Category Archives: Inflation

Comments on China’s temporary hike of Reserve Requirements

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The lesson should be changing reserve requirements for a non convertibility currency, as the yuan is domestically for all practical purposes, doesn’t alter liquidity, but does alter balance sheet composition and pricing necessary to hit return on equity targets.

And looks to me more like their stealth inflation problem hinted at previously hasn’t yet been reigned in to their satisfaction?

  • 50bp hike in RRR for six large banks, valid for two months
  • the unusual temporary move reflects the central bank (PBoC)’s concern over strong lending appetite and hot money inflow
  • the PBoC is likely to follow up with more measures based the effectiveness of current policy
  • a lesson to the developed country on how difficult it is to rein in excessive liquidity

According to Reuters, China has raised reserve requirements by 50 basis points for six large commercial banks to 17.5%. It is reported that the move is only temporary and will be in place for two months. However there is no official statement from the central bank yet.

These six banks account for around 40% of China’s total lending and nearly 50% of the total bank assets. The 50bp hike in reserve requirement ratios will lock up about CNY150 bn of deposits.

We think the unusual temporary measure reflects the PBoC’s concern over excessive liquidity in the domestic economy on the backdrop of a robust growth. The total banking lending from January to August has reached 76% of the full-year target (CNY7.5 trillion), which means the monthly lending needs to be below CNY450 bn. However the domestic credit demand still seems to be very strong. Another possible reason for this move is the mounting evidence that the hot money is flowing back due the increasing pressure on the yuan appreciation.

The PBoC move speaks of the problems in managing a generous liquidity policy and stands as both a warning and a contrast to those other central banks considering a further round of quantitative easing. Once a generous liquidity policy is in place, it becomes difficult to wean dependent companies off the cheap and easy liquidity flow. Whereas the PBoC is not “pushing on a string” and there is genuine demand for this liquidity, the warning to the US federal reserve is clear. Even for economically well-administered economies, the latter stages of generous liquidity policies become very difficult to manage. Zombie (cheap liquidity dependent) companies, potential asset bubbles and the intractability excess liquidity are all legacy issues central banks
considering QE2 must consider.

Except that those are not the result of QE, but of what is functionally fiscal support for zombies, and the only effect zombies have on the real economy is that they waste valuable labor hours. Unfortunately no one seems to know how to keep fiscal drag low enough to sustain full employment so they see political benefit to useless employment.

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Austerity Will Push Euro to $1.50 by Year End: Economist

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This story was abstracted from a long phone interview a couple of days ago and is reasonably well reported.
It was a follow up to my last interview with them when the euro was 119.
At the time all forecasts there were seeing were for it to keep going down.

Unreported was the part of the discussion reviewing that the traditional export model keeps fiscal tight enough to keep domestic demand relatively low, and at the same time buys fx to prevent currency appreciation and keep real costs down to help the exporters. And that the ECB has an ideological constraint against buying US dollars, in that building dollar reserves would give the appearance of the dollar backing the euro, when they want the euro to be a reserve currency.
(And interesting that they kept my name out of the title.)

Austerity Will Push Euro to $1.50 by Year End: Economist

By Antonia Oprita

October 7 (CNBC) — The euro will keep rising and will likely end the year at up to $1.50, as the European Central Bank pursues a highly deflationary policy, despite buying euro-denominated bonds, economist Warren Mosler, founder and principal of broker/dealer AVM, told CNBC.com.

Mosler, who predicted that the euro would bounce back towards $1.60 in June, when the single European currency was trading at around $1.19, said there was nothing to stop the euro’s [EUR=X 1.3965 0.0036 (+0.26%) ]appreciation versus the dollar, short of a policy response from the European Central Bank.

“If it (the euro) keeps going at the rate it’s going, it could go to $1.45-$1.50 by the end of the year,” he said.

The ECB started buying government bonds belonging to distressed euro zone members such as Greece, Ireland, Portugal and Spain to ease market concern regarding these countries’ ability to fund themselves and some analysts have said the measure may be inflationary.

But the policy is, if anything, deflationary because it is accompanied by tough austerity conditions, Mosler said.

“They’re causing a shortage of euros by requiring governments to rein in spending. It’s a highly deflationary move and that’s what is driving the euro higher,” he said.

“Right now the ECB and the euro zone are tightening up their supply of euros.”

Billionaire investor George Soros accused Germany earlier this week ofdragging the euro zone in a deflationary spiral by promoting austerity measures.

Many analysts have said that the ECB is promoting policies that go hand in hand with the euro zone’s biggest member’s fears of inflation.

One element of uncertainty is the ECB’s willingness to continue to buy government bonds, Mosler warned.

“No-one knows how long the ECB are going to do it… they could change their mind tomorrow,” he said.

But market speculators, while being able to attack the euro zone’s weakest members, will not be able to speculate against the central bank, which can print money and distribute it among its members at any time, Mosler said.

“The markets cannot punish the ECB. They can’t punish the issuer of the currency,” he said. “When you’re the issuer of a modern currency, you can credit an account and there’s nothing the market can do about it.”

He reiterated his view that the ECB has now de facto shifted to deciding fiscal policy for the countries in the single currency area, since their help by buying bonds comes with conditions regarding cutting debt and budget deficits.

Another factor behind the euro’s appreciation will be China’s announcement that it will buy Greek debt, which was hailed in Europe as proof of confidence in Greece’s ability to pay its debt.

“China would like nothing more than to buy euros – they’re doing it through buying Greek debt. That’s just one more force for a stronger euro,” Mosler said.

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Comments on the Blumenthal McMahon Debate

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Comments on the Blumenthal McMahon Debate

The debate organizers opted not to include me as the representative of the third largest political party in Connecticut, the Independent Party. I did, however, watch the proceedings on television. We are in an economic emergency, and I’m running for the US Senate strictly as a matter of conscience to offer my knowledge, experience, and proposals to fix our broken economy and create the 20 million new jobs we desperately need. To that end I offer my comments.

But let me first respond to the question on the death penalty. Both candidates proclaimed their unconditional support for it, while I am categorically against it. That fact that more than 100 convicted murderers on death row have been found not guilty and released after DNA testing became available is reason enough for me to ban this unnecessary measure which has likely put to death untold numbers of innocent people.

With regard to jobs and the economy, both candidates recognized that small businesses account for about 70% of private sector jobs, and both candidates proposed a variety of tax measures to help small business. And while both candidates favored not letting middle income tax cuts expire next year, and Mrs. McMahon further supported not raising taxes on anyone, neither of those proposals actually lower taxes from their current levels.

Sadly, the problem is that neither candidate recognizes that it is SALES that create jobs. Consequently, they did not focus on proposals designed to increase sales. Restaurants, department stores, and other small businesses don’t cut staff when sales are good and they are full of paying customers. They cut staff when sales fall. We’ve lost 8 million jobs because sales fell and business in general remains slow. So while Mrs. McMahon stated that entrepreneurial activity is what creates jobs through risk taking, she failed to recognize that they do that only when prospects for actually selling their goods and services are favorable, and, particularly, when they have a backlog of orders.

Thus, while lowering taxes for small business certainly doesn’t hurt, it’s not what creates jobs. My lead proposal to create millions of new jobs is a full payroll tax (FICA) suspension for both employers AND for all employees. This will increase take home pay by about 8% which means a person earning $50,000 a year will see his take home pay go up by over $300 per month, which will boost sales and create jobs the right way, from the bottom up, and not from the failed top down trickle down bailout policies of the last several years. It also lowers costs for all businesses, which helps keep prices down. We have to take strong measures to get sales back up to where they should be.

Next, I want to address one of the more famous sound bytes from this debate. Mrs. McMahon specifically stated that “government doesn’t create jobs, the private sector does” and Mr. Blumenthal did not disagree. What both candidates failed to recognize is the government’s central role in private sector job creation. Government’s role is the creation and maintenance of public infrastructure necessary for the functioning of the private sector. This includes in the general sense the legal system, the monetary system, public safety, and other related and essential support functions. This infrastructure employs real people in real jobs providing real benefits without which there would be no viable private sector. So in that sense government does indeed create real jobs, both directly and indirectly.

In summary, neither candidate showed that they understood that sales create private sector jobs, and neither candidate directly proposed measures such as my payroll tax suspension for employees to increase our spending power to restore sales and create jobs. Instead, they proposed measures that certainly won’t hurt, but will fall far short of what’s needed to put America back to work.

Next, Mr. Blumenthal repeatedly called for policy to force China to end its ‘currency manipulation,’ along with ‘buy America’ proposals and proposals to reverse the flow of American jobs overseas, to the point of criticizing Mrs. McMahon for purchasing imported goods. Mrs. McMahon implicitly agreed with the premise, countering by explaining that US corporate tax policy was to blame for companies moving overseas. Again, unfortunately, both candidates have things fundamentally backwards on this issue as well. I suspect that is because the unions they are undoubtedly catering to also have it backwards and are sadly working against their own best interesets.

The real problem is not the imports, or the jobs going overseas. The problem is that we are grossly over taxed for the size of government we have, and don’t have enough take home pay to buy enough goods and services to keep everyone at home fully employed.

As every Professor of Economics knows, and every first year student is taught, imports are real benefits and exports are real costs. You can think of each nation’s real wealth this way: take the ‘pile’ of goods and services we produce at home, then add to that pile the goods and services the rest of the world sends us, then subtract from that the pile of goods and services we send overseas. What we are left with is our real wealth. As you can see, the problem is not what we buy from overseas. That adds to our pile and makes us richer. The problem is the unemployment here at home, which is best addressed by my payroll tax suspension which gives people working for a living enough spending money to increase sales enough to create the jobs we need here at home. The trick is to get taxes low enough so that we have enough spending money to buy everything we can produce here at home with everyone working, plus everything the rest of the world wants to sell us.

In the debate, both candidates also stressed the importance of deficit reduction, with both concerned about the debt we are leaving our children. The problem is that they have both bought into the deficit mythology that has gotten the U.S. economy to where it is today. In order to restore American prosperity create American jobs it is critical to dispell this mythology, and I am on mission to stomp it out forever.

The fact is that the U.S. government is not ‘out of money’ or ‘about to go broke.’ That talk is pure fear mongering. Unlike state and local governments (which can go broke), the Federal government is the actual issuer and operator of the US dollar. It utilizes its Federal Reserve Bank and the commercial banks (where all of our bank accounts are) to make payments and receive payments. It makes all payments, such as Social Security payments, simply by marking numbers up in our bank accounts. Those numbers don’t come from anywhere, as Fed Chairman Bernanke testified last year and other Fed officials have repeated. There is no gold coin that drops into a bucket at the fed when you pay your taxes and they don’t hammer one into their computers when they pay a Social Security check.

To repeat: There is no such thing as the Federal government running out of money. Government checks don’t ever bounce.

That is not to say that ‘over spending’ can’t drive up prices and eventually result in inflation. It does mean, however, that Social Security is not broken. It can’t be. The checks will never bounce. And I have signed a pledge never to cut Social Security benefits or eligibility. However, unfortunately for all of us, there is a commission on “fiscal responsibility and reform” supported by the Democrats and the Republicans, which, conveniently after the election, will recommend ways to cut Social Security and Medicare. An important part of my mission is to make sure they do not succeed.

Often, when I explain this, people will ask if I am proposing that we just ‘print the money,’ as if today there is a distinction between printing money and some other way of government spending. I tell them that ‘printing money’ is a long outdated gold standard distinction that meant we had printed more paper money than we had gold backing it. Today, you can’t ‘cash in’ your dollars at the Fed for gold. Dollars are just numbers in bank accounts, or actual cash. So all I’m doing is describing the one and only way spending and taxing always takes place with today’s monetary system.

The other question that seems to be on everyone’s mind is how then do we pay off China? The answer is actually quite simple when you understand how it works in its most basic form.

First, one has to understand China doesn’t start out with any dollars. They get them from selling things to us. When China gets paid, those dollars go into its checking account, which is also called a reserve account, at the Fed (Federal Reserve Bank). US Treasury securities including T bills, notes, and bonds are nothing more than savings accounts at the Fed. So when China buys Treasury securities all that happens is their dollars shift from their checking account at the Fed to their savings account at the Fed. That’s called ‘the US going into debt.’ You can call it whatever you want, but it is really just transferring dollars from China’s checking to its savings. The total US debt of about $13 trillion is simply the dollars in savings accounts at the Fed. And how is that repaid by the tens of billions every week as the various Treasury securities mature? All the Fed does is shift those dollars (plus interest) from the savings accounts back to the checking accounts. That’s it, debt paid. And no checks from anyone’s children and grandchildren are involved. But what if China decides not to ‘buy our debt’? This simply means their money stays in their checking account at the Fed and never goes to their savings account. There is no reason for anyone to care in which Fed account China’s dollars are kept. Further, if China doesn’t want dollars at all, their only option is to buy something with them just like anyone else.

All of this causes one to view deficit spending in a very different light. Deficit spending for the Federal government is very different than most people imagine. When the Federal government spends more than it taxes, that extra money spent simply winds up in savings accounts at the Fed. In other words, it adds to the savings of the economy. With this in mind and knowing that, by definition, deficit reduction means either increasing taxes or cutting spending, we can see that both of those actions take money out of our economy – the worst possible thing to do at a time like this. While I strongly favor cutting wasteful and unnecessary Federal spending, I also recognize that with today’s high unemployment any spending cuts must be matched by tax cuts of at least that much to ensure money is not removed from the economy. What actually matters is the real economy, and not the deficit which is nothing more than the savings accounts at the Federal Reserve Bank. Don’t you think that if the debt was really a problem something very bad would have happened long before it got to $13 trillion?

Mrs. McMahon’s nonsensical statement about using unspent stimulus money to pay down the national debt would be like saying you are going to use your remaining line on your credit card to pay off your debt. And Mr. Blumenthal’s failure to respond to such an obvious absurdity likewise shows he too is sorely lacking in his understanding of economics and job creation at this time of economic emergency.

The health insurance issue again highlighted their lack of understanding of markets and economics for all parties concerned. Both candidates missed the point that there is not yet an operational plan to guarantee coverage for those with pre existing conditions. The problem is that if you can’t be turned down for insurance because you are already sick, you don’t need to buy insurance until AFTER you need medical attention. To address that situation, they’ve discussed fining people who don’t buy insurance. But if the fines aren’t at least as high as the insurance premiums, people will just pay the fines. And then insurance companies will only be selling insurance to people already in need of treatment, which means the premiums will be higher than the costs of the needed treatment to cover the insurance company’s costs. Unfortunately, however nobly intended, the entire concept is unworkable under the current structure, and neither candidate indicated any awareness of this.

With regard to TARP funding for banks, again, neither candidate got it right. The fact is TARP was nothing more than regulatory forbearance that allowed the banks to continue to function with reduced levels of private capital, along with terms and conditions regarding operations, compensation, etc. No additional public funds were actually involved. The FDIC was, for all practical purposes, already guaranteeing the depositors from loss should all the private capital of any one bank be lost. Adding TARP money to secure depositors from loss when they were already FDIC guaranteed made no sense at all and added nothing. Nor did ‘paying back the TARP money,’ which necessarily did nothing more than let funds sit in reserve accounts at the Fed, make any difference.

To summarize the economic issues, neither candidate showed that they understood that sales create private sector jobs, and neither candidate directly proposed measures such as my payroll tax suspension for employees to increase our spending power to restore sales and create jobs. Instead, they proposed measures that certainly won’t hurt, but will fall far short of what’s needed to put America back to work. During this time of financial crisis, even with the best of intentions, neither candidate is qualified to represent our best interests and fix our economy.

Mr. Blumenthal has been a tireless public servant and advocate for the people of Connecticut for a very long time, and I have no doubt he’ll continue to do that if elected Senator. Unfortunately, much of his understanding of current issues is completely backwards. For example, his tireless and well-intentioned efforts in regard to foreign trade are far more likely to destroy jobs than create them. And nothing could be more subversive than Mrs. McMahon’s promised vote for a balanced budget amendment, which would take over $1 trillion out of our economy, destroying tens of millions of jobs, and threatening our liberties as well in the ensuing social unrest that.

We are in an economic emergency, and both candidates have put forth proposals that would unknowingly destroy millions of jobs in a terrible depression. I am running for the US Senate solely as a matter of conscience as the candidate uniquely qualified to support the proposals that will create the 20 million jobs we need, and defeat the forces at work that are attempting to slash Social Security and Medicare.

Also, unlike the other candidates, creating jobs has been my life work, and not just election talk. My published writings and proposals have already created millions of jobs around the world, and I have met regularly with Congressmen and Senators from both parties promoting full employment and prosperity, as well as fighting back against the proposed cuts to Social Security and Medicare.

I urge you to please visit www.moslerforsenate.com and read my proposals, my qualifications, and my endorsements.

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in case you thought Dallas Fed Pres Fisher understands monetary operations and banking

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Fisher Speech

Summary from MNS:
FED: Dallas Fed Pres Fisher (votes on FOMC in ’11) is a hawk on QE2.
Says “it is not clear that the benefits of further quantitative
easing outweigh the costs,” especially if U.S. has “anemic recovery, but
not one that slips into reverse gear.” Barring further shock, he has
“concerns about the efficacy of further expanding the Fed’s balance
sheet until our political authorities better align fiscal and regulatory
initiatives with the needs of job creators. Otherwise, further
quantitative easing might be pushing on a string. In the worst case, it
could flood the engine of the economy with gas that might later ignite
inflation.”

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U.S. Data/Dudley

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Karim writes:

Data: General impression is manufacturing is slowing but ‘building blocks’ for consumer getting better (sorry for delay)

Consumer

  • Personal income up 0.5% in Aug and now running 3.3% y/y


This is a very significant positive. With personal income rising at this rate the chances of negative growth are slim and none.

  • Savings rate back up to 5.8% from 5.7%


Funded by the ongoing federal deficit.

  • Also of interest is core PCE at 0.1%, keeps Y/Y rate at 1.4% for the 3rd straight month-pretty far from deflation territory and close to the Fed’s desired 1.5-2.0% range

Coupled with the unemployment rate keeps the Fed on hold for now.

Also, watch car sales as today’s data looks pretty good. Cars and housing would be the signal that domestic credit expansion is beginning to kick in.

    ISM

  • “Business results (top and bottom line) continue to meet or exceed our operating plan and exceed prior year performance by double digits.” (Chemical Products)
  • “Business continues flat relative to prior month and is expected to remain flat. Commodities continue to be the main concern heading into 2011.” (Food, Beverage & Tobacco Products)
  • “Our business is softening due to seasonal considerations. Overall, our situation is much better than 2009.” (Machinery)
  • “Customers seem to be pulling back on orders. I suspect that they are trying to reduce their inventory for the approaching year-end.” (Transportation Equipment)
  • “Strategic customers reducing order quantities.” (Computer & Electronic Products)

Most ISM categories weaker, but still in expansion mode; New Orders vs Inventories Spread not looking great



ISM Sept Aug
Index 54.4 56.3
Prices paid 70.5 61.5
Production 56.5 59.9
New Orders 51.1 53.1
Inventories 55.6 51.4
Employment 56.5 60.4
Export Orders 54.5 55.5
Imports 56.5 56.5


Dudley

  • Key line in speech today: “further action is likely to be warranted unless the economic outlook evolves in away that makes me more confident that we will see better outcomes for both employment and inflation before too long.”
  • Doesn’t sound too patient!



And looks to me like better days are coming.

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Japan Recap- Prime Minister Says Huge Public Debt Unsustainable

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More modest signs of improvement in Japan, with employment and spending improving.

Unfortunately, the Prime Minister seems be about to make the same mistake of past Prime Ministers and take action to reduce the govt’s deficit.

In contrast, China seems to have recognized govt spending spending (and lending by state owned banks that is in fact thinly disguised govt spending) is not operationally dependent on revenue, and that there is no solvency issue nor external constraints on local currency expenditure. China seems to understand the risks are inflation, making adjustments as they see that political threat arise.

See comments below.

Aug Job-To-Applicant Ratio: 0.54% vs 0.54% (expect) / 0.53% (last)

Aug Jobless Rate: 5.1% vs 5.1% (expect) / 5.2% (last)

Aug Household Spending (YoY): 1.7% vs 1.4% (expect) / 1.1% (last)

Sep Tokyo CPI (YoY): -0.6% vs -0.9% (expect) / -1.0% (last)

Sep Tokyo CPI Ex-Fresh Food (YoY): -1.0% vs -1.0% (expect) / -1.1% (last)

Sep Tokyo CPI Ex-Fresh Food & Energy (YoY): -1.3% vs -1.4% (expect) / -1.4% (last)

Aug National CPI (YoY): -0.9% vs -0.9% (expect) / -0.9% (last)

Aug National CPI Ex-Fresh Food (YoY): -1.0% vs -1.0% (expect) / -1.1% (last)

Aug National CPI Ex-Fresh Food & Energy (YoY): -1.5% vs -1.5% (expect) / -1.5% (last)

Japan Prime Minister Says Huge Public Debt Unsustainable

October (Reuters) — Japan’s prime minister warned on Friday that the country’s fiscal situation was unsustainable given its huge public debt, and called for multiparty tax reform talks as he struggles with a fragile economy and a divided parliament.

With perhaps the world’s largest public debt, severe prior downgrades by the ratings agencies, perhaps the strongest currency in the world, mild deflation, and yet ten year JGB’s hovering around 1%, you’d think the historical evidence alone would convince them there is no solvency or funding or ‘sustainability’ issue. But clearly it doesn’t. And while those in monetary operations at the BOJ understand there is no sustainability issue, it is not their place to mention it (much like the US).

Naoto Kan also repeated his resolve to curb a rise in the yen that threatens to derail Japan’s export-led economic recovery, urged the central bank to do more to fight deflation, and expressed hope that opposition parties would join in talks on a extra budget he wants to enact soon.

This seems to indicate he’s pushing for a higher deficit? Or will there be a new tax to ‘pay for it?’ And the only way to weaken the yen vs the dollar is to buy dollars, which is what I call off balance sheet deficit spending. It ‘works’ and there are no operational limits to the amount of fx a CB can buy. But it’s a poor second choice to a domestic tax cut or spending increase.

Japan’s core consumer prices marked their 18th straight month of annual declines in August, as deflation grips an economy struggling with a rising yen, slowing exports and a surprise decline in output. But the jobless rate fell and the availability of jobs improved slightly, data showed on Friday.

Yes, the deficit did go up in the financial crisis slowdown and got large enough to support growth. The question is whether they allow that to continue.

Kan, who took office in June as Japan’s fifth leader in three years, faces a tough time wooing the opposition support that is vital to enact laws since his Democratic Party of Japan (DPJ) and a tiny partner lack a majority in parliament’s upper house.

The government faces the delicate task of reining in debt while keeping the economy going. Japan has built up a huge public debt burden, now nearly twice the size of its $5 trillion economy, during two decades of economic stagnation.

It might help if the media stopped calling it a burden, as it’s clearly not a burden in any sense. particularly with a 0 rate policy (not that it matters for solvency).

“If the current fiscal situation is left alone, it will be unsustainable at some point,” Kan said in a speech at the start of an extra session of parliament.

I doubt he could define ‘unsustainable’ but no one asks as the errant sustainability assumption is pervasive.

He also vowed to achieve Tokyo’s goal of bringing the primary budget balance, which excludes revenue from bond sales and debt-servicing costs, into the black within a decade.

Extra Budget

Kan, whose past calls for debating a hike in the 5 percent sales tax had contributed to a July upper house election defeat, said Japan needs a social welfare system that citizens could trust even if that meants added financial burden on the public.

Multiparty debate on tax reform including the sales tax is thus indispensable, Kan said, reiterating that he would seek a mandate from voters before deciding on the sale tax rise.

The government is crafting an extra budget for the fiscal year to March 31 to stimulate the economy by supporting job seekers and families with children, but has sent mixed signals about the size of the package and how it will fund it.

It does look like they plan on ‘funding it’

Some in the cabinet, such as the economics minister, have said new debt issuance should not be ruled out, but the finance minister is firmly against the idea.

National Strategy Minister Koichiro Gemba has said Japan could fund measures worth around 4.6 trillion yen ($55 billion) by tapping reserves, thereby avoiding new bond issuance.

Functionally this would be the same as deficit spending.

“The biggest task for this parliamentary session is enacting a supplementary budget to finance economic steps. I sincerely hope for constructive debate among ruling and opposition parties,” Kan said in the speech.

Efforts to gain such opposition support will be complicated by a bitter feud with China.

Kan is under fire for appearing to cave in to Beijing’s demands to free a Chinese fishing boat captain detained last month after his trawler collided with Japanese patrol boats near disputed islands in the East China Sea.

The prime minister on Friday reiterated that good ties with China, in the process of replacing Japan as the world’s second-biggest economy, were vital but also expressed concern about Beijing’s military buildup and aggressive maritime activities.

China still has bitter memories of the last war with Japan.

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Seth Carpenter paper

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On Tue, Sep 28, 2010 at 12:36 PM, Eileen wrote:

Did Hell freeze over and I missed it??

Seth B. Carpenter and Selva Demiralp, recently posted a discussion paper on the Federal Reserve Board’s website, titled Money, Reserves, and the Transmission of Monetary Policy: Does the Money Multiplier Exist?

The authors note that bank reserves increased dramatically since the start of the financial crisis. Reserves are up a staggering 2,173% from $47.3bn on September 10, 2008, just before the financial crisis began, to $1.1tn now. Yet M2 is up only 11.4% since September 10, 2008, and bank loans are down $140.2bn. The textbook money multiplier model predicts that money growth and bank lending should have soared along with reserves, stimulating economic activity and boosting inflation. The Fed study concluded that “if the level of reserves is expected to have an impact on the economy, it seems unlikely that a standard multiplier story will explain the effect.”

That not only repudiates the textbook money multiplier model but also raises lots of questions about the goal of the Fed’s quantitative easing policies.

The Carpenter/Demiralp study quotes former Fed Vice Chairman Donald Kohn saying the following about the money multiplier in a March 24, 2010 speech: http://www.federalreserve.gov/newsevents/speech/kohn20100324a.htm

“The huge quantity of bank reserves that were created has been seen largely as a byproduct of the purchases that would be unlikely to have a significant independent effect on financial markets and the economy. This view is not consistent with the simple models in many textbooks or the monetarist tradition in monetary policy, which emphasizes a line of causation from reserves to the money supply to economic activity and inflation. . . . We will need to watch and study this channel carefully.”

Here are more shocking revelations from the study under review: “In the absence of a multiplier, open market operations, which simply change reserve balances, do not directly affect lending behavior at the aggregate level. Put differently, if the quantity of reserves is relevant for the transmission of monetary policy, a different mechanism must be found.

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Warren Mosler: Obama’s China Policy Will Destroy U.S. Jobs and Create Inflation

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Warren Mosler: Obama’s China Policy Will Destroy
U.S. Jobs and Create Inflation

Noted Economist and Senate Candidate: Forcing The Yuan Up and The Dollar Down Is The Worst Possible Option For Creating U.S. Jobs


Middletown, CT. – September 28, 2010 – Warren Mosler, internationally renowned financial and job creation expert and Connecticut’s Independent Party Candidate for the US Senate lashed out today at the Obama administration’s weak dollar policy in relation to China. “The first thing forcing China to revalue its currency will do is destroy US jobs, not create them,” said Mosler. “When China causes its currency to appreciate against the dollar, thus driving the value of the dollar down, it gives Chinese workers what amounts to a pay raise which will be passed along to U.S. consumers in the form of higher prices – in other words, inflation. These higher prices mean U.S. consumers can buy less, which results in fewer American jobs.”

According to available data, the U.S. lost approximately 8 million jobs two years ago because sales fell. When sales are restored, jobs will be restored. “A restaurant, department store, or any other business doesn’t lay off staff when they are filled with customers. So, giving Chinese workers a pay raise that will kill U.S. sales, cause inflation, and cut Americans’ spending power is not the way to bring this economy back from the brink or create the American jobs we desperately need!” asserted Mosler. In contrast, Mosler’s plan to create good-paying private sector jobs features a full payroll tax (FICA) holiday. That will make sure our consumers have enough spending power to be able to buy both whatever we can produce here at home with full employment, plus whatever the rest of the world wants to sell us, just like a decade ago when unemployment was under 4%, growth was strong, inflation low, and net imports were at record levels. Additionally, Mosler is concerned that Obama’s current inflationary policy can rapidly escalate into a debilitating trade war with China. In fact, in what amounts to a dangerous, high stakes international game of chicken, China has already announced it was placing a tariff on US poultry exports in retaliation for U.S. demands for currency revaluation.

Richard Blumenthal’s lock-step position with the Obama White House on China and Linda McMahon’s conspicuous silence on this critical issue vividly show that they are simply not qualified to create the 20 million new jobs we desperately need. “If you needed heart surgery, you wouldn’t let just anyone do it. In this time of economic emergency, I am the candidate that has the necessary knowledge, experience and in-depth understanding of our economy on a nuts and bolts level to make effective policy,” said Mosler. Quite simply, now is the time to take decisive action and Warren Mosler is the only candidate in this race who is qualified for the job.

About Warren Mosler
Warren Mosler is running as an Independent. His populist economic message features: 1) a full payroll tax (FICA) holiday so that people working for a living can afford to buy the goods and services they produce. 2) $500 per capita Federal revenue distribution for the states 3) An $8/hr federally funded job to anyone willing and able to work to facilitate the transition from unemployment to private sector employment. He has also pledged never to vote for cuts in Social Security payments or benefits. Warren is a native of Manchester, Conn., where his father worked in a small insurance office and his mother was a night-shift nurse. After graduating from the University of Connecticut (BA Economics, 1971), and working on financial trading desks in NYC and Chicago, Warren started his current investment firm in 1982. For the last twenty years, Warren has also been involved in the academic community, publishing numerous journal articles, and giving conference presentations around the globe. Mosler’s new book “The 7 Deadly Innocent Frauds of Economic Policy” is a non technical guide to the actual workings of the monetary system and exposes the most commonly held misconceptions. He also founded Mosler Automotive, which builds the Mosler MT900, the world’s top performance car that also gets 30 mpg at 55 mph.

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What Policies for Global Prosperity?

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Antonio Foglia and Andrea Terzi interview Warren Mosler, Distinguished Research Associate of the Center for Full Employment and Price Stability, University of Missouri, Kansas City (participating via videoconferencing)

April 20, 2010

*Antonio Foglia* (AF): I have known Warren from his previous life as an investor, where he definitely proved his skills. Now, he is an economist and, as all economists, he thinks he has a recipe to fix the world. He is also becoming a politician, so he now has another reason for having a recipe to fix the world, and we are definitely most interested in learning what his recipes are today, at a very special conjuncture in the world.

Warren, thanks for being connected with us this evening. I know you are in Connecticut now. We are in Switzerland, so I think a more general point of view of the world is probably more of interest to all of us although I understand that you might be more current on how to fix the U.S., as that is where you hope to have an impact soon.

*Andrea Terzi* (AT): Hello from the Franklin Auditorium, Warren. The floor is yours.

*Warren Mosler* (WM): Thank you. Well, the most obvious observation is that unemployment is evidence of a lack of aggregate demand, so what the world is lacking is sufficient aggregate demand.

In the United States, my prescription includes 1) what we call a payroll tax holiday, i.e., a tax reduction, 2) a revenue distribution to the states by the federal government and 3) a federally funded $8.00-per-hour job for anyone willing and able to work. *

For the euro zone, I propose a distribution from the European Central Bank to the national governments of perhaps as much as 20 percent of GDP to be done on a per capita basis so it will be fair to all the member nations*. The interesting thing is that it would not increase spending, or demand, or inflation, because spending is already constrained by the Stability and Growth Pact (SGP), and so nations would still be required to keep spending down to whatever the EU requires, but what it does do is to eliminate the debt and financing issues, and it takes away the credit risk from the euro zone. The other thing it does is it gives the EU a far more powerful tool for enforcing its requirements. What happens is that anyone who does not comply with the EU’s requirements would risk losing this annual payment. Right now, anyone who does not comply gets fined, but, as we know, fines are not easy to enforce.

*AF*: I think that after three hours of Keynesian presentations today I didn’t expect anything else than an extra vote for more aggregate demand stimulation, on one side, and the irrelevance of printing more money, on the other side. Somehow, though, I do personally remain concerned, and don’t fully understand how, in the long run, this will not have side effects as people begin to actually expect the fact that more money is going to be printed, more demand is going to be stimulated in less and less productive ways (because it is basically government spending rather than private spending). If I look at history there is little evidence of how you get out from the sort of Keynesian policy that you are proposing, that is certainly very effective in stopping a depression from developing (and we are grateful that policy makers did that), but I don’t understand how you then stop those policies, and how the exit from those policies can happen in the medium and long term.

*WM*: Okay, so you put up a lot of things there. So I’ll start from the beginning. First of all, for the U.S., I’m talking about restoring income for people working for a living which will raise the sales in the private sector right now, so it’s not a question of government. You talk about stimulus, but I’m not talking about adding stimulus. I’m talking about removing drag. You can’t get something for nothing. If you have somebody running and a plastic bag falls over his head that slows him down you can remove that plastic bag. We are still limited by our productive potential, and what we have now are restrictive policies that are keeping us from achieving it. Restrictive policies are demand leakages. In the U.S., there is a powerful incentive not to spend your income as this goes into a pension fund, and in Europe you have the same types of things that reduce aggregate demand. The only way any sector can successfully “net save” is if another sector goes into deficit, so what the government is doing when it lowers taxes or increases spending, depending on what the case may be, is filling the hole in demand created by the demand leakages.

My proposal for the EU doesn’t increase anyone’s spending. All it does is this: As long as countries are in compliance with spending limits set by the EU, they receive the allocation. As soon as they are not in compliance, they risk losing this payment, in which case the market will severely punish them and cut them off. So, to address your questions, I am not advocating any excess spending stimulus beyond just making up for the drags created by what I call “saving desires” and “demand leakages” which are largely a function of the institutional structure.

Let me just say it in one more way. A government like the U.S. has to determine what the right size of government is. For example: what is the right size for the legal system? You don’t want to have to wait two years to get a court date, but you don’t want to have people calling you up asking you come to court because there are a lot of vacancies, so maybe the right waiting period is, say, 60 days. So you then size your legal system and your legal employees for that kind of public service.

Equally, you have to size the military for what the mission is. You have to size the whole government. *Once you’ve sized your government properly, you then have to determine the correct level of taxes that is needed to sustain the level of private-sector activity that you want, and invariably those taxes are going to be less than the size of the government.* So, even if you want a smaller government, which is fine, you then have to have taxes that are even lower. Why? Because that’s the only way you are going to accommodate your private sector on its savings desires.

*AT*: I know where you are coming from, Warren, and I’m sure you realize that your proposal that the ECB distribute money to European governments makes many people here in Europe jump on their seats for two reasons. One: the ECB is prevented by statute from financing national governments; and two: people fear that this is further additional printing money, creating inflation. Would you mind going back to your proposal and explaining to me and the audience, step by step, what this distribution really means, where this money comes from, and where it is going, in this score-keeping exercise that is the true character of a monetary economy?

*WM*: Right, exactly. So, yes, it would require unanimous approval of EU governments. What I’m saying is that European governments have accounts at the ECB. Under my proposal, the ECB would put a credit balance into government accounts. So what will happen is that the balance in their accounts will go up. *Just because a balance on a national bank account goes up, it does not mean there is any additional spending. It is spending that causes inflation, not just the existence of a credit balance on a central bank computer.* But what would then happen is that in the normal course of spending, borrowing and debt management, this balance would be worked down. Not by an increased volume of spending and not by a change in anything else, but it would just be worked down because, for example, when the Greek bonds would mature, the government would be able to continue its normal spending (this would be limited by compliance with the SGP and other international agencies) without having to refinance its bonds. But once the credit balance is used up, then Greece would continue its normal refinancing, but with a level of debt reduced by about 20 percent GDP the first year.

So again this has no effect on the real economy, no effect on real spending. The only effect is that there would be fewer Greek securities outstanding, and that Greek debt levels would be lower and coming down, which would facilitate their continued funding once the credit balance is used up. So it’s purely, as you stated, an operational consideration and not a real economic consideration, and yes, *people would be afraid of things that they don’t understand*. But anyone who understood central banking from the inside at the operational level would realize that this would have absolutely no effect on inflation, employment, and income in a real economy, other than to facilitate the normal funding of national governments.

*AT*: Are you saying that the effect of such annual distribution would be like the effect of the discovery of a new gold mine every year in a country under the gold standard?

*WM*: Well, no, it’s different, because on a gold standard what we call the money supply is constrained in any case, whereas when you get to a currency it’s the opposite: the currency itself is never constrained. So you have a whole different dynamic.

Let me just expose my point from a slightly different point of view. The reason the EU can’t simply guarantee all the nations, and the ECB can’t simply guarantee all the national governments is because if they did, whoever “deficit spends” the most, wins. You would get a race to the bottom of extreme moral hazard that quickly winds up in impossible inflation. So there has to be some kind of mechanism to control government deficit spending for the member nations*. They did it through the SGP, that sets the 3 percent limit, and there’s no way around that dilemma. It can’t be done through market forces. It has to be done through the SGP. What they did is to leave the national government on a stand-alone basis, so there would be market discipline, but we’ve seen that that does not work either. They’ve got to get back to a situation where they are not subject to the mercy of market forces but at the same time they don’t want the moral hazard of some unlimited fiscal expansion where anybody can run a 5, 10, 20 percent deficit with inflationary effects.

My proposal eliminates the credit risk at the national government level, so they are no longer restrained by the markets in their ability to borrow, but it makes them dependent on annual distributions from the ECB in order to maintain this freedom to fund themselves*.

And because they are dependent on the ECB’s annual check, the ECB has a policy to then be able to remove that check to impose discipline on these countries. *By having this policy tool to withhold payments, rather than implement fines, the EU would be in a much stronger position to enforce the deficit limits they need to prevent the race to the bottom of nations*.

*AT*: Your proposed ECB distribution would have the immediate effect of reducing the interest rate spread between German and Greek bonds. However, if the 3-percent deficit constraint remains in place, there is not much hope of prosperity in Europe. Do you agree?

*WM*: Right. The demand management would be based on the SGP: if they decide a 3-percent deficit is not adequate for the level of aggregate demand they may go up to 4, 5, or 6 percent or whatever level they choose. It’s always a political decision for them, and it’s always going to be a political decision. If they choose something too low, then they’re going to have higher unemployment. If they choose something too high, they’re going to have inflation.

And so it’s going to be a political choice, no matter how you look at. But the thing is, how do you enforce the political choice? Right now they can’t enforce it. Right now, they’ve been enforcing it through the fining of member nations. But it doesn’t work. So they’ve lost their enforcement tool.

The other problem they have is this: because of the credit sensitivity of the national governments, when countercyclical deficits go up like now, which are needed to restore aggregate demand, output and employment, what happens is that the deficits challenge the creditworthiness of the national governments. *This is an impossible situation with national governments risking default because of the insolvency risk. They are in a completely impossible position to accomplish any of their goals. *

Whereas, reversing the situation, i.e., going from “fines as discipline” to “withholding payments as discipline” puts them in a position that is manageable. It still then requires wise management for the correct level of deficits, for the correct level of aggregate demand, but at least it’s possible. Right now, it’s unstable equilibrium, and what I am proposing switches it to a stable equilibrium, as they used to say in engineering class.

*AF*: If I understand correctly, the essence of the policies that you are suggesting, both in the U.S. and in Europe, involve a certain level of deficit spending and debt accumulation. Then one could expect the dollar/euro exchange rate not to move much because people would probably tend to dislike both currencies the same way. How would you see the interaction of these two areas with emerging markets that are in a totally different economic environment and cycle, and whose currencies are actually currently on the rise?

*WM*: Right, if you look at nations like India and even Brazil, they all have high interest rates and high deficits that help them get through. China, as well, maintains an extremely high deficit offsetting its internal savings desires. China may have overdone it, and it has to face an inflation problem, but this is a different story. *I think that the U.S. is in a far better situation than the euro zone right now, because our budget deficits do not represent the sustainability issues or credit issues*.

The EU has put its member nations in the same position as the U.S. states, as if Germany, or Greece, were like Connecticut, or California. They put all their member nations in the same position as state governments but without the federal government spending that the U.S. uses to help them out. This puts the whole burden of sustaining aggregate demand on European member nations. To get an analogy in the U.S., *if the U.S. had to run a trillion and a half million dollar deficit last year at the federal level, and if the only way that could have happened was at the state level, the U.S. would have been in much the same position as the EU, with all our states right on the edge of default.* So because we have our deficit at the federal level, instead of state level, we are in a much stronger position than the EU right now.

You may have already reviewed the mechanics of how nations like the U.S. or the U.K. do their public spending in the conference, but let me do it very quickly. When the United States spends money that it doesn’t tax, it credits the reserve account of whoever gets that money. Now, a reserve account at the central bank is nothing more than a checking account.

Let me now use the example of China so I can combine the problem of external debt with deficit spending at the same time. China gets its dollars by selling goods and services in the United States. When China gets paid, the dollars go into its checking account at the Federal Reserve Bank, and when China buys Treasury securities, all that happens is that the Federal Reserve transfers the funds from their checking account at the Federal Reserve to their securities accounts at the Federal Reserve. U.S. Treasury securities are accounted much like savings accounts at a normal commercial bank. When they do that, it’s called “increasing the national debt”, although when it’s in their checking account it doesn’t count as national debt. The whole point is that the spending of dollars by the federal government is nothing more than the Federal Reserve Bank changing numbers off in someone’s reserve account. The person doing this at the Treasury doesn’t care if funds are in the reserve account at the central bank; it makes no difference at all, operationally. *There is no operational connection between spending, taxing, and debt management.* Operationally, they are completely distinct. And the way any government like the United States or the U.K. or Japan pays off its debt is the same: just transfer funds from someone’s security accounts back to the reserve accounts at your own central bank, that’s it. And this happens every week with hundreds of billions of dollars. None of this acts as an operational constraint on government spending. There is no solvency issue. There is no default condition in the central banks’ computer.

Now, when you get to the EU, it all changes because all this has been moved down to the national government level, and it’s not at some kind of federal level the way it is in the United States. There is no default risk for the U.S., for the U.K., or for Japan where the debt is triple that of the U.S. and double that of Greece. It is all just a matter of transferring funds from one account to another in your own central bank.

*AT*: I’m glad you touched upon the question of China accumulating credits with the U.S., because this is poorly understood. Money that Chinese earn by sending merchandise to the United States are credits in the U.S., and these credit units are nonredeemable, so Chinese owners can do nothing with these things unless they use them to buy American products, and if they do, those units become profits for American firms. But there is also another possibility, which sometimes raises concerns in the larger public, and this is what happens if China should choose to get rid of these dollars by selling the U.S. securities they own. While the amount of dollars owned by foreigners doesn’t change, the price of the dollar would in fact decline. If China sells off American debt, dollar depreciation may be substantial.

*WM*: Operationally, it’s not a problem because if they bought euros from the Deutsche Bank, we would move their dollars from their account at the Fed to the Deutsche Bank account at the Fed. The problem might be that the value of the dollar would go down. Well, one thing you’ve got to take note of is that the U.S. administration is trying to get China to revaluate currency upward, and this is no different from selling off dollars, right? So, what you are talking about (selling off dollars) is something the U.S. is trying to force to happen, would you agree with that?

*AT*: Yes!

*WM*: Okay, so we’re saying that we’re trying to force this disastrous scenario—that we must avoid at all costs—to happen. This is a very confused policy. *What would actually happen if China were to sell off dollars? Well, first of all, the real wealth of the U.S. would not change: the real wealth of any country is everything you can produce domestically at full employment plus whatever the rest of the world sends you minus what you have to send them, which we call real terms of trade.* This is something that used to be important in economics and has really gone by the wayside. And the other thing is what happens to distribution. While it doesn’t directly impact the wealth of the U.S., *the falling dollar affects distribution within U.S., distribution between those who profits from exports and those who benefit from imports.* And that can only be adjusted with domestic policy. So, number one, we are trying to make this thing happen that we are afraid of, and number two, if it does happen, it is a demand-distribution problem, and there are domestic policies to just make sure this happens the way we want it to be.

*AT*: Would you like to elaborate on another theme of today’s symposium? How do you see the income distribution effects of the U.S. fiscal package? Is it going in the right direction in your opinion?

*WM*: Well, we had 5 percent growth on the average maybe for the last 2 quarters while unemployment has continued to go up. If GDP is rising and people in the world are getting hurt, and real wages are continuing to fall, then who is getting the real growth? Well, everybody else. And so what we’ve seen from a Democratic administration is perhaps the largest transfer of real wealth from low income to high income groups in the history of the world. Now, I don’t think that was the intention of their policies but it has certainly been a result, and it comes from a government that does not understand monetary operations and a monetary system and how it works.

*AT*: Warren, what would be your first priority, the one action that you would enforce immediately to improve the current situation?

*WM*: The United States has a punishing regressive tax which we call payroll taxes. These take out a fixed percent of our income, 15 percent (7.5 percent paid by employees and 7.5 percent by employers), so it starts from the very first dollar you earn, and the cap is $108,000 a year. *I would immediately declare a payroll tax holiday, suspend the collection of these taxes. This would fix the economy immediately from the bottom up. A person making $50,000 a year would see an extra $325 a month in his pay check, simply by having the government stop subtracting these funds from his or her pay.

Our economy has always worked best if people working for a living have enough take-home pay to be able to buy the goods and services that they produce. Right now, in the United States, people working for a living are so squeezed they can pay for gasoline and for food and that’s about it, maybe a little bit of their insurance payments, and so we’ve had an economic and social disaster. *The cause of the financial crisis has been people unable to make their payments.* The only difference between a Triple-A loan and “toxic assets” is whether people are making their payments or not. And you can fund the banks and restore their capital and do everything else, but it doesn’t help anyone making their payments. We’re two years into this and we’re still seeing delinquencies moving up, although they levelled off a little bit, at unthinkably high levels. Hundreds of thousands of people getting thrown out of their homes—that’s the wrong way for a Democratic administration to address a financial crisis.

To fund a bank, simply stop taking the money away from people working for a living so they can make their payments and fix the financial crisis from the bottom up. *All that businesses and banks need and want at the end of the day is a market for their products; they want people who can afford to make their payments and buy their products.* So my first policy would deliver exactly that, which is what I think we need to take the first big step to reverse what’s going on.

*AT*: The action you proposed, the payroll tax holiday, entails some form of discretionary fiscal policy and this raises two questions. First, discretionary fiscal policy has been discredited. Economists like to model politicians’ behavior in a way that we cannot trust their decisions as they just aim at winning the next elections. So how do we make sure that discretionary fiscal policy would be used correctly to achieve full employment and avoid inflation?

*WM*: My proposal is not talking about discretionary spending. It’s about cutting taxes and restoring incomes for people who are actually working for a living, who are the people that at the end of the day we all depend on for our lifestyle, so it is not an increase in government spending, it is a tax cut on people working for a living. The only reason this hasn’t happened is because of what I call “the innocent fraud” (from my book, *The seven deadly innocent frauds*, available on my website), that the government has run out of money, the government is broke, the federal government has to get funding, has to get revenues from those who pay tax, or it has to borrow from China and leave it to our children to pay back. This is complete myth, and it is the only barrier between us and prosperity. Now, in terms of using excess capacity and create inflation, the theory says yes, it can happen, though I’ve never seen it in my forty years in the financial markets.

As they say, in order to get out of a hole, first you have to stop digging, right? Right now, we’ve got an enormous amount of excess capacity in the United States. Unemployment is at 10% only because they changed the way they define it. Using the old method, we have up to 22% unemployment.

The payroll tax holiday will both increase spending power and lower costs, so we get a little bit of deflationary effect as spending starts. Should there be a time when we see demand starts threatening the price level, then it can come a point where it makes sense to raise taxes, but not to pay for China, not to pay for social security, not to pay for Afghanistan (we just need to change the numbers up in bank accounts) but to cool down demand. We have to understand that taxes function to regulate aggregate demand and not to fund expenditures.

*AT*: Discretionary fiscal policy also includes discretionary changes in taxes, not only discretionary changes in spending, so how do we make sure that the political ruling class will raise taxes when needed?

*WM*: Well, right now they’re raising taxes, so they don’t seem to have much of a reluctance to do that, and they also understand that voters have an intense dislike for inflation. It’s not justified by the economic analysis, it’s just an emotional dislike for inflation. They believe it’s the government robbing people of their savings and they believe it’s morally wrong. And so they are always under intense pressure to make sure that inflation does not get out of control or they are going to lose their jobs. But that’s the checks and balances in a democracy. It’s what the population votes for. And the American population has shown itself to vote against inflation time and time again. The population decides they want more or less inflation, it boils down to whether you believe in democracy or you don’t. And I’m on the side to believe in democracy.

*AT*: In terms of democracy, this choice is not available to Europeans right now. The ECB has been given an institutional mandate of price stability, and the decision of what’s more evil, inflation or unemployment, has been removed from voters’ preferences on the ground that price stability is the premise to growth and full employment!

But I’m afraid our time is over. Warren, thank you very much. Although the volcano in Iceland prevented you from attending today, at least we had this opportunity to discuss via teleconference.

*WM*: Was the volcano a result of the financial crisis over there?

*AF*: It was a way for Iceland to take revenge on the Brits!

Warren, we thank you very much for making this conference possible and thank you for your time. I encourage anybody who is interested to go to your website to get a view of your most recent ideas, and all the best from this side of the Atlantic on your campaign.

*WM*: Thank you. If anyone has more questions just write to my email address warren.mosler@gmail.com and I’ll be happy to correspond with anyone looking for more information.

*AT*: Thank you Warren.

*WM*: Okay, thank you all!

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Fed Mulls Trillion-Dollar Policy Question

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Fed Mulls Trillion-Dollar Policy Question

How much of a boost to the U.S. recovery could another trillion dollars or two buy?

None, never has, never will. get over it!!! It’s about price (interest rates), not quantity. and lower interest rates won’t do much, if anything, for aggregate demand, output, and employment.

That’s a tricky question for the Federal Reserve when it meets Tuesday to debate what would warrant pumping more money into the financial system.

QE shifts balances from securities accounts to reserve accounts. Net financial assets remain unchanged.

To battle the financial crisis, the Fed bought $1.7 trillion of longer-term Treasury and mortgage-related bonds, supplementing its pledge to keep interest rates near zero for a long time.

That lowered long term rates in general a tad or so, maybe. What brought long rates down was the notion that the Fed would be low for long due to the weak econ forecasts.

All told, it helped stabilize a collapsing financial system and to avert what could have been a second Great Depression.

Yes, buying the likes of GE commercial paper may have kept GE alive. That’s a case of taking credit risk and ‘investing’ in a company when the private sector would not, rather than using the receivership process, as happened with AIG and Lehman, though with differing degrees of govt. support.

Now, faced with a 9.6 percent jobless rate and below-target inflation, Fed policymakers are trying to gauge how much they could achieve if they resume massive quantitative easing.

Their research staff will probably tell them it’s all psychological

Few analysts expect the Fed to launch a new round of bond buying this week, and uncertainty over the impact of fresh moves may be a factor keeping the central bank on the sidelines. 
 

“I think part of the hesitancy of the committee to use quantitative easing a second time around relates to views of its effectiveness,” said Vince Reinhart, a former Fed staffer.

Exactly. The astute ones know there is no effect of consequence

At the Fed’s August meeting it decided to reinvest maturing mortgage-debt in Treasuries to keep its balance sheet steady, a move many analysts saw as a precursor to more easing.
 
Proponents of a relaunch of large-scale bond-buying say it will help prevent inflation expectations from falling and spur growth by further reducing borrowing costs for consumers and businesses.

Still mired in mythical inflations expectations theory

Skeptics say the economic recovery has just hit a weak patch. They argue that more easing could be ineffective in helping the economy, potentially damaging Fed credibility. 

 
An incremental drop in long-term yields may not be enough to force banks to stop hoarding safe-haven Treasuries and make loans to businesses instead, some analysts warn.

As if banks are turning down good loans at 5% to buy TSY secs at 1%

Some policymakers worry that more easing could fuel market imbalances or sow the seeds of sky-high inflation ahead.

 
There is also the risk that the Fed spooks investors.

All sounds very scientific to me…

“My own view is that any radical balance sheet program would be seen by many as an act of desperation which would dampen business sentiment and depress non-financial borrowing even more,” said Wrightson ICAP Chief Economist Lou Crandall.

 
Hard to Measure Success

 
Fed bond purchases can have two effects. They can increase liquidity in strained markets

As if marginal changes in liquidity alter the real economy

and, by lowering yields, force investors to look for returns in riskier asset classes, helping to boost the supply of credit in the economy.

That would lower the price of credit some from where it is, not increase the supply

In addition, some officials believe bond buying helps solidify trust among investors that the Fed will keep policy easy for longer, further helping to lower borrowing costs.

Investors know the Fed’s reaction function is based on inflation and employment, which they believe are largely functions of economic conditions.

The New York Federal Reserve Bank estimates that the $1.7 trillion of purchases lowered the yield on the 10-year Treasury note by between 30 and 100 basis points.

The estimate is based in part on the sharp drop in yields that occurred when the Fed first announced its large-scale bond-buying program.

 
But this “announcement effect” approach does not show how yields acted over the course of the program and may not appropriately capture the impact, analysts say.

 
It is tough to gauge how much of a move in yields can be tied to the Fed’s actions after the fact, and it is also extremely difficult to predict the impact of another move.

 
When it comes to the benchmark overnight federal funds rate, “you can come up with rough orders of magnitude of the impact, but with quantitative easing there is so much uncertainty, you can’t calculate it with any type of precision,” said Dino Kos, former head of the New York Fed’s markets group and a managing director at Portales Partners LLC.

 
The success of the first round of purchases may have been amplified by the stressed nature of markets at the time, as well as the fact that the purchases were focused on the smaller, less-liquid agency mortgage-backed securities market.

 
“If you show up and purchase assets when markets are stressed, you are not pushing back against much conviction so you can move prices more easily,” said Reinhart, the former Fed staffer.

 
To get a significant effect in the Treasury market—where any new round of purchases would likely be centered—could be harder, says Mark Gertler, a professor at New York University.

 
“Evidence suggests it would take a huge purchase of long-term government bonds, maybe the whole market, to really have any effect, and the effect would be quite uncertain.”

 
Rather than announcing such an eye-popping amount upfront, the Fed could decide to buy Treasuries in smaller steps, calibrated to the economic outlook at each meeting.

 
Forecasting firm Macroeconomic Advisors estimates each $100 billion in asset buys could lower the yield on the 10-year Treasury note by 0.03 percentage point.

 
That is a marginal move that could go unnoticed, though if Fed buying helped nudge up the inflation rate it could get a bit more of a bang for its buck on real rates.

 
Even a small amount of easing is not to be sneezed at, says Michael Feroli, chief U.S. economist at JPMorgan Chase.

 
“If you have a headache and only one aspirin left, do you decide not to take it because you wish you had two aspirins?”

“Mosler says that since the Fed buying secs is functionally the same as the Tsy not issuing them in the first place, why not just have the Tsy stop issuing long term securities if the goal is to lower long term rates? And the benefit of lower rates is that with today’s institutional structure they probably reduce aggregate demand and thereby allow for lower taxes for a given size govt. But when the govt doesn’t understand this and keeps taxes too high we all pay the price with higher unemployment and a wider output gap.”

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