when borrowers and lenders find each other directly) fall where they may due to competitive pressures.

Fed plans repo markets revamp

by Henny Sender and Michael Mackenzie

June 21 (FT) — The US Federal Reserve is considering dramatic changes to the giant repurchase – or repo – markets where banks around the world raise overnight dollar loans.

The plans include creating a utility to replace the Wall Street banks that handle transactions, people familiar with the matter say.

The Fed’s deliberations are partly motivated by concerns that the structure of the US overnight repurchase market may have exacerbated the financial turmoil that accompanied the failure of Lehman Brothers in September last year.

Fed officials plan to meet next month with market participants to discuss reforms.

People familiar with the Fed’s thinking say it is looking into the creation of a mechanism to replace the clearing banks – the biggest of which are JPMorgan Chase and Bank of New York Mellon – that serve as intermediaries between borrowers and lenders.

“The Fed is raising questions about whether the system really protects the interests of all participants,” says one person familiar with the Fed’s thinking.

In the repo markets, borrowers, such as banks, pledge collateral in return for overnight loans from lenders, such as money market funds.

The clearing banks stand between the parties, providing services such as valuing the collateral and advancing cash during the hours when trades are being made and unwound.

Fed officials fear this arrangement puts the clearing banks in a difficult position in a crisis. As the value of the securities falls, clearing banks have an obligation to demand more collateral to avoid losses. But in doing so, they could destabilise a rival.

“The clearing banks fear the positions of the investment banks are so large that a default would be difficult for them to manage,” the person familiar with the Fed’s thinking said.

“[Everyone] is thinking about how to remove conflicts of interest of the clearing banks and the investment banks so that the investment banks aren’t vulnerable to a sudden restriction of credit.”

The system’s complications were evident during Lehman’s collapse. JPMorgan, one of Lehman’s biggest trading partners, acted as its clearing bank in the repo market and – along with BoNY Mellon – served as the clearing bank for the New York Federal Reserve’s credit facility for securities ­companies.

Lawyers for the Lehman estate and for creditors have raised questions about whether JPMorgan acted too aggressively in seizing and marking down Lehman’s collateral.

Hedge funds have bought Lehman debt on the theory that the estate can claw back some of that collateral in court.

Citing confidentiality concerns, JPMorgan declined to comment.

The Fed hopes to have a new repo system in place by October, when its credit facility for securities companies is to close.


[top]

Share

Laffer WSJ opinion piece

Posted on by


[Skip to the end]

Get Ready for Inflation and Higher Interest Rates

The unprecedented expansion of the money supply could make the ’70s look benign.

By Arthur B. Laffer

June 10th (WSJ)— Rahm Emanuel was only giving voice to widespread political wisdom when he said that a crisis should never be “wasted.” Crises enable vastly accelerated political agendas and initiatives scarcely conceivable under calmer circumstances. So it goes now.

Here we stand more than a year into a grave economic crisis with a projected budget deficit of 13% of GDP. That’s more than twice the size of the next largest deficit since World War II. And this projected deficit is the culmination of a year when the federal government, at taxpayers’ expense, acquired enormous stakes in the banking, auto, mortgage, health-care and insurance industries.

Art knows the difference between purchasing financial assets (usually done by the Fed) and purchasing goods and services (and indirectly through transfer payments) but here elects to ignore it.

With the crisis, the ill-conceived government reactions, and the ensuing economic downturn, the unfunded liabilities of federal programs — such as Social Security, civil-service and military pensions, the Pension Benefit Guarantee Corporation, Medicare and Medicaid — are over the $100 trillion mark. With U.S. GDP and federal tax receipts at about $14 trillion and $2.4 trillion respectively, such a debt all but guarantees higher interest rates, massive tax increases, and partial default on government promises.

He also recognizes the demand leakages including pension fund contributions, insurance reserves, USD financial accumulations of non residents, IRA’s, other corporate reserves, etc. tend to compound geometrically and are thereby strong contractionary biases.

But as bad as the fiscal picture is, panic-driven monetary policies portend to have even more dire consequences. We can expect rapidly rising prices and much, much higher interest rates over the next four or five years, and a concomitant deleterious impact on output and employment not unlike the late 1970s.

He also knows causation runs from loans to deposits and reserves and not from reserves to anything at all.

I’ve had this discussion personally with him and I wrote ‘soft currency economics’ jointly with Mark McNary who worked at art’s firm with both involved.

About eight months ago, starting in early September 2008, the Bernanke Fed did an abrupt about-face and radically increased the monetary base — which is comprised of currency in circulation, member bank reserves held at the Fed, and vault cash — by a little less than $1 trillion. The Fed controls the monetary base 100% and does so by purchasing and selling assets in the open market. By such a radical move, the Fed signaled a 180-degree shift in its focus from an anti-inflation position to an anti-deflation position.

Bank reserves are crucially important because they are the foundation upon which banks are able to expand their liabilities and thereby increase the quantity of money.

He knows this is not the case. He knows that lending is in no case reserve constrained, and that it’s about price and not quantity.

Banks are required to hold a certain fraction of their liabilities — demand deposits and other checkable deposits — in reserves held at the Fed or in vault cash. Prior to the huge increase in bank reserves, banks had been constrained from expanding loans by their reserve positions.

There were no banks of any consequence constrained from lending by their reserve positions that I know of.

In fact, they all had excess collateral they could have taken to the discount window as needed.

There were some banks constrained by capital considerations but that’s an entirely different story.

That’s why adding the excess reserves didn’t change anything with regards to lending.

Art knows this as well.

They weren’t able to inject liquidity into the economy, which had been so desperately needed in response to the liquidity crisis that began in 2007 and continued into 2008. But since last September, all of that has changed. Banks now have huge amounts of excess reserves, enabling them to make lots of net new loans.

Yet a chart of lending shows no changes as functions of reserve positions.

The way a bank or the banking system makes new loans is conceptually pretty simple. Banks find an entity that they believe to be credit-worthy that also wants a loan, and in exchange for the new company’s IOU (i.e., loan) the bank opens up a checking account for the customer. For the bank’s sake, the hope is that the interest paid by the borrower more than makes up for the cost and risk of the loan. The recently ballyhooed “stress tests” on banks are nothing more than checking how well a bank can weather differing levels of default risk.

Correct. And these loans are not reserve constrained.

And even if they were somehow constrained by reserves, innovations in sweep accounts have reduced reserve requirements to near 0.

What’s important for the overall economy, however, is how fast these loans are made and how rapidly the quantity of money increases.

Most important is the level of spending which may or may not be a function of the lending that creates the ‘quantity of money’ as defined by Art. And he knows that as well.

For our purposes, money is the sum total of all currency in circulation, bank demand deposits, other checkable deposits, and travelers checks (economists call this M1). When reserve constraints on banks are removed, it does take the banks time to make new loans. But given sufficient time, they will make enough new loans until they are once again reserve constrained.

He knows they are never reserve constrained.

The expansion of money, given an increase in the monetary base, is inevitable, and will ultimately result in higher inflation and interest rates. In shorter time frames, the expansion of money can also result in higher stock prices, a weaker currency, and increases in commodity prices such as oil and gold.

In general the causation runs in the other direction, as he also knows.

At present, banks are doing just what we would expect them to do. They are making new loans and increasing overall bank liabilities (i.e., money). The 12-month growth rate of M1 is now in the 15% range, and close to its highest level in the past half century.

He also knows a lot of this simply replaced commercial paper issuance and other forms of non bank lending, and that total credit is the more useful indicator of lending activity.

With an increased trust in the overall banking system, the panic demand for money has begun to and should continue to recede. The dramatic drop in output and employment in the U.S. economy will also reduce the demand for money. Reduced demand for money combined with rapid growth in money is a surefire recipe for inflation and higher interest rates. The higher interest rates themselves will also further reduce the demand for money, thereby exacerbating inflationary pressures. It’s a catch-22.

He also knows interest rates are voted on by the fed and that term rates reflect anticipated Fed moves.

It’s difficult to estimate the magnitude of the inflationary and interest-rate consequences of the Fed’s actions because, frankly, we haven’t ever seen anything like this in the U.S.

He knows there are no consequences. The Fed is like the kid in the car seat with a steering wheel who thinks he’s driving.

To date what’s happened is potentially far more inflationary than were the monetary policies of the 1970s, when the prime interest rate peaked at 21.5% and inflation peaked in the low double digits. Gold prices went from $35 per ounce to $850 per ounce, and the dollar collapsed on the foreign exchanges. It wasn’t a pretty picture.

He knows that was caused by cost push from Saudi price setting that was broken by the deregulation of natural gas in 1978 that resulted in a 15 million barrel per day supply response as our utilities switched from oil to natural gas.

Now the Fed can, and I believe should, do what it must to mitigate the inevitable consequences of its unwarranted increase in the monetary base. It should contract the monetary base back to where it otherwise would have been, plus a slight increase geared toward economic expansion.

All that would do is raise rates some due to the fed selling its securities.

Or the Fed could repo its position so the banks would hold overnight collateral rather than over night reserves. Functionally that changes nothing except for creating a lot more book keeping work.

Absent this major contraction in the monetary base, the Fed should increase reserve requirements on member banks to absorb the excess reserves.

This is just plain silly.

Art knows there is no remaining ‘monetary purpose’ of reserves since we went off the gold standard, which he understands as well as anyone.

Canada and others dropped reserve requirements long ago with no consequences beyond a reduced accounting burden.

Given that banks are now paid interest on their reserves and short-term rates are very low, raising reserve requirements should not exact too much of a penalty on the banking system, and the long-term gains of the lessened inflation would many times over warrant whatever short-term costs there might be.

No penalty and no inflation consequences either.

Alas, I doubt very much that the Fed will do what is necessary to guard against future inflation and higher interest rates. If the Fed were to reduce the monetary base by $1 trillion, it would need to sell a net $1 trillion in bonds. This would put the Fed in direct competition with Treasury’s planned issuance of about $2 trillion worth of bonds over the coming 12 months. Failed auctions would become the norm and bond prices would tumble, reflecting a massive oversupply of government bonds.

Yes, yields would go higher, though not as disorderly as he forecasts.

And, as previously discussed, there’s no reason to do that unless the fed wants higher rates.

In addition, a rapid contraction of the monetary base as I propose would cause a contraction in bank lending, or at best limited expansion. This is exactly what happened in 2000 and 2001 when the Fed contracted the monetary base the last time. The economy quickly dipped into recession.

He knows the contraction of the base back then did not cause anything.

While the short-term pain of a deepened recession is quite sharp, the long-term consequences of double-digit inflation are devastating. For Fed Chairman Ben Bernanke it’s a Hobson’s choice. For me the issue is how to protect assets for my grandchildren.

The best gift he could give his grand children is to tell the story right way around as he knows is the case.

Mr. Laffer is the chairman of Laffer Associates and co-author of “The End of Prosperity: How Higher Taxes Will Doom the Economy — If We Let It Happen” (Threshold, 2008).


[top]

Share

‘Legacy of Debt’ Gives Fiscal Stimulus Bad Name: Caroline Baum

Posted on by


[Skip to the end]

This article gives Baum a bad name.

‘Legacy of Debt’ Gives Fiscal Stimulus Bad Name: Caroline Baum

Commentary by Caroline Baum

June 5(Bloomberg) — By the time the U.S. government unveiled its Public Private Investment Partnership in March, the toxic loans and securities clogging bank balance sheets had become “legacy assets.”

What if deficit hawks took the same tack and marketed the $787 billion fiscal stimulus as “legacy debt?”

They would be making yet another error. This is no basis for an article unless one is intent on being part of the problem rather than part of the answer.

“The $787 billion the U.S. Treasury will be borrowing or confiscating from you via taxation will saddle future generations with a legacy of debt,” the press release might read. “Your children and grandchildren can look forward to higher taxes, a lower standard of living and minimal government support in their old age.”

Wonderful, another deficit terrorist spewing counterproductive rhetoric and irresponsible journalism.

First, there is no intergenerational transfer of debt in real terms. Whatever goods and services our children produce will be consumed by whoever happens to be alive at that time. And a nominal government deficit does not keep them from operating at less than full employment.

Second, government securities function as benefits for investors, not costs. One buys them voluntarily and, at the macro level, directly or indirectly, as an alternative to holding reserve balances at the Fed. This means they are purchased at prices where they are preferred to holding balances at the Fed. Nothing is ‘taken away’ by sales of treasury securities and total (non government)holdings of financial assets remain unchanged.

Third, taxes function to reduce aggregate demand. Taxes need be raised in the future when aggregate demand is deemed too high, and not the deficit per se. That is a scenario of low unemployment and high consumption relative to available resources. Not ‘a lower standard of living’ or ‘minimal government support in their old age.’

Maybe the public would balk. And maybe some member of Congress would be bold enough to sponsor a measure to call off the still-uncommitted expenditures.

And thereby contribute to even lower output and employment.

After all, the economy appears to be recovering without fiscal stimulus.

??? The relative improvement has come only after the (non TARP) deficit got over 6% of GDP
And it has barely slowed the collapse.

The 9.4% unemployment is clear evidence aggregate demand is grossly deficient.

The rate of decline in real gross domestic product has slowed from an average 6 percent in the fourth quarter of last year and first quarter of 2009. Real GDP is expected to fall 1.9 percent in the current quarter, according to the median forecast of 61 economists in a Bloomberg News survey from early May. Less negative is the first step toward positive.

Yes, due to the ‘automatic stabilizers’ increasing the deficit, as above.

And only when GDP grows faster than productivity does the output gap fall.

And that’s before any real money gets spent. So far $36.7 billion has been distributed via various government agencies, according to Recovery.gov, the Web site that tracks where your tax dollars are going. That’s 7.4 percent of the $499 billion of outlays ($288 billion of the $787 billion is “tax relief”) and 29 percent of the funds that have been committed to a purpose or a project.

Patient, Heal Thyself

Tax relief comes in the form of larger monthly paychecks for workers and tax credits — for investment in renewable sources of energy, for first-time home buyers — that are encouraging activity now even though the benefit is in the future.

Still, it’s a trickle, not a waterfall.

So if fiscal stimulus can’t take credit for the improvement in the economy, what can? The answer is a combination of monetary policy and self-healing (an economy’s natural tendency is to grow).

Wrong. It’s been all fiscal to this point. Yes, its healed itself, via the very ugly automatic fiscal stabilizers of falling revenue and rising transfer payments with rising unemployment. This could have been avoided with proactive fiscal measures last July.
The Federal Reserve has thrown the kitchen sink at the economy, using traditional and non-traditional means to provide liquidity and credit when the banking system wasn’t up to the task.

Lower rates have drained aggregate demand as savers lost a lot more income than borrowers gained. The Fed’s portfolio alone has removed over $50 billion of annual interest income from savers and investors.

Fed’s CPR

Even before the Fed lowered the overnight interbank lending rate to 0 to 0.25 percent in December,

Savers have seen rates fall by about 5%, reducing aggregate demand, while most borrowers have seen little, if any, drop in rates as bank net interest margins widened to over 4%. And this additional bank income has a marginal propensity to consume of near 0.

the central bank was already ministering to markets and institutions outside its normal discount window customers, otherwise known as depository institutions. It was supporting the commercial paper market; had committed to purchase mortgage-backed securities and agency debt; had agreed to finance investor purchases of asset-backed securities; and had leant support to specific institutions, taking on some of Bear Stearns’s toxic, I mean, legacy, assets in March 2008 and bailing out American International Group in September.

Yes, and all of this has served to lower the term structure of rates and reduce saver’s incomes.

That’s the beauty of monetary policy. It can be implemented instantaneously. The Fed’s challenge is to be as quick on the return trip.

And, as per Bernanke’s 2004 paper, said rate cuts reduce aggregate demand via the ‘fiscal channel’ which means it reduces interest paid by government which needs to be offset by easier fiscal policy to not be a drag on output and employment.

The problem with fiscal stimulus, aside from the fact that it’s a misnomer, is that it arrives too late.

And further delayed by articles like.

Also, a payroll tax cut is instant, as would be per capita revenue sharing checks to the states.

At least that was the standard criticism prior to the enactment of the $787 billion American Reinvestment and Recovery Act of 2009 in February. The government’s tax and spending policies require the approval of a majority of the 100 senators and 435 members of the House of Representatives. And as we know, these 535 individuals sometimes confuse the people’s business with their own: getting re-elected.

True, which includes dealing with public opinion that is further jaded by unintentionally subversive articles like this one.

Preferred Stimuli

This time around, a new president with solid majorities in both Houses of Congress was able to saddle future generations with trillions of dollars of debt less than a month after he took office. The Congressional Budget Office projects the debt- to-GDP ratio rising to 70 percent in 2011, the highest since the early 1950s, when the U.S. was winding down the war effort.

You are including purchases of financial assets which is highly misleading and shows a further lack of understanding of public accounting.

If you believe, as I do, that monetary policy is the more potent of the stimuli, that fiscal “stimulus” just transfers spending from tomorrow to today and from the private sector to the government, with no net long-term gain, then maybe it’s time to stand up for the next generation.

And stand against the accounting identities.

Government deficits add directly non government savings of financial assets. To the penny.

Changes in interest rates only shift incomes between savers and investors.

And all the econometric evidence shows ‘monetary policy’ does little or nothing while fiscal policy is directly traced to changes in GDP.

Besides, where is it written that the ill effects of years of over-consumption and under-saving have to be repaired in a year? Instant gratification means future deprivation.

Over consumption? Did we consume more than we produced? No, investment remained positive during the growth years, which were years of high investment as well. That is not over consumption.

Now, with the recession and consumer pull back, is when investment is falling and we can be said to be thereby over consuming.

Word Choice

Fed Chairman Ben Bernanke used part of his June 3 testimony to the House Budget Committee to warn of the consequences of unchecked spending, even in the face of recession and financial instability.
“Unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth,” he said.

Yes, sadly, he’s in that camp as well. As is the entire administration if you believe their current rhetoric.

If it takes a marketing gimmick — labeling fiscal stimulus a “legacy of debt” — to convey the message to the public and Congress, so be it.

How about taking the effort to get it right and trying to undo the damage you’ve done…

(Caroline Baum, author of “Just What I Said,” is a Bloomberg News columnist. The opinions expressed are her own.)

Opinions are her own, as selectively published by Bloomberg News.


[top]

Share

Merkel attacks central banks

Posted on by


[Skip to the end]


>   Karim writes:

>   Surprising comments show political difficulties of QE in Europe. With fiscal policy constrained
>   and the Euro strong, that means more pressure on ‘conventional’ monetary policy: ECB to
>   keep o/n rate low for long.

Yes, agreed. Shows no understanding of monetary operations whatsoever.

With the old German model they had tight fiscal to keep domestic demand and costs down to drive exports. And they also bought $US to keep the mark at ‘competitive’ levels.

With the euro they are also keeping fiscal relatively tight to keep a lid on domestic demand and costs to drive exports, but can’t buy $US for ideological reasons (that would look like the euro is backed by dollars, etc.) so instead of exports rising the currency appreciates to levels where exports remain stagnant.

Merkel attacks central banks

by Bertrand Benoit and Ralph Atkins

June 2(FT) —Angela Merkel, the German chancellor, criticised the world’s main central banks in surprisingly strong terms on Tuesday, suggesting that their unconventional monetary policies could fuel rather than defuse the economic crisis.

The attack on the US Federal Reserve, the Bank of England and the European Central Bank is remarkable coming from a leader who had so far scrupulously adhered to her country’s tradition on never commenting on monetary policy.

“What other central banks have been doing must stop now. I am very sceptical about the extent of the Fed’s actions and the way the Bank of England has carved its own little line in Europe,” she told a conference in Berlin.

“Even the European Central Bank has somewhat bowed to international pressure with its purchase of covered bonds,” she said. “We must return to independent and sensible monetary policies, otherwise we will be back to where we are now in 10 years’ time.”

Ms Merkel’s decision to ignore one of the cardinal rules of German politics – an unwritten ban on commenting monetary policy out of respect from central bank independence – suggests Berlin is far more concerned about the route taken by the ECB than had hitherto transpired.

Berlin is concerned that the central banks will struggle to re-absorb the vast amount of liquidity they are pouring into the markets and about the long-term inflationary potential of hyper-lose monetary policies.

The ECB’s efforts have been focused on pumping unlimited liquidity into the eurozone banking system for increasingly long periods. But last month (May), it followed the US Federal Reserve and Bank of England in announcing an asset purchase programme to help a return to more normal market conditions.

The ECB announced it had agreed in principle to buy €60bn in “covered bonds”, which are issued by banks and backed by public sector loans or mortgages.

The covered bond purchases, however, were only agreed after extensive discussions within the 22-strong ECB governing council. According to one version of May’s meeting, the council had discussed a €125bn asset purchase programme that would also have included other private sector assets, but only the purchase of covered bonds was agreed.

Axel Weber, ECB council member and president of Germany’s Bundesbank, has been among those who expressed scepticism about direct intervention in financial markets. In a Financial Times interview in April he expressed “a clear preference for continuing to focus our attention on the bank financing channel”.

Mr Weber has also been among the most proactive council members in warning that the monetary stimulus injected into the economy will have to be reduced or even reverse quickly once the economic situation improves.

Details of the covered bond purchase scheme will be unveiled by the ECB after its meeting on Thursday. One likely solution is that the package will be split according to eurozone countries’ capital shares in the ECB, which would result in Germany accounting for about 25 per cent of the €60bn programme. Meanwhile, the ECB is widely expected to leave its main interest rate unchanged at 1 per cent, its lowest ever.


[top]

Share

Professor John Taylor on the exploding debt

Posted on by


[Skip to the end]

From the good professor who brought us the ‘Taylor Rule’ for Fed funds:

Exploding debt threatens America

by John Taylor

May 26 — Standard and Poor’s decision to downgrade its outlook for British sovereign debt from “stable” to “negative” should be a wake-up call for the US Congress and administration. Let us hope they wake up.

And yet another black mark on the ratings agencies.

Under President Barack Obama’s budget plan, the federal debt is exploding. To be precise, it is rising – and will continue to rise – much faster than gross domestic product, a measure of America’s ability to service it.

Gdp is a measure of our ability to change numbers on our own spread sheet?

The federal debt was equivalent to 41 per cent of GDP at the end of 2008; the Congressional Budget Office projects it will increase to 82 per cent of GDP in 10 years. With no change in policy, it could hit 100 per cent of GDP in just another five years.

Almost as high as Italy and Italy does not even have its own currency.

“A government debt burden of that [100 per cent] level, if sustained, would in Standard & Poor’s view be incompatible with a triple A rating,” as the risk rating agency stated last week.

Now there’s quality support for an academic position…

I believe the risk posed by this debt is systemic and could do more damage to the economy than the recent financial crisis.

‘Believe’? Without even anecdotal support? Is that the best he can do? This is very poor scholarship at best.

To understand the size of the risk,

I think he means the size of the deficit, but is loading the language for effect.

Is that what serious academics do?

take a look at the numbers that Standard and Poor’s considers. The deficit in 2019 is expected by the CBO to be $1,200bn (€859bn, £754bn). Income tax revenues are expected to be about $2,000bn that year, so a permanent 60 per cent across-the-board tax increase would be required to balance the budget. Clearly this will not and should not happen. So how else can debt service payments be brought down as a share of GDP?

This presumes an unspoken imperative to bring them down. Again poor scholarship.

Inflation will do it. But how much? To bring the debt-to-GDP ratio down to the same level as at the end of 2008 would take a doubling of prices. That 100 per cent increase would make nominal GDP twice as high and thus cut the debt-to-GDP ratio in half, back to 41 from 82 per cent. A 100 per cent increase in the price level means about 10 per cent inflation for 10 years. But it would not be that smooth – probably more like the great inflation of the late 1960s and 1970s with boom followed by bust and recession every three or four years, and a successively higher inflation rate after each recession.

Ok. Inflation, if it happens as above, can bring down the debt ratio. How does this tie to his initial concern over solvency implied in his reference to the AAA rating being a risk for our ‘ability to service it?’

And still no reason is presented that 41% is somehow ‘better’ than 82%.

Nor any analysis of aggregate demand, and how the demand adds and demand leakages interact. Just an ungrounded presumption that a lower debt to GDP ratio is somehow superior in some unrevealed sense.

The fact that the Federal Reserve is now buying longer-term Treasuries in an effort to keep Treasury yields low adds credibility to this scary story, because it suggests that the debt will be monetised.

So what does ‘monetised’ mean? I submit it means absolutely nothing with non convertible currency and a floating fx policy.

That the Fed may have a difficult task reducing its own ballooning balance sheet to prevent inflation increases the risks considerably.

And the presumption that the Fed’s balance sheet per se with a non convertible currency and floating exchange rate policy is ludicrous. All central bankers worth any salt know that causation runs from loans to deposits and reserves, and never from reserves to anything.

And 100 per cent inflation would, of course, mean a 100 per cent depreciation of the dollar.

He’s got that math right- if prices remain where they are today in the other currencies and purchasing power parity holds. And he also knows both of those are, for all practical purposes, never the case.

Why has he turned from academic to propagandist? Krugman envy???

Americans would have to pay $2.80 for a euro; the Japanese could buy a dollar for Y50; and gold would be $2,000 per ounce. This is not a forecast, because policy can change;

And it assumes the above, Professor Taylor

rather it is an indication of how much systemic risk the government is now creating.

So currency depreciation is systemic risk?

Why might Washington sleep through this wake-up call? You can already hear the excuses.

“We have an unprecedented financial crisis and we must run unprecedented deficits.” While there is debate about whether a large deficit today provides economic stimulus, there is no economic theory or evidence that shows that deficits in five or 10 years will help to get us out of this recession.

Huh? None??? What’s he been reading other than his own writings and the mainstream tagalongs?

Such thinking is irresponsible. If you believe deficits are good in bad times, then the responsible policy is to try to balance the budget in good times.

Ahah, a logic expert!!! That makes no sense at all.

The CBO projects that the economy will be back to delivering on its potential growth by 2014. A responsible budget would lay out proposals for balancing the budget by then rather than aim for trillion-dollar deficits.

‘Responsible’??? As if there is a morality issue regarding the budget deficit per se???

“But we will cut the deficit in half.” CBO analysts project that the deficit will be the same in 2019 as the administration estimates for 2010, a zero per cent cut.

“We inherited this mess.” The debt was 41 per cent of GDP at the end of 1988, President Ronald Reagan’s last year in office, the same as at the end of 2008, President George W. Bush’s last year in office. If one thinks policies from Reagan to Bush were mistakes does it make any sense to double down on those mistakes, as with the 80 per cent debt-to-GDP level projected when Mr Obama leaves office?

The biggest economic mistake of our life time might have been not immediately reversing the Clinton surpluses when demand fell apart right after 2000. And, worse, spinning those years to convince Americans that the surpluses were responsible for sustaining the good times, when in fact they ended them, as they always do. Bloomberg reported the surplus that ended in 2001 was the longest since 1927-1930. Do those dates ring a bell???

The time for such excuses is over. They paint a picture of a government that is not working, one that creates risks rather than reduces them. Good government should be a nonpartisan issue. I have written that government actions and interventions in the past several years caused, prolonged and worsened the financial crisis.

Lack of a fiscal adjustment last July is what allowed the subsequent collapse

The problem is that policy is getting worse not better. Top government officials, including the heads of the US Treasury, the Fed, the Federal Deposit Insurance Corporation and the Securities and Exchange Commission are calling for the creation of a powerful systemic risk regulator to reign in systemic risk in the private sector. But their government is now the most serious source of systemic risk.

Finally something I agree with. Our biggest risk is that government starts reigning in the deficits or fails to further expand them should the output and employment remain sub trend.

The good news is that it is not too late. There is time to wake up, to make a mid-course correction, to get back on track. Many blame the rating agencies for not telling us about systemic risks in the private sector that lead to this crisis. Let us not ignore them when they try to tell us about the risks in the government sector that will lead to the next one.

The writer, a professor of economics at Stanford and a senior fellow at the Hoover Institution, is the author of ‘Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis’

It’s not too late for a payroll tax holiday, revenue sharing with the states on a per capita basis, and federal funding of an $8 hr job for anyone willing and able to work that includes federal health care, to restore agg demand from the bottom up, restoring output, employment, and ending the financial crisis as credit quality improves.


[top]

Share

China policy obamanation

Posted on by


[Skip to the end]

We do not need China or anyone else to buy our securities and we net benefit enormously from net imports in general.

The profoundly confused China policy comes from an administration that both does not understand the monetary system and does not understand that imports are real benefits and exports real costs:

Policies are being held hostage to Communist China’s demands.

by Adrian Van Eck

May 29 — The communist rulers of China have laid down a threat to the government of the United States of America. They are the largest foreign holders of treasury bonds. They say they fear that the huge Federal deficit this year – four times the record deficit set last year – will bring on inflation of such a magnitude as to threaten the buying power of their treasury holdings. They have said that if Washington does not stop this massive deficit spending (much of it financed with money created by Fed Chairman Ben Bernanke and the Federal Reserve)

All–not some, or most of government spending is a matter of ‘changing numbers in bank accounts at the fed’ (as per Bernanke’s statement last month).
Govt spending adds varying degrees of aggregate demand, government taxing reduces demand, and government borrowing supports interest rates. ‘Financing’ as the word is generally used does not apply to the issuer of a non convertible currency with a floating exchange rate.

they will protect their own interests by dumping all of their holdings of U.S. treasuries on the market for whatever price they can get for them. They say they will do so even if that collapses the U.S. dollar and pulls down not only the American economy but the economy of the entire world.

To date ‘their own interest’ has been that of supporting their export industries by suppressing their real wages.
So this statement would indicate they are threatening to move away from an export led strategy. Possible, but hard to believe and contradicts what follows here.

Apparently Washington has taken this threat seriously. All of a sudden China is being overrun by important officials from the U.S. Government. Speaker of the House Nancy Pelosi is one of the Americans traveling to Beijing. In past years she has been well known in both the U.S, and China as one who dislikes the rulers of Mainland China. A few years ago she barely escaped being arrested by a pack of Party goons as she led a group of Americans protesting China’s policies toward the formerly independent nation of Tibet, which China overran and conquered soon after they won the Chinese Civil War some 60 years ago. A few days ago she was fawning over China’s Government leaders, telling them how we want to cooperate with them in working to protect the environment. (As usual they blamed America for polluting the Earth, ignoring the fact that it is China which is the worst polluter anywhere.) She must have almost gagged on her own sweet words as she talked.

The second important American Government official in China was Secretary of State Hillary Clinton. She has never been thought of as an enemy of China’s communist rulers, so it was easier for her to talk with them. (There were rumors that money from China helped fund her husband’s re-election campaign.) Unfortunately the visit came about as China’s neighbor and close ally – North Korea – exploded a nuclear device reported to be as powerful as the one America dropped on Hiroshima in 1945. They also fired off several rockets. All of this violated the terms of an agreement they signed in 2006 – an agreement that brought them enormous quantities of fuel oil and food. When the nations that negotiated that treaty protested the nuclear explosion, North Korea announced that it was renouncing its agreement to a truce that ended the war in the 1950’s. That again called for Secretary of State Clinton to try and patch up relations without pushing the virtual outlaw nation into crossing the border and attacking South Korea. This made the response to China in threatening America – a definite form of blackmail, as nations such as India and Japan agreed – a secondary issue with Hillary.

That left Treasury Secretary Geithner to absorb the heaviest verbal blows from China’s leaders during his own visit to Beijing. They knew that Geithner, as the president of the independent Federal Reserve Bank of New York, the largest and most important of the privately-owned regional Feds, had himself made threats to China shortly before being confirmed by the Senate to take over the top job at Treasury. He had told the Senate that if China did not stop manipulating the yuan in the foreign exchange market to gain an unfair advantage in its trade he would be in favor of America taking steps on its own to counter this in the foreign exchange market.

What sense does all this make?

China was buying dollars to keep the dollar strong and the yuan weak as part of their strategy to support exports by suppressing domestic costs vs rest of world costs.

Geithner was pushing for a weaker dollar as a way to reduce China’s exports by, in effect, causing prices of goods made in China at Wal-Mart to rise to the point where they wouldn’t sell as well.

Now China is threatening to do the opposite- push the dollar down by selling its USD financial assets, and Geithner is doing the opposite by trying to stop them.

He has since had to swallow those words and now he has to swallow as well threats against America by China.

This administration is in it way over its head and is pursuing a totally confused policy.

We thought it was fascinating that no one in the media mentioned Ben Bernanke or commented on his complete absence from the dialogue with China. So I will take it on myself to make such a comment. Bernanke is, after all, the one man closely tied to the creation of the money that so offends the communists in Beijing and one might have expected him to be involved in current talks with China’s rulers – under normal circumstances. A while back, he went to China as part of a delegation and he was asked to make a speech at a university where China trains many of its economists. Bernanke was brutally candid in his remarks. He pointed out precisely all of the mistakes he felt they were making in their centrally planned economy – and predicted that they were heading for trouble so bad that it might bring the ruling Party and the country down, just as a dozen prior dynasties had come crashing down during China’s long history. The woman who serves as China’s economics minister was livid with rage after his remarks. She took over and screamed insults at him for a half hour. Then she called President Bush and said that Bernanke was “persona non grata,” a diplomatic phrase meaning he would never again be welcomed to China. Months later when a Chinese delegation paid a return visit to Washington, they carefully avoided the Fed’s marble headquarters.

Not a whisper has escaped that anyone knows about from the ideas expressed by Tim Geithner concerning China’s threats if America does not sharply curb its deficit spending.

For China’s export strategy to ‘succeed’ they need high levels of aggregate demand in the US.

Yet it is clear from everything happening in Washington that this Administration has absolutely zero intention of stopping its near reckless abandon of any restraint in Federal spending.

In fact, the deficit spending has not even begun to get high enough to restore aggregate demand to levels where unemployment stops rising, never mind falling.

We need to remove a lot more fiscal drag to restore demand, now the unsustainable (non-government) credit chennels have been capped.

Quite the contrary, as new demands are made they are coming up with more plans to lavish Federal spending on recipients. For example, the latest we are hearing regarding General Motors is that the Federal Government may be willing to hand the company $50 billion on top of the money allocated to them already. But Washington would then want to gain 70% ownership in what critics are calling “Federal Motors.”

The problem here is the administrations looks for public purpose in the ‘input’ side rather than the output side. The public purpose of industry is the output it produces, not how the inputs, particularly labor, get rewarded.

Output is directed by markets working within institutional structure which can be modified to influence output towards public purpose while sustaining full employment at all times. But not with an administration that has it all backwards.

And now we have California’s demand that the Federal Government guarantee $18 billion in State borrowing to fund their own wild deficit spending. Political pressures are building to make this happen. If that does happen, a lot of other states will be lining up at the White House front door to demand the same treatment.

The answer here is to give all states $500 per capita of revenue sharing with no strings attached. California would get about $17 billion.

That way it’s ‘fair’ and there is no ‘moral hazard’ issue.
But, again, this hasn’t even been discussed.

This brings us to a topic that is being brushed aside as being too unlikely to even deserve treatment as a rumor. Thus it is being dismissed out of hand in the national media. Yet it is springing up from several key Washington sources and that makes us suspicious that where there is so much smoke there may be fire. What I am talking about, of course, is the sudden discussion of an American Value Added Tax – another name for a national sales tax. It would apply to goods and services alike. Most nations in the world including China itself now have such a VAT tax. It is called value added because each company is taxed only on the value it adds to raw materials or parts it buys and manufactures or assembles into a product. Trucks and hairdressers and even lawyers would be taxed under a VAT.

Even at a rate as low as 10%, which would be seen as very low in the world, it would raise a ton of money. Some are proposing a rate high enough to allow the income tax to be ended but that idea is being shot down by agents of the Administration. The idea would be sold to conservatives as a way to avoid the huge inflation that China is warning against… and also to make unlikely that America would be forced to go back to pre-Reagan Federal income tax rates of just about double those paid today. And industry would be told that – just as happens in other nations with a VAT – it would be forgiven on any goods or services marked for export. I think these VAT tax rumors are for real and I suggest you keep an eye on this. More next week. Adrian Van Eck.

The VAT is even more regressive than the payroll taxes still on the books.

And with consumption being the entire point of the economics it makes no sense to tax consumption in general.

‘Sin’ and ‘luxury’ taxes are different- the idea is to limit consumption of those items subject to the tax, and not to raise revenue. The success of the tax is then judged by how few dollars are collected, not how many as with the VAT.

Now more than ever the US would benefit from an administration that understood the monetary system and the simple fundamentals regarding imports and exports.

But this is not going to happen, and we will continue to pay the price.


[top]

Share

Dollar Is Dirt, Treasuries Are Toast, AAA Is Gone: Gilbert

Posted on by


[Skip to the end]


Dollar Is Dirt, Treasuries Are Toast, AAA Is Gone

by Mark Gilbert

May 21 (Bloomberg) —

The odds on the dollar, Treasury
bonds and the U.S. government’s AAA grade all heading for the
dumpster are shortening.

True, but for the wrong reason. There is no solvency issue, but markets are pricing it in anyway.

While currency forecasting is a mug’s game and bond yields
can’t quite decide whether to dive toward deflation or surge in
anticipation of inflation, every time I think about that credit
rating, I hear what Agent Smith in the “Matrix” movies called
“the sound of inevitability.”

Several policy missteps suggest that investors should stop
trusting — and lending to — the U.S. government. These include
the state’s pressure on Bank of America Corp. to buy Merrill
Lynch & Co.; the priority given to Chrysler LLC’s unions over
the automaker’s secured creditors; and the freedom that some
banks will regain to supersize executive bonuses by giving back
part of the government money bolstering their balance sheets.

When you buy treasury securities the government debits your transaction account and credits your securities account at the Fed.

When those securities mature the government debits your securities account and credits your transaction account. That is all there is too it.

There is no solvency issue at the operational level

Currency markets have been in a weird state of what looks
almost like equilibrium for the past couple of months. What’s
really going on is something akin to an evenly matched tug of
war that fails to move the ribbon tied around the center of the
rope, giving the impression of harmony while powerful forces do
silent battle until someone slips.

“All currencies are being debased dramatically by their
central banks at extraordinary speeds and so in relative terms
it appears there is no currency problem,” Lee Quaintance and
Paul Brodsky of QB Asset Management said in a research note
earlier this month. “In reality, however, paper money is highly
vulnerable to a public catalyst that serves to acknowledge it is
all merely vapor money.”

The ‘value’ is the purchasing power of real goods and services.
The largest and deepest thing for sale is labor.
Seems like currency still buys labor at pretty much the same price as the recent past,
And maybe even a bit more.

In fact, it may buy a bit more of just about everything vs a year ago. Particularly houses and land.

But yes, next year can always bring a different story.

Flesh Wounds

Why pick on the dollar, though? Well, not necessarily
because the U.S. economy is in worse shape than those of the
euro area, the U.K. or Japan. The biggest problem is that
external investors — particularly China — have more skin in
the dollar game than in euros, yen or pounds, which makes the
U.S. currency the most likely candidate to meet the cleaver in a
crisis of confidence about post-crunch government finances.

China owns about $744 billion of U.S. Treasury bonds in its
$2 trillion of foreign-exchange reserves.

Chinese exports, though, are dropping as the global economy
weakens, with overseas shipments declining 23 percent in
April from a year earlier, leaving a nation that has already
expressed concern about its U.S. investments with less to spend
in future.

China doesn’t ‘spend’ it’s dollars on real goods and services which is why they
Have a trade surplus in the first place.

They sold things in exchange for ‘dollar balances’ which are financial assets and
then exchanged some of those balances for alternative USD financial assets as they
accumulated $744 billion of financial assets.

‘Heavy Hand of Government’

Those kinds of concerns are starting to surface in a
steepening of the U.S. yield curve, driven by an increase in 10-
and 30-year U.S. Treasury yields.

True, though there is no economic imperative for the treasury to issue a 30 year security in the first place.

In fact, the treasury issuing securities and the Fed later buying them is functionally identical to the treasury never issuing them in the first place.

(note that Charles Goodhart of the Bank of England has recently been proposing the UK do exactly that- cease issuing long securities rather than issuing them and having the BOE buy them.)

The 10-year note currently
yields 3.23 percent, about 235 basis points more than the two-
year security, which marks a near doubling of the spread since
the end of last year.

Yes, though from very low flight to quality yields at the height of the fear of oblivion.

“When the government parks its tanks on capitalism’s
lawns, that spells trouble for those who invest, add value and
create jobs,” says Tim Price, director of investments at PFP
Wealth Management in London. “Trillion-dollar bailouts do not
only leave massive public-sector deficits in their wake, they
also leave the presence of the heavy hand of government all over
industry and markets, so the outlook for government bonds is
less promising than the economic textbooks on deflation would
have us believe.”

A totally confused chain of logic, though government does often reduce shareholder value when it intervenes. But that’s a different point.

Earlier this month, the U.S. reported the first budget
deficit for April in 26 years, with spending exceeding revenue
by $20.9 billion, even though that’s the month when taxpayers
have to stump up to the Internal Revenue Service and the
government’s coffers should be overflowing. So far this fiscal
year, the U.S. shortfall is $802.3 billion, more than five times
the $153.5 billion gap in the year-earlier period.

Those are the ‘automatic stabilizers’ at work, which, fortunately, are out of the hands of
Congress. While they work the ugly way- falling employment and rising transfer payments- they do work to restore net financial assets to the private, non government sectors and thereby reverse the contraction.

Budget deficits = non govt ‘savings’ of financial assets
To the penny
It’s even an accounting identity. Not theory. Ask anyone at the CBO.

Deathly Deficit

For the fiscal year ending Sept. 30, the Congressional
Budget Office forecasts a record deficit of $1.75 trillion,

That includes the purchase of financial assets which doesn’t add to aggregate demand.

Up until now the fed has always bought the financial assets when government wanted to do that and that hasn’t ‘counted’ as deficit spending for exactly that reason.

This time around the treasury bought financial assets and confused things, much like 1936 when social security first started and was accounted for off budget rather than consolidated as we quickly figured out was the right way to do it and it’s fortunately been done that way ever since.

almost four times the previous year’s $454.8 billion shortfall
and about 13 percent of gross domestic product. Bear in mind
that the target demanded of European nations wanting to join the
euro was a deficit no greater than 3 percent of GDP.

Yes, which is responsible for their poor economic performance as well.

David Walker, a former U.S. comptroller general,

And foremost US deficit terrorist

wrote in
the Financial Times on May 12 that the U.S.’s top credit rating
looks incompatible with “an accumulated negative net worth” of
more than $11 trillion and “additional off-balance-sheet
obligations” of $45 trillion. “One could even argue that our
government does not deserve a triple A credit rating based on
our current financial condition, structural fiscal imbalances
and political stalemate,” he wrote.

As if government payments are operationally constrained by revenues.

They are not, as chairman Bernanke made clear a few weeks ago
when he explained how he makes payments by changing numbers in bank accounts.

That is the only way there is for government to spend in its own currency, which
is nothing more than the process of making spread sheet entries on its own books.

Any constraints on the US ability to make payments in dollars is necessarily self imposed (and
can just as readily be removed by those wanting to spend the money.)

Said another way, government checks don’t bounce unless government decides to bounce its own checks.

If you want to claim govt won’t pay because it will vote not to pay, fine.

But not because ‘deficits can’t be financed’ or any other nonsense like that.

No Default

It is undeniable that the U.S. government’s ability to
finance its borrowing commitments has deteriorated as its
deficit has ballooned.

The ability to deficit spend is the ability to make entries on its own spreadsheets.
Nothing more.
The idea that that can ‘deteriorate’ indicates a fundamental lack of understanding of monetary operations.

Dropping the U.S. from the top rating
grade, though, wouldn’t mean the nation is about to default on
its debt obligations; there’s a subtle distinction between
ability to pay and propensity to fail to pay.

And a less subtle distinction between knowing how it works and not knowing how it works.

There’s also a
compelling argument that no government should be enjoying the
benefits of a top credit grade in the current financial climate.

There’s nothing to ‘enjoy’ or even care about.

Note Japan was heavily downgraded with a debt to GDP ratio triple the US,
With no ill effects as three month rates remained near 0 for the last
15 years and 10 year Japanese govt bonds fluctuated between .5 and 1.5%

Using the definitions outlined by Standard & Poor’s, a one-
step cut into the AA rated category would nudge the U.S.’s
creditworthiness into a “very strong” capacity to fulfill its
commitments, just weaker than the “extremely strong”
capabilities demanded of AAA rated borrowers.

S&P cannot change the actual creditworthiness of the US, or any other
issuer of its own currency. There can be no solvency issue no matter what they do.

That seems an
appropriately nuanced sanction — albeit one that the rating
companies might turn out to be too cowardly to impose.

(Mark Gilbert is a Bloomberg News columnist. The opinions
expressed are his own.)


[top]

Share

Dallas Fed interview

Posted on by


[Skip to the end]

Don’t Monetize the Debt

by Mary Anastasia O’Grady

May 23 (WSJ) — From his perch high atop the palatial Dallas Federal Reserve Bank, overlooking what he calls “the most modern, efficient city in America,” Richard Fisher says he is always on the lookout for rising prices. But that’s not what’s worrying the bank’s president right now.

His bigger concern these days would seem to be what he calls “the perception of risk” that has been created by the Fed’s purchases of Treasury bonds, mortgage-backed securities and Fannie Mae paper.

Mr. Fisher acknowledges that events in the financial markets last year required some unusual Fed action in the commercial lending market. But he says the longer-term debt, particularly the Treasurys, is making investors nervous. The looming challenge, he says, is to reassure markets that the Fed is not going to be “the handmaiden” to fiscal profligacy. “I think the trick here is to assist the functioning of the private markets without signaling in any way, shape or form that the Federal Reserve will be party to monetizing fiscal largess, deficits or the stimulus program.”

If he actually understood it I would expect him to say the concept is inapplicable with a non convertible currency and floating exchange rate regime.

Richard Fisher.

The very fact that a Fed regional bank president has to raise this issue is not very comforting. It conjures up images of Argentina. And as Mr. Fisher explains, he’s not the only one worrying about it. He has just returned from a trip to China, where “senior officials of the Chinese government grill[ed] me about whether or not we are going to monetize the actions of our legislature.” He adds, “I must have been asked about that a hundred times in China.”

Without knowing the right answer which is that lending is in no case reserve constrianed.
Causation runs from loans to deposits and reserves, and not from reserves to loans.

A native of Los Angeles who grew up in Mexico, Mr. Fisher was educated at Harvard, Oxford and Stanford.

Must have skipped the classes in reserve accounting.

He spent his earliest days in government at Jimmy Carter’s Treasury. He says that taught him a life-long lesson about inflation. It was “inflation that destroyed that presidency,” he says. He adds that he learned a lot from then Fed Chairman Paul Volcker, who had to “break [inflation’s] back.”

Deregulating natural gas in 1978 is what broke the back of inflation as utilities switched from crude to natural gas and even cuts of 15 million barrels per day by OPEC were not enough to keep control of prices.

Mr. Fisher has led the Dallas Fed since 2005 and has developed a reputation as the Federal Open Market Committee’s (FOMC) lead inflation worrywart. In September he told a New York audience that “rates held too low, for too long during the previous Fed regime were an accomplice to [the] reckless behavior” that brought about the economic troubles we are now living through. He also warned that the Treasury’s $700 billion plan to buy toxic assets from financial institutions would be “one more straw on the back of the frightfully encumbered camel that is the federal government ledger.”

In a speech at the Kennedy School of Government in February, he wrung his hands about “the very deep hole [our political leaders] have dug in incurring unfunded liabilities of retirement and health-care obligations” that “we at the Dallas Fed believe total over $99 trillion.”

Hopefully he is worried about possible inflation and not solvency.

In March, he is believed to have vociferously objected in closed-door FOMC meetings to the proposal to buy U.S. Treasury bonds. So with long-term Treasury yields moving up sharply despite Fed intentions to bring down mortgage rates, I’ve flown to Dallas to see what he’s thinking now.

Hopefully he is concerned with the purchases possibly lowering interest rates too much for his liking and not about the size of the fed’s balance sheet.

Regarding what caused the credit bubble, he repeats his assertion about the Fed’s role: “It is human instinct when rates are low and the yield curve is flat to reach for greater risk and enhanced yield and returns.” (Later, he adds that this is not to cast aspersions on former Fed Chairman Alan Greenspan and reminds me that these decisions are made by the FOMC.)

“The second thing is that the regulators didn’t do their job, including the Federal Reserve.” To this he adds what he calls unusual circumstances, including “the fruits and tailwinds of globalization, billions of people added to the labor supply, new factories and productivity coming from places it had never come from before.” And finally, he says, there was the ‘mathematization’ of risk.” Institutions were “building risk models” and relying heavily on “quant jocks” when “in the end there can be no substitute for good judgment.”

Never does mention the role of fiscal policy. Like the massive 2003 retro tax cuts and spending increases that drove the next few years, including housing. Helped of course by the lender fraud.

What about another group of alleged culprits: the government-anointed rating agencies? Mr. Fisher doesn’t mince words. “I served on corporate boards. The way rating agencies worked is that they were paid by the people they rated. I saw that from the inside.” He says he also saw this “inherent conflict of interest” as a fund manager. “I never paid attention to the rating agencies. If you relied on them you got . . . you know,” he says, sparing me the gory details. “You did your own analysis. What is clear is that rating agencies always change something after it is obvious to everyone else. That’s why we never relied on them.” That’s a bit disconcerting since the Fed still uses these same agencies in managing its own portfolio.

Agreed. Can’t have it both ways. And now they are threatening to downgrade the US government as well

I wonder whether the same bubble-producing Fed errors aren’t being repeated now as Washington scrambles to avoid a sustained economic downturn.

He surprises me by siding with the deflation hawks. “I don’t think that’s the risk right now.” Why? One factor influencing his view is the Dallas Fed’s “trim mean calculation,” which looks at price changes of more than 180 items and excludes the extremes. Dallas researchers have found that “the price increases are less and less. Ex-energy, ex-food, ex-tobacco you’ve got some mild deflation here and no inflation in the [broader] headline index.”

Mr. Fisher says he also has a group of about 50 CEOs around the U.S. and the world that he calls on, all off the record, before almost every FOMC meeting. “I don’t impart any information, I just listen carefully to what they are seeing through their own eyes. And that gives me a sense of what’s happening on the ground, you might say on Main Street as opposed to Wall Street.”

It’s good to know that a guy so obsessed with price stability doesn’t see inflation on the horizon. But inflation and bubble trouble almost always get going before they are recognized. Moreover, the Fed has to pay attention to the 1978 Full Employment and Balanced Growth Act — a.k.a. Humphrey-Hawkins — and employment is a lagging indicator of economic activity. This could create a Fed bias in favor of inflating. So I push him again.

“I want to make sure that your readers understand that I don’t know a single person on the FOMC who is rooting for inflation or who is tolerant of inflation.” The committee knows very well, he assures me, that “you cannot have sustainable employment growth without price stability. And by price stability I mean that we cannot tolerate deflation or the ravages of inflation.”

Mr. Fisher defends the Fed’s actions that were designed to “stabilize the financial system as it literally fell apart and prevent the economy from imploding.” Yet he admits that there is unfinished work. Policy makers have to be “always mindful that whatever you put in, you are going to have to take out at some point. And also be mindful that there are these perceptions [about the possibility of monetizing the debt], which is why I have been sensitive about the issue of purchasing Treasurys.”

Yes, seems the Fed is worried about perceptions they know not to be true, but struggles to come with a way to communicate the operational realities.

He returns to events on his recent trip to Asia, which besides China included stops in Japan, Hong Kong, Singapore and Korea. “I wasn’t asked once about mortgage-backed securities. But I was asked at every single meeting about our purchase of Treasurys. That seemed to be the principal preoccupation of those that were invested with their surpluses mostly in the United States. That seems to be the issue people are most worried about.”

As I listen I am reminded that it’s not just the Asians who have expressed concern. In his Kennedy School speech, Mr. Fisher himself fretted about the U.S. fiscal picture. He acknowledges that he has raised the issue “ad nauseam” and doesn’t apologize. “Throughout history,” he says, “what the political class has done is they have turned to the central bank to print their way out of an unfunded liability. We can’t let that happen. That’s when you open the floodgates. So I hope and I pray that our political leaders will just have to take this bull by the horns at some point. You can’t run away from it.”

Does not sound like he understands, operationally, what that is currently all about, but instead still uses gold standard rhetoric.

Voices like Mr. Fisher’s can be a problem for the politicians, which may be why recently there have been rumblings in Washington about revoking the automatic FOMC membership that comes with being a regional bank president. Does Mr. Fisher have any thoughts about that?

This is nothing new, he points out, briefly reviewing the history of the political struggle over monetary policy in the U.S. “The reason why the banks were put in the mix by [President Woodrow] Wilson in 1913, the reason it was structured the way it was structured, was so that you could offset the political power of Washington and the money center in New York with the regional banks. They represented Main Street.

Yes, there is a power struggle going on in the Fed

“Now we have this great populist fervor and the banks are arguing for Main Street, largely. I have heard these arguments before and studied the history. I am not losing a lot of sleep over it,” he says with a defiant Texas twang that I had not previously detected. “I don’t think that it’d be the best signal to send to the market right now that you want to totally politicize the process.”

Speaking of which, Texas bankers don’t have much good to say about the Troubled Asset Relief Program (TARP), according to Mr. Fisher. “Its been complicated by the politics because you have a special investigator, special prosecutor, and all I can tell you is that in my district here most of the people who wanted in on the TARP no longer want in on the TARP.”

At heart, Mr. Fisher says he is an advocate for letting markets clear on their own. “You know that I am a big believer in Schumpeter’s creative destruction,” he says referring to the term coined by the late Austrian economist. “The destructive part is always painful, politically messy, it hurts like hell but you hopefully will allow the adjustments to be made so that the creative part can take place.” Texas went through that process in the 1980s, he says, and came back stronger.

This is doubtless why, with Washington taking on a larger role in the American economy every day, the worries linger. On the wall behind his desk is a 1907 gouache painting by Antonio De Simone of the American steam sailing vessel Varuna plowing through stormy seas. Just like most everything else on the walls, bookshelves and table tops around his office — and even the dollar-sign cuff links he wears to work — it represents something.

He says that he has had this painting behind his desk for the past 30 years as a reminder of the importance of purpose and duty in rough seas. “The ship,” he explains, “has to maintain its integrity.” What is more, “no mathematical model can steer you through the kind of seas in that picture there. In the end someone has the wheel.” He adds: “On monetary policy it’s the Federal Reserve.”

Ms. O’Grady writes the Journal’s Americas column.


[top]

Share

America’s Triple A Rating at Risk

Posted on by


[Skip to the end]

He’s public enemy #1 and senior spokesman for all the deficit terrorists.

He’s also an intellectually dishonest, paid propagandist.

I’ve got the recording posted on my website from the Mike Norman show where he agrees government solvency is not a risk.

If anyone has his email address feel free to email this to him.

The ratings agencies, however, don’t understand the monetary system, and it is indeed possible they will downgrade the US much like they have downgraded Japan.

While this did no harm to Japan and won’t hurt the US, it could be damaging for eurozone nations who are institutionally dependent on funding. However, even in Europe, the ECB has already stretched the limits of the Treaty and would likely go further as needed (though that is not a certainty.)

America’s Triple A Rating is at Risk

by David Walker

May 12 (FT) — Long before the current financial crisis, nearly two years ago, a little-noticed cloud darkened the horizon for the US government. It was ignored. But now that shadow, in the form of a warning from a top credit rating agency that the nation risked losing its triple A rating if it did not start putting its finances in order, is coming back to haunt us.

That warning from Moodys focused on the exploding healthcare and Social Security costs that threaten to engulf the federal government in debt over coming decades. The facts show we are in even worse shape now, and there are signs that confidence in America’s ability to control its finances is eroding.

Prices have risen on credit default insurance on US government bonds, meaning it costs investors more to protect their investment in Treasury bonds against default than before the crisis hit. It even, briefly, cost more to buy protection on US government debt than on debt issued by McDonald’s. Another warning sign has come from across the Pacific, where the Chinese premier and the head of the People’s Bank of China have expressed concern about America’s longer-term credit worthiness and the value of the dollar.

The US, despite the downturn, has the resources, expertise and resilience to restore its economy and meet its obligations. Moreover, many of the trillions of dollars recently funneled into the financial system will hopefully rescue it and stimulate our economy.

The US government has had a triple A credit rating since 1917, but it is unclear how long this will continue to be the case. In my view, either one of two developments could be enough to cause us to lose our top rating.

First, while comprehensive healthcare reform is needed, it must not further harm our nation’s financial condition. Doing so would send a signal that fiscal prudence is being ignored in the drive to meet societal wants, further mortgaging the country’s future.

Second, failure by the federal government to create a process that would enable tough spending, tax and budget control choices to be made after we turn the corner on the economy would send a signal that our political system is not up to the task of addressing the large, known and growing structural imbalances confronting us.

For too long, the US has delayed making the tough but necessary choices needed to reverse its deteriorating financial condition. One could even argue that our government does not deserve a triple A credit rating based on our current financial condition, structural fiscal imbalances and political stalemate. The credit rating agencies have been wildly wrong before, not least with mortgage-backed securities.

How can one justify bestowing a triple A rating on an entity with an accumulated negative net worth of more than $11,000bn (€8,000bn, £7,000bn) and additional off-balance sheet obligations of $45,000bn? An entity that is set to run a $1,800bn-plus deficit for the current year and trillion dollar-plus deficits for years to come?

He knows as per the recording on my website that the US government spending in USD is not constrained by revenues, and that any default would be due to a political decision not to pay, and not financial circumstances per se.

James Galbraith and I recently testified at the gao/fasb hearings on sustainability immediately following Walker.

Our presentation is on my website.

The panel agreed with us and reportedly has changed their report, including the elimination of the concern over intergenerational transfers.

I have fought on the front lines of the war for fiscal responsibility for almost six years. We should have been more wary of tax cuts in 2001 without matching spending cuts that would have prevented the budget going deeply into deficit. That mistake was compounded in 2003, when President George W. Bush proposed expanding Medicare to include a prescription drug benefit. We must learn from past mistakes.

Fiscal irresponsibility comes in two primary forms – acts of commission and of omission. Both are in danger of undermining our future.

First, Washington is about to embark on another major healthcare reform debate, this time over the need for comprehensive healthcare reform. The debate is driven, in large part, by the recognition that healthcare costs are the single largest contributor to our nation’s fiscal imbalance. It also recognises that the US is the only large industrialised nation without some level of guaranteed health coverage.

There is no question that this nation needs to pursue comprehensive healthcare reform that should address the important dimensions of coverage, cost, quality and personal responsibility. But while comprehensive reform is called for and some basic level of universal coverage is appropriate, it is critically important that we not shoot ourselves again. Comprehensive healthcare reform should significantly reduce the huge unfunded healthcare promises we already have (over $36,000bn for Medicare alone as of last September), as well as the large and growing structural deficits that threaten our future.

One way out of these problems is for the president and Congress to create a “fiscal future commission” where everything is on the table, including budget controls, entitlement programme reforms and tax increases. This commission should venture beyond Washington’s Beltway to engage the American people, using digital technologies in an unparalleled manner. If it can achieve a predetermined super-majority vote on a package of recommendations, they should be guaranteed a vote in Congress.

Recent research conducted for the Peterson Foundation shows that 90 per cent of Americans want the federal government to put its own financial house in order. It also shows that the public supports the creation of a fiscal commission by a two-to-one margin. Yet Washington still sleeps, and it is clear that we cannot count on politicians to make tough transformational changes on multiple fronts using the regular legislative process. We have to act before we face a much larger economic crisis. Let’s not wait until a credit rating downgrade. The time for Washington to wake up is now.

David Walker is chief executive of the Peter G. Peterson Foundation and former comptroller general of the US


[top]

Share

Bernanke

Posted on by


[Skip to the end]

Karim writes:

Bernanke Testimony (All quotes in italics)

  • We are likely to see further sizable job losses and increased unemployment in coming months
  • Recent data also suggest that the pace of contraction may be slowing, and they include some tentative signs that final demand, especially demand by households, may be stabilizing. In coming months, households’ spending power will be boosted by the fiscal stimulus program, and we have seen some improvement in consumer sentiment. Nonetheless, a number of factors are likely to continue to weigh on consumer spending, among them the weak labor market and the declines in equity and housing wealth that households have experienced over the past two years. In addition, credit conditions for consumers remain tight.
  • The housing market, which has been in decline for three years, has also shown some signs of bottoming
  • The available indicators of business investment remain extremely weak.
  • Conditions in the commercial real estate sector are poor.
  • We continue to expect economic activity to bottom out, then to turn up later this year.
  • The supply of mortgage credit is still relatively tight, and mortgage activity remains heavily dependent on the support of government programs or the government-sponsored enterprises.
  • Investors seemed to adopt a more positive outlook on the condition of financial institutions after several large banks reported profits in the first quarter, but readings from the credit default swap market and other indicators show that substantial concerns about the banking industry remain.

The section below appears to warn about the impact of rising rates, wider credit spreads, and weaker equities. i.e., the Fed wont be looking to snuff out any rallies. Also, slack to expand even after recovery takes hold, meaning disinflation continues, with ‘expectations’ being main factor preventing deflation.

  • An important caveat is that our forecast assumes continuing gradual repair of the financial system; a relapse in financial conditions would be a significant drag on economic activity and could cause the incipient recovery to stall.
  • Even after a recovery gets under way, the rate of growth of real economic activity is likely to remain below its longer-run potential for a while, implying that the current slack in resource utilization will increase further. We expect that the recovery will only gradually gain momentum and that economic slack will diminish slowly. In particular, businesses are likely to be cautious about hiring, implying that the unemployment rate could remain high for a time, even after economic growth resumes.
  • In this environment, we anticipate that inflation will remain low. Indeed, given the sizable margin of slack in resource utilization and diminished cost pressures from oil and other commodities, inflation is likely to move down some over the next year relative to its pace in 2008. However, inflation expectations, as measured by various household and business surveys, appear to have remained relatively stable, which should limit further declines in inflation.


[top]

Share