Tag Archives: Central Bank

President Obama entering the fray

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More of the blind leading the blind. The one thing they all agree on, at great expense to global well being, is the budget deficits are all too large and the need for shared sacrifice and all that.

No chance for anything constructive to come out of any of this.

And these masters of their money machines don’t even know how to inflate, as they all desperately try to inflate with their versions of quantitative easing, which, functionally, is just another demand draining tax.

*DJ Merkel, Obama Discussed How To Boost EFSF Firepower Without ECB
*DJ Obama To Merkel: We Are Totally Invested In Your Success – Source
*DJ Geithner, Schaeuble May Meet To Discuss IMF Role In Euro Crisis -Source

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The Independent: UK Bank deputy chief warning

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Bank deputy chief warns of market trouble to come

by Ben Russell, Political Correspondent and Sean O’Grady

Britain is facing the risk of renewed turmoil in the financial markets, the new deputy governor of the Bank of England warned yesterday.

Professor Charlie Bean, the deputy governor for monetary policy and a former chief economist at the Bank, raised the prospect of a slowing global economy triggering a new round of problems with corporate loans and said that the impact of the credit squeeze could be greater than Bank projections.

Yes, but unlike the Eurozone, the BoE is permitted to ‘write the check’ as in the treasury.

National solvency is not an issue in the UK as it is in the Eurozone when weakness is addressed.

He told members of the Commons Treasury Select Committee that Britain faced “major conflicting risks” threatening the Government’s inflation target from the problems of a slowing economy and rising commodity prices.

Yes, the twin themes of weakness and inflation.

In a memorandum to the committee, Professor Bean warned that the “dislocation” in the financial markets “probably has further to run, especially if a slowing economy here and abroad generates a second round of write-downs, this time associated with corporate loans. Moreover, the impact of the tightening in the terms of availability of credit could prove greater than is embodied in the central case in our most recent set of projections”.

Agreed. And while ‘writing the check’ can readily address these issues with no risk to government solvency, it will also support the higher prices he next discusses:

He said that increasing oil and other commodity price rises would lead to higher inflation becoming “embedded in the economy”, warning that people might seek to offset price increases by making higher wage demands. He said: “There is no doubt that the UK economy presently faces the most challenging set of circumstances since at least the early 1990s and probably earlier.”

Professor Bean said oil prices could continue to rise for another two years and cautioned that Britain faced the danger of a pay-price spiral if workers tried to compensate by pushing up wages. He said: “It certainly poses a significant challenge. There is no doubt about that at all. It may be a relatively unlikely event but it could be particularly unfortunate if it happened, if households and businesses start losing faith in the idea that inflation will stay low, round about the target, they start building it into their pay and prices and inflation becomes much more embedded into the system… Provided pay growth remains subdued, the current pick-up in inflation will be temporary.”

Living standards, the deputy governor stressed, will inevitably be lower because of the global inflation in commodity prices.

Agreed. It’s all about real terms of trade, which have also been declining rapidly in the US as evidenced by the drop in growth of GDP and the drop in non-oil trade deficit.

My guess is the most likely political response in the US and the UK is proactive deficit spending from the treasury to address the weakness and higher interest rates to address the inflation.

Unfortunately the deficit spending that supports domestic demand will also support crude consumption (as well as housing) and ‘monetize’ the ever higher crude prices being set by the Saudis, thereby supporting ‘inflation’ in general.

And this will trigger ever higher interest rates from the Central Bank as inflation trends even higher.

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2008-01-21 Update

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Major themes intact:

  • weak economy
  • higher prices

Weakness:

US demand soft but supported by exports.

US export strength resulting from non resident ‘desires’ to reduce the rate of accumulation of $US net financial assets. This driving force is ideologically entrenched and not likely to reverse in the next several months.

In previous posts, I suggested the world is ‘leveraged’ to the US demand for $700 billion per year in net imports, as determined by the non resident desire to accumulate 700 billion in $US net financial assets.

US net imports were something over 2% of rest of world GDP, and the investment to support that demand as it grew was probably worth another 1% or more of world GDP.

The shift from an increasing to decreasing US trade deficit is a negative demand shock to rest of world economies.

This comes at a time when most nations have decreasing government budget deficits as a percent of their GDP, also reducing demand.

The shift away from the rest of world accumulation of $US financial assets should continue. Much of it came from foreign CB’s. And now, with Tsy Sec Paulson threatening to call any CB that buys $US a ‘currency manipulator’, it is unlikely the desire to accumulate $US financial assets will reverse sufficiently to stop the increase in US exports. I’m sure, for example, Japan would already have bought $US in substantial size if not for the US ‘weak dollar’ policy.

All else equal, increasing exports is a decrease in the standard of living (exports are a real cost, imports a benefit), so Americans will be continuing to work but consuming less, as higher prices slow incomes, and output goes to non residents.

I also expect a quick fiscal package that will add about 1% to US GDP for a few quarters, further supporting a ‘muddling through’ of US GDP.

Additional fiscal proposals will be coming forward and likely to be passed by Congress. It’s an election year and Congress doesn’t connect fiscal policy with inflation, and the Fed probably doesn’t either, as they consider it strictly a monetary phenomena as a point of rhetoric.

Higher Prices:

Higher prices world wide are coming from both increased competition for resources and imperfect competition in the production and distribution of crude oil. In particular, the Saudis, and maybe the Russians as well, are acting as swing producer. They simply set price and let output adjust to demand conditions.

So the question is how high they will set price. President Bush recently visited the Saudis asking for lower prices, and perhaps the recent drop in prices can be attributed to those meetings. But the current dip in prices may also be speculators reducing positions, which creates short term dips in price, which the Saudis slowly follow down with their posted prices to disguise the fact they are price setters, before resuming their price hikes.

At current prices, Saudi production has actually been slowly increasing, indicating demand is firm at current prices and the Saudis are free to continue raising them as long as desired.

The current US fiscal proposals are designed to help people pay the higher energy prices, further supporting demand for Saudi oil.

They may also be realizing that if they spend their increased income on US goods and services, US GDP is sustained and real terms of trade shift towards the oil producers.

Conclusion:

  • The real economy muddling through
  • Inflation pressures continuing

A word on the financial sector’s continuing interruptions:

With floating exchange rates and countercyclical tax structures we won’t see the old fixed exchange rate types of real sector collapses.

The Eurozone banking sector is the exception, and remains vulnerable to systemic failure, as they don’t have credible deposit insurance in place, and, in fact, the one institution that can readily ‘write the check’ (the ECB) is specifically prohibited by treaty from doing so.

Today, in most major economies, fiscal balances move to substantial, demand supporting deficits with an increase in unemployment of only a few percentage points. Note the US is already proactively adding 1% to the budget deficit with unemployment rising only 0.3% at the last initial observation in December. In fact, fiscal relaxation is being undertaken to relieve financial sector stress, and not stress in the real economy.

Food and energy have had near triple digit increases over the last year or so. Even if they level off, or fall modestly, the cost pressures will continue to move through the economy for several quarters, and can keep core inflation prices above Fed comfort zones for a considerable period of time.

Fiscal measures to support GDP will add to the perception of inflationary pressures.

The popular press is starting to discuss how inflation is hurting working people. For example, I just saw Glen Beck note that with inflation at 4.1% for 07 real wages fell for the first time in a long time, and he proclaimed inflation the bigger fundamental threat than the weakening economy.

I also discussed the mortgage market with a small but national mortgage banker. He’s down 50% year over year, but said the absolute declines leveled off in October, including California. He also pointed out one of my old trade ideas is back – when discounts on pools become excessive to current market rates, buy discounted pools of mortgages and then pay mortgage bankers enough of that discount to be able refinance the individual loans at below market rates.

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Why I expect US exports to continue to be very strong..

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The desire to accumulate $US financial assets has been diminished for at least the following reasons:

  1. Treasury policy – Paulson is actively pushing both a strong yuan and threatening any other CB that buys $US with the label of ‘currency manipulator.’ CB’s had been perhaps the largest source of $US financial assets accumulation and are now limited to compounding of interest.
  2. US foreign policy is probably driving CB’s in less than friendly nations to diversify their reserves away from $US financial assets.
  3. Fed policy has the appearance of a ‘beggar thy neighbor’/’inflate your way out of debt’ policy, as the Fed aggressively cuts rates in the face of inflation not seen in 25 years.

This all sets in motion a downward pricing of the $US as non residents sell them to each other at lower and lower prices in this effort to lower their rate of accumulation of $US financial assets. But these financial assets can only ‘go away’ when they get spent or invested in the US, when US prices are low enough to cause this to happen. The rapid rise in exports and accelerated non resident buying of US real estate and other assets is anecdotal evidence this is taking place as theory predicts.

This is a very large cyclical force that should continue to drive rapidly rising exports for perhaps a year or more. Weak foreign economies should have little effect on this process, as that weakness doesn’t reduce the desire of portfolio managers to shift out of $US financial assets.

This is also highly inflationary for the US. This buying by non residents both drives down the $US and drives up the prices of US exports, now rising at a 7% clip last I checked.

The desired shift is probably well over $1 trillion which means exports will increase by a good part of that to facilitate this transfer.

This can sustain US GDP in the face of falling domestic demand, which will stay relatively low until housing picks up. Employment will remain reasonably good, but standards of living fall as we produce as much, but export more and consume less. We get paid to work but can buy less due to high prices, with our remaining production exported to those wishing to reduce their accumulated $US financial assets.

We’ve been talking about this possibility about a long time, but seems our trade negotiators have finally got their wish.

Meanwhile, Saudis continue to act the swing producer. In fact, they told Bush today they have 2 million bpd capacity in reserve, and that markets are well supplied. At their price, of course.

Probably have been some year end allocations out of crude by pension funds as with the price hikes they would need to sell some to keep the same ‘weight’ in their portfolios. That should be ending soon.

And I agree with Karim, the Fed is not likely to act on inflation until core starts to rise or their measures of inflation expectations start to rise, despite the fact that mainstream theory clearly says if any of that happens it’s too late. Seems to me the senior FOMC members are putting their jobs on the line by taking that kind of systemic risk, which their own theory tells them is far higher than the risk of any lost output from a .

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Crisis may make 1929 look a ‘walk in the park’

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Crisis may make 1929 look a ‘walk in the park’

Telegraph
by Ambrose Evans-Pritchard

As central banks continue to splash their cash over the system, so far to little effect, Ambrose Evans-Pritchard argues that things risk spiralling out of their control

Twenty billion dollars here, $20bn there, and a lush half-trillion from the European Central Bank at give-away rates for Christmas.
Buckets of liquidity are being splashed over the North Atlantic banking system, so far with meagre or fleeting effects.

It’s about price, not quantity (net funds are not altered), and the CB actions have helped set ‘policy rates’ at desired levels.

That is all the CBs can do, apart from altering the absolute level of rates, which, by their own research, does little or nothing and with considerable lags.

Not to say changing rates isn’t disruptive as it shifts nominal income/wealth between borrowers and savers of all sorts.

As the credit paralysis stretches through its fifth month, a chorus of economists has begun to warn that the world’s central banks are fighting the wrong war, and perhaps risk a policy error of epochal proportions.

“Liquidity doesn’t do anything in this situation,” says Anna Schwartz, the doyenne of US monetarism and life-time student (with Milton Friedman) of the Great Depression.

The last major, international fixed exchange rate/gold standard implosion. Other since – ERM, Mexico, Russia, Argentina – have been ‘contained’ to the fixed fx regions.

“It cannot deal with the underlying fear that lots of firms are going bankrupt. The banks and the hedge funds have not fully acknowledged who is in trouble. That is the critical issue,” she adds.

The critical issue at the macro policy level is what it is all doing to the aggregate demand that sustains output, employment, and growth. So far so good on that front, but it remains vulnerable, especially given the state of knowledge of macro economics and fiscal/monetary policy around the globe.

Lenders are hoarding the cash, shunning peers as if all were sub-prime lepers. Spreads on three-month Euribor and Libor – the interbank rates used to price contracts and Club Med mortgages – are stuck at 80 basis points even after the latest blitz. The monetary screw has tightened by default.

The CB can readily peg Fed Funds vs. LIBOR at any spread they wish to target.

York professor Peter Spencer, chief economist for the ITEM Club, says the global authorities have just weeks to get this right, or trigger disaster.

Seems they pretty much did before year end. Spreads are narrower now and presumably at CB targets.

“The central banks are rapidly losing control. By not cutting interest rates nearly far enough or fast enough, they are
allowing the money markets to dictate policy. We are long past worrying about moral hazard,” he says.

They have allowed ‘markets’ to dictate as the entire FOMC and others have revealed a troubling lack of monetary operations and reserve accounting.

“They still have another couple of months before this starts imploding. Things are very unstable and can move incredibly fast. I don’t think the central banks are going to make a major policy error, but if they do, this could make 1929 look like a walk in the park,” he adds.

Hard to do with floating exchange rates, but not impossible if they try hard enough!

The Bank of England knows the risk. Markets director Paul Tucker says the crisis has moved beyond the collapse of mortgage securities, and is now eating into the bedrock of banking capital. “We must try to avoid the vicious circle in which tighter liquidity conditions, lower asset values, impaired capital resources, reduced credit supply, and slower aggregate demand feed back on each other,” he says.

Seems a lack of understanding of the ‘suppy side’ of money/credit is pervasive and gives rise to all kinds of ‘uncertainties’ (AKA – fears, as in being scared to an extreme).

New York’s Federal Reserve chief Tim Geithner echoed the words, warning of an “adverse self-reinforcing dynamic”, banker-speak for a downward spiral. The Fed has broken decades of practice by inviting all US depositary banks to its lending window, bringing dodgy mortgage securities as collateral.

Banks can only own what the government puts on their ‘legal list’, and banks can issue government insured deposits, which is government funding, in order to fund government approved assets.

Functionally, there is no difference between issuing government insured deposits to fund their legal assets and using the discount window to do the same. The only difference may be the price of the funds, and the fed controls that as a matter of policy.

Quietly, insiders are perusing an obscure paper by Fed staffers David Small and Jim Clouse. It explores what can be done under the Federal Reserve Act when all else fails.

Section 13 (3) allows the Fed to take emergency action when banks become “unwilling or very reluctant to provide credit”. A vote by five governors can – in “exigent circumstances” – authorise the bank to lend money to anybody, and take upon itself the credit risk. This clause has not been evoked since the Slump.

The government already does this. They already determine legal bank assets, capital requirements, and via various government agencies and association advance government guaranteed loans of all types.

This is business as usual – all presumably for public purpose.

Get over it!!!

Yet still the central banks shrink from seriously grasping the rate-cut nettle. Understandably so. They are caught between the Scylla of the debt crunch and the Charybdis of inflation. It is not yet certain which is the more powerful force.

Yes, as they cling to the belief that ‘inflation’ is a ‘strong’ function of interest rates, while it is an oil monopolist or two and a government induced and supported link from crude to food via biofuels that are driving up CPI and inflation in general.

America’s headline CPI screamed to 4.3 per cent in November. This may be a rogue figure, the tail effects of an oil, commodity, and food price spike. If so, the Fed missed its chance months ago to prepare the markets for such a case. It is now stymied.

CPI might also be headed higher if crude continues its advance.

This has eerie echoes of Japan in late-1990, when inflation rose to 4 per cent on a mini price-surge across Asia. As the Bank of Japan fretted about an inflation scare, the country’s financial system tipped into the abyss.

As I recall, it was a tax hike that hurt GDP.

Yes, the world economies are vulnerable to a drop in GDP growth, but the financial press seems to have the reasoning totally confused.

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it’s about price, not quantity

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It’s about price, not quantity.

CB’s don’t alter net reserve positions – they ‘offset operating factors’ and set interest rates.

Fed to redeem $14.02 bln of bill holdings Dec. 27

Thu Dec 20, 2007 11:20am EST

NEW YORK, Dec 20 (Reuters) – The U.S. Federal Reserve said on Thursday it will redeem the full amount of maturing Treasury bill holdings, amounting to $14.02 billion on Dec. 27.

The redemption, a move to drain liquidity from the banking system, will take place via the Federal Reserve’s System Open Market Account or SOMA.

“The Federal Reserve Open Market Trading Desk will continue to evaluate the need for the use of other tools, including further
Treasury bill redemptions, reverse repurchase agreements and Treasury bill sales,” the Fed said in a statement on the New York Fed’s Web site. (Reporting by John Parry; Editing by James Dalgleish)

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