Today, the editorial pages are full of discussion over the falling value of the dollar and what to do about it.
As could be expected, the fundamentalist preacher of a rigid, dogmatic Keynesianism, Paul Krugman, has his say in the New York Times this morning (see “Misguided Monetary Mentalities”: http://www.nytimes.com/2009/10/12/opinion/12krugman.html?_r=1). As is typical of someone that is locked into a reductionist view of the world, Krugman spends as much time calling people names as he does putting forth his dogma.
In the Financial Times we find two other points of view presented, views that are backed up by experience and historical support.
The first comment is by Roger Altman, who was in the Treasury Department during the Carter administration and was deputy US Treasury secretary in the Clinton administration. He also is an investment banker and private equity investor. Altman was present when the international investment community moved against the dollar in the latter half of the 1970s. He was also present in the 1990s when the Clinton administration had to calm international markets that had battered the dollar from 1985 until attention was given to its falling value. He has seen, at first hand, how international sentiment can respond to fiscal irresponsibility and monetary ease to force a country to adjust its economic policies. And, as he says, it is not a pretty sight.
In his comments in the Financial Times, Altman recognizes that there are still short term economic ills that need attending to (see “How To Avoid Greenback Grief”, http://www.ft.com/cms/s/0/8bdc802e-b675-11de-8a28-00144feab49a.html). But, he argues, “the dismal deficit outlook poses a huge longer-term threat. Indeed, it is just a matter of time before global financial markets reject this fiscal trajectory.”
Washington, right now, is in “a nearly impossible fiscal position.” Amen, to this.
And the problem is exacerbated because no one believes what America’s leaders are saying. In the other commentary in the Financial Times by Wolfgang Münchau (see “The Case for a Weaker Dollar”: http://www.ft.com/cms/s/0/7a6b599c-b679-11de-8a28-00144feab49a.html) the author states “I do not buy the strong-dollar pledges by Tim Geithner, Treasury secretary, and Larry Summers, director of the National Economic Council. They have to say that. It is the official policy line. The bond markets would go crazy otherwise”
But, Altman is right. There are two problems, the short run and the longer run. In the short run, attention must be paid to the weaknesses in the economy. What exactly the right policy is for this period of time is something for another post. However, there is a short run problem.
The difficulty is that financial market participants are not convinced that there is a longer-term policy. Altman states “Vague promises will not work.” And, it has been vague promises that we have been getting.
A firmer approach is needed! Altman argues that “for 2011 and beyond, the fiscal challenge is fearsome.” The United States must prepare a credible approach to its fiscal policy and present a unified front to the world that it will, in fact, bring the federal budget under control and live with that promise. Believability is crucial!
“It is true that Mr. Obama inherited the deficit. But, like Afghanistan, it is his responsibility now. Only he can forge a process for solving it.”
Mr. Münchau, in his commentary, goes through much of the argument that Altman makes, but then takes a more Euro-centric plea for a weaker dollar. To him a weaker dollar would allow for a greater balance of economic interests to be reached in the world today. This is consistent with the view that the European community play a stronger role in the Group of Twenty (the G-20) in order to achieve greater world co-operation. (See my post on this subject: http://seekingalpha.com/article/165088-the-g20-time-for-a-u-s-attitude-adjustment.) A weak dollar, to this author, is desirable because it strengthens the world monetary system. This is a policy coming from the experience of the European Union. It is grounded in the history of that body.
It does not seem, to me, to be in the interest of the United States to adopt a “weak dollar” policy, although that seems to be the one that it has adopted. As Altman states, if Geithner or Summers or Bernanke advocated a weak dollar there would be a run for the exits and the dollar would experience a dramatic decline. No, this does not seem to me to be a realistic alternative.
Thus, we are back to current fiscal (and monetary) policy. I still go back to the statement written by Paul Volcker: “the most important price to a nation is the price of its currency.” The United States cannot afford a “weak dollar” policy.
Yet, almost by default, the Obama administration is taking that path. And, the “true believers”, like Krugman, shout out Amen! Here we have someone that has not even been the chair of the Princeton Economics Department, as Ben Bernanke was before he became the Chairman of the Board of Governors of the Federal Reserve System, preaching the Keynesian gospel to those in his tent and they too, respond, Amen!
There are those that have experienced the response of world financial markets to governments that follow irresponsible fiscal budget policies. Altman is one that was on the firing line. From the past fifty years, we do know that investors will not allow these policies to continue forever.
Now I will introduce my Keynesian argument, a tactic that most commentators do at least once in their articles these days. Keynes, when asked why he changed his mind as often as he did replied: “When the facts change, I change my mind. What do you do?”
It is remarkable that the followers of an individual that was as open to new information as Keynes was keep such a reductionist mindset. Perhaps it is because their only experience comes from reading a book.
Showing posts with label Larry Summers. Show all posts
Showing posts with label Larry Summers. Show all posts
Monday, October 12, 2009
Friday, October 9, 2009
The Beat Goes On Concerning the Dollar
More headlines this morning on the dollar strategy of the Obama administration. First, the main headline in the Wall Street Journal contains the blast: “U. S. Stands By as Dollar Falls.” (See http://online.wsj.com/article/SB125498941145272887.html#mod=todays_us_page_one.) Then the lead editorial follows up with “The Dollar Adrift.” (See http://online.wsj.com/article/SB10001424052748703746604574461473511618150.html.)
We also learn that the administration was worried enough about this type of thinking to send out Chairman Bernanke and presidential advisor Larry Summers to indicate how serious the Obama Administration is in maintaining a strong dollar.
Again the phrase “Watch the hips and not the lips” comes to mind. There is very little the administration can do right now to introduce fiscal responsibility into what they are proposing. The die has already been cast and no one sees a quick reversal of the administration’s mindset.
And, this is the problem. Time-after-time in the last half of the 20th century countries got themselves into predicaments like the one being faced by the United States. Uncontrolled government budgets with the promise of growing amounts of debt outstanding. Connected with this fiscal irresponsibility was the concern that central banks were really not independent of the national government. This is a situation not unlike that currently in place in the United States.
There were a number of books that came out in the late 1980s and early 1990s that basically asked the question: “Is national economic policy in the hands of unknown bankers and financial interests around the world?” The general scenario depicted was that of a national government that proposed large and growing budget deficits that seemed unsustainable without the support of a captive central bank that would monetize the debt as pressure on local interest rates grew. The reaction of these “unknown bankers and financial interests” was to sell the currency of that nation and force the national government to reverse direction and introduce fiscally responsible budgets.
The primary example of such a historical event was that which occurred during the presidency of François Mitterrand in France. The French Franc came under such pressure that Mitterrand backed off his budget proposals and became fiscally quite conservative and supported the independence of the French central bank.
The issue here is not so much the size of the deficits, although that can be important, or the ratio of the deficits to GDP, or the ratio of government debt to GDP. The question relates to whether or not the government is acting in a fiscally responsible way and will it continue to do so in the future. The side question to this is the independence of the central bank.
Absolute numbers are fine, but it is the direction those numbers are going that are the crucial concern.
The facts to me are as follows: since the 1960s, the United States government has erred on the side of fiscal ease in terms of the budgeting process. This has not been a Republican or a Democratic fault. The leadership in both parties has contributed to the stance of fiscal leniency that has existed within the federal government over this time period.
During this time the value of the dollar has trended downward, with one or two side-trips.
During the Bush (43) administration fiscal irresponsibility got way out-of-hand. The fiscal irresponsibility was supported by monetary irresponsibility. Thus, we get to the current situation.
Nothing has changed!
Financial markets are seeing the same behavior in the current administration that they observed in the previous administration. O’Neill, Snow, Paulson, and Geithner are all of one package. Greenspan and Bernanke are linked at the hip. And, the words coming out of the mouths of our leaders seem to be “pre-recorded.”
I have been trying to call attention to this issue for four or five years now. Very little attention has been paid to the issue even though at one time in the Bush (43) administration the value of the dollar had declined by about 40%.
The problem is that there are no good solutions to the situation when you let it go for that long. The obvious picture is that of a binge drinker that has been an alcoholic for a lengthy period of time. More and more people are going to get hurt and this will just add to the many that are feeling pain at the present time. But, that is what happens when people lose their discipline and become addicted.
The event we see over and over again in economics is that ultimately the system has to correct, either on its own or with the help of those that are a part of the system. And, the correction takes place sooner, or, later, but it eventually takes place. Unfortunately along the way, as with alcoholics, some of the best attempts of “friends” to cure the patient only end up exacerbating the situation.
We also learn that the administration was worried enough about this type of thinking to send out Chairman Bernanke and presidential advisor Larry Summers to indicate how serious the Obama Administration is in maintaining a strong dollar.
Again the phrase “Watch the hips and not the lips” comes to mind. There is very little the administration can do right now to introduce fiscal responsibility into what they are proposing. The die has already been cast and no one sees a quick reversal of the administration’s mindset.
And, this is the problem. Time-after-time in the last half of the 20th century countries got themselves into predicaments like the one being faced by the United States. Uncontrolled government budgets with the promise of growing amounts of debt outstanding. Connected with this fiscal irresponsibility was the concern that central banks were really not independent of the national government. This is a situation not unlike that currently in place in the United States.
There were a number of books that came out in the late 1980s and early 1990s that basically asked the question: “Is national economic policy in the hands of unknown bankers and financial interests around the world?” The general scenario depicted was that of a national government that proposed large and growing budget deficits that seemed unsustainable without the support of a captive central bank that would monetize the debt as pressure on local interest rates grew. The reaction of these “unknown bankers and financial interests” was to sell the currency of that nation and force the national government to reverse direction and introduce fiscally responsible budgets.
The primary example of such a historical event was that which occurred during the presidency of François Mitterrand in France. The French Franc came under such pressure that Mitterrand backed off his budget proposals and became fiscally quite conservative and supported the independence of the French central bank.
The issue here is not so much the size of the deficits, although that can be important, or the ratio of the deficits to GDP, or the ratio of government debt to GDP. The question relates to whether or not the government is acting in a fiscally responsible way and will it continue to do so in the future. The side question to this is the independence of the central bank.
Absolute numbers are fine, but it is the direction those numbers are going that are the crucial concern.
The facts to me are as follows: since the 1960s, the United States government has erred on the side of fiscal ease in terms of the budgeting process. This has not been a Republican or a Democratic fault. The leadership in both parties has contributed to the stance of fiscal leniency that has existed within the federal government over this time period.
During this time the value of the dollar has trended downward, with one or two side-trips.
During the Bush (43) administration fiscal irresponsibility got way out-of-hand. The fiscal irresponsibility was supported by monetary irresponsibility. Thus, we get to the current situation.
Nothing has changed!
Financial markets are seeing the same behavior in the current administration that they observed in the previous administration. O’Neill, Snow, Paulson, and Geithner are all of one package. Greenspan and Bernanke are linked at the hip. And, the words coming out of the mouths of our leaders seem to be “pre-recorded.”
I have been trying to call attention to this issue for four or five years now. Very little attention has been paid to the issue even though at one time in the Bush (43) administration the value of the dollar had declined by about 40%.
The problem is that there are no good solutions to the situation when you let it go for that long. The obvious picture is that of a binge drinker that has been an alcoholic for a lengthy period of time. More and more people are going to get hurt and this will just add to the many that are feeling pain at the present time. But, that is what happens when people lose their discipline and become addicted.
The event we see over and over again in economics is that ultimately the system has to correct, either on its own or with the help of those that are a part of the system. And, the correction takes place sooner, or, later, but it eventually takes place. Unfortunately along the way, as with alcoholics, some of the best attempts of “friends” to cure the patient only end up exacerbating the situation.
Sunday, February 1, 2009
Concerns about the Obama Stimulus Plan
As the Obama Stimulus Plan becomes more and more of a reality, many different people are asking many different questions about it. To me, there are four basic issues that need to be debated very seriously before any such plan is passed by Congress. The first question is…how fast do we really need to move in passing such a plan? Second…how big does the stimulus package really need to be? Third…how is all the debt created by such a plan going to be financed? And fourth, can the stimulus really be withdrawn once the crisis is over?
In terms of speed of enactment we hear over and over again that speed is of the essence. Things are really bad…and things are going to get a lot worse. We need to get into the game and do something as quickly as possible!
We heard this argument before, not too long ago. It was reported in the Wall Street Journal, that “Federal Reserve Chairman Ben Bernanke reached the end of his rope on Wednesday afternoon, September 17.” Bernanke was reacting to things falling apart in the financial industry. He called Treasury Secretary Hank Paulson and said that the administration had to move. Thursday September 18. Paulson responded that he was “on board”. Bernanke insisted that Congressional leaders had to be assembled…which Paulson set up for that Friday evening. Bernanke read them the riot act at that meeting and insisted that a bill…what became TARP…be enacted no later than Monday or everything would fall apart. (For more on this see my post on Seeking Alpha of November 16, 2008, “The Bailout Plan: Did Bernanke Panic?”) The bill was not enacted that Monday and the last half of the TARP money was not released until just recently.
Now we are hearing the call again. We must hurry. The Obama Stimulus Plan has been put on the fast track…and the pressure is on to get the plan enacted by Congress by President’s Day, February 16. But, does this plan really need to be enacted that quickly? Is it better to have any plan by President’s Day or is it better to have a plan that works?
It seems to me that the pressure to get something done quickly has important implications for the second question asked above. Since so little is known about how effective the plan will be…the issue becomes…MORE IS BETTER! Given the uncertainty of how the plan will work, it is important to throw as much as possible against the wall in the hopes that some of it will stick.
Wow! What a way to run a government! But that is what Bernanke/Paulson did.
And, this approach gives rise to the new justification for the program…confidence. The argument goes that “If the government shows that it is serious in ending the recession and this seriousness is reflected in the size of the stimulus package…this will spur on an increase in confidence…which is just what the economy needs right now!”
Let me get this straight. It doesn’t really matter whether or not the stimulus plan works…what is important is that the stimulus plan be very large…so that people will regain confidence.
And, if this is the underlying theory behind the stimulus plan…how is this going to raise the confidence of the world wide investment community…which relates to the third question presented above…to invest in the debt of the United States government?
Oh, well…the United States dollar is the world’s reserve currency and the United States debt is the place for world investors to go when there is a “flight to quality” in world financial markets. Given this fact, people will continue to flock to United States Treasury issues. No doubt about it!
As Alice Rivlin, economist of the Brookings Institution, former member of the Board of Governors of the Federal Reserve System, First Director of the Congressional Budget Office, and Director of the Office of Management and Budget (a cabinet position and appointed by President Bill Clinton a Democrat) recently testified before Congress…”We seem to be counting on the Chinese to keep investing to pay for this (the U. S. deficits) and we’re assuming that the rest of the world isn’t going to lose confidence once we use this moment to spend on a whole range of programs. And, I’m not sure that’s the right assumption.”
Rivlin also has something to say about the fourth question…the question about what happens in the long run. She states that “Because we’re doing this outside the budget process, it means that no one has to talk about what the long-term effects of any of this might be.” That is, what is going to happen beyond the short run if much of this expenditure is still going into the economy as the economy begins to grow again. No one is anticipating how this situation might be dealt with.
As Niall Ferguson, who shares his time between Harvard University and Oxford University, stated recently at Davos…and I am paraphrasing…the new administration seems to believe that by creating an impressive amount of new leverage that it can resolve a financial crisis created by an excessive amount of leverage.
So, I go back to the first question…do we really need to rush so quickly? Yes, I agree with President Obama…he won…he gets to set the table. But, does he want to do it right…or does he just want to do it?
The Congress is supposed to be a deliberative body…it is supposed to mull things over…kick them around…debate and dialogue with one another. Isn’t it better to get something right…than to not do something well…or to do something that may not work?
Projects should not just be put into a stimulus plan…just because they are a “good idea” or because “they are something we want to do and they are available.” Projects, to be included, need to have some real justification for their inclusion in such a plan…the benefit of the project (the whole flow of benefits accruing from the project) should exceed the social cost of the project. Questions should be asked about the timing of the project and when the expected benefits are expected to be received. The Congress should be very intentional about what it is going to do…how much it is going to spend. Success of execution should be the key criteria as to whether a project gets included in the plan…not just the speed of passing the bill.
If Congress were to judge the plan…the whole plan as well as the components of the plan…in this fashion, then something more specific could be said about the size of the plan. Given that every element of the plan could stand up to some form of cost-benefit analysis then the size of the plan would be less of an issue. We would have some rationale for the size of the plan…it would not be a question of hoping some of the material thrown against the wall would stick! The parts of the plan would be chosen because they work…not because they make the plan “large”.
There still will remain questions about financing a stimulus plan. A plan constructed as suggested above would still result in the creation of a lot of new debt the United States government would have to issue. But, the investment community would have more justification to “trust” the plan because the Congress has done its homework…and, if the Congress had done its homework there would be something to say about how the debt will be financed and paid down in the future. That is, the United States government would be acting like a responsible steward of its fiscal responsibilities, something world financial markets have not seen for eight years or so.
To me, this is a crucial issue the Obama administration and the United States government has to deal with…restoring confidence in the fiscal credibility of the United States…something that Bush43 fell far short of doing. Rushing into the fray with a hastily constructed, ill-conceived stimulus plan, one that relies on the Chinese and the rest-of-the-world to finance with no thought for the future is not going to resolve the financial and economic mess we are now experiencing.
In terms of speed of enactment we hear over and over again that speed is of the essence. Things are really bad…and things are going to get a lot worse. We need to get into the game and do something as quickly as possible!
We heard this argument before, not too long ago. It was reported in the Wall Street Journal, that “Federal Reserve Chairman Ben Bernanke reached the end of his rope on Wednesday afternoon, September 17.” Bernanke was reacting to things falling apart in the financial industry. He called Treasury Secretary Hank Paulson and said that the administration had to move. Thursday September 18. Paulson responded that he was “on board”. Bernanke insisted that Congressional leaders had to be assembled…which Paulson set up for that Friday evening. Bernanke read them the riot act at that meeting and insisted that a bill…what became TARP…be enacted no later than Monday or everything would fall apart. (For more on this see my post on Seeking Alpha of November 16, 2008, “The Bailout Plan: Did Bernanke Panic?”) The bill was not enacted that Monday and the last half of the TARP money was not released until just recently.
Now we are hearing the call again. We must hurry. The Obama Stimulus Plan has been put on the fast track…and the pressure is on to get the plan enacted by Congress by President’s Day, February 16. But, does this plan really need to be enacted that quickly? Is it better to have any plan by President’s Day or is it better to have a plan that works?
It seems to me that the pressure to get something done quickly has important implications for the second question asked above. Since so little is known about how effective the plan will be…the issue becomes…MORE IS BETTER! Given the uncertainty of how the plan will work, it is important to throw as much as possible against the wall in the hopes that some of it will stick.
Wow! What a way to run a government! But that is what Bernanke/Paulson did.
And, this approach gives rise to the new justification for the program…confidence. The argument goes that “If the government shows that it is serious in ending the recession and this seriousness is reflected in the size of the stimulus package…this will spur on an increase in confidence…which is just what the economy needs right now!”
Let me get this straight. It doesn’t really matter whether or not the stimulus plan works…what is important is that the stimulus plan be very large…so that people will regain confidence.
And, if this is the underlying theory behind the stimulus plan…how is this going to raise the confidence of the world wide investment community…which relates to the third question presented above…to invest in the debt of the United States government?
Oh, well…the United States dollar is the world’s reserve currency and the United States debt is the place for world investors to go when there is a “flight to quality” in world financial markets. Given this fact, people will continue to flock to United States Treasury issues. No doubt about it!
As Alice Rivlin, economist of the Brookings Institution, former member of the Board of Governors of the Federal Reserve System, First Director of the Congressional Budget Office, and Director of the Office of Management and Budget (a cabinet position and appointed by President Bill Clinton a Democrat) recently testified before Congress…”We seem to be counting on the Chinese to keep investing to pay for this (the U. S. deficits) and we’re assuming that the rest of the world isn’t going to lose confidence once we use this moment to spend on a whole range of programs. And, I’m not sure that’s the right assumption.”
Rivlin also has something to say about the fourth question…the question about what happens in the long run. She states that “Because we’re doing this outside the budget process, it means that no one has to talk about what the long-term effects of any of this might be.” That is, what is going to happen beyond the short run if much of this expenditure is still going into the economy as the economy begins to grow again. No one is anticipating how this situation might be dealt with.
As Niall Ferguson, who shares his time between Harvard University and Oxford University, stated recently at Davos…and I am paraphrasing…the new administration seems to believe that by creating an impressive amount of new leverage that it can resolve a financial crisis created by an excessive amount of leverage.
So, I go back to the first question…do we really need to rush so quickly? Yes, I agree with President Obama…he won…he gets to set the table. But, does he want to do it right…or does he just want to do it?
The Congress is supposed to be a deliberative body…it is supposed to mull things over…kick them around…debate and dialogue with one another. Isn’t it better to get something right…than to not do something well…or to do something that may not work?
Projects should not just be put into a stimulus plan…just because they are a “good idea” or because “they are something we want to do and they are available.” Projects, to be included, need to have some real justification for their inclusion in such a plan…the benefit of the project (the whole flow of benefits accruing from the project) should exceed the social cost of the project. Questions should be asked about the timing of the project and when the expected benefits are expected to be received. The Congress should be very intentional about what it is going to do…how much it is going to spend. Success of execution should be the key criteria as to whether a project gets included in the plan…not just the speed of passing the bill.
If Congress were to judge the plan…the whole plan as well as the components of the plan…in this fashion, then something more specific could be said about the size of the plan. Given that every element of the plan could stand up to some form of cost-benefit analysis then the size of the plan would be less of an issue. We would have some rationale for the size of the plan…it would not be a question of hoping some of the material thrown against the wall would stick! The parts of the plan would be chosen because they work…not because they make the plan “large”.
There still will remain questions about financing a stimulus plan. A plan constructed as suggested above would still result in the creation of a lot of new debt the United States government would have to issue. But, the investment community would have more justification to “trust” the plan because the Congress has done its homework…and, if the Congress had done its homework there would be something to say about how the debt will be financed and paid down in the future. That is, the United States government would be acting like a responsible steward of its fiscal responsibilities, something world financial markets have not seen for eight years or so.
To me, this is a crucial issue the Obama administration and the United States government has to deal with…restoring confidence in the fiscal credibility of the United States…something that Bush43 fell far short of doing. Rushing into the fray with a hastily constructed, ill-conceived stimulus plan, one that relies on the Chinese and the rest-of-the-world to finance with no thought for the future is not going to resolve the financial and economic mess we are now experiencing.
Wednesday, January 21, 2009
Where Will the Federal Reserve Go?
The Federal Reserve evolved over the years to perform three major tasks: to supply liquidity to commercial banks and the financial markets (specifically as the “lender of last resort”); to manage the monetary system so as to encourage economic growth, yet contain inflation; and to oversee the health of the banks who were members of the Federal Reserve System through regulation, examination, and supervision.
Whereas the Federal Reserve System is supposed to fight a liquidity crisis, a very short term phenomenon, it was not set up to resolve a solvency crisis, a longer term situation. The problem faced in a liquidity crisis is that, for one reason or another, an institution or a few institutions want to sell quickly some kind of a financial asset but there are few, if any, buyers. The responsibility of the Federal Reserve is to supply liquidity to the market on a short term basis so that the market will stabilize and buyers of these financial assets will return to the market.
We have gone through our liquidity crises this time around. Liquidity crises are surprises…we are not prepared for them…and this is why the response has to be quick and decisive. I say that we have gone through our liquidity crises this time around because investors are very wary about ALL asset classes now and the surprises that come to light on a regular basis are how deep the losses on assets continue to be…not that there are losses.
The Federal Reserve is not set up to solve a solvency crisis. The solvency crisis is a capital adequacy problem. It is a problem related to how large the losses are related to the book value of the assets. Yes, there are liquidity issues related to these troubled assets…they may not be able to be sold…or they cannot be sold. If this is the case the question becomes whether or not the problems related to these assets can be worked out and if so how much of the asset value will be retained…if any of it can be retained. And, the solvency crisis is of a longer term nature than the liquidity crisis.
The Federal Reserve, over the past 13 months has drastically changed the way it operates in an effort to provide liquidity to financial markets. Attention has been directed to the expansion of the asset portfolio of the Federal Reserve System. In the last 13 months, the line item labeled “Total Factors Supplying Reserve Funds” that appears on the Federal Reserve Statistical Release, H.4.1, “Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks,” has increased by approximately $1.2 trillion. The increase is from $0.9 trillion on Wednesday November 28, 2007 to $2.1 trillion on Wednesday January 14, 2009. All of this increase has come since Wednesday September 3, 2008 when the balance totaled $0.94 trillion.
I include December 2007 in this calculation for it was in this month that we first got the innovation called the Term Auction Credit Facility introduced to the Fed’s tools of operation. And, as they say, the rest is history.
The major changes include a decline in the “Securities Held Outright” of $275 billion, the account that includes Treasury securities the instrument that the Federal Reserve has traditionally used to conduct monetary policy. But even this figure is misleading because this category now includes “Federal Agency Debt Securities” and “Mortgage-backed Securities”. These two accounts have gone up by about $23 billion over the past 13 months, so that the decline in Treasury securities held by the Fed has actually declined by about $300 billion.
What has accounted, therefore, for the $1.5 trillion increase? (The $1.5 trillion comes from the $1.2 trillion increase in Factors Supplying Reserves and the decline of $0.3 trillion of Treasury Securities held.) “Term Auction Credit” injections accounted for almost $0.4 trillion, “Other Federal Reserve Assets” rose by almost $0.6 trillion and “Net portfolio holdings of Commercial Paper Funding Facility LLC” rose by a little over $0.3 trillion. The other roughly $0.2 trillion came from minor accounts like the increase in primary borrowings from the discount window, primary dealer and other broker-dealer credit, credit extended to AIG, the assets connected with the Bear Stearns bailout, and Asset-backed Commercial Paper Money Market Mutual Fund Liquidity Facility.
And, what is the point of listing all of these different sources of funds? The point is to highlight that most of the funds were injected into the market in order to provide liquidity to different sectors of the financial markets in an effort to “unfreeze” lending. The securities provided to the Federal Reserve to serve as collateral for these “loans” are supposedly of the highest credit quality. The rest of the funds…really a minor part of them…only about $113 billion…is to hold assets connected with the bailouts of AIG and Bear Stearns. That is, almost all of the funds were supplied to the market for liquidity reasons…not for solvency reasons. Thus, the Fed is sticking to one of its primary functions and not entering into the area of “capital adequacy” problems.
The capital adequacy problem should not be an issue that the Federal Reserve takes up. To do so would cause a major conflict with its primary responsibility…to conduct monetary policy.
To me, this is an issue primarily for the Treasury Department because it is very closely related to ownership...and when we start talking about ownership we start thinking of “nationalization”…and I believe that a lot of people have trouble walking down this road. However, given the depth of the problems of the banking industry, the issue of nationalization is going to come up and must be thoroughly discussed and debated. This is a major step for any nation to take…and most nations around the world that are looking at this problem in the face are treating the issue very gently. Even those nations who have governments that look to more governmental involvement in the economy at being very careful.
Fed Chairman Bernanke has stated that the United States cannot just rely on the Obama stimulus plan to get the economy going…and he is right. But, the Federal Reserve has supplied a lot of liquidity to financial markets…and, they will stand ready to supply more liquidity if it is needed. However, the Fed cannot do much more at this time. I hope it does not have many more tricks up its sleeve to surprise us with as it did this past year. In this respect, I think the Fed needs to be careful going forward and not get impatient and do something way off the wall.
As you may remember, I am not a great fan of Bernanke and I had hoped that he would offer to step down so that President Obama could select a Chairman of the Fed that would be more capable. I believe that Bernanke panicked last September (See “The ‘Bailout Plan: Did Bernanke Panic?” on Seeking Alpha, http://seekingalpha.com/author/john-m-mason/articles/latest, November 16, 2008.) Paulson was over whelmed, Bush 43 was absent without leave, and there was no one else in the administration with the intellectual quality to counter Bernanke’s arguments. As a result we got the mess labeled TARP…which was ill-planned, ill-debated, and mismanaged from the start…which has turned into its own source of disaster.
Frankly, I am concerned about where the Fed is headed. There are certainly stronger intellects around in the Obama administration…Larry Summers particularly comes to mind. However, the Fed has a certain independence that forces one to worry when you do not have confidence in its leadership.
Where will the Fed go? One should not be surprised by the central bank. A central bank needs to be steady and secure at the helm. A central bank needs to provide confidence to markets and institutions. I do not sense that participants in the financial markets feel this way at this time about the current Federal Reserve System.
Whereas the Federal Reserve System is supposed to fight a liquidity crisis, a very short term phenomenon, it was not set up to resolve a solvency crisis, a longer term situation. The problem faced in a liquidity crisis is that, for one reason or another, an institution or a few institutions want to sell quickly some kind of a financial asset but there are few, if any, buyers. The responsibility of the Federal Reserve is to supply liquidity to the market on a short term basis so that the market will stabilize and buyers of these financial assets will return to the market.
We have gone through our liquidity crises this time around. Liquidity crises are surprises…we are not prepared for them…and this is why the response has to be quick and decisive. I say that we have gone through our liquidity crises this time around because investors are very wary about ALL asset classes now and the surprises that come to light on a regular basis are how deep the losses on assets continue to be…not that there are losses.
The Federal Reserve is not set up to solve a solvency crisis. The solvency crisis is a capital adequacy problem. It is a problem related to how large the losses are related to the book value of the assets. Yes, there are liquidity issues related to these troubled assets…they may not be able to be sold…or they cannot be sold. If this is the case the question becomes whether or not the problems related to these assets can be worked out and if so how much of the asset value will be retained…if any of it can be retained. And, the solvency crisis is of a longer term nature than the liquidity crisis.
The Federal Reserve, over the past 13 months has drastically changed the way it operates in an effort to provide liquidity to financial markets. Attention has been directed to the expansion of the asset portfolio of the Federal Reserve System. In the last 13 months, the line item labeled “Total Factors Supplying Reserve Funds” that appears on the Federal Reserve Statistical Release, H.4.1, “Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks,” has increased by approximately $1.2 trillion. The increase is from $0.9 trillion on Wednesday November 28, 2007 to $2.1 trillion on Wednesday January 14, 2009. All of this increase has come since Wednesday September 3, 2008 when the balance totaled $0.94 trillion.
I include December 2007 in this calculation for it was in this month that we first got the innovation called the Term Auction Credit Facility introduced to the Fed’s tools of operation. And, as they say, the rest is history.
The major changes include a decline in the “Securities Held Outright” of $275 billion, the account that includes Treasury securities the instrument that the Federal Reserve has traditionally used to conduct monetary policy. But even this figure is misleading because this category now includes “Federal Agency Debt Securities” and “Mortgage-backed Securities”. These two accounts have gone up by about $23 billion over the past 13 months, so that the decline in Treasury securities held by the Fed has actually declined by about $300 billion.
What has accounted, therefore, for the $1.5 trillion increase? (The $1.5 trillion comes from the $1.2 trillion increase in Factors Supplying Reserves and the decline of $0.3 trillion of Treasury Securities held.) “Term Auction Credit” injections accounted for almost $0.4 trillion, “Other Federal Reserve Assets” rose by almost $0.6 trillion and “Net portfolio holdings of Commercial Paper Funding Facility LLC” rose by a little over $0.3 trillion. The other roughly $0.2 trillion came from minor accounts like the increase in primary borrowings from the discount window, primary dealer and other broker-dealer credit, credit extended to AIG, the assets connected with the Bear Stearns bailout, and Asset-backed Commercial Paper Money Market Mutual Fund Liquidity Facility.
And, what is the point of listing all of these different sources of funds? The point is to highlight that most of the funds were injected into the market in order to provide liquidity to different sectors of the financial markets in an effort to “unfreeze” lending. The securities provided to the Federal Reserve to serve as collateral for these “loans” are supposedly of the highest credit quality. The rest of the funds…really a minor part of them…only about $113 billion…is to hold assets connected with the bailouts of AIG and Bear Stearns. That is, almost all of the funds were supplied to the market for liquidity reasons…not for solvency reasons. Thus, the Fed is sticking to one of its primary functions and not entering into the area of “capital adequacy” problems.
The capital adequacy problem should not be an issue that the Federal Reserve takes up. To do so would cause a major conflict with its primary responsibility…to conduct monetary policy.
To me, this is an issue primarily for the Treasury Department because it is very closely related to ownership...and when we start talking about ownership we start thinking of “nationalization”…and I believe that a lot of people have trouble walking down this road. However, given the depth of the problems of the banking industry, the issue of nationalization is going to come up and must be thoroughly discussed and debated. This is a major step for any nation to take…and most nations around the world that are looking at this problem in the face are treating the issue very gently. Even those nations who have governments that look to more governmental involvement in the economy at being very careful.
Fed Chairman Bernanke has stated that the United States cannot just rely on the Obama stimulus plan to get the economy going…and he is right. But, the Federal Reserve has supplied a lot of liquidity to financial markets…and, they will stand ready to supply more liquidity if it is needed. However, the Fed cannot do much more at this time. I hope it does not have many more tricks up its sleeve to surprise us with as it did this past year. In this respect, I think the Fed needs to be careful going forward and not get impatient and do something way off the wall.
As you may remember, I am not a great fan of Bernanke and I had hoped that he would offer to step down so that President Obama could select a Chairman of the Fed that would be more capable. I believe that Bernanke panicked last September (See “The ‘Bailout Plan: Did Bernanke Panic?” on Seeking Alpha, http://seekingalpha.com/author/john-m-mason/articles/latest, November 16, 2008.) Paulson was over whelmed, Bush 43 was absent without leave, and there was no one else in the administration with the intellectual quality to counter Bernanke’s arguments. As a result we got the mess labeled TARP…which was ill-planned, ill-debated, and mismanaged from the start…which has turned into its own source of disaster.
Frankly, I am concerned about where the Fed is headed. There are certainly stronger intellects around in the Obama administration…Larry Summers particularly comes to mind. However, the Fed has a certain independence that forces one to worry when you do not have confidence in its leadership.
Where will the Fed go? One should not be surprised by the central bank. A central bank needs to be steady and secure at the helm. A central bank needs to provide confidence to markets and institutions. I do not sense that participants in the financial markets feel this way at this time about the current Federal Reserve System.
Sunday, November 23, 2008
The Coming Stimulus Package
Yes, we do have a President (elect)! (See “A Whiff of Leadership?” posted November 22, 2008 at http://maseportfolio.blogspot.com/ . An economic stimulus package is in the works. The underlying philosophy…the risks of not doing something big are bigger than the risks associated with inflation and an economic cleanup when the economy shifts into first gear rather than reverse.
We have seen this attitude taken by the Federal Reserve. The Fed, as we have been writing about in this blog, has not wanted to be short in supplying liquidity to the financial markets. Federal Reserve assets have more than doubled in the past ten weeks. Chairman Ben Bernanke has been given the name Helicopter Ben during this barrage of funds. But, the argument goes, the risk is too great to not put money into the financial system until the financial markets begin to function again.
Liquidity is apparently not going to get the economy humming again…spending of the private sector is going into the tank. Lending in the financial markets is not going to kick-start consumer spending or investment spending…state and local government expenditure is also in decline…so the belief is that the federal government must step into the gap and stimulate incomes and employment.
The talk seems to indicate that the Obama economic stimulus package is going to be somewhere in the neighborhood of $700 billion…of similar size to the bailout package of a couple of months ago. The idea…like that of the bailout package…is that the stimulus package must be a large number.
One thing that is crucial in all of this is that the Obama administration must give off the impression that it is operating under control…that it is disciplined. This is a hard thing to do when the philosophy of the stimulus package is the one described above. However, the administration must appear to be very intentional, on top of the situation, and ready to do what is necessary in response to new information. That is, the Obama administration must rebuild confidence in the federal government. Establishing confidence at the top is necessary because it will help to rebuild the confidence of the whole system as I discuss in “Discipline or the Lack Thereof” posted November 20, 2009, at http://maseportfolio.blogspot.com/.
President-elect Obama seems to be aware of this need to set the tone for the future. I think people, and markets, will respond very well to this because they are so hungry for leadership at this time…and are very, very anxious. So, we see two things going on right now…first, the appointment of top quality people to important positions…and, second, the intentional effort to create programs and get the discussion in Congress and the economy going so that action can be taken as soon as possible. The important emphasis right now is that the effort is intentional, not passive or just reactive.
Just a final note about the apparent appointment of Larry Summers to head the National Economic Council: this may be an inspired choice. No one questions the intelligence and ability of Summers. Being in the White House, acting as the coordinator of the economic policies of the President, monitoring the President’s economic agenda, and serving as close advisor to the President may not only fit his personality best but may be the real place his talents can fill the needs of the nation. It also superbly complements the other appointments that the President-elect has made to build his economic team.
We have seen this attitude taken by the Federal Reserve. The Fed, as we have been writing about in this blog, has not wanted to be short in supplying liquidity to the financial markets. Federal Reserve assets have more than doubled in the past ten weeks. Chairman Ben Bernanke has been given the name Helicopter Ben during this barrage of funds. But, the argument goes, the risk is too great to not put money into the financial system until the financial markets begin to function again.
Liquidity is apparently not going to get the economy humming again…spending of the private sector is going into the tank. Lending in the financial markets is not going to kick-start consumer spending or investment spending…state and local government expenditure is also in decline…so the belief is that the federal government must step into the gap and stimulate incomes and employment.
The talk seems to indicate that the Obama economic stimulus package is going to be somewhere in the neighborhood of $700 billion…of similar size to the bailout package of a couple of months ago. The idea…like that of the bailout package…is that the stimulus package must be a large number.
One thing that is crucial in all of this is that the Obama administration must give off the impression that it is operating under control…that it is disciplined. This is a hard thing to do when the philosophy of the stimulus package is the one described above. However, the administration must appear to be very intentional, on top of the situation, and ready to do what is necessary in response to new information. That is, the Obama administration must rebuild confidence in the federal government. Establishing confidence at the top is necessary because it will help to rebuild the confidence of the whole system as I discuss in “Discipline or the Lack Thereof” posted November 20, 2009, at http://maseportfolio.blogspot.com/.
President-elect Obama seems to be aware of this need to set the tone for the future. I think people, and markets, will respond very well to this because they are so hungry for leadership at this time…and are very, very anxious. So, we see two things going on right now…first, the appointment of top quality people to important positions…and, second, the intentional effort to create programs and get the discussion in Congress and the economy going so that action can be taken as soon as possible. The important emphasis right now is that the effort is intentional, not passive or just reactive.
Just a final note about the apparent appointment of Larry Summers to head the National Economic Council: this may be an inspired choice. No one questions the intelligence and ability of Summers. Being in the White House, acting as the coordinator of the economic policies of the President, monitoring the President’s economic agenda, and serving as close advisor to the President may not only fit his personality best but may be the real place his talents can fill the needs of the nation. It also superbly complements the other appointments that the President-elect has made to build his economic team.
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