Showing posts with label Fed. Show all posts
Showing posts with label Fed. Show all posts

Wednesday, October 26, 2011

Ron Paul's Sensible Reminders of Central Bank Limits

Ron Paul, Texas Republican Representative and presidential candidate, wrote a well-reasoned editorial in Thursday's edition of the Wall Street Journal entitled Blame the Fed for the Financial Crisis.

Without getting into mind-numbing detail, let me focus on one key passage of his piece,

"The Federal Reserve has caused every single boom and bust that has occurred in this country since the bank's creation in 1913. It pumps new money into the financial system to lower interest rates and spur the economy. Adding new money increases the supply of money, making the price of money over time—the interest rate—lower than the market would make it. These lower interest rates affect the allocation of resources, causing capital to be malinvested throughout the economy. So certain projects and ventures that appear profitable when funded at artificially low interest rates are not in fact the best use of those resources.



The great contribution of the Austrian school of economics to economic theory was in its description of this business cycle: the process of booms and busts, and their origins in monetary intervention by the government in cooperation with the banking system. Yet policy makers at the Federal Reserve still fail to understand the causes of our most recent financial crisis. So they find themselves unable to come up with an adequate solution.



In many respects the governors of the Federal Reserve System and the members of the Federal Open Market Committee are like all other high-ranking powerful officials. Because they make decisions that profoundly affect the workings of the economy and because they have hundreds of bright economists working for them doing research and collecting data, they buy into the pretense of knowledge—the illusion that because they have all these resources at their fingertips they therefore have the ability to guide the economy as they see fit.



Nothing could be further from the truth. No attitude could be more destructive. ...the notion that the marketplace, where people freely decide what they need and want to pay for, is the only effective way to allocate resources—may be obvious to many ordinary Americans. But it has not influenced government leaders today, who do not seem to see the importance of prices to the functioning of a market economy.


The manner of thinking of the Federal Reserve now is no different than that of the former Soviet Union, which employed hundreds of thousands of people to perform research and provide calculations in an attempt to mimic the price system of the West's (relatively) free markets. Despite the obvious lesson to be drawn from the Soviet collapse, the U.S. still has not fully absorbed it.

The Fed has painted itself so far into a corner now that even if it wanted to raise interest rates, as a practical matter it might not be able to do so. But it will do something, we know, because the pressure to "just do something" often outweighs all other considerations.



If the Fed would stop intervening and distorting the market, and would allow the functioning of a truly free market that deals with profit and loss, our economy could recover. The continued existence of an organization that can create trillions of dollars out of thin air to purchase financial assets and prop up a fundamentally insolvent banking system is a black mark on an economy that professes to be free."



It's an instructive and, I believe, correct analysis of what the Fed has done to the US economy for nearly a century since it was created by Congress. In response to populist pressure for a dispersed federal authority, unlike the old First and Second Banks of the US, the regional organization of the Fed was designed to represent the interests more than simply the US financial sector.

Rather than trying to exercise more control over the monster which Congress created, it could, instead, follow the advice of the late Milton Friedman and replace the institution's monetary policy authority with a  rule-based approach to monetary base management. John Taylor has suggested a rule which assumes the existence of the Fed, but provides an interest rate-setting formula.

But what Congressman Paul so correctly emphasizes is that the Fed, having a staff and budget, has come to believe it can manipulate the money supply to some good effect, rather than simply adjust its growth to relevant factors involving population and GDP.

As with other governmental institutions, once chartered and funded, the Fed is unlikely to ever unilaterally relinquish its powers and/or admit it is mistaken in its ability to beneficially attempt to fine-tune monetary policy.

Thursday, October 20, 2011

The Fed's Beige Book et.al.

I wrote this post on Tuesday suggesting there are few reasons to believe that the US economy is in recovery or expansion, and more to expect some sort of continued sluggishness or recession.

Yesterday's Fed Beige book release didn't seem to help matters. Today's Wall Street Journal article on the subject stressed the report's mention of weak economic growth and no good news on jobs. In short, the good news was, well, no really bad news.

On Bloomberg television after the report's release, a Chase economist kept saying there won't be another recession, but that was about it. He seemed mostly focused on that point, while soft-pedaling when pressed by the anchor to discuss any really good economic news from the Fed.

This morning's housing data featured a drop in the sale of existing homes. Meanwhile, Angela Merkel cancelled her big speech to the German legislature on the Euro bailout mess. Grecians continue to riot.

The result in US equity markets? A 1200 S&P, plus or minus a few points depending upon exactly when you look today. Sustained volatility.

Hardly what I'd call the underpinnings of a strong, healthy, vibrant equity market.

Monday, July 11, 2011

Goldman Sachs' Secret Fed Bailout Becomes Public

Last Thursday's Wall Street Journal contained some of the detailed information recently released by the Fed under FOI filings by various business media involving previously-undisclosed emergency loans to large US financial services firms during the financial crisis of 2008-09.

Prominently appearing was Goldman Sachs, for a $15B loan for a month at a laughably low rate. Also included were a few foreign-domiciled banks and various US entities, as well.

This sort of activity and inexplicably fickle discretionary lending is precisely why some call for an end to the Fed.

Why, for example, was AIG never given the opportunity to access these loans? How about Countrywide, WaMu and Wachovia? On what basis were they less deserving than Goldman Sachs?

I suppose Bear Stearns' failure to attract Fed loans would be excused on the basis of it being so early in the crisis. But the others are legitimate questions.

This is the type of selective, subjective government intervention to save favorites and punish those it didn't favor, which upsets investors and causes them to shy away from risking capital when government behaves so punitively with public money and unlimited credit.

Personally, I would have loved seeing Goldman Sachs forced into Chapter 11 protection, its trading units continuing to function to support prices of its inventories of instruments in their markets, while bids for the profitable units were entertained and the management which allowed Goldman to become overextended on unrenewable short-term funding were dismissed.

The ultimate penalty to those senior managers, and the investors who so unwisely trusted them, would have been a deserved loss of jobs and equity investments.

Markets would have continued to function, and useful units would have continued to operate, as well. But those who bet foolishly on a constant ability to fund the firm short-term would have suffered appropriately.

Tuesday, May 10, 2011

Barney Frank Tries To Re-Centralize US Monetary Policy

Perhaps because his party is now in the minority in the House, Barney Frank's latest zany idea for banking regulation change hasn't had much life after its initial splash on the day he released it and did the tour of business cable channels.

Frank's latest bad idea, to use Gerald O'Driscoll's term (from his Wall Street Journal editorial on Frank's bill) is to remove the presidents of the regional Federal Reserve banks from voting on the FOMC. Currently, the FOMC has 12 members- seven Fed governors and 5 presidents of Regional Fed banks, the latter on a rotating basis.

From this design, it's clear that the FOMC is already composed of a majority of federal political appointees. The Regional Fed bank presidents, meant in the original Fed design to prevent another Bank of the United States, are chosen by the boards of those banks. Thus each Fed district has the potential to be independent in its selection of presidents and the nature of its research. Various indices and research traditions are associated with specific Fed regional banks.

Thus, on one level, it's ironic that a member of the more populist political party would now want to essentially remove all populist influence on the FOMC. In today's financial services sector, restricting the FOMC to political appointees is essentially the same, as O'Driscoll contends, as making it an adjunct of the nation's larger banks and brokerages.

How odd that an institution designed to meet the Democrats' original demands to defuse monetary power from Washington and New York should return, full circle, to this point.

Just knowing Barney Frank was co-author of the monstrous Dodd-Frank bill should be enough to ignore his latest folly.

But there's a deeper theme at play. It may have taken one hundred years, but federalism, combined with the nation's larger capital markets players, never really stop in their quest to concentrate monetary authority among themselves.

Call it the Bank of the US, or the Fed, either way, it represents a consolidation that seems unwise at a time when the Fed has returned to fully monetizing the Treasury's record debt, and then some.

Truly an irony, in an era of global finance and evolution to electronically-based, rather than the older, cronyistic style of open outcry floor trading.

Friday, April 29, 2011

Boeing, The NLRB, Right-To-Work States & Bernanke

The NLRB's ruling against Boeing's production facilities in right-to-work South Carolina are clear evidence of government's schizophrenic attitudes toward business.

On one hand, we have Wednesday's remarks by Fed chairman Bernanke, at his press conference, that employment and economic growth are desirable objectives. His maintenance of ultra-low rates reflects his belief and hope that these, alone, will spur economic growth.

Then we have the NLRB's partisan, pro-union vote to curtail Boeing's opening of a second production line for its 787 Dreamliner in a state that doesn't require closed or union shops.

Lamar Alexander wrote a persuasive editorial just a week later explaining how, as governor, he was able to lure Nissan's plant to Tennessee, rather than neighboring Kentucky, because the former is a right-to-work state.

Alexander went further, arguing that the NLRB's Boeing decision will cause foreign and even domestic producers to see a risk that having operations in even one unionized state could subject them to capricious NLRB rulings forbidding them from doing business in any of the 23 states that are right-to-work.

Makes no sense, does it? Bernanke claiming to be holding rates low to facilitate greater economic activity and employment, while the NLRB rules to restrict employment to higher-wage states that will, consequently, employ fewer to build those 787s.

Easy money and government hand-wringing over slow employment growth are false when the same government acts to create such massive uncertainty for corporations, such as in the Boeing case. Decisions such as the NLRB's effectively abrogate corporate decisions on locating production facilities, which will necessarily affect their subsequent decisions concerning putting their companies at risk in the US to such deep and serious government intervention into their internal operations.

Perhaps Boeing's next move is to relocate the South Carolina lines in other countries.

Thursday, March 17, 2011

Bill Dudley's iPads

Tuesday's Wall Street Journal carried an editorial describing audience reactions to New York Fed President Bill Dudley, a Goldman Sachs veteran, as he tried to explain that the cost of living isn't rising.

Apparently, Dudley said,

"Today you can buy an iPad2 that costs the same as an iPad  1 that is twice as powerful. You have to look at the prices of all things."

Well, all things except food and energy, if you're the Fed.

According to the Journal, amidst laughter over Dudley's remarks, someone in the audience replied,

"I can't eat an iPad."

While another shouted,

"When was the last time, sir, that you went grocery shopping?"

In yesterday's post regarding inflation, I noted that not everyone ascribes all price movements to inflation or, for that matter, deflation. Those terms are reserved for monetary creation in excess of, or less than, the growth of an economy.

Just because prices rise, or fall, doesn't mean they are due to (monetary) inflation.

It's pretty distressing that the New York Fed's President can't distinguish between prices which fall due to improved productivity or value-added, prices which rise due to demand, and price moves resulting from reactions to excessive money creation.

Wednesday, March 16, 2011

Kelly Evans On The Fed & Oil Prices

Monday's Wall Street Journal had an Ahead of the Tape column by Kelly Evans entitled The Federal Reserve Faces an Oil Dilemma.

In her piece, Evans offered the pros and cons of the Fed's prospective sterilization of oil's price increases. She dutifully trotted out the usual arguments involving effective taxation, consumer spending consequences, QE2, monetary easing and how all of these effects might relate to US economic growth.

What I found odd was that Evans, who is typically very well-versed in both economics and business, completely missed the obvious point.

That is, the Fed's primary job remains dollar price stability. In reality, it really shouldn't be so overly-concerned with adjusting for oil's price, or the various follow-on effects on the US economy. Rather, by maintaining stable prices, in dollars, given supply and demand forces, and money supply growth in concert with some variant of the Taylor Rule, the Fed can provide at least one fairly consistent, if not constant, in an otherwise rapidly-changing economic landscape.

In truth, the Fed isn't going to 'get it right' if it really tries to solve all the simultaneous equations which are theoretically required to arrive at the correct, perfect economic policy prescription for the US economy.

The fact is, despite the Fed or Congress, the US economy, like all economies, must suffer through cycles. And that includes slowdowns and recessions.

The Fed can mitigate (monetary) inflation, and the US economy may still experience rises in the prices of some goods due to demand-supply imbalances. When I learned economics, we called that a price signal. If prices rise, some demand ebbs, while more supply is coaxed into the market, and others seek to replace the goods, the price rises of which have provided opportunities.

To suggest that the Fed can somehow, with just one monetary lever, sterilize the effects of so many disparate inputs to our economic system is laughable. And wrong.

I'm surprise Evans didn't go that route in her column. It would have been more helpful than writing in such a way as to suggest that the Fed has choices which include actually resolving these conflicting economic forces in some perfect or preferred manner beyond simply maintaining price stability.

Wednesday, March 02, 2011

The Ben Bernanke On Capitol Hill Yesterday

I caught some of The Ben Bernanke's testimony on the Hill yesterday, and let me tell you, it was nauseating.

But for me, the two low points were Ben insisting:

- the Fed needs to retain its dual mandate of managing the money supply and targeting full employment.

- there's no risk of US economic inflation.

The first must have Milton Friedman spinning in his grave. And perhaps Paul Volcker spit out his cigar when/if he heard it. Ever since dim-witted Hubert Humphrey championed the added full employment mandate, the Fed has been hampered in its ability to do focus on the one thing that nobody else can do- manage the US money supply. To finally face a friendly House and possibly ambivalent Senate and refuse the chance to formally escape this monstrosity is unforgivable.

The second certainly had Milton spinning. Not to mention tons of pundits laughing at Ben's sophistry.

It got so bad that later, on CNBC, senior economic idiot Steve Liesman made up a whole spiel to explain why Ben was right.

Between excessive money creation over the past two and a half years, and easy dollar-induced rises in commodity prices, we certainly have inflation. The fact that it's not conventional labor-sector cost-push doesn't mean it isn't happening.

Friedman was right. Get rid of the Fed and use a Taylor-style rule to manage the money supply.

Friday, February 04, 2011

Odds & Ends From CNBC

I saw a couple of inane segments recently on CNBC that I felt merited comment.

This morning, former Fed member Randy Krozner appeared on the morning program to do damage control in the wake of Helicopter Ben's recent public remarks at a press club.

Unbelievably, Krozner denied that there's any inflation coming down the road in the US economy! No chance. None. Totally unfounded fears. This seems curiously at odds with a recent Wall Street Journal article (post about it here) and the comments of a guest on CNBC just this week.

Energy, in the form of oil prices, and food both seem empirically to be heading sharply upward. So why can't Krozner see that?

Oh, wait. The government uses an inflation measure that strips out.....food and energy!

Perfect. Our central bank has blinders on when it comes to inflation.

Then Krozner waved off concerns that any inflation would require rate increases that could choke off employment gains. Again, hardly reassuring or based in reality.

The other segment which left me somewhat incredulous earlier this week as yet another discussion between co-anchors spotlighting, ex post, one or two companies which have had huge total returns for the last 12 or 18 months. This seems to be a favorite CNBC pastime. Find a company with a single period of incredible market outperformance, preferably in triple digits, then laud it as an investment, and ask the perennial question,

'So, is it still a good investment, or is it too late to get in, and time to unload?'

My own proprietary equity research found that there are a fairly large number of such short-term outperforming companies. The problem is that few of them become long term outperformers. So investors are forced to time their exits. Never an easy task.

In effect, CNBC's continuing focus on recent one-hit wonders seems to me to be the epitome of irresponsible reporting on financial investing. I pity anyone who takes any investment advice from the network seriously.

Friday, January 28, 2011

Recalling Basic Economics

I had an interesting conversation at my fitness club the other day with an acquaintance who is in the accounting/consulting field. We were discussing the current economic situation, and he asked me, to paraphrase,

'What do you think of the notion being circulated that Bernanke is pursuing QE2 and low rates in order to drive equity market prices up, to make businesses and investors feel better, so to better spark a real economic recovery?'

I replied that, if true, it's a misguided approach. I noted that, for those who recall their basic economics, we're now in a classic Keynesian liquidity trap. Rates aren't driving investment and, if anything, as I've written in some prior posts, are likely to fund marginal, unwise projects, because of the ultra-low rates and their inability to include adequate risk pricing.

We discussed the wasted so-called stimulus spending and added deficits, neither of which have really affected the unemployment rate.

It was then that, in answer to my colleague's question concerning what should have been done, I repeated my belief that banks and other firms, e.g., GM, contrary to auto czar Rattner's contentions, in need of capital should have been allowed to properly enter a formal Chapter 11 process. Profitable operations would have been protected and either spun off or sold. Unprofitable operations would have been liquidated, which is what Citigroup and GM subsequently did. Merging failed banks is no longer a major issue, given FDIC deposit insurance. This myth that large-scale bank failures cripple the economy persist only so long as government and industry officials allow it to perpetuate.

Once you've insured depositors, what's the risk? Loans are transferred or sold. Operations are transferred and merged. Shareholders lose, which is appropriate. Bondholders line up in order of seniority, according to bankruptcy law.

Where's the problem? We're overbanked in the US as it is.

Then I touched on the inequity of government's enforcement of a mortgage foreclosure moratorium. How unfair it has been for existing owners to be given breaks, while equally-deserving buyers at the true, lower market-clearing housing prices are denied the opportunity to do so. Which only delays a true housing recovery.

Anyway, my colleague agreed with my suggestions. But, further, I recalled for both of us some more basic economics, i.e., you can't have recoveries without real recessions. You can't have the release of resources- capital and labor- without the liquidation of failed firms. If firms aren't allowed to fail, resources don't experience the necessary Schumpeterian recycling into new uses.

We can't experience robust economic recoveries without full economic recessions. Despite politically-originated attempts to chop off the downside phases of economic cycles, we can't always be in an expansion. Real capitalistic economies have expansions and contractions.

King Canute couldn't stem the tides, and our government can't rewrite economic laws to eliminate periods of economic contraction.

Monday, December 13, 2010

A Farm Belt Asset Bubble?

Thursday's Wall Street Journal's lead staff editorial was entitled The Farm Belt Boom.

In yet another piece of a larger inflationary mosaic, the piece detailed the recent dramatic rises in land prices in the US farm belt. For example,

"The Federal Reserve Bank of Chicago reported in November that farmland values across the upper Midwest have jumped 10% since 2009. The year-over-year increases were even more dramatic in some states- 13% in Iowa, 11% in Indiana......Land fever is running rampant."

The Journal editorial credits global crop prices, but also adds this cautionary information,

"But the price surge has been so rapid and so broad across nearly all commodities.....that it can't merely be a function of new demand for specific grains.

This is where monetary policy comes in. As the greenback declines amid easy Fed policy, commodities rise in value. Farmland booms have typically coincided with periods of Fed easing, such as the 1970s and the late 1980s. It's no accident in our view that the latest commodity price surge began this summer when the Fed's talk about another round of quantitative easing began in earnest.

The problem comes if the boom is an artificial, money-fed bubble."

Which echoes my recent post discussing the risks to banks of the low-rate environment,

"One is, obviously, the greater probability of asset bubbles, against which loans may be made, in low-rate environments. We just saw this over the last seven years. Now rates continue to hover at record lows.

The second aspect involves risks versus rates. At ultra-low rates, projects of marginal merit appear to be worthwhile and may be funded. Yet they are precisely the most vulnerable loans, once rates begin to move upwards towards more normal, sustainable levels."


Somewhere, banks are lending to buyers of this expensive farmland. At some point, if and when this commodity price boom softens or turns south, the typical outcomes will obtain, i.e., over leveraged landowners, bankrupt farmers and insolvent banks holding worthless loans on now much-less valuable farmland.

As the Journal piece concludes,

"We hope Fed Chairman Ben Bernanke is right when he says asset bubbles and price spikes in commodities are nothing to worry about. Of course, he said the same thing about housing and oil in the last decade. We're not predicting an imminent bust, but we do hope someone at the Fed is watching prices grow in farm country."
Scary, isn't it? We're not two years on from the financial meltdown caused by an overheated mortgage banking sector, exacerbated by low rates, and the Fed is still biased toward keeping them ultra-low.

Wednesday, November 24, 2010

Humphrey-Hawkins On The Chopping Block

Back almost a year ago, in February of 2009, I wrote this post mentioning the ill-conceived Humphrey-Hawkins Bill regarding the Fed's mandate. In it, I noted,

"To fully understand this, one has to go back to Paul Volcker's tenure to understand that Congress routinely has threatened the independence of the Federal Reserve System, which it created as a populist alternative to a single central bank, when and if it does not seem to be sufficiently lubricating national finance with the growth of the money supply.



"Thanks to William Jennings Bryant's advocacy of American farmers' cry for coinage of silver, to devalue dollar-denominated debts by inflating the money supply at the turn of the century, the Fed system was designed to give each of the country's regions a Reserve bank, and, thus, a say in money supply management. It was a populist solution which would lessen the chances of another J. Pierpont Morgan-led rescue of the US financial system as occurred in the Panic of 1907.


Much later, in the waning days of Hubert Humphrey's life, the hapless liberal Democrat's misguided Humphrey-Hawkins Full Employment (and Balanced Growth) Bill (Act) was passed, mandating that the Fed maintain equal focus on two objectives: appropriate money supply growth consistent with low inflation, and full employment. The former, of course, is often at odds with the latter.


And it was this issue to which Greenspan was referring, by implication. If he had tried to rein in subprime lending by more vigorous bank examination and quashing of these activities, Congress would have hauled him up before some committee to explain his actions, which would have dampened economic growth, particularly at the expense of home ownership by lower-income groups.


This Greenspan was unwilling to do."


There are two points which are important to understand from this passage, the CNBC program about which it was written, and Humphrey-Hawkins, generally.

The Act was a grotesque mistake passed at a time when America had become somewhat indolent and expectant. Acknowledging harsh economic realities wasn't in vogue. The reality that there are periods in which tradeoffs must be made between monetary policy and employment was simply ignored, to be legislatively banished like some sort of King Canute ordering the tides to recede.

The dual mandate idea was an idiotic mistake of epic proportions, foisted upon the American economy by uninformed political hacks.

It was yet another example of a constant theme in American politics since the 1913 creation of the Fed, i.e., Congressional threats to restructure, limit or abolish the Fed, should the latter pursue its price stability mandate too zealously.
Now, thanks to the recent election outcomes, QE2 and failed fiscal stimulus spending of the past two years, there's serious talk of repealing Humphrey-Hawkins.
Until I read the recent Wall Street Journal lead staff editorial in last weekend's edition, The Fed's Bipolar Mandate, I hadn't really considered how much economic damage occurred in the years following the Act's passage. In a sense, H-H legislatively institutionalized what had become a 1960s-era trick. The Fed chairman would goose the money supply prior to presidential elections, in hopes of being reappointed in exchange for providing favorable, expansionary monetary policy.
 
The editorial notes how frequently current Fed officials have referred to the Fed's employment mandate as a basis for QE2. Yet, Fed Governor Kevin Warsh recently wrote a Journal editorial in which he dismissed the Fed's ability to even affect such economic ends with purely monetary policy.
 
Now, as the recent Journal staff editorial observes,
 
"The irony is that critics of QE2 are being portrayed as enemies of Fed independence, when the truth is the opposite. Ending the dual mandate would liberate the central bank to focus on the single task of stable prices, which is hard enough in a world of fiat money and no formal price rule."
 
Congress created the Fed, and it constantly harasses the bank's chairman, threatening intervention if politically-popular monetary policy isn't provided. This is old news, and really has to simply be ignored.
 
The only chance the US has of regaining some monetary self-discipline is for Congress to repeal its own prior stupidity, leaving the Fed the simpler, more achievable aim of providing price stability for the US dollar.

Friday, November 19, 2010

The YouTube Viral Quantitative Easing Video

Perhaps you've heard of this video by now. It appeared on YouTube on November 10th. As of the morning of November 18th, as I'm writing this post, it has had just over 1.5MM views.

The creator of the video appeared on CNBC's early afternoon program yesterday. He is a former commodities trader who produced the clip to explain QE & QE2 to his economically-challenged friends. On air, he deferred his specific thoughts about QE2 to the video, but, later, agreed that, in a word, he does not agree with the Fed's policy.

For some clarification before you watch the clip, I noted a few factual errors. Ben Bernanke has prior monetary policy experience. He is generally regarded as a leading expert on the economic history of the Great Depression, and served on the Fed prior to his being named as Chairman.

I also think that the video is a bit unfair in characterizing Goldman Sach's mission as 'ripping off the American people.' Prior posts under that label will reveal that I feel the firm is rapacious and dangerous with which to do business. If you interact with Goldman on a professional basis, even as a so-called client, prepare to be dealt with sharply and without undue concern for your welfare. You are well-advised to look after your own interests, because the firm will certainly look after its own equally with, if not before yours, even if you are their client.

But, that said, it has certain expertise which may be used on its clients' behalf's. And you can, if you wish, always share in their alleged ill-gotten gains through purchase of their publicly-traded stock.

In case the embedded video doesn't play, you can go to the clip here.


Wednesday, November 17, 2010

Regarding Alan Blinder's Defense of Bernanke

I do not possess a PhD in economics. Not even a BA in the subject. However, I do hold two business degrees, the completion of which provided me with a substantial amount of both micro and macro economic education, plus a healthy dose of anti-trust law and economics.

Thus, when I read Alan Blinder's In Defense of Ben Bernanke in Monday's Wall Street Journal, my initial reaction was one of potential academic inadequacy to question or critique Blinder's contentions. But, upon rereading his editorial, I realized that many of what I see as his errors are not those of abstruse higher-level economics, so much as those of reasoning and logic. On those bases, I feel quite comfortable discussing his piece.

Blinder begins by claiming "one current catchphrase is "job-killing spending.""

Really? Alan gives no cite on this. So much for PhD-level work, eh? His opening salvo is an unsourced complaint. Even so, it's not government spending that is killing jobs. It's over-regulation, erratic government takeovers of portions of the economy, and vague taxation policies. The spending, by the way, didn't go for infrastructure, as promised, but mostly for transfer payments. Which didn't create jobs, but allegedly saved some. Hardly the same thing.

He then uses an ad hominum argument by calling his friend's detractors "the economic equivalent of the Flat Earth Society." Again, hardly academic-quality reasoning. Or, maybe it is.

Only at the end, by the way, does Blinder tell you what his current position already should. As a Princeton economics professor, he would be well-acquainted with Bernanke. This isn't an objective defense of the Fed chairman. It's somehow personal.

But, back to Blinder's editorial.

Blinder then writes,

"Yet critics are branding QE2 a radical departure from past practices and a dangerous experiment."



He counters that QE2 is really just a big ol' open market operation like the Fed constantly performs. Nothing to be scared of.

But in this recent post, I discussed the Wall Street Journal's lead staff editorial which expressed concerned for QE2's heretofore unheard of effects on the Fed's balance sheet. It is, actually, a dangerous experiment. Blinder's attempt to gloss over type and maturity of assets is misleading.

He continues in his editorial,

"The next charge is that QE2 will be inflationary. Partly true. The Fed actually wants a bit more inflation because, now and for the foreseeable future, inflation is running below its informal 1.5% to 2% target. In fact, there's some concern that inflation will dip below zero—into deflation. The Fed, thank goodness, is determined to stop that. We don't want to be the next Japan now, do we?"

For a counter argument to this, read posts here, here, here and here regarding recent, true inflation rates among commodities and other economic inputs. Virtually every knowledgeable observer realizes that the Fed has switched inflationary measures in order to avoid admitting how commodities in everyday use, e.g., food, energy, metals, are skyrocketing thanks to two phenomena. One is dollar weakness, the other is increased demand by newly-enriched nations. Blinder is just wrong on this argument, following the Fed's lead and choosing convenient measures of inflation which aren't practical, but allow him to claim we're closer to deflation than inflation.

Blinder finishes his item-by-item defense with this passage,
"The final major charge, levied especially by a number of foreign officials, is that the Fed's new policy amounts to currency manipulation: deliberately lowering the international value of the dollar to gain competitive advantage for U.S. exporters. Is there any truth to this? Not if words have any meaning."



Blinder follows with a conventional description of interest-rate effects on capital inflows versus trade-related inflows thanks to a cheaper dollar, claiming nobody knows which will dominate, so Ben is innocent. I don't think that's an adequate or even relevant defense. Just because Ben isn't sure if the trade flows will win out doesn't mean he's not hoping they will.
 
Then there was Blinder's attempt to clean up various other troubling comments about QE2,
 
"More important, the U.S. is a sovereign nation with a right to its own monetary policy. So I was stunned when a top aide to the Russian president suggested that the Fed should consult with other countries before making major policy decisions. Come again? An independent central bank doesn't even consult with its own government.



Finally, there's that old hobgoblin: consistency. Critics tell us that QE2 won't give the U.S. economy much of a boost but will lead to rampant inflation. Both? How does that work?


If buying Treasurys is a weak policy tool, a view with which I have some sympathy, then it shouldn't be very inflationary. There is no magic link between growth of the central bank's balance sheet and inflation. People, businesses and banks have to take actions—like spending more, investing more, and lending more—to connect the two. If they don't, we will get neither faster growth nor higher inflation, just more idle bank reserves.


But I don't run the Fed. Maybe Chairman Bernanke's ideas are better than mine and, in any case, the planned QE2 is far better than doing nothing. It is not a shot in the dark, not a radical departure from conventional monetary policy, and certainly not a form of currency manipulation."

Blinder contends QE2 is weak medicine, so, no problem. He then lambastes those who believe that QE2's effectiveness and damage must be proportional. But that's not at all true. QE2 can easily trigger inflation without doing much in the way of boosting US economic activity. I think the more relevant approach is to ask Blinder to explain why the effects should be equal?

Then Blinder switches gears, and claims that if QE2 doesn't work, all we'll have is idle bank reserves. Here, he ignores the effects of all that money creation on the perceptions of the world's investors on dollar valuation.



Finally, is QE2 really "far better than doing nothing?" This is a peculiarly Keynesian view with which Austrian school economists, including Milton Friedman, would never agree. And it is certainly not the first two of Blinder's last three descriptors. And if it's not the third, it's a pretty good facsimile of it.

Tuesday, November 09, 2010

Fed Governor Kevin Warsh's Straight Talk In The WSJ

Yesterday's Wall Street Journal editorial by Fed Governor Kevin Warsh seemed, at least to me, to be an unusual one for a sitting Fed Board member.

Unlike the double-speak and evasions we've grown used to in testimony on Capitol Hill by Greenspan and Bernanke when asked about fiscal policy, Warsh clearly states,

"Given what ails the economy, additional monetary policy measures are poor substitutes for more powerful pro-growth policies."

Warsh goes further, criticizing the last few years of temporary stimulus measures, culminating with this passage,

"Fiscal authorities should resist the temptation to increase government expenditures continually in order to compensate for shortfalls of private consumption and investment. A strict economic diet of fiscal austerity has greater appeal, a kind of penance owed for the excesses of the past. But root-canal economics also does not constitute optimal economic policy.

The U.S. would be better off with a third way: pro-growth economic policy. The U.S. and world economies urgently need stronger growth, and the adoption of pro-growth economic policies would strengthen incentives to invest in capital and labor over the horizon, paving the way for robust job-creation and higher living standards."

This is, to my knowledge, fairly unprecedented talk by a Fed Governor. In today's environment, it borders on political speech, given the very wide distance between Democrats and Republicans on so many fiscal policies. Warsh clearly sides with the latter.

Toward the end of his piece, he cautiously acknowledges that QE2 is making the Fed a Treasuries price setter, not taker. Something CNBC's Rick Santelli bemoaned on air late last week. Warsh rather carefully shares that concern with these words,

"As the Fed's balance sheet expands, it becomes more of a price maker than a price taker in the Treasury market. If market participants come to doubt these prices- or their reliance on these prices proves fleeting- risk premiums across asset classes and geographies could move unexpectedly."

Volumes are implied in those last two words.

Warsh ends his editorial with a nod to the growing currency wars, triggered by the Fed's own depreciation policy. But he doesn't suggest any solution. Instead, he refers vaguely to FOMC "tools and conviction to adjust policies appropriately."

Trouble is, he began his piece by pointing out that monetary policy can't substitute for good fiscal policies. And can't overcome bad fiscal policies.

So, except for the last line of Fed-style happy talk, Warsh seems to depart from the usual institutional silence or vagueness on macroeconomic fiscal policies.

If you connect the dots in his editorial with rising anger by other central banks and conservative American politicians over US monetary policy, it should cause significant concern. Because what Warsh is really saying is that the Fed is going to be unable to fix the problems caused by reckless US fiscal policies, new, exorbitant debt levels, and rising international anger at both US fiscal and monetary policies.

Thursday, November 04, 2010

The Fed's Balance Sheet & Leverage

The Wall Street Journal lead staff editorial yesterday detailed the rather horrifying nature of the current Fed balance sheet.

It's rather shocking to be informed that, with the 2008 financial crisis now past, the various short-term credit facilities with which the Fed took in short-term instruments in exchange for cash, have ended. Instead, the Fed owns, on current value, $1.1T in mortgage-backed securities and $154B in GSE debt.

The editorial notes that, while these securities provide a sort of phantom income of some $70B in fiscal 2010 which covers some of the budget deficit, they also pose a highly significant interest-rate risk to the Fed's balance sheet. Simply put, if and when rates inevitably move up, whether from tightening by the Fed, or selling of these securities, the remainder on the Fed's balance sheet will naturally decline in value.

Unlike US commercial banks, which are capitalized at about 8%, the Fed is now running at a 1.45% capital/assets ratio. Yet the assets are half-composed of highly risky fixed income instruments.

We are now actually in the position of potentially seeing our central bank have its assets decline in value to an extent that it wipes out the notional capital of the institution.

This surely must be the most perverse form of financial bubbles we have yet to see. The editorial points out that any added income booked in the past few years from the Fed's fantastically-bloated balance sheet is sure to be overwhelmed by asset-value losses in the years ahead, if things don't go perfectly when these private-sector fixed income instruments are unwound.

Scary, isn't it?

Tuesday, October 26, 2010

Joseph Stiglitz On Quantitative Easing 2

Nobel Laureate and Columbia University liberal economist Joseph Stiglitz wrote a fairly scathing editorial concerning QE2. He begins his piece thus,

"The Federal Reserve, having done so much to create the problems in which the economy is now mired, having mistakenly thought that even after the housing bubble burst the problems were contained, and having underestimated the severity of the problem, now wants to make a contribution to preventing the economy from sinking into a Japanese-style malaise. How? As Chairman Ben Bernanke announced last week, through large-scale purchases of U.S. Treasurys—called quantitative easing, or QE."

Stiglitz then lists three problems he sees with QE2:

"The problem is that, with interest rates already near zero, there is little the Fed can do to restart the economy—and doing the wrong thing can do considerable damage. In 2001, (then) record-low interest rates didn't reignite investment in plant and equipment. They did, however, replace the tech bubble with an even more dangerous housing bubble. We are now dealing with the legacy of that bubble, with excess capacity in real estate and excess leverage in households.

Yet even if the banks were willing and able to lend, lending to SMEs is typically collateral-based, and the value of the most common form of collateral, real estate, has fallen 30% to 40%. No wonder then that credit availability is so constrained. But QE in the form of buying U.S. Treasurys is not likely to affect this much. It will have some effect in lowering mortgage rates, and lower mortgage rates will put a little more money into people's pockets. Higher real-estate prices may also allow some SMEs to borrow more. But these effects, though positive, are likely to be small—so small as to make a barely perceptible difference in America's persistent unemployment.


There is another downside risk: QE may not even succeed in lowering interest rates, or lowering them very much. Given the magnitude of excess capacity, there is little risk of inflation today. But if the inflation hawks come to believe that the risk of future inflation is real, then they'll believe that short-term interest rates will rise. This will mean that long-term interest rates, even now, may actually rise, in spite of the massive Fed intervention, because long-term interest rates are based on expectations of future short-term interest rates.



QE poses a third risk: The bursting of the bond market bubble that the Fed is seeking to develop—the sequel to the tech and housing bubbles—will clearly have adverse effects on the economy, as we should have learned by now."


Stiglitz seems quite complete in his cataloging the problems with QE2 will do. It can't really ignite economic growth, due to the so-called liquidity trap. It won't help the small- and medium-sized US businesses (SMEs), which have more need than large firms for financing. And it may cause a bubble in one of the last unbubbled parts of the financial sector- fixed income. And, he notes, it continues the international currency devaluation competition which can easily hurt the US more than it helps us.

He concludes with a brief restatement of his argument,

"The upside of QE is limited. The money simply won't go to where it's needed, and the wealth effects are too small. The downside is a risk of global volatility, a currency war, and a global financial market that is increasingly fragmented and distorted. If the U.S. wins the battle of competitive devaluation, it may prove to be a pyrrhic victory, as our gains come at the expense of others—including those to whom we hope to export."

I think his last point is extremely valid and largely ignored by the US Treasury and the Fed. Yet it's the one which anyone with a sense of economic history knows contributed greatly to the US economic damage during the Great Depression.

We'd better hope Stiglitz is wrong, but I doubt he is.

Wednesday, October 20, 2010

David Malpass, WSJ & CNBC

David Malpass, the economist and former Deputy Assistant Treasury Secretary, wrote an excellent editorial in yesterday's Wall Street Journal entitled How the Fed Is Holding Back Recovery.

Malpass contends that Bernanke's easy money, low-interest rate policy is destroying US jobs and causing significant, difficult-to-reverse shifts in the US economy.

Specifically, he wrote,

"Corporate and government jobs are faring better than small business jobs, another major structural change that Fed purchases will exacerbate by channeling cheap credit to big entities.

Jobs are moving to Asia as Washington's weak-dollar policy causes trillions of dollars to move abroad to protect against the risk of U.S. inflation and dollar debasement. Investors put their money into foreign factories, mines and workers, creating a boom there. They avoid long-term job-creating investments here, instead buying short-term IOUs from our government.

The damage is substantial. Near-zero interest rates are hammering savers, while transferring hundreds of billions of dollars annually to bond issuers- mostly governments, banks and bigger corporations. The weaker dollar is pushing risk capital away from this country and toward Asia and emerging markets."

No longer a candidate for the US Senate, from New York, Malpass is once again appearing on CNBC, and he did so yesterday in support of his Journal piece. As usual, he articulately advanced his theses.

The comedy, to be charitable, came when the co-anchor introduced CNBC's senior economic idiot Steve Liesman to debate Malpass' recent editorial.

It would be different if the network had retained the services of, say, Alan Reynolds, Greg Mankiew, Joseph Stiglitz or some other well-known and -respected economist for these sorts of discussions. Even hiring a lesser-known economist who at least has a PhD, has published some relevant macroeconomic research, and perhaps worked at the Fed, Treasury or for a major corporation or economic consultant would make sense.

But Liesman has no economics degree. He's a journalist with a misguided interest in economics.

Having Liesman debate Malpass would be like me, with my interest in physics and mathematics, debating some physicist with an endowed chair from MIT, CalTech or a similarly well-regarded institution. While I might be capable of understanding the physicist's remarks, and asking some questions, I would be out of my depth advancing a separate explanation for some phenomenon under discussion.

And that's pretty much how it went for Liesman. He babbled nonsensically, using a variety of terms and measures which he evidently thought mattered. The worst was when he summed up his differences with Malpass, using language to the effect that 'in his opinion,' blah blah blah.....as if anyone cares what that would be.

To return to my analogy, if I were to be debating a physicist, I would probably have prepared by asking other noted, well-regarded, perhaps prize-winning physicists what they thought of my opponent's ideas. That way, I wouldn't be presuming to put my own undegreed, untested physics ideas on a par with the real physicist, but, rather, I'd be standing in for other physicists of note and representing their questions, concerns and rebuttals.

But that wasn't what Liesman did. He has been in the job with CNBC for so long that he apparently believes he's an economist, and capable of advancing his own independent economic constructs against real economists with Phds and experience in responsible, real-world positions in the field.

The longer CNBC employs Liesman in any economics-related capacity, the longer it damages its own credibility on economic matters.

Friday, October 08, 2010

More Evidence of Unlearned Lessons At The Fed

Today's lead Wall Street Journal staff editorial, The "Limited Inflationists," was a real eye-opener.

In it, the author identified Sumner Slichter, a Harvard University economist in the 1950s, as the intellectual father of the notion that a little managed inflation is good for an economy.

Early on, the piece states,

"In a hearing on Capitol Hill, his views drew a famous rebuke from Fed Chairman William McChesney Martin, but Slichter's ideas gained currency in the 1950s and 1960s and eventually laid the groundwork for the not-so-gradual inflation of the 1970s.


Slichter died in 1959, but he is staging a rebirth at none other than Martin's former home, the Federal Reserve. A galaxy of Fed officials has fanned out to argue for another round of "quantitative easing," or a further expansion of the Fed balance sheet to boost the economy. The "limited inflationists" are once again at America's monetary helm, promising happier days from rising prices while downplaying the costs and risks."

The editorial then goes on to detail the various players on the Fed Open-Market Committee who are now targeting inflation levels, claiming there is wiggle room, because the actual rate of inflation is below their target, so a little more of it won't hurt.

The author offers some evidence that the QE2 planned to effect this inflation won't achieve very much for the $500B spent.

But the real message comes near the end of the editorial,

"The case for QE2 assumes that the problem with the economy is merely a lack of money. But trillions of dollars are already sitting unused on bank and corporate balance sheets. The real problem isn't lack of capital but a capital strike, as businesses refuse to take risks or hire new workers thanks to uncertainty over government policy, including higher taxes and regulatory burdens. More Fed easing in this environment risks "pushing on a string," adding money to little economic effect.



By keeping interest rates artificially low, the Fed is also contributing to a misallocation of capital and perhaps new asset bubbles. Messrs. Bernanke and Evans say they see no signs of inflation, as measured by the lagging indicator of the consumer price index."

These are both very important points.  Most informed observers of the current business situation understand that the author is correct. It's uncertainty with respect to governmental actions on many fronts that has immobilized capital and investment, not rate levels. And more bubbles and capital misallocation are likely, in a repeat of Greenspan's mistakes of the early years of the past decade.

"But investors are having no trouble bidding up the price of commodities, including oil and gold. A rising price of oil will have its own negative impact on growth, as we know from the experience of $147 oil in mid-2008. A commodity price spike might well erase any benefit from the expected decline of 15 basis points in long-term bond yields."

This is a particularly astute observation. Bernanke & Co. are running around announcing that, since the CPI and other baskets of goods aren't rising too fast in price, there's little inflation. They conveniently ignore the commodity bubbles now building. CNBC's Rick Santelli has noted this often in the past months.

Why is, in years past, Fed officials admitted, in hindsight, to asset pricing bubbles, but now, while observing them again, they choose to blithely ignore them and focus on more benevolent measures which are currently behaving to their liking?

Finally, the editorial delivers the coup de grace,

"As the protector of the world's reserve currency, the Fed also risks more global monetary disruption. The mere anticipation of QE2 has already caused Japan to pursue its own purchases of exotic assets, while Britain may do the same, as they and other countries try to avoid sharp rises in their currencies against the dollar. The European Central Bank may well have to follow, as the entire world adopts the "limited inflation" philosophy. In such a world, it's hardly surprising that gold has climbed in price against all major fiat currencies as a remaining store of value."

Forget all the foregoing technical points, if you wish. The argument which should trump all others is that of the Fed standing for price stability for the world's reserve currency. If it doesn't choose to do this, it is abdicating an important responsibility, and inviting further efforts to dethrone the dollar from this role.

That would be a mistake from which America, like Great Britain in the early 1900s, will probably never recover. Thus, the final paragraph of the piece,


"Which brings us back to Sumner Slichter and the limited inflationists. Amid the political and media interest in their ideas, Fed Chairman Martin appeared before the Senate Finance Committee. "There is no validity whatever in the idea that any inflation, once accepted, can be confined to moderate proportions," the father of the modern Fed thundered, in a warning that would be vindicated after his retirement in 1970. That's a warning as well for the QE Street Band."

No kidding. Just ask Paul Volcker.

Tuesday, September 28, 2010

Selective Recall: Former Fed Governor Randy Kroszner On CNBC This Morning

Former Fed governor Randy Kroszner appeared on CNBC this morning, fully displaying a case of extremely selective memory regarding monetary policy and the Great Depression.

When co-anchor and token conservative Joe Kernen asked Kroszner  if it wasn't possible tit was time to just let the economy recover on its own, Krosznerhat  immediately channeled the ghost of the Great Depression, claiming 'they tried that in the 1930s and look what you got.'

Evidently, Kroszner's only knowledge of history comes from Friedman and Kagan's A Monetary History of the United States.

Never mind the tax hikes, regulatory assault on business, a plethora of government agencies designed to compete with business (e.g., TVA), and the Smoot-Hawley Tariff. In Kroszner's world, simply noting the admitted mistake of excessive tightening and employment of the 'real bills' doctrine choked US money supply during the Depression, so its opposite must be employed now, e.g., excessive monetary easing.

I guess when you've been a member of the Fed, it's impossible for you to see it as a warped, possibly-unconstitutional, grossly imperfect and usually badly-run central bank. Kroszner clearly has no ability to even entertain the thought that, as Alan Reynolds' research has shown, a little over a year ago in the Wall Street Journal, that the Fed's interventions in periods of economic softness have deepened and lengthened US recessions.

When challenged, Kroszner solemnly intones or implies that now-familiar argument so often used by the current administration in defense of its wasted, nearly-pointless fiscal stimulus programs,

'Ah, but it would have been so much worse without Fed intervention.'

By appearing on CNBC with the grandeur of a monetary wizard, and the deference of the co-anchors, Kroszner delivers a sense of certainty and absolutism in defense of any Fed intervention, no matter how massive nor disruptive of naturally-clearing and healing financial markets. And no matter that actual evidence of Kroszner's contentions is non-existent.