In the Financial Times today, Martin Wolf comes out swinging (free registration required) against those who are afraid the Fed’s Quantitative Easing programs carry a danger of sparking serious inflation.
The essence of the contemporary monetary system is creation of money, out of nothing, by private banks’ often foolish lending. Why is such privatisation of a public function right and proper, but action by the central bank, to meet pressing public need, a road to catastrophe? When banks will not lend and the broad money supply is barely growing, that is just what it should be doing (see chart).
The hysterics then add that it is impossible to shrink the Fed’s balance sheet fast enough to prevent excessive monetary expansion. That is also nonsense. If the economy took off, nothing would be easier. Indeed, the Fed explained precisely what it would do in its monetary report to Congress last July. If the worst came to the worst, it could just raise reserve requirements. Since many of its critics believe in 100 per cent reserve banking, why should they object to a move in that direction?
Now turn to the argument that the Fed is deliberately weakening the dollar. Any moderately aware person knows that the Fed’s mandate does not include the external value of the dollar. Those governments that have piled up an extra $6,800bn in foreign reserves since January 2000, much of it in dollars, are consenting adults. Not only did no one ask China, the foremost example, to add the huge sum of $2,400bn to its reserves, but many strongly asked it not to do so.
Everything he says is correct, but that’s not really any help, because the implications are pretty severe, even if he’s completely right.
First, let’s assume the Fed can, via repos or changes in reserve requirements, sterilize the increase in the money supply. The problem then becomes when does the Fed do this sterilization. let’s go back to 1981-1982. When the Fed was looking at monetary aggregates in the wake of the 1981 recession, they saw the money supply growing far faster than their target. At the time, the Fed’s primary tool was securities sales and purchases to control the rate of growth in the money supply directly, while letting the markets set interest rates. (Today, the fed primarily uses changes in the Discount Rate and Federal Funds target rate to run monetary policy.)
When the Fed saw those big increases in money supply, they immediately moved to sterilize the increases, to keep inflation in check. Sadly, the lack of velocity in the money supply, i.e., its actual rate of use in transactions, was near zero. as a result, the Fed’s tightening threw the economy into another recession, with unemployment rising to 11%. The policy may have been correct, but the timing was wrong.
So, what guarantee do we have that the Fed will perform sterilization at precisely the right time? If they move too early, the economy shuts down, a la 1982. Too late, and inflation takes off. Then the Fed would really have to tighten, which would probably result in another recession to wring out the extra inflation.
The trouble with the Fed is that monetary policy moves take 6-18 months to fully percolate through the economy. And they make these decisions based on economic data gathered in previous months. It’s like driving down the street by looking only at the rear-view mirror.
That makes proper timing by the Fed…hard.
Perhaps the Fed will operate as if run by infinitely wise solons, who know precisely when to sterilize their quantitative easing, either through repo operations, or raising the banks’ reserve requirements appropriately.
If it doesn’t, however, we’re looking at either another steep recession, or a bout of serious inflation, follwed by another serious recession to tame the inflation.
Oh, and even if the Fed is that good, it doesn’t address the problem of how the Chinese will react to any increased currency risk they face by holding dollar-denominated securities if the value of the dollar falls in the FOREX. As Mr. Wolf admits, the Fed’s mandate has nothing to do with the foreign exchange value of the dollar. So, maybe, the Chinese will decide to sell as much of their holdings in Treasuries as they can. That implies a serious decline in treasury prices, and a concommittant rise in bond yields, i.e., interest rates. Aaaand, we’re back to a possibility of a steep recession again Especially if they do it while the Fed is already in the middle of money supply sterilization operations.
So, I guess the question is, “How much to you trust in the ability of the Federal Reserve to do exactly the right thing, at exactly the right time?” And, “How much do you trust the Chinese to go along with all this?”
The chairs of the Obama Debt Commission – charged with putting a blueprint together to reduce the deficit and put the government’s finances on sound footing – have released their preliminary recommendations. And their recommendations are, as most who have monitored this situation should know, harsh. Of course they must be – because the government has spent itself into a position where harsh and drastic measures are both necessary and called for.
Expect those that compose much of that government, at least on the left, find such austerity “unacceptable” in the words of Nancy Pelosi (whose PAYGO has been so instrumental in preventing this situation from being worse /sarc). Before we get into the recommendations, let’s get one thing clear:
Those changes and others, none of which would take effect before 2012 to avoid undermining the tepid economic recovery, would erase nearly $4 trillion from projected deficits through 2020, the proposal says, and stabilize the accumulated debt.
That’s $4 trillion from a projected $10+ trillion in projected deficit spending over the next 8 years. So we’re still talking about years of deficit spending. And not one dollar will come off the debt – it will only “stabilize” it.
The point is that if doing what is necessary to cut the deficit spending of the next 10 years by 40% is “unacceptable”, imagine what any solution given to tackle the debt will be. Paul Krugman calls the recommendations “unserious”.
Really? Is there anyone out there who doesn’t understand that there is absolutely nothing “unserious” about the problems we face or the fact that to solve them drastic spending cuts are necessary? Krugman is apparently incensed that the recommendations involve 75% spending cuts and 25% tax increases (the tax increases are essentially the elimination of deductions, the lowering of taxes across the board and the broadening of the tax base).
But how in the world do you stop deficit spending if you don’t drastically cut spending itself?
The commission chairs recommend cuts or changes is all areas – entitlements, defense, non-discretionary spending, discretionary spending. Some thing sure not to please anyone. For instance, they recommend raising the retirement age on Social Security for future retirees, as well as cutting benefit increases. In defense, their goal is 100 billion in cuts. As I’ve said before, defense cuts can be made and should. Just so it is fat and not muscle that goes.
The plan is harsh medicine for the minority that believe that government is the answer to everything. And, as you’ll see (just watch) they will fight these recommendations tooth and nail. Republicans, on the other hand, have reacted cautiously. I’m not sure why. They’ve talked about cuts in spending and simplifying the tax code for years. Here’s a commission talking about both and recommending they be done.
Politics, fingers in the wind, and ideology begin to emerge. What the chairmen have done is taken the discussion from a nebulous “we’d like to see spending cuts” to “put up or shut up” with specific recommendations.
It is going to be instructive to see how both parties and the president react. It is the latter, in particular, I’m interested in watching:
Mr. Obama created the commission last February in the hope it would provide political cover for bold action against deficits in 2011. His stance now, in the wake of his party’s drubbing, will go a long way toward telling whether he tacks to the political center — by embracing such proposals — or shifts to the left and leaves them on a shelf.
Anyone – who votes for “leaves them on the shelf?”
[ad] Empty ad slot (#1)!
The reactions to the Federal Reserve’s announcement that they would embark on a new, $600 billion round of quantitative easing is raising reactions from all around the world.
Unbridled printing of dollars is the biggest risk to the global economy, an adviser to the Chinese central bank said in comments published on Thursday, a day after the Federal Reserve unveiled a new round of monetary easing.
German Economy Minister Rainer Bruederle said on Thursday he was concerned at U.S. efforts to stimulate growth by injecting liquidity into its struggling economy.
“I view that not without concern,” Bruederle said, adding that a variety of measures were needed to solve the problem and it was not enough to pump in liquidity alone…
Bruederle also said there was some truth to the criticism that the United States was influencing the dollar’s exchange rate with monetary policy and voiced concern about increased protectionism in different forms around the world.
Brazilian officials from the president down have slammed the Federal Reserve’s decision to depress US interest rates by buying billions of dollars of government bonds, warning that it could lead to retaliatory measures.
“It’s no use throwing dollars out of a helicopter,” Guido Mantega, the finance minister, said on Thursday. “The only result is to devalue the dollar to achieve greater competitiveness on international markets.”
Brazil, especially, seems to be treating this as a currency devaluation war, and, according to the Financial Times, really doesn’t like that.
But the worries go far beyond trade and protectionism issues brought about by fears of devaluation. It’s the domestic inflationary effects which have many–including me–worried:
Federal Reserve policies have put the US dollar the risk of crashing, which will hammer consumers through higher prices, strategist Axel Merk told CNBC…
“So we will have a cost-push inflation. We’re going to get inflation but not where Bernanke wants to have it. We’re not going to get wages to go up. We’ll get the price at the gas pump to go up instead.”
We’re right on a path towards high inflation and slow economic growth, otherwise known as “stagflation”. Except that there’s a lot more monetary expansion this time than we experienced in the 1970s. Maybe we’ll have to coin a new term, like “hyperstagflation”.
Oh, and in case you were wondering, it begins like this.
This is one of those cases where the headline numbers and claims of new jobs are so totally out of step with reality, that it’s hard to believe how badly the banner numbers reverse the actual employment situation. In fact, I’d argue that this month highlights perfectly why the Bureau of Labor Statistics needs to thoroughly revise the way the Employment Situation is reported.
To understand why, let’s look at the “A” Tables of the Employment Situation report. Take a careful look at the “Employed” line in the table. Last month, there were (in thousands) 139,391 persons employed. This month, there were (in thousands) 139,061 employed. So, non-farm payrolls may have increased by 151,000 jobs, but there are 330,000 fewer employed Americans than there were last month.
The total civilian, non-institutional adult population, in thousands, was 238,530 this month. With the historical long-term trend rate of labor force participation of 66.2%, that means the actual size of the labor force should be 157,907. With only 139,061 persons actually employed, the real unemployment rate is actually 13.6%, up from 13.2% last month, and from 12.8% in May.
The current labor force participation rate of 64.5 is the lowest since November of 1984.
Essentially, the employment situation worsened last month, rather than getting better. The only reason it looks better is because so many people are just dropping out of the labor force. When they do so, they magically disappear from the official banner statistics.
What is actually happening is that job growth is not keeping up with population growth, so every month, real employment is declining. It’s nice to see that employers have added 151,000 payroll jobs, but that simply isn’t a rate that keeps pace with job force growth. To give you an idea of how this is working, since Oct 09, the civilian non-institutional adult population has increased by 1,980 thousand people, while at the same time, the number of employed has risen by 819 thousand. That means that there is a deficit of 1,161 thousand jobs that has built up over the last year.
The banner statistics of payroll jobs and unemployment rate are increasingly out of step with the true employment situation.
An incredible election night by any measure. The obvious question that pundits will be concentrating on is “what does it mean”?
Well I think there is consensus on both sides that it doesn’t mean that the voters love Republicans. Even establishment Republicans are acknowledging that fact. And Marco Rubio made that clear in his acceptance speech where he called this a “second chance” not an embrace of the GOP.
So that leaves us with a number of other options to consider. What needs to be kept in mind is this is the third consecutive wave election and in each case the party holding the White House suffered losses. That’s unprecedented. And this particular midterm is the largest shift of seats since 1936 (update: House numbers now have a projected 242 seats on the GOP side, a net of +64 – historic or as one Democrat strategist said, a defeat for Democrats of “biblical proportion”). So one meme that isn’t going to fly is this election is “no big deal”. Democrats got spanked and got spanked hard. They have a lot of work to do to win back voters.
Another thing that seems to be a developing narrative is that this is a repudiation of the Obama agenda. I think that’s true to an extent. The biggest driver of the dissatisfaction with Democrats is the health care law as indicated by polls. And they are certainly mad about the deficit spending. But as Charles Krauthammer said last night, “this isn’t a failure of communication by the Democrats, this is a failure of policy”. So it would seem that at least part of the vote was a repudiation of the president despite claims by some on the left that its only about the economy.
That said, part of it is also about the economy. Historically the party in power doesn’t do well in a down economy. So that too must be factored in to the formula. While much of that is beyond government’s control, that which it could impact was perceived as poorly done. Very poorly done. That exacerbated the loss. And, with the focus on health care reform, most Americans thought that the legislative priorities were wrong as well. Voters have historically turned to the GOP to handle economic matters. But this is still no mandate for the GOP.
Finally voter anger hasn’t gone anywhere, it’s just taking a breather. Again, watch the direction of the country polls over the coming two years. It’s an interesting set up in DC now. Democrats actually would have been better off if the Senate had gone to the Republicans. They still control it and the Presidency and that leaves the onus on them as we head toward 2012. It also gives the GOP a free hand to pass whatever it wants in the House, regardless of where it goes, if anywhere, and make the case that they tried to reform what the people wanted reformed and Democrats (in the Senate and the President) stood in their way (reverse the “obstructionists” claim).
I think, after last night, that 2012 is definitely in play. It will be interesting to see how both parties react. I’m eagerly awaiting the Obama presser at 1 pm today when we’ll hear the first reaction from the President. But as always with him, judge him by his actions, not his words. His words have become empty rhetoric that many times doesn’t support what he ends up doing.
[ad] Empty ad slot (#1)!
While the US remains mired in recession (despite the claim its over) and the usual suspects are claiming we need to spend even more money we don’t have, Germany has managed a minor miracle. Eschewing a large stimulus package and instead opting for austerity and pro-business legislation, it has seen almost the opposite of US results:
"Although October’s decline in unemployment turned out weaker than expected, the underlying trend in the German labor market clearly remains one of rapid improvement on the back of strong economic growth," said Aline Schuiling from ABN Amro.
Data on Europe’s biggest economy over the past week has been bullish, signaling its unexpectedly strong recovery could hold up in the face of signs of fragility in the global economy.
Consumer morale remains at its highest level since May 2008 going into November on expectations for a further rebound, a survey by GfK market research group showed on Tuesday.
Business sentiment hit its highest level in 3-1/2 years in October and firms’ expectations also improved, a survey showed last week, and the corporate outlook continued to improve on Thursday.
As I’ve pointed out in many other posts, this isn’t rocket science. People respond to incentives. People respond positively to positive incentives. That’s what is happening in Germany which has economically battled back first from the absorption of East Germany and now a deep recession to a position of prosperity and growing economic stability.
Meanwhile here we’re about to go into QE2 all while popinjays like Paul Krugman encourage us to go more deeply in debt as a country because everyone knows that government spends money much more wisely and well than do individuals.
[ad] Empty ad slot (#1)!
So much for administration spin about the effectiveness of TARP. Neil Barofsky, TARP’s special inspector general, deals the administration narrative a shot to the head. In effect, he tells Americans angry about the program they have a right to be:
…[M]any Americans to continue to view TARP with anger, cynicism, and mistrust. While some of that hostility may be misplaced, much of it is based on entirely legitimate concerns about the lack of transparency, program mismanagement and flawed decision-making processes that continue to plague the program.
“When Treasury refuses for more than a year to require TARP recipients to account for the use of TARP funds, or claims that Capital Purchase Program participants were “healthy, viable” institutions knowing full well that some are not, or when it provides hundreds of billions of dollars in TARP assistance to institutions, and then relies on those same institutions to self-report any violations of their obligations to TARP, it damages the public’s trust to a degree that is difficult to repair.”
Ya think? And you remember all the rhetoric about forestalling foreclosure? Uh, FAIL:
[T]he most specific of TARP’s Main Street goals, “preserving homeownership,” has so far fallen woefully short, with TARP’s portion of the Administration’s mortgage modification program yielding only approximately 207,000 (out of a total of 467,000) ongoing permanent modifications since TARP’s inception, a number that stands in stark contrast to the 5.5 million homes receiving foreclosure filings and more than 1.7 million homes that have been lost to foreclosure since January 2009.
Now, I’m not agreeing that any of that should have been done – this is about claims the administration and Democrats made for spending the money.
Question: where has the money really gone?
Oh, and you remember “spurring lending” as a key reason for TARP? Not so much. In fact, not much at all:
“TARP has failed to ‘increase lending,’ with small businesses in particular unable to secure badly needed credit. Indeed, even now, overall lending continues to contract, despite the hundreds of billions of TARP dollars provided to banks with the express purpose to increase lending.”
Meanwhile in the "moral hazard" department – success:
“…[I]ncreased moral hazard and concentration in the financial industry continue to be a TARP legacy. The biggest banks are bigger than ever, fueled by Government support and taxpayer-assisted mergers and acquisitions. And the repeated statements that the Government would stand by these banks during the financial crisis has given a significant advantage to the larger “too big to fail” banks, as reflected in their enhanced credit ratings borne from a market perception that the Government will still not let these institutions fail, although the impact of this cost may be blunted by recently enacted regulatory reform.”
Almost a trillion dollars and they really don’t know where it has gone. Additionally, they’ve not at all achieved the goals for which they tried to tell the public this money was so damned important.
Lack of transparency? Mismanagement? Flawed decision-making? Why weren’t those things included in the administration’s spin.
And we just let them take health care from us as well.
[ad] Empty ad slot (#1)!
This speech by Dave Cote, CEO of Honeywell (to the Chamber of Commerce) was forwarded to me by a friend. It is one of the best summaries of our fiscal/financial problems I’ve seen in a while. Usually, when I see a 34 minute video I’m loath to give the time necessary to watch it, but this one is both fascinating and deeply disturbing. Take the time.
Cote lays out in words and charts our coming fiscal train wreck if we don’t do something “proactively”. As he says in the speech, we can do what is necessary to solve the problem or at some point, the bond market (as it did in the case of Greece) will do it for us. One will be painful, the other is catastrophic.
Dale’s post below about “Following the House of Bourbon” is essentially given facts and figures by this presentation. For instance, the discussion about China’s defense expenditures being paid for by our interest payments. Cotes points out that if spending remains unchanged through 2020, we’ll be paying almost a trillion dollars in interest a year. At this point, foreign governments own 45% of our 9 trillion in debt. China owns at least a trillion of it. And there’s no end in sight of the sale of government debt here.
The last point Cote makes that echoes Dales warning is about how quickly this will happen if we don’t do something.
While the problem builds slowly and inexorably, financial markets respond abruptly. When that decline does happen, it won’t be a case of minor monthly changes that give us 15 months to adjust. The hurt will come overnight as the herd moves against us. And then it’s too late.
That could happen at any time without warning triggered, as Dale points out, by some seemingly insignificant occurrence that normally would receive only passing attention. I don’t think, for the most part, people understand that very important point or they’d be beating down the doors of Congress.
Cotes also addresses “political will” and whether we have the will to do what is necessary (and endure the political consequences) to get this nation’s fiscal policy on the road to sanity. He notes that the public is more engaged now that in quite some time (and that’s a good thing) but are really focused on the wrong things (although they do recognize the gravity of the situation, he thinks they’re focused on fairly irrelevant portions of it).
The distilled point of course is politicians only have the spine the public gives them and unless they’re assured the public is behind doing what has to be done to solve the crisis, their risk-averse nature will have them continue to kick the can down the road.
Anyway, highly recommended. It will give you a great idea of what our situation is, where we’re headed and what the results of continuing to ignore it promise.
[ad] Empty ad slot (#1)!
Krugman’s latest approach to demanding more deficit spending – er, excuse me, “stimulus” spending – centers on the impending election. The Democrats wouldn’t be about to see an electoral tsunami if they’d just listened to him and spent more. The economy would be recovering and we’d only be talking about nominal losses in the mid-term as is historically the case with just about every President.
The real story of this election, then, is that of an economic policy that failed to deliver. Why? Because it was greatly inadequate to the task.
And he further states:
If you look back now at the economic forecast originally used to justify the Obama economic plan, what’s striking is that forecast’s optimism about the economy’s ability to heal itself. Even without their plan, Obama economists predicted, the unemployment rate would peak at 9 percent, then fall rapidly. Fiscal stimulus was needed only to mitigate the worst — as an “insurance package against catastrophic failure,” as Lawrence Summers, later the administration’s top economist, reportedly said in a memo to the president-elect.
In fact, when you look back at the spending forecast that accompanied the Obama plan, you’ll find something very strange (as we’ve pointed out before). You’ll find that it spent more than Mr. Krugman said was necessary at the time:
All indications are that the new administration will offer a major stimulus package. My own back-of-the-envelope calculations say that the package should be huge, on the order of $600 billion.
It should be huge, huge I tell you! $600 billion at least. We ended up with $900+ instead new figures show. It was 50% bigger than Krugman called for but, now, it was “totally inadequate”.
If you, like me, have essentially turned off the one-note bleat from this guy it is because other than calling for more spending he never, ever reviews his work or analyzes the results of someone actually following his advice. It was huge, it was more than he asked for, and it FAILED.
Has that sunk in yet, Mr. Krugman – your suggestion was less than what was spent and the result was an increase in unemployment and a decrease in economic activity. That, to most, means the idea of a “huge” amount of deficit spending did not have the effect you and the administration claimed it would. It. Failed.
Unlike Mr. Krugman, most of us have come to terms with the Einstein definition of insanity and resist doing the same thing over and over again expecting different results.
Obviously that’s not the case with Mr. Paul “one-note” Krugman. Tuning him out is a perfectly acceptable reaction to his ceaseless call for more deficit spending.
[ad] Empty ad slot (#1)!
That’s a pretty brutal add. But it has a nice early 20th century “yellow peril” vibe.
It might also be quite prescient.