When is the last time you heard that an American President was lectured to?
Mr. Obama…it’s time to change teams.
If you want to have any chance of getting re-elected in 2012 then you better make some changes now, both in the team that you have surrounded yourself with and with the economic and financial philosophy that has been followed.
Just remember, however, that Bush nominated Mr. Bernanke for the position of Chairman of the Board of Governors of the Federal Reserve System and an appointee of Mr. Bush, that is Mr. Bernanke, oversaw the appointment of Tim Geithner as the President of the Federal Reserve Bank of New York.
Obviously, these two people, Ben and Tim, are holdovers from the presidency that caused the mess that Mr. Obama now finds himself in.
Mr. Summers is on the way out and Ms. Romer has departed. A large part of the economic team that was in place is leaving or has left.
Clean house. Start again.
The economic model your team has worked with is out-of-date and inappropriate for the current situation.
We have been told for at least two years now that the problems in the banking sector are liquidity problems. But, liquidity problems are of short-term nature and need to be resolved within a relatively short period of time. (See http://seekingalpha.com/article/235712-it-s-a-solvency-problem-not-a-liquidity-problem.)
The policies that are used to combat a liquidity crisis are also of a short-term nature. These policies are based upon the need to supply the market with liquidity so that asset prices will stop dropping.
Given this interpretation, the Federal Reserve, under Ben’s leadership, has supplied liquidity…and more liquidity…and more liquidity to resolve the issue.
This is a sign that the model being used by Ben and the Fed is inappropriate for the particular situation that they face.
In terms of fiscal policy, the situation is similar. The “experts” in the Obama administration, led by Tim, have called for more spending…and more spending…and more spending.
In both cases, the reason given why the policy prescription is not working is that the particular stimulus package tried has not been large enough. The solution Ben and Tim have given is to make the policy package larger. More spending…and more liquidity!
This is a sign that something is wrong!
The model and the analysis being used are not appropriate. It is time to change policy advisors and the model being used to develop economic policy.
In the financial markets, the problems that exist are solvency problems. Households are declaring bankruptcy in record numbers and foreclosures on homes continue to run at very high rates. Small businesses are also declaring bankruptcy and loan demand coming from small businesses is dropping as of the last Federal Reserve survey. Thousands of small banks are on the verge of insolvency. (See http://seekingalpha.com/article/235712-it-s-a-solvency-problem-not-a-liquidity-problem.)
And, guess what? The monetary policy that the Federal Reserve is following has successfully resulted in the accumulation of massive amounts of cash in the hands of large banks and large corporations. I am just waiting for the acquisition binge to begin once the economy stabilizes a little more. So much for "Main Street"!
In the economy, the “consensus” economic model that has been used over the past fifty years is still contributing to the “more-of-the-same” policies that are being followed by the Federal Reserve and the Treasury Department.
Yet, over these past fifty years the application of this model has produced the following results: the United States has moved from an “under”-employment rate of around 8% of the working population to about 25% in the current environment; these policies have also resulted in the capacity utilization in industry moving from about 93% in the 1960s to about 75% at the present time, constantly eroding throughout the whole time period; and, the distribution of income in the United States over this fifty years has moved dramatically toward the end of the most wealthy.
The foreign exchange markets have signaled to the United States that something is wrong! Over the past fifty years, the value of the dollar has declined by more than 40% in foreign exchange markets. After a recovery in the latter part of the 1990s, the value of the dollar once again tanked until we hit the financial crisis of 2008 and there was a “stampede to quality.” Once this “stampede” was over and markets and economies stabilized, the value of the dollar declined once again. And, after Ben made his remarks in Jackson Hole concerning the forthcoming quantitative easing, the value of the dollar plunged 7% in a matter of weeks.
Paul Volker has written that the most important price in a country is the price of its currency in terms of other currencies. If the value of your currency declines, this is a sign of weakness…weakness in your economy and in your economic policies.
And, here we are. Thursday November 11, 2010, the President of the United States was lectured to by Hu Jintao, the Chinese President, over the United States currency. Other world leaders, from Germany, Great Britain, and Brazil, have also reprimanded the President over the United States currency situation. (http://seekingalpha.com/article/236430-release-from-the-g20-what-more-needs-to-be-said)
Furthermore, given the election results in the mid-term elections held last week, the American people seem to have a problem with United States economic policies.
The President needs different advice. The President needs different advisors. Ben and Tim need to go!
Showing posts with label Paul Volcker. Show all posts
Showing posts with label Paul Volcker. Show all posts
Friday, November 12, 2010
Wednesday, July 28, 2010
Looking at the Dollar Again
As European financial markets seem to be stabilizing, it is time to look again at the value of the dollar. After the heat over the sovereign debt crisis cooled somewhat the value of the dollar, once more, headed south. Over the past two years or so, global markets have seemed to be saying, if the financial world is going to fall apart today, I want to be holding some kind of dollar assets. However, if I am to bet on the value of the dollar over an extended period of time, then I want to hold assets denominated in other currencies.
As one can see from this chart showing a trade-weighted index of the United States dollar against the major currencies of the world, the general drift of the value of the dollar since the early 1970s has been downward. There are two major upswings. The first relates to the tightening of credit by the Federal Reserve under the leadership of Paul Volcker. This is the upswing that goes from about 1980 to 1986. The second upswing came during the federal budget tightening led by Treasury Secretary Robert Rubin which eventually resulted in a budget surplus and lasted from about 1995 into 2001.
During the last two years or so, there have been two minor upward movements in the value of the dollar. These minor swings came during the fall of 2008 into 2009 and in the spring of 2010 connected with the sovereign debt crisis in Europe. This last upswing seems to have peaked as the dollar, once again, heads downward.
Although the rise in the value of the dollar during the first of these movements was “across the board”, the primary reason for the rise in the value of the dollar in the latter period was the movement of money out of the euro. But, given the actions of the European Union and given the results of the “stress tests” applied to European banks, confidence seems to be returning to the Euro.
So, the long-run trend in the value of the dollar still seems to be downwards.
To me, the price of a nation’s currency is still the most important price in that nation. The fact that the long-run trend of the dollar is down highlights the fact that the international financial community continues to believe that there are still structural problems in the United States that must be dealt with. And, one can add, that these structural problems are not connected with one political party or the other. Both parties have contributed to these structural problems and, until there is a major change in the way Americans think, these structural problems will not go away. Hence, the bet is still on a falling value of the dollar.
What are the major structural problems?
Let’s start with just three. First, is the federal government deficit. Again, this is not a problem that has just occurred. The gross federal debt of the United States has increased at a compound rate of about 7% from 1961 through 2009. “Official” estimates of the deficit over the next ten years are for the deficit to increase by $8 to $10 trillion. I have been a little more pessimistic, arguing that the deficits will be more like $15 trillion. The lower estimate will still keep the growth rate of the debt above 7% a year.
Second, the commercial banking system has over $1.0 in excess reserves! The Federal Reserve is planning an “exit” strategy to remove these reserves from the banking system as the economic recovery picks up steam. However, there is little evidence provided over the past fifty years or so that the Fed can or will be able to keep these reserves from getting into the spending stream especially given the amount of the federal debt that is going to have to be financed over the next ten years.
Third, there are major dislocations in terms of the allocation of corporate assets, of corporate capital, both physical and human, in the United States. (See my post http://seekingalpha.com/article/216450-the-source-of-economic-success.) To correct these dislocations will take a lengthy period of time which indicates that the country will not recover as rapidly as it would if these dislocations did not exist. This will just exacerbate the problems caused by the two situations mentioned above. Again, this is seen as a negative in terms of pricing the dollar in foreign exchange markets.
I have been a dollar “bear” for a long time. The reason is that the general thinking about economic policy in the United States has been wrong since the early 1960s. International financial markets seem to support this assessment. And, this thinking appears in both the Republican and the Democratic leadership. I had hopes that changes were taking place when Paul Volcker was Chairman of the Board of Governors of the Federal Reserve System. I had similar hopes when Treasury Secretary Robert Rubin led the charge to reduce the federal deficits in the 1990s. In each case, “the dark side” eventually prevailed.
There is nothing I see in the future to make me think that the value of the dollar will rise except in times of global financial crisis where there is a “flight to quality”. But, these will eventually run out if nothing is done to resolve the longer-run issues. As far as I can see, there certainly is no leader on the present stage that can bring about the changes that are needed. Therefore, I remain “bearish”.
Wednesday, March 31, 2010
Mr. Volcker Speaks
Former Fed Chairman, Paul Volcker spoke yesterday at the Peterson Institute for International Economics. All week I had been hearing comments about this speech and how people seemed to be waiting for Volker’s remarks. Yet, this morning, there was only one report on the speech which appeared in the New York Times (http://www.nytimes.com/2010/03/31/business/31regulate.html?ref=business) and then it was buried at the bottom of page B6 of the business section.
It seems as if Volcker didn’t really say very much. In fact, the discussion of his remarks was combined with a discussion of the words of Robert Gibbs, the White House Press Secretary. The bottom line: it is highly likely that the United States will get a re-regulation package for its financial system this year. Gibbs even said that “the Senate might move on the legislation by the end of May”.
Just a couple of comments on the issues that were mentioned in this article.
First, the article states that the legislation to “overhaul the nation’s financial system…is intended to prevent a recurrence of the conditions that led to the 2008 financial crisis and the government bailouts that followed.”
If this is what the legislation is intended to do, we have already lost the battle. As I have stated over and over again, the problem with regulatory legislation is that it is always fighting the last war.
Let me state this as bluntly as possible: We will never have “a recurrence of the conditions that led to the 2008 financial crisis!”
Financial crises do not repeat themselves.
I do agree with Carmen Reinhart and Ken Rogoff in their book “This Time is Different” that the buildup to a financial crisis is always accompanied by the cry of those riding the crest of the economic expansion that “This time is different!” This claim, however, refers to the belief of the perpetrators of the claim that no collapse will follow the buildup that they are going through.
When I say that financial crises do not repeat themselves I mean that the specific conditions preceding a financial collapse, the specific behavior of the financial institutions and the financial leaders, are always different from past collapses. There is new technology, new instruments, new institutional arrangements, and so forth. Things change significantly enough so that the new regulations put into effect at the end of the last financial collapse don’t quite apply to the conditions that exist before the next financial collapse.
This gets into my second point which addresses Volcker’s concern about the growth of the financial services industry relative to the growth in other sectors in the rest of the economy.
We are told that “Mr. Volcker was critical of the broad growth in the financial services industry in recent decades. Finance came to represent an ever-greater share of corporate profits, even as average earnings for most American workers did not rise.”
Volker is quoted as saying “The question that really jumps out for me is, given all that data, whether the enormous gains in the financial sector—in compensation and profits—reflect the relative contributions that sector has made to the growth of human welfare.”
The article continues, “He also asked whether the financial sector contributed to underlying imbalances in the economy, as Americans raided their savings and relied on a housing bubble to maintain excessively high consumptions levels.”
My response to this is that from 1961 through 2008, the purchasing power of the dollar declined by almost 85%. In this inflationary environment, many American families came to believe that the best way to “save” was to buy a house and watch the value of the house rise. In addition, they could further leverage the constantly rising value of their house to “maintain excessively high consumptions levels.”
Mr. Volcker, more than anyone else in the United States, recognized the problem created by the inflationary environment of the late 1970s and early 1980s and, during his tenure as the Chairman of the Board of Governors of the Federal Reserve System, fought inflation with all that the Fed could bring against this destructive dragon. He deserves major praise for what he accomplished at this time.
Still, over this 1961-2008 period, inflation was the major economic incentive in existence in the economy. By the end of the 1960s, commercial banks had innovated to the point that they became “liability managers” and created the ability to expand to any size that they wanted. This happened because the start of this inflationary period made it necessary for banks to have the flexibility to expand beyond the geographic and asset constraints that restricted their ability to compete.
In the early 1970s the mortgage-backed security was invented (by the government by-the-way) and in the middle 1980s the mortgage market became the largest component of the capital markets. As inflationary expectations rose and resulted in higher interest rates during this time, interest rate risk became more of an issue and the interest rate futures market was created.
Need I say more? Financial innovation thrived in the inflationary environment and, as a consequence, the financial industry grew! And, grew! And grew!
Did the “enormous gains in the financial sector reflect the relative contributions that sector has made to the growth in human welfare”? Did “the financial sector contribute to underlying imbalances in the economy”?
I think you know how I would answer both of these questions.
Another piece of the news this morning struck me. Citigroup is spinning off Primerica (http://www.ft.com/cms/s/0/cef26d7c-3c41-11df-b316-00144feabdc0.html). Primerica was one of the first companies purchased by Sandy Weill in the late 1980s that became part of the financial conglomerate Citigroup. Everything about financial innovation and the relative growth of the financial services sector of the economy during this inflationary period is captured in Weill’s wild ride to the top as he constructed Citigroup piece by piece.
And, now we have the dismantling of Citigroup. Is this picture the icon of the new age of finance?
Higher capital requirements can contribute to sounder financial behavior. More disclosure and increased audit standards can also contribute to sounder financial behavior. Still, we cannot build a regulatory structure that will prevent a recurrence of financial crises whether based on the 2008 experience or the experience of some other time period. Furthermore, we cannot prevent greedy politicians from supporting policies that create an inflationary bias to the economy in order to get re-elected.
Regulation of the “bad guys” on Wall Street is popular now. However, it won’t prevent a volatile future.
It seems as if Volcker didn’t really say very much. In fact, the discussion of his remarks was combined with a discussion of the words of Robert Gibbs, the White House Press Secretary. The bottom line: it is highly likely that the United States will get a re-regulation package for its financial system this year. Gibbs even said that “the Senate might move on the legislation by the end of May”.
Just a couple of comments on the issues that were mentioned in this article.
First, the article states that the legislation to “overhaul the nation’s financial system…is intended to prevent a recurrence of the conditions that led to the 2008 financial crisis and the government bailouts that followed.”
If this is what the legislation is intended to do, we have already lost the battle. As I have stated over and over again, the problem with regulatory legislation is that it is always fighting the last war.
Let me state this as bluntly as possible: We will never have “a recurrence of the conditions that led to the 2008 financial crisis!”
Financial crises do not repeat themselves.
I do agree with Carmen Reinhart and Ken Rogoff in their book “This Time is Different” that the buildup to a financial crisis is always accompanied by the cry of those riding the crest of the economic expansion that “This time is different!” This claim, however, refers to the belief of the perpetrators of the claim that no collapse will follow the buildup that they are going through.
When I say that financial crises do not repeat themselves I mean that the specific conditions preceding a financial collapse, the specific behavior of the financial institutions and the financial leaders, are always different from past collapses. There is new technology, new instruments, new institutional arrangements, and so forth. Things change significantly enough so that the new regulations put into effect at the end of the last financial collapse don’t quite apply to the conditions that exist before the next financial collapse.
This gets into my second point which addresses Volcker’s concern about the growth of the financial services industry relative to the growth in other sectors in the rest of the economy.
We are told that “Mr. Volcker was critical of the broad growth in the financial services industry in recent decades. Finance came to represent an ever-greater share of corporate profits, even as average earnings for most American workers did not rise.”
Volker is quoted as saying “The question that really jumps out for me is, given all that data, whether the enormous gains in the financial sector—in compensation and profits—reflect the relative contributions that sector has made to the growth of human welfare.”
The article continues, “He also asked whether the financial sector contributed to underlying imbalances in the economy, as Americans raided their savings and relied on a housing bubble to maintain excessively high consumptions levels.”
My response to this is that from 1961 through 2008, the purchasing power of the dollar declined by almost 85%. In this inflationary environment, many American families came to believe that the best way to “save” was to buy a house and watch the value of the house rise. In addition, they could further leverage the constantly rising value of their house to “maintain excessively high consumptions levels.”
Mr. Volcker, more than anyone else in the United States, recognized the problem created by the inflationary environment of the late 1970s and early 1980s and, during his tenure as the Chairman of the Board of Governors of the Federal Reserve System, fought inflation with all that the Fed could bring against this destructive dragon. He deserves major praise for what he accomplished at this time.
Still, over this 1961-2008 period, inflation was the major economic incentive in existence in the economy. By the end of the 1960s, commercial banks had innovated to the point that they became “liability managers” and created the ability to expand to any size that they wanted. This happened because the start of this inflationary period made it necessary for banks to have the flexibility to expand beyond the geographic and asset constraints that restricted their ability to compete.
In the early 1970s the mortgage-backed security was invented (by the government by-the-way) and in the middle 1980s the mortgage market became the largest component of the capital markets. As inflationary expectations rose and resulted in higher interest rates during this time, interest rate risk became more of an issue and the interest rate futures market was created.
Need I say more? Financial innovation thrived in the inflationary environment and, as a consequence, the financial industry grew! And, grew! And grew!
Did the “enormous gains in the financial sector reflect the relative contributions that sector has made to the growth in human welfare”? Did “the financial sector contribute to underlying imbalances in the economy”?
I think you know how I would answer both of these questions.
Another piece of the news this morning struck me. Citigroup is spinning off Primerica (http://www.ft.com/cms/s/0/cef26d7c-3c41-11df-b316-00144feabdc0.html). Primerica was one of the first companies purchased by Sandy Weill in the late 1980s that became part of the financial conglomerate Citigroup. Everything about financial innovation and the relative growth of the financial services sector of the economy during this inflationary period is captured in Weill’s wild ride to the top as he constructed Citigroup piece by piece.
And, now we have the dismantling of Citigroup. Is this picture the icon of the new age of finance?
Higher capital requirements can contribute to sounder financial behavior. More disclosure and increased audit standards can also contribute to sounder financial behavior. Still, we cannot build a regulatory structure that will prevent a recurrence of financial crises whether based on the 2008 experience or the experience of some other time period. Furthermore, we cannot prevent greedy politicians from supporting policies that create an inflationary bias to the economy in order to get re-elected.
Regulation of the “bad guys” on Wall Street is popular now. However, it won’t prevent a volatile future.
Wednesday, March 10, 2010
A Time for Crybabies
The headlines of the day: “European Leaders Call for Crackdown on Derivatives” (http://www.nytimes.com/2010/03/10/business/global/10swaps.html?hpw) and “Call for Action on Speculation Rules” (http://www.ft.com/cms/s/0/7a22b968-2bad-11df-a5c7-00144feabdc0.html).
Alternative headlines to these are “Financial Markets Call for Crackdown on Undisciplined and Irresponsible Government Budget Behavior” or “Call for Action on Fiscal Policy Biases.”
This is the time for cry-babies and the leaders of many nations in the world are not letting us down.
Their basic theme is “All our problems can be laid at the feet of the financial community, its innovations, and its speculative behavior. We need better and tougher regulation and we need stricter laws and rules about what can be done. Doing this will make everything better!”
This, however, is getting “cause and effect” turned around!
My question is, “Who created the inflationary environment of the last fifty or sixty years that resulted in the financial innovation and speculation that resulted? Who promoted almost perpetual government budget deficits, in recessions as well as booms, and who underwrote this deficit spending with supportive monetary policies that encouraged the expansions but fought the contractions? Who is responsible for the 85% decline in the purchasing power of the United
States dollar since January 1961?”
The stage was set in the United States in 1946 when Congress passed the “Full Employment Act of 1946.” In 1961, an administration took over the presidency that was devoted to the Keynesian full employment policy. In 1971, President Nixon in an effort to stimulate the economy to get himself re-elected claimed that “We are all Keynesians now!” In this effort to get re-elected, Nixon appointed Arthur Burns as the Chairman of the Board of Governors of the Federal Reserve System. Monetary policy supported the effort to achieve the economic goals Nixon believed he needed to have in order to get re-elected. Then in 1978, Congress enacted the “Full Employment and Balanced Growth Act”, often referred to as the “Humphrey-Hawkins Full Employment Act.”
The true test of government monetary and fiscal policy, as written into the law of the land was full employment and high levels of economic growth. And, explicitly or implicitly, countries throughout the free world followed this pattern in the post World War II world.
And, what resulted from this policy bias?
Well, by the last half of 1968 we had high-grade corporate bond rates in the 6.5% range. These yields had not really gotten much above 4% until late 1959 into 1960, and did not cross 5% until the middle of the latter decade. It was during the late 1960s that researchers started discussing the presence of “inflationary expectations” in interest rates, a concern that vanished toward the end of the 1920s.
In the 1960s we also saw the first real post-World War II financial innovation take place. The primary source of business credit at that time was the commercial banks. As the presence of inflation spread and in order to expand their capacity to lend and to compete against banks worldwide, United States commercial banks developed the negotiable Certificate of Deposit, the Euro dollar, and the use of Commercial Paper to raise funds through bank holding companies. Large banks ceased to have funding limits on their ability to raise money to lend. This was an omen for the future.
In August 1971, President Nixon froze wages and prices and took the United States off of the gold standard. Inflation had obviously reached a point where it had become a concern of the nation.
The bid to get Nixon re-elected re-ignited inflationary pressures and his predecessor Gerald Ford attempted to Whip Inflation Now! (The WIN campaign) By the middle of 1979 inflation had become so bad in the United States that President Jimmy Carter had to appoint someone of the prestige of Paul Volcker to take over at the Fed and “get serious” about the high levels of inflation existing in the country.
In the 1980s financial innovation was rampant. One only needs to go to the Michael Lewis book, “Liar’s Poker” to get an idea of how much financial innovation had taken over Wall Street by the middle of the decade. Increasing tensions between the Reagan administration and Volcker resulted in Volcker resigning in August 1987. Someone much more conciliatory, Alan Greenspan, got appointed Fed Chairman.
All one needs to be said about Greenspan is that the term the “Greenspan put” was created during his tenure. Greenspan supported economic expansion, but protected financial markets on the downside. In the 1990s the United States experienced credit bubbles, the best known being the dot-com boom…and bust. The 2000s saw bubbles in both the housing market and the stock market. And, during the credit inflation of the 1990s and the 2000s financial innovation exploded!
And, I haven’t touched on the governmental deficits created since the 1980s that the Federal
Reserve was helping to underwrite. But, enough said about the United States.
Leaders throughout the free world behaved in this manner through much of the last fifty years. There were, of course, earlier periods in which the cry-babies came out. This occurred numerous times, but the blame then was placed on those “shadowy people” known as “the international bankers.” Government deficits and loose monetary policy resulted in a sell-off of the currency of the country. This sell-off continued until the government made some efforts to bring on fiscal discipline and give some independence to its central bank. But, again, the governments assumed little of the blame; it was always the fault of “the bankers”.
Governmental leaders just don’t get it. Inflation becomes the music that everyone has to dance to. As long as inflation continues the dance goes on. As Charles “Chuck” Prince III, the former CEO of Citigroup famously said, “As long as the music continues to play, you must keep dancing.” And people and governments kept borrowing, bankers and other financial geniuses continued to craft new financial innovations, and bonuses continued to rise. And the music went on and on…
One of the difficulties of economics is that in most situations it takes time for things to work themselves out. That is, there can sometimes be a long lapse of time between the cause of something and the effect that the action brings about.
A classic example given is the long run impact of rent controls. Rent controls are great for renters in the short run. But, if low rents result in landlords reducing the amount of maintenance applied to the rent-controlled properties, the properties deteriorate in quality. Blame is then assessed against the greedy landlords and not against the rent controls.
We see a similar situation in the case of the financial speculation the governmental leaders are crying out against. Blame is assessed against the “bankers” and not against those that created the inflationary environment that produced the financial innovation and subsequent financial transactions. Unfortunately, a lot of people, those that can’t really defend themselves, get hurt in the process.
Whereas the renters got hurt in the previous example; workers, the people that were being helped by the governmental policies, are the ones that end up suffering when the music ends and people stop dancing. See “Irish Take Bitter Medicine to Survive Age of Red Ink”: http://online.wsj.com/article/SB20001424052748704486504575097672075207734.html#mod=todays_us_page_one.
Alternative headlines to these are “Financial Markets Call for Crackdown on Undisciplined and Irresponsible Government Budget Behavior” or “Call for Action on Fiscal Policy Biases.”
This is the time for cry-babies and the leaders of many nations in the world are not letting us down.
Their basic theme is “All our problems can be laid at the feet of the financial community, its innovations, and its speculative behavior. We need better and tougher regulation and we need stricter laws and rules about what can be done. Doing this will make everything better!”
This, however, is getting “cause and effect” turned around!
My question is, “Who created the inflationary environment of the last fifty or sixty years that resulted in the financial innovation and speculation that resulted? Who promoted almost perpetual government budget deficits, in recessions as well as booms, and who underwrote this deficit spending with supportive monetary policies that encouraged the expansions but fought the contractions? Who is responsible for the 85% decline in the purchasing power of the United
States dollar since January 1961?”
The stage was set in the United States in 1946 when Congress passed the “Full Employment Act of 1946.” In 1961, an administration took over the presidency that was devoted to the Keynesian full employment policy. In 1971, President Nixon in an effort to stimulate the economy to get himself re-elected claimed that “We are all Keynesians now!” In this effort to get re-elected, Nixon appointed Arthur Burns as the Chairman of the Board of Governors of the Federal Reserve System. Monetary policy supported the effort to achieve the economic goals Nixon believed he needed to have in order to get re-elected. Then in 1978, Congress enacted the “Full Employment and Balanced Growth Act”, often referred to as the “Humphrey-Hawkins Full Employment Act.”
The true test of government monetary and fiscal policy, as written into the law of the land was full employment and high levels of economic growth. And, explicitly or implicitly, countries throughout the free world followed this pattern in the post World War II world.
And, what resulted from this policy bias?
Well, by the last half of 1968 we had high-grade corporate bond rates in the 6.5% range. These yields had not really gotten much above 4% until late 1959 into 1960, and did not cross 5% until the middle of the latter decade. It was during the late 1960s that researchers started discussing the presence of “inflationary expectations” in interest rates, a concern that vanished toward the end of the 1920s.
In the 1960s we also saw the first real post-World War II financial innovation take place. The primary source of business credit at that time was the commercial banks. As the presence of inflation spread and in order to expand their capacity to lend and to compete against banks worldwide, United States commercial banks developed the negotiable Certificate of Deposit, the Euro dollar, and the use of Commercial Paper to raise funds through bank holding companies. Large banks ceased to have funding limits on their ability to raise money to lend. This was an omen for the future.
In August 1971, President Nixon froze wages and prices and took the United States off of the gold standard. Inflation had obviously reached a point where it had become a concern of the nation.
The bid to get Nixon re-elected re-ignited inflationary pressures and his predecessor Gerald Ford attempted to Whip Inflation Now! (The WIN campaign) By the middle of 1979 inflation had become so bad in the United States that President Jimmy Carter had to appoint someone of the prestige of Paul Volcker to take over at the Fed and “get serious” about the high levels of inflation existing in the country.
In the 1980s financial innovation was rampant. One only needs to go to the Michael Lewis book, “Liar’s Poker” to get an idea of how much financial innovation had taken over Wall Street by the middle of the decade. Increasing tensions between the Reagan administration and Volcker resulted in Volcker resigning in August 1987. Someone much more conciliatory, Alan Greenspan, got appointed Fed Chairman.
All one needs to be said about Greenspan is that the term the “Greenspan put” was created during his tenure. Greenspan supported economic expansion, but protected financial markets on the downside. In the 1990s the United States experienced credit bubbles, the best known being the dot-com boom…and bust. The 2000s saw bubbles in both the housing market and the stock market. And, during the credit inflation of the 1990s and the 2000s financial innovation exploded!
And, I haven’t touched on the governmental deficits created since the 1980s that the Federal
Reserve was helping to underwrite. But, enough said about the United States.
Leaders throughout the free world behaved in this manner through much of the last fifty years. There were, of course, earlier periods in which the cry-babies came out. This occurred numerous times, but the blame then was placed on those “shadowy people” known as “the international bankers.” Government deficits and loose monetary policy resulted in a sell-off of the currency of the country. This sell-off continued until the government made some efforts to bring on fiscal discipline and give some independence to its central bank. But, again, the governments assumed little of the blame; it was always the fault of “the bankers”.
Governmental leaders just don’t get it. Inflation becomes the music that everyone has to dance to. As long as inflation continues the dance goes on. As Charles “Chuck” Prince III, the former CEO of Citigroup famously said, “As long as the music continues to play, you must keep dancing.” And people and governments kept borrowing, bankers and other financial geniuses continued to craft new financial innovations, and bonuses continued to rise. And the music went on and on…
One of the difficulties of economics is that in most situations it takes time for things to work themselves out. That is, there can sometimes be a long lapse of time between the cause of something and the effect that the action brings about.
A classic example given is the long run impact of rent controls. Rent controls are great for renters in the short run. But, if low rents result in landlords reducing the amount of maintenance applied to the rent-controlled properties, the properties deteriorate in quality. Blame is then assessed against the greedy landlords and not against the rent controls.
We see a similar situation in the case of the financial speculation the governmental leaders are crying out against. Blame is assessed against the “bankers” and not against those that created the inflationary environment that produced the financial innovation and subsequent financial transactions. Unfortunately, a lot of people, those that can’t really defend themselves, get hurt in the process.
Whereas the renters got hurt in the previous example; workers, the people that were being helped by the governmental policies, are the ones that end up suffering when the music ends and people stop dancing. See “Irish Take Bitter Medicine to Survive Age of Red Ink”: http://online.wsj.com/article/SB20001424052748704486504575097672075207734.html#mod=todays_us_page_one.
Sunday, January 24, 2010
Regulation and Information--Part A
One of the things that bothers me about all the talk concerning the re-regulation of banks and other financial institutions is that it is “framed” within the context of the Great Depression and the Glass-Steagall Act, the Banking Act of 1933.
Get real people, times have changed!
We are not back in the age of the manufacturing, we are in the information age. We are not early in the 20th century, we are at the beginning of the 21st century. And, while no person commands my respect in the same way that Paul Volcker does, we do not need regulation that is in the mold of Glass-Steagall.
Finance is information. This dollar bill can be exchanged for that dollar bill. These dollars can be exchanged for so many Euros. Even more so, my set of 0s and 1s can be traded for your set of 0s and 1s: your checking account, my debit card, and her credit card.
Even individuals don’t trade in anything more than 0s and 1s these days. Finance, even at the most elemental level is just about information. And the more sophisticated that one gets, the more esoteric the information flow can become. And, that is the issue.
But, the post-World War II transformation in the financial industry began in earnest in the 1960s. The commercial banks were constrained by the Glass-Steagall Act and by geographic constraints. Yet, the world was growing. And, the banks, in order to be competitive in the world needed to become bigger and more geographically dispersed.
Three financial innovations were in place by the end of the 1960s that began to change of everything: the creation of the Bank Holding Company; the invention of the large denomination negotiable Certificate of Deposit; and the Eurodollar account.
The Bank Holding Company gave banks a freedom that they did not have when their charters limited their activity to just being a deposit taking bank. The large denomination negotiable Certificate of Deposit was an innovation that indicated that just about any financial instrument could become marketable. The development of the Eurodollar market showed that banks could raise funds worldwide and in different forms.
These three changes, when combined, turned large banks into liability managers and not asset managers. In essence, the invention of the large CD and the Eurodollar put an end to any constraints on the size of a financial institution. These instruments allowed banks to buy or sell all the funds they wanted at the going market interest rate. For all intents and purposes, by the start of the 1970s all interstate constraints on bank operations were history. And, except for capital requirements, all constraints on the size of financial institutions were history. The ability to manage liabilities ended these boundaries.
Other developments took place during this time. I will just discuss two of them. The first is the mortgage-backed security. In the 1960s politicians decided that if more housing got into the hands of the middle income classes that there would be a greater chance that they could get re-elected. They considered the mortgage, a long term asset. Then they looked at pension funds and insurance companies and saw that these institutions held long term assets. Mortgages were not quite what the pension funds or insurance companies wanted: mortgages came in sizes less than $100,000 in value when they wanted assets in the millions of dollars; also mortgages paid principal and interest whereas these funds and companies just wanted interest payments. So there were some hurdles to overcome.
As people worked with the idea, they saw that the mortgages generated and held by depository institutions could be bundled up into another form of security in order to get the size of asset needed. They also worked with the idea that the cash flow streams from the initial mortgages could be cut up in different ways so as to make individual streams of cash flows that were more desirable to the pension funds and insurance companies. Eventually they saw that securities could even be created that paid just interest (Interest Only securities or IOs) or that just made principal payments (Principal Only or P0s).
Bottom line, cash flows could be cut up (or in current terms ‘sliced and diced’) in any way that could sell! And, what is the abstract view of this? Cash flows are just 0s and 1s and 0s and 1s can be put in any form that anyone wants. These cash flow 0s and 1s could have assets behind them like houses, autos, or credit cards, or they could just be cash flows. What difference did it really make?
Of course, it could make a lot of difference. (I can’t be too ironic in what I write!)
If cash flows could just be created, why not asset values? Hence the idea of “notional” values.
Take an interest rate swap, for example. No money changes hands, the whole transaction is based on ‘notional’ values. Thus, a swap of a fixed interest payment arrangement for a variable interest payment arrangement could be achieved. Both parties are ‘better off’ and there is no real exchange of liabilities.
I could go on, but I don’t think I need to. By now you can see where I am going. Finance, today, is just 0s and 1s and people, individuals as well as institutions, don’t need real assets on which to base cash flows and cash flows can be ‘sliced and diced’ in any way imaginable so as to meet the needs and desires of those that want to acquire them. In essence, everything, all information, can be computerized and treated as interchangeable.
At least in the machines: at least ‘on paper’. But, this is the modern world of finance. That is why mathematicians, statisticians, physicists, and other “Quants” can play with this stuff. The modern world of finance is just information and information is just 0s and 1s. At the highest level, it is not people and assets and things. It is just 0s and 1s.
And, if you are concerned with this then you need to be aware of what is coming. This is the world of the future. There is a vibrant area of study that deals with information markets. The idea is that everything, and I mean everything, can be transformed into information and a market can be created for it. Robert Shiller, the behavioral economist of “Irrational Exuberance” is one of the leaders of this field.
Modern day finance is the model with the idea that this model can be extended to anything and everything. So get ready!
The fundamental point I want to make today is that the world of finance in the Age of Information is entirely different than the world of finance in the Age of Manufacturing. The 1930s are not directly transferrable into the 2010s! The rules and regulation of the modern world are not the same as the rules and regulations that needed to be applied to the world of the thirties. And the way to regulate the world of the 2010s is the subject of my next post.
Let me just close by saying that even Paul Volcker missed the point when he said that the only banking innovation of the last 50 years that was significant was the ATM machine, that all the other financial innovation contributed nothing to the age. The ATM is an ‘information age’ machine and is a part of the innovation that took place in the Age of Information. If one really understands this age then one cannot make the distinction between the ATM and all the other financial innovations that took place during this time period. Volcker has missed the point!
Get real people, times have changed!
We are not back in the age of the manufacturing, we are in the information age. We are not early in the 20th century, we are at the beginning of the 21st century. And, while no person commands my respect in the same way that Paul Volcker does, we do not need regulation that is in the mold of Glass-Steagall.
Finance is information. This dollar bill can be exchanged for that dollar bill. These dollars can be exchanged for so many Euros. Even more so, my set of 0s and 1s can be traded for your set of 0s and 1s: your checking account, my debit card, and her credit card.
Even individuals don’t trade in anything more than 0s and 1s these days. Finance, even at the most elemental level is just about information. And the more sophisticated that one gets, the more esoteric the information flow can become. And, that is the issue.
But, the post-World War II transformation in the financial industry began in earnest in the 1960s. The commercial banks were constrained by the Glass-Steagall Act and by geographic constraints. Yet, the world was growing. And, the banks, in order to be competitive in the world needed to become bigger and more geographically dispersed.
Three financial innovations were in place by the end of the 1960s that began to change of everything: the creation of the Bank Holding Company; the invention of the large denomination negotiable Certificate of Deposit; and the Eurodollar account.
The Bank Holding Company gave banks a freedom that they did not have when their charters limited their activity to just being a deposit taking bank. The large denomination negotiable Certificate of Deposit was an innovation that indicated that just about any financial instrument could become marketable. The development of the Eurodollar market showed that banks could raise funds worldwide and in different forms.
These three changes, when combined, turned large banks into liability managers and not asset managers. In essence, the invention of the large CD and the Eurodollar put an end to any constraints on the size of a financial institution. These instruments allowed banks to buy or sell all the funds they wanted at the going market interest rate. For all intents and purposes, by the start of the 1970s all interstate constraints on bank operations were history. And, except for capital requirements, all constraints on the size of financial institutions were history. The ability to manage liabilities ended these boundaries.
Other developments took place during this time. I will just discuss two of them. The first is the mortgage-backed security. In the 1960s politicians decided that if more housing got into the hands of the middle income classes that there would be a greater chance that they could get re-elected. They considered the mortgage, a long term asset. Then they looked at pension funds and insurance companies and saw that these institutions held long term assets. Mortgages were not quite what the pension funds or insurance companies wanted: mortgages came in sizes less than $100,000 in value when they wanted assets in the millions of dollars; also mortgages paid principal and interest whereas these funds and companies just wanted interest payments. So there were some hurdles to overcome.
As people worked with the idea, they saw that the mortgages generated and held by depository institutions could be bundled up into another form of security in order to get the size of asset needed. They also worked with the idea that the cash flow streams from the initial mortgages could be cut up in different ways so as to make individual streams of cash flows that were more desirable to the pension funds and insurance companies. Eventually they saw that securities could even be created that paid just interest (Interest Only securities or IOs) or that just made principal payments (Principal Only or P0s).
Bottom line, cash flows could be cut up (or in current terms ‘sliced and diced’) in any way that could sell! And, what is the abstract view of this? Cash flows are just 0s and 1s and 0s and 1s can be put in any form that anyone wants. These cash flow 0s and 1s could have assets behind them like houses, autos, or credit cards, or they could just be cash flows. What difference did it really make?
Of course, it could make a lot of difference. (I can’t be too ironic in what I write!)
If cash flows could just be created, why not asset values? Hence the idea of “notional” values.
Take an interest rate swap, for example. No money changes hands, the whole transaction is based on ‘notional’ values. Thus, a swap of a fixed interest payment arrangement for a variable interest payment arrangement could be achieved. Both parties are ‘better off’ and there is no real exchange of liabilities.
I could go on, but I don’t think I need to. By now you can see where I am going. Finance, today, is just 0s and 1s and people, individuals as well as institutions, don’t need real assets on which to base cash flows and cash flows can be ‘sliced and diced’ in any way imaginable so as to meet the needs and desires of those that want to acquire them. In essence, everything, all information, can be computerized and treated as interchangeable.
At least in the machines: at least ‘on paper’. But, this is the modern world of finance. That is why mathematicians, statisticians, physicists, and other “Quants” can play with this stuff. The modern world of finance is just information and information is just 0s and 1s. At the highest level, it is not people and assets and things. It is just 0s and 1s.
And, if you are concerned with this then you need to be aware of what is coming. This is the world of the future. There is a vibrant area of study that deals with information markets. The idea is that everything, and I mean everything, can be transformed into information and a market can be created for it. Robert Shiller, the behavioral economist of “Irrational Exuberance” is one of the leaders of this field.
Modern day finance is the model with the idea that this model can be extended to anything and everything. So get ready!
The fundamental point I want to make today is that the world of finance in the Age of Information is entirely different than the world of finance in the Age of Manufacturing. The 1930s are not directly transferrable into the 2010s! The rules and regulation of the modern world are not the same as the rules and regulations that needed to be applied to the world of the thirties. And the way to regulate the world of the 2010s is the subject of my next post.
Let me just close by saying that even Paul Volcker missed the point when he said that the only banking innovation of the last 50 years that was significant was the ATM machine, that all the other financial innovation contributed nothing to the age. The ATM is an ‘information age’ machine and is a part of the innovation that took place in the Age of Information. If one really understands this age then one cannot make the distinction between the ATM and all the other financial innovations that took place during this time period. Volcker has missed the point!
Thursday, December 17, 2009
Will Bernanke Never Learn?
The report from the Federal Reserve yesterday was positive. The headline in the Wall Street Journal was typical: “Fed More Upbeat, but Keeps Lid on Rates.” In other Federal Reserve news we hear that the Fed is going to phase out the special facilities set up during the financial crisis.
So, what else is new? (http://seekingalpha.com/article/178117-federal-reserve-exit-watch-part-5)
Our fearless leader, Time’s Person of the Year, POTY, Chairman Benjamin Shalom Bernanke, was an avid supporter of Alan Greenspan and low, low interest rates earlier this decade, rates that spurred on the credit bubble in housing and elsewhere. In 2007, Chairman Bernanke was late in identifying the fact that the economy was slowing and that there was a looming financial crisis on the horizon. Then, Time’s POTY seemingly panicked after the bailout of AIG in September 2008 and this resulted in the rushed passage of TARP. (http://seekingalpha.com/article/106186-the-bailout-plan-did-bernanke-panic)
Once it was finally accepted that there was a financial crisis, POTY saw to it that just about everything that could be thrown against the wall, was...thrown against the wall. In this he has been deemed a savior. The balance sheet of the Fed ballooned from about $900 billion to roughly $2.1 trillion.
Now, POTY is seeing that the target rate of interest for the conduct of monetary policy can hardly be differentiated from zero and this target has been maintained since December 16, 2008.
WOW! The Fed’s zero target rate of interest was one year old YESTERDAY!
Excess reserves in the banking system have gone from about $2 billion to over $1.1 trillion!
And, what is the result?
Big banks are eating this up! There are two articles in the morning papers that attest to this. See the column by John Gapper in the Financial Times, “How America let banks off the lease”: http://www.ft.com/cms/s/0/0ad195f8-ea7a-11de-a9f5-00144feab49a.html. Gapper writes, “As the FT reported on Wednesday, banks and hedge funds have made huge profits in distressed debt trading in the past year, aided by the Federal Reserve keeping short-term interest rates low. Meanwhile, the banks that turned out to be too big to be allowed to fail are bigger than ever.”
Next, the op-ed piece in the Wall Street Journal by Gerald P. O’Driscoll, Jr., “Obama vs. the Banks”: http://online.wsj.com/article/SB20001424052748704398304574597910616856696.html#mod=todays_us_opinion. O’Driscoll states “that banks can raise short-term money at very low interest rates and buy safe, 10-year Treasury bonds at around 3.5%. The Bernanke Fed has promised to maintain its policy for ‘for an extended period.’ That translates into an extended opportunity for banks to engage in this interest-rate arbitrage.” He then asks, “Why would a banker take on traditional loans, which even in good times come with some risk of loss?” Seems like I have been arguing this point for at least six months now in assorted blog posts.
But, of even more importance is the attitude of the bankers toward financial innovation.
There is no better environment for financial innovation than the one that we are now experiencing. I would argue very strongly that financial innovation is taking place right now even though we may not see all the different forms the innovation is taking. And, the current round of financial innovation is coming at the expense of regular borrowing and lending. And, the financial innovation is benefitting the large, financially savvy financial institutions and not the small- and medium-sized organizations that don’t have the resources, or, the inclination, or, the freedom, since they still have plenty of questionable assets to deal with. Hail, Wall Street! See you later Main Street!
For the past fifty years or so, the government of the United States has basically followed an expansionary economic policy that has provided a safety-net to the financial system, and established an inflationary bias within the economy. There is no better environment for financial innovation than this!
The banks, the financial system, the non-financial system, and governments have innovated like mad during this time period.
The current federal government is just continuing to underwrite this practice at the present time.
POTY and the current administration are just exacerbating the situation they are so heavily criticizing.
And, as Gapper states, "the banks that turned out to be too big to be allowed to fail are bigger now than ever."
POTY and the current administration may win, politically, in the short run because the big bankers seem to have a deaf ear: See http://seekingalpha.com/article/178269-defining-the-banking-situation-as-a-political-issue.
In the longer run, the victory may go to another side. Paul Volcker seems to be taking the other side of the argument. See the article by Simon Johnson in The New Republic: “Is History on Paul Volcker’s Side?” http://www.tnr.com/blog/the-plank/history-paul-volckers-side.
The bottom line, however, is that Benjamin Shalom Bernanke doesn’t seem to get it…once again! Time after time, the Fed Chairman has seemed to miss the mark. Because of this record, one, I think, can seriously ask the question: “Why should we expect Bernanke to be correct this time?”
In nominating the Chairman for another term, President Obama seems to believe that Bernanke will be correct this time. More than anything else the president has done, even sending more troops into Afghanistan, his bet on the re-appointment of Chairman Bernanke may determine how his presidency is perceived by future historians. A lot is riding on Chairman Bernanke.
So, what else is new? (http://seekingalpha.com/article/178117-federal-reserve-exit-watch-part-5)
Our fearless leader, Time’s Person of the Year, POTY, Chairman Benjamin Shalom Bernanke, was an avid supporter of Alan Greenspan and low, low interest rates earlier this decade, rates that spurred on the credit bubble in housing and elsewhere. In 2007, Chairman Bernanke was late in identifying the fact that the economy was slowing and that there was a looming financial crisis on the horizon. Then, Time’s POTY seemingly panicked after the bailout of AIG in September 2008 and this resulted in the rushed passage of TARP. (http://seekingalpha.com/article/106186-the-bailout-plan-did-bernanke-panic)
Once it was finally accepted that there was a financial crisis, POTY saw to it that just about everything that could be thrown against the wall, was...thrown against the wall. In this he has been deemed a savior. The balance sheet of the Fed ballooned from about $900 billion to roughly $2.1 trillion.
Now, POTY is seeing that the target rate of interest for the conduct of monetary policy can hardly be differentiated from zero and this target has been maintained since December 16, 2008.
WOW! The Fed’s zero target rate of interest was one year old YESTERDAY!
Excess reserves in the banking system have gone from about $2 billion to over $1.1 trillion!
And, what is the result?
Big banks are eating this up! There are two articles in the morning papers that attest to this. See the column by John Gapper in the Financial Times, “How America let banks off the lease”: http://www.ft.com/cms/s/0/0ad195f8-ea7a-11de-a9f5-00144feab49a.html. Gapper writes, “As the FT reported on Wednesday, banks and hedge funds have made huge profits in distressed debt trading in the past year, aided by the Federal Reserve keeping short-term interest rates low. Meanwhile, the banks that turned out to be too big to be allowed to fail are bigger than ever.”
Next, the op-ed piece in the Wall Street Journal by Gerald P. O’Driscoll, Jr., “Obama vs. the Banks”: http://online.wsj.com/article/SB20001424052748704398304574597910616856696.html#mod=todays_us_opinion. O’Driscoll states “that banks can raise short-term money at very low interest rates and buy safe, 10-year Treasury bonds at around 3.5%. The Bernanke Fed has promised to maintain its policy for ‘for an extended period.’ That translates into an extended opportunity for banks to engage in this interest-rate arbitrage.” He then asks, “Why would a banker take on traditional loans, which even in good times come with some risk of loss?” Seems like I have been arguing this point for at least six months now in assorted blog posts.
But, of even more importance is the attitude of the bankers toward financial innovation.
There is no better environment for financial innovation than the one that we are now experiencing. I would argue very strongly that financial innovation is taking place right now even though we may not see all the different forms the innovation is taking. And, the current round of financial innovation is coming at the expense of regular borrowing and lending. And, the financial innovation is benefitting the large, financially savvy financial institutions and not the small- and medium-sized organizations that don’t have the resources, or, the inclination, or, the freedom, since they still have plenty of questionable assets to deal with. Hail, Wall Street! See you later Main Street!
For the past fifty years or so, the government of the United States has basically followed an expansionary economic policy that has provided a safety-net to the financial system, and established an inflationary bias within the economy. There is no better environment for financial innovation than this!
The banks, the financial system, the non-financial system, and governments have innovated like mad during this time period.
The current federal government is just continuing to underwrite this practice at the present time.
POTY and the current administration are just exacerbating the situation they are so heavily criticizing.
And, as Gapper states, "the banks that turned out to be too big to be allowed to fail are bigger now than ever."
POTY and the current administration may win, politically, in the short run because the big bankers seem to have a deaf ear: See http://seekingalpha.com/article/178269-defining-the-banking-situation-as-a-political-issue.
In the longer run, the victory may go to another side. Paul Volcker seems to be taking the other side of the argument. See the article by Simon Johnson in The New Republic: “Is History on Paul Volcker’s Side?” http://www.tnr.com/blog/the-plank/history-paul-volckers-side.
The bottom line, however, is that Benjamin Shalom Bernanke doesn’t seem to get it…once again! Time after time, the Fed Chairman has seemed to miss the mark. Because of this record, one, I think, can seriously ask the question: “Why should we expect Bernanke to be correct this time?”
In nominating the Chairman for another term, President Obama seems to believe that Bernanke will be correct this time. More than anything else the president has done, even sending more troops into Afghanistan, his bet on the re-appointment of Chairman Bernanke may determine how his presidency is perceived by future historians. A lot is riding on Chairman Bernanke.
Friday, November 13, 2009
A Strong Dollar?
“It is very important to the United States that we have a strong dollar.”
So said the United States Secretary of the Treasury.
Yes, Paul O’Neill said that.
Oh, yes, John Snow said that.
And, Hank Paulson.
Oh, you say, that the quote is attributed to Tim Geithner, who made the statement yesterday at a news conference of Asia-Pacific finance ministers.
As my good friends would say, “you have to walk the walk, not just talk the talk!” Or, in the case of those looking on, “watch the hips, not the lips!”
The only public person alive today that, in my mind, has any credibility on this issue is Paul Volcker. And, it is Paul Volcker that has written, “A nation’s exchange rate is the single most important price in its economy; it will influence the entire range of individual prices, imports and exports, and even the level of economic activity. So it is hard for any government to ignore large swings in its exchange rate…” (This quote is found on page 232 in the book “Changing Fortunes: The World’s Money and the Threat to American Leadership” by Paul Volcker and Toyoo Gyohten, Times Books, 1992.)
The United States government has no credibility left when it comes to the value of the United States dollar.
During the administration of Bush 43, the value of the United States dollar fell by 37% against an index of major currencies from February 2002 to March 2008 while the dollar fell in value by 45% against the Euro from February 2002 to July 2008.
The United States dollar did rebound at the time of the financial crisis: up 19% against the index of major currencies and up 23% against the Euro.
However, since February of this year the United States dollar fell back by about 13% against the index of major currencies and by about 15% against the Euro.
In watching the hips, not the lips, we see, for the United States government, potential cumulative fiscal deficits of $15 to $20 trillion over the next 10 years. We have a banking system with almost $1.1 trillion in excess reserves during the two week period ending November 4, 2009. We are faced with an unknown “exit strategy” to remove these excess reserves on the part of the Federal Reserve System.
And all this with several other “shocks” on the horizon. Obama “owns” Afghanistan now and it is totally unknown what his “new strategy” for that country will mean in terms of more government spending. Then there is the health care initiative. Obama has said that the program should not add “one dime” to the deficit, yet all indications are that whatever is passed will add to the deficit, although we don’t know what that amount will be. Then there is the climate change bill along with some other proposals that are setting in the wings.
Oh, yes, people within the administration have suggested that the rest of the TARP money, whatever that amounts to, can be applied to reducing the deficit. Whoopee!
I hear the Obama administration talking the talk. I don’t see them walking the walk.
And what about Bernanke. He is staying particularly silent these days. Oh, yes, we learned from the New York Times earlier this week that he is letting Barney Frank do all his talking for him.
The strong dollar is, at present, a myth!
It will continue to remain weak and its value will continue to trend downward for the foreseeable future.
How far am I looking forward?
I will continue to believe that the dollar will remain weak until someone emerges that has some credibility. Right now, I don’t know where that person is going to come from.
So said the United States Secretary of the Treasury.
Yes, Paul O’Neill said that.
Oh, yes, John Snow said that.
And, Hank Paulson.
Oh, you say, that the quote is attributed to Tim Geithner, who made the statement yesterday at a news conference of Asia-Pacific finance ministers.
As my good friends would say, “you have to walk the walk, not just talk the talk!” Or, in the case of those looking on, “watch the hips, not the lips!”
The only public person alive today that, in my mind, has any credibility on this issue is Paul Volcker. And, it is Paul Volcker that has written, “A nation’s exchange rate is the single most important price in its economy; it will influence the entire range of individual prices, imports and exports, and even the level of economic activity. So it is hard for any government to ignore large swings in its exchange rate…” (This quote is found on page 232 in the book “Changing Fortunes: The World’s Money and the Threat to American Leadership” by Paul Volcker and Toyoo Gyohten, Times Books, 1992.)
The United States government has no credibility left when it comes to the value of the United States dollar.
During the administration of Bush 43, the value of the United States dollar fell by 37% against an index of major currencies from February 2002 to March 2008 while the dollar fell in value by 45% against the Euro from February 2002 to July 2008.
The United States dollar did rebound at the time of the financial crisis: up 19% against the index of major currencies and up 23% against the Euro.
However, since February of this year the United States dollar fell back by about 13% against the index of major currencies and by about 15% against the Euro.
In watching the hips, not the lips, we see, for the United States government, potential cumulative fiscal deficits of $15 to $20 trillion over the next 10 years. We have a banking system with almost $1.1 trillion in excess reserves during the two week period ending November 4, 2009. We are faced with an unknown “exit strategy” to remove these excess reserves on the part of the Federal Reserve System.
And all this with several other “shocks” on the horizon. Obama “owns” Afghanistan now and it is totally unknown what his “new strategy” for that country will mean in terms of more government spending. Then there is the health care initiative. Obama has said that the program should not add “one dime” to the deficit, yet all indications are that whatever is passed will add to the deficit, although we don’t know what that amount will be. Then there is the climate change bill along with some other proposals that are setting in the wings.
Oh, yes, people within the administration have suggested that the rest of the TARP money, whatever that amounts to, can be applied to reducing the deficit. Whoopee!
I hear the Obama administration talking the talk. I don’t see them walking the walk.
And what about Bernanke. He is staying particularly silent these days. Oh, yes, we learned from the New York Times earlier this week that he is letting Barney Frank do all his talking for him.
The strong dollar is, at present, a myth!
It will continue to remain weak and its value will continue to trend downward for the foreseeable future.
How far am I looking forward?
I will continue to believe that the dollar will remain weak until someone emerges that has some credibility. Right now, I don’t know where that person is going to come from.
Wednesday, August 5, 2009
A Market Grade for the Obama Economic Policy
There is a brutal way to grade administrations on their economic policies: look at what foreign exchange traders do to the currency of a country. This has been a test of political administrations around the world since the world removed itself from the gold standard in August 1971.
If we use the movement of the value of a country’s currency as a grading mechanism then this is how the Obama administration stacks up since it took office on January 20, 2009. The value of the dollar against the Euro from January 20 through July 31, 2009 has dropped 9.3%. Using early morning figures registered today, the drop has been 10.1%. The value of the dollar against Major Currencies has dropped 9.5%.
These are not very good grades!
What are the underlying factors behind this decline? First, the administration is proposing a huge deficit for this year, $2.0 trillion, a deficit that dwarfs all other deficits in United States history! And, some experts are projecting deficits that will continue to average around $1.0 trillion per year for the next ten years or so. Second, a monetary policy that is keeping short term interest rates extremely low, and it has been stated that these rates will be kept that low until possibly 2011.
Any comparisons?
The Bush administration saw the value of the dollar peak in March 2002 and then decline about 40% into 2008.
What were the underlying factors behind this decline? First, the administration created huge deficits by historical standards, deficits that continued throughout the entire Bush administration. Second, there was a monetary policy that kept short term interest rates extremely low, and it kept them at an extremely low level for two years or so.
Let me quote Paul Volcker once again. He has written that “a nation’s exchange rate is the single most important price in its economy.” This is from the book “Changing Fortunes: The World’s Money and the Threat to American Leadership,” by Paul Volcker and Toyoo Gyohten (Times Books: New York), page 232.
When are we going to learn?
If we use the movement of the value of a country’s currency as a grading mechanism then this is how the Obama administration stacks up since it took office on January 20, 2009. The value of the dollar against the Euro from January 20 through July 31, 2009 has dropped 9.3%. Using early morning figures registered today, the drop has been 10.1%. The value of the dollar against Major Currencies has dropped 9.5%.
These are not very good grades!
What are the underlying factors behind this decline? First, the administration is proposing a huge deficit for this year, $2.0 trillion, a deficit that dwarfs all other deficits in United States history! And, some experts are projecting deficits that will continue to average around $1.0 trillion per year for the next ten years or so. Second, a monetary policy that is keeping short term interest rates extremely low, and it has been stated that these rates will be kept that low until possibly 2011.
Any comparisons?
The Bush administration saw the value of the dollar peak in March 2002 and then decline about 40% into 2008.
What were the underlying factors behind this decline? First, the administration created huge deficits by historical standards, deficits that continued throughout the entire Bush administration. Second, there was a monetary policy that kept short term interest rates extremely low, and it kept them at an extremely low level for two years or so.
Let me quote Paul Volcker once again. He has written that “a nation’s exchange rate is the single most important price in its economy.” This is from the book “Changing Fortunes: The World’s Money and the Threat to American Leadership,” by Paul Volcker and Toyoo Gyohten (Times Books: New York), page 232.
When are we going to learn?
Thursday, March 19, 2009
The Fed Moves to Monetize
The Federal Reserve shocked the financial markets yesterday. The Fed released the results of its just-ended Federal Open Market Committee meeting and the response was immediate—stock market indices went up—and the value of the dollar went down!
The reason—the Open Market Committee approved a plan to purchase up to $300 billion of longer-term Treasury securities over the next six months. This is in addition to a plan to increase the Fed’s purchase of up to an additional $750 billion of agency mortgage-backed securities.
The stock markets took this surprise as a positive sign that the Fed was being true to what Chairman Ben Bernanke had indicated in recent speeches and interviews—“the Federal Reserve will employ all available tools to promote economic recovery.” (Oh, he also added “and to preserve price stability.”) Good news—right? Well, the stock market seemed to be “mixed” today.
The foreign exchange markets took another view and the value of the dollar dropped sharply, and the selloff was “widespread” according to the Wall Street Journal. Bad news—right? Well, the value of the dollar continued to decline today.
It is a complex story. I have been one that has continuously expressed concern over the long term prospects for the dollar in foreign exchange markets. See for example my post “The Obama Stimulus Plan and the Dollar: Is There a Connection (http://seekingalpha.com/article/114310-the-obama-stimulus-plan-and-the-dollar-is-there-a-connection). The concern is over the huge United States budget deficit and how this deficit is to be financed in future years. The long-run view of such large deficits is that a substantial portion of them will have to be monetized by the central bank. The fundamental effort of all Keynesian fiscal policy is to inflate or reflate the economy.
There are some complicating factors to this simple story. Through all the financial and economic turmoil of the past six months the dollar has not declined in value but has actually strengthened. If participants in the financial markets are so concerned about the deficits of the United States government and the possibility that the Federal Reserve will monetize a bunch of the debt, why has the value of the dollar gone in the direction it has? Why hasn’t the value of the dollar tanked, instead?
For one, the United States dollar is the “world” currency and it still is the currency of choice in times of uncertainty and turmoil. Thus, the strength of the dollar has, to a large extent, been the result of a “flight to safety” on the part of many investors in the world. It will, undoubtedly, continue to be a “safe haven” for much of the world’s wealth for a long while into the future.
Second, because most of the whole world is in some kind of a recession and are following similar fiscal and monetary policies, it becomes difficult to discern which currencies throughout the world are going to be the worst off. If changes in the value of currencies are a result of changes in the relative prospect for future inflation in different countries, then the exchange rates will ultimately be dependent upon just how each of these countries handles the pressures created by their own stimulus packages.
As for the United States dollar, the most important factor determining its value in the near term is going to be the “safety” factor. Still, other factors, like the aggressive posture of the Federal Open Market Committee cannot be ignored. And, this seems to be what is happening right now in foreign exchange markets. I would argue that even though this latter movement might be a short-run phenomenon, a person concerned with the future health of the United States economy should not ignore what the foreign exchange market might be telling us.
I continue to go to this statement of Paul Volcker: “a nation’s exchange rate is the single most important price in the economy.” (Paul Volcker and Toyoo Gyohten, “Changing Fortunes: the World’s Money and the Threat to American Leadership,” (New York: Times Books, 1992), p. 232.) Consequently, what is happening or will happen to this price should be of major concern to investors. This price will carry with it the view of the world investment community about how the United States is conducting its fiscal and monetary policies.
This is something that the Obama administration and the Federal Reserve System need to pay attention to. The most recent example of ignoring information like this came during the years of the Bush administration. In 2001 a tax cut was passed by the government that took the government budget from a surplus to a deficit position. This was followed by increasing expenditures that went to support several military engagements around the world. The fundamental market response to this was that the value of the dollar began to decline early in 2002.
In addition to this the Federal Reserve System kept short term interest rates at very low levels (the effective Federal Funds rate was below 2% from early in 2002 until the beginning of 2005) for an extended period of time which resulted in negative real rates of interest during this interval. Participants in foreign exchange markets continued to put pressure on the value of the dollar into the summer of 2008. Even though officials in the Bush administration and the Federal Reserve System claimed that they were watching the value of the dollar and maintaining its value was an important goal, little or nothing was done about this decline and the market value continued to sink.
The value of the dollar is something that we need to continue to watch closely. The concern over the monetary and fiscal policies of the Obama administration is not misplaced. A warning shot was issued this week by the Chinese Premier Wen Jiabao when he indicated that he was a “little bit worried” about the safety of the U. S. Treasury bonds that his government owns. The reaction of the foreign exchange market to the Fed’s announcement about their plan to buy up to $300 billion of longer-term Treasury securities is another. And, there is also the concern of some analysts that the real financial and economic issue facing the United States is one of “too much debt” and that this debt overload is exacerbating the economic slowdown. As the historian Niall Ferguson, author of “The Ascent of Money” (see review at http://seekingalpha.com/article/120595-a-financial-history-of-the-world), has stated, “the solution to the problem of having too much debt around is not creating more debt.”
Is the decision of the Federal Open Market Committee to purchase up to $300 billion of longer-term Treasury issues the next step in the monetizing of the debt? Will the release of this information contribute to a further decline in the value of the dollar? There are, of course, a lot of “known unknowns” and “unknown unknowns” at this time. Obviously, it is a very risky time. However, in my view, eventually the value of the dollar will continue to erode. History has shown that this is what eventually happens in situations like the one we are in.
The reason—the Open Market Committee approved a plan to purchase up to $300 billion of longer-term Treasury securities over the next six months. This is in addition to a plan to increase the Fed’s purchase of up to an additional $750 billion of agency mortgage-backed securities.
The stock markets took this surprise as a positive sign that the Fed was being true to what Chairman Ben Bernanke had indicated in recent speeches and interviews—“the Federal Reserve will employ all available tools to promote economic recovery.” (Oh, he also added “and to preserve price stability.”) Good news—right? Well, the stock market seemed to be “mixed” today.
The foreign exchange markets took another view and the value of the dollar dropped sharply, and the selloff was “widespread” according to the Wall Street Journal. Bad news—right? Well, the value of the dollar continued to decline today.
It is a complex story. I have been one that has continuously expressed concern over the long term prospects for the dollar in foreign exchange markets. See for example my post “The Obama Stimulus Plan and the Dollar: Is There a Connection (http://seekingalpha.com/article/114310-the-obama-stimulus-plan-and-the-dollar-is-there-a-connection). The concern is over the huge United States budget deficit and how this deficit is to be financed in future years. The long-run view of such large deficits is that a substantial portion of them will have to be monetized by the central bank. The fundamental effort of all Keynesian fiscal policy is to inflate or reflate the economy.
There are some complicating factors to this simple story. Through all the financial and economic turmoil of the past six months the dollar has not declined in value but has actually strengthened. If participants in the financial markets are so concerned about the deficits of the United States government and the possibility that the Federal Reserve will monetize a bunch of the debt, why has the value of the dollar gone in the direction it has? Why hasn’t the value of the dollar tanked, instead?
For one, the United States dollar is the “world” currency and it still is the currency of choice in times of uncertainty and turmoil. Thus, the strength of the dollar has, to a large extent, been the result of a “flight to safety” on the part of many investors in the world. It will, undoubtedly, continue to be a “safe haven” for much of the world’s wealth for a long while into the future.
Second, because most of the whole world is in some kind of a recession and are following similar fiscal and monetary policies, it becomes difficult to discern which currencies throughout the world are going to be the worst off. If changes in the value of currencies are a result of changes in the relative prospect for future inflation in different countries, then the exchange rates will ultimately be dependent upon just how each of these countries handles the pressures created by their own stimulus packages.
As for the United States dollar, the most important factor determining its value in the near term is going to be the “safety” factor. Still, other factors, like the aggressive posture of the Federal Open Market Committee cannot be ignored. And, this seems to be what is happening right now in foreign exchange markets. I would argue that even though this latter movement might be a short-run phenomenon, a person concerned with the future health of the United States economy should not ignore what the foreign exchange market might be telling us.
I continue to go to this statement of Paul Volcker: “a nation’s exchange rate is the single most important price in the economy.” (Paul Volcker and Toyoo Gyohten, “Changing Fortunes: the World’s Money and the Threat to American Leadership,” (New York: Times Books, 1992), p. 232.) Consequently, what is happening or will happen to this price should be of major concern to investors. This price will carry with it the view of the world investment community about how the United States is conducting its fiscal and monetary policies.
This is something that the Obama administration and the Federal Reserve System need to pay attention to. The most recent example of ignoring information like this came during the years of the Bush administration. In 2001 a tax cut was passed by the government that took the government budget from a surplus to a deficit position. This was followed by increasing expenditures that went to support several military engagements around the world. The fundamental market response to this was that the value of the dollar began to decline early in 2002.
In addition to this the Federal Reserve System kept short term interest rates at very low levels (the effective Federal Funds rate was below 2% from early in 2002 until the beginning of 2005) for an extended period of time which resulted in negative real rates of interest during this interval. Participants in foreign exchange markets continued to put pressure on the value of the dollar into the summer of 2008. Even though officials in the Bush administration and the Federal Reserve System claimed that they were watching the value of the dollar and maintaining its value was an important goal, little or nothing was done about this decline and the market value continued to sink.
The value of the dollar is something that we need to continue to watch closely. The concern over the monetary and fiscal policies of the Obama administration is not misplaced. A warning shot was issued this week by the Chinese Premier Wen Jiabao when he indicated that he was a “little bit worried” about the safety of the U. S. Treasury bonds that his government owns. The reaction of the foreign exchange market to the Fed’s announcement about their plan to buy up to $300 billion of longer-term Treasury securities is another. And, there is also the concern of some analysts that the real financial and economic issue facing the United States is one of “too much debt” and that this debt overload is exacerbating the economic slowdown. As the historian Niall Ferguson, author of “The Ascent of Money” (see review at http://seekingalpha.com/article/120595-a-financial-history-of-the-world), has stated, “the solution to the problem of having too much debt around is not creating more debt.”
Is the decision of the Federal Open Market Committee to purchase up to $300 billion of longer-term Treasury issues the next step in the monetizing of the debt? Will the release of this information contribute to a further decline in the value of the dollar? There are, of course, a lot of “known unknowns” and “unknown unknowns” at this time. Obviously, it is a very risky time. However, in my view, eventually the value of the dollar will continue to erode. History has shown that this is what eventually happens in situations like the one we are in.
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