From the Wall Street Journal this morning:
“U.S. families—by defaulting on their loans and scrimping on expenses—shouldered a smaller debt burden in 2010 than at any point in the previous six years, putting them in position to start spending more.
Total U.S. household debt, including mortgages and credit cards, fell for the second straight year in 2010 to $13.4 trillion, the Federal Reserve reported Thursday. That came to 116% of disposable income, down from a peak debt burden of 130% in 2007, and the lowest level since the fourth quarter of 2004.” (See “Families Slice Debt to Lowest in 6 Years,” http://professional.wsj.com/article/SB10001424052748704823004576192602754071800.html?mod=WSJPRO_hps_LEFTWhatsNews.)
The logic in this is that people reduce debt so that they can spend more. I think that is called a “non sequitur”.
If people (and businesses) get more and more in debt over a fifty year period (as they have since 1960) and this contributes to the worst recession since the Great Depression the objective of these people (and businesses) getting out of debt is so that they can get more in debt once again?
I thought that if people (and businesses) got themselves so leveraged up and so “over-extended” that they found themselves in serious financial trouble and were faced with foreclosure on their real estate and personal (or business) bankruptcy that what they would try and do is bring their debt more in line with their incomes so that they could manage their debt.
I thought that maybe people (and businesses) would become more prudent and try and manage their debt in a way that would allow them more “peace of mind” not having to scramble to make principal or interest payments every month.
And we read that there are 11 million people who find themselves owing more on their mortgages than their home is worth on the market.
And we read that about one out of every four individuals of working age is under-employed.
And, we read that the income distribution is skewed toward the high income end worse than it has ever been in the history of the United States.
And, we read that America is bifurcating more and more based on education and race.
And, we read that many state and local governments can’t meet their pension commitments and can’t balance their budgets so that they are cutting jobs, cutting pensions, and cutting education.
Some people are spending. Some people are using credit again. Some people are buying very nice homes. Some people are paying for very expensive educations.
But, this spending and credit extension is not across the board.
The inflation over the past fifty years created the ideal environment for debt creation. The inflation was not large enough to create a panic. From time-to-time, the inflation was not enough to really see.
Yet, from 1960 to the present time, the purchasing power of the dollar has fallen by 85%. The dollar that could buy a dollar’s worth of goods in 1960 can only buy about fifteen cents worth of goods now.
This was the perfect scenario for the creation of credit, for financial innovation, and for the growth of the finance industry.
This could not have been a better environment for the consumer culture to thrive where people could feed their insatiable appetites for goods and think that things were great.
And, now a substantial part of our economy is mired in this debt and struggling hard to get their heads above water. They don’t need to pile on more debt…they need some stability and consistency to their lives.
Yet, many are pushing to get the “credit machine” going again. The federal government is setting the standard (as it has over the past fifty years) by living way beyond its means and threatening to increase its debt by $15 trillion or more over the next ten years.
The Federal Reserve has pumped almost $1.4 trillion in excess reserves into the banking system in order to get the banks’ lending again.
We want families to be “in position to start spending more” as the Wall Street Journal article stated.
A credit inflation is just what is needed.
Each time we restart the “credit inflation” button again, more and more people seem to be in a position in which they are excluded from its benefits. They are under-employed, substantially in debt, and excluded from benefitting from further increases in prices.
This means each time the “credit inflation” button is pushed again, only a smaller proportion of the population can participate in subsequent expansion.
Maybe this is why it is taking us so long to get the economy “moving again.”
History has shown that this “show” cannot go on forever. The difficulty is in knowing just when the “show” is over.
The government is trying to start the music playing again. And, those that can are supposed to begin dancing. But, maybe this time only the financial industry will be dancing (http://seekingalpha.com/article/255748-will-the-financial-industry-dance-alone).
Showing posts with label federal debt. Show all posts
Showing posts with label federal debt. Show all posts
Friday, March 11, 2011
Tuesday, November 23, 2010
Bailouts or Defaults?
This question is the defining question in finance and economics today.
Yet, the predominant approach used in macroeconomic policymaking does not include debt and the possibility of defaults in its model. So, the policy answer is obvious. The policy makers must “bailout” individuals, banks and businesses, and governments.
Well, forget individuals, let them default!
But, we need to save banks and businesses…and governments. Provide them with cash grants. Provide them with excessive amounts of liquidity. Defaults of banks and businesses and governments are not a part of our theoretical picture of the world.
Look through the book “”Ben Bernanke’s Fed” written by Ethan Harris, a former research officer at the Federal Reserve Bank of New York and published by Harvard Business in 2008. Chapter 2 is called “How the World Works: a Brief Course in Macroeconomics.” Here we get a picture of the basic model the Federal Reserve uses in its analysis of the state of the world.
“Getting into the head of the Fed requires a basic primer on how the economy and monetary policy works, Harris writes, “Nonetheless, a relatively simple framework underlies much of the discussion at central banks today.”
The foundation of the Fed’s analysis, according to Harris is something called “the Phillips Curve” which supposedly captures the tradeoff between inflation and unemployment. This, of course, incorporates the two government policy objectives written into law in 1978 and affectionately referred to as the Humphrey-Hawkins Full Employment Act.
Harris continues that “Bernanke is a proponent of the ‘financial accelerator model,’” which brings the credit market into the picture. “The idea that strong financial and credit conditions and a strong economy can reinforce each other to create economic booms (and that weak conditions can interact to create busts). During booms, both firms and households have stronger incomes and their assets are worth more, encouraging relaxed lending rules. Easy lending makes the economy even stronger and that, in turn encourages even easier lending standards.”
In other words, Bernanke, and people within the Fed, believe that pumping credit into the economy produces “stronger incomes” and “assets are worth more.” Thus there is a wealth effect. But, as long as inflation is “in check” there will be no problems on the “real” side of the economy and unemployment will be reduced. BINGO!
However, within this view of the world, there are no problems with debt loads, foreclosures, and bankruptcies. Piece of cake…just throw more spaghetti against the wall! (See “Bernanke’s Next Round of Spaghetti Tossing”: http://seekingalpha.com/article/233773-bernanke-s-next-round-of-spaghetti-tossing.)
Remember, Keynes won and Irving Fisher lost the battle for the hearts and minds of the economics profession. To resolve economic downturns just create more and more debt. Forget about the fact that debt has to be paid off. Just toss more liquidity into the markets.
Defaults are not considered in the model because the assumption is that the problem is one of liquidity, not solvency. (See http://seekingalpha.com/article/235712-it-s-a-solvency-problem-not-a-liquidity-problem.)
Therefore, individuals, banks and businesses, and governments can issue all the debt they want and the Federal Reserve, the European Central Bank, the United States government, or the European Union can step in and solve any discomforting situations that arise through bailouts and loose monetary policy.
However, debt does matter! And, defaults should not just fall on individuals and families. Foreclosures and bankruptcies are very common into the world today.
Yet, governments continue to try and sweep solvency issues “under-the-rug” when it comes to banks and businesses…and to governments.
The only time we really hear about problems of this sort within these institutions is the weekly list of bank closings overseen by the FDIC. But, this information tends to end up on the fifth or sixth page of the business section of the newspaper and rarely, if ever, gets into the radio or television news. Maybe this news, week-after-week, is too boring. However, the FDIC is closing three to four banks a week and they have been doing this for more than a year. Still there are nearly 900 banks on the FDICs list of problem banks, and this does not include a thousand or more banks that are sliding into this problem bank list but have not reached the “statistical” test of being on the list.
This has to be the case within the sector of non-financial businesses. How many small- to medium-sized firms are still on the brink of insolvency? My guess is…a lot. It seems like every week there are more and more empty spaces in the strip malls and other business buildings.
And, then there are the state and local governments. The municipal bond market is in a mess!
In the banking week ending November 19, 2010, the Federal Reserve reports that the average yield on State and Local bonds was 4.72 percent. In the same week 30-year U. S. Treasury bonds yielded 4.30 percent. And, State and Local bonds are not taxed.
WHEN HAVE YOU SEEN AN INTEREST RATE RELATIONSHIP LIKE THIS BEFORE?
Now we get into sovereign debt. Let me just start listing the problems: Greece, Ireland, Portugal, Spain, Italy, France…
Need I say more?
And, what about the United States? On September 30, 2009, the Gross Federal debt outstanding was almost $12 trillion; the Federal debt held by the public was about $8 trillion on that date. And, what if the Gross Federal debt more than doubles over the next ten years as I have been predicting? How acceptable will the debt of the United States government be in the world?
DEBT MATTERS!
Why isn’t debt included in the models the policy makers use? We can’t continue to operate under the assumption that debt doesn’t matter and that all we need to do, policy wise, is throw more spaghetti against the wall.
People, other than individuals, families, small businesses, and small banks, must come to realize that there is a penalty for taking on too much debt. That penalty is default followed by bringing one’s books under control. People must learn that the solution to issuing debt is not issuing more debt!
Yet, the predominant approach used in macroeconomic policymaking does not include debt and the possibility of defaults in its model. So, the policy answer is obvious. The policy makers must “bailout” individuals, banks and businesses, and governments.
Well, forget individuals, let them default!
But, we need to save banks and businesses…and governments. Provide them with cash grants. Provide them with excessive amounts of liquidity. Defaults of banks and businesses and governments are not a part of our theoretical picture of the world.
Look through the book “”Ben Bernanke’s Fed” written by Ethan Harris, a former research officer at the Federal Reserve Bank of New York and published by Harvard Business in 2008. Chapter 2 is called “How the World Works: a Brief Course in Macroeconomics.” Here we get a picture of the basic model the Federal Reserve uses in its analysis of the state of the world.
“Getting into the head of the Fed requires a basic primer on how the economy and monetary policy works, Harris writes, “Nonetheless, a relatively simple framework underlies much of the discussion at central banks today.”
The foundation of the Fed’s analysis, according to Harris is something called “the Phillips Curve” which supposedly captures the tradeoff between inflation and unemployment. This, of course, incorporates the two government policy objectives written into law in 1978 and affectionately referred to as the Humphrey-Hawkins Full Employment Act.
Harris continues that “Bernanke is a proponent of the ‘financial accelerator model,’” which brings the credit market into the picture. “The idea that strong financial and credit conditions and a strong economy can reinforce each other to create economic booms (and that weak conditions can interact to create busts). During booms, both firms and households have stronger incomes and their assets are worth more, encouraging relaxed lending rules. Easy lending makes the economy even stronger and that, in turn encourages even easier lending standards.”
In other words, Bernanke, and people within the Fed, believe that pumping credit into the economy produces “stronger incomes” and “assets are worth more.” Thus there is a wealth effect. But, as long as inflation is “in check” there will be no problems on the “real” side of the economy and unemployment will be reduced. BINGO!
However, within this view of the world, there are no problems with debt loads, foreclosures, and bankruptcies. Piece of cake…just throw more spaghetti against the wall! (See “Bernanke’s Next Round of Spaghetti Tossing”: http://seekingalpha.com/article/233773-bernanke-s-next-round-of-spaghetti-tossing.)
Remember, Keynes won and Irving Fisher lost the battle for the hearts and minds of the economics profession. To resolve economic downturns just create more and more debt. Forget about the fact that debt has to be paid off. Just toss more liquidity into the markets.
Defaults are not considered in the model because the assumption is that the problem is one of liquidity, not solvency. (See http://seekingalpha.com/article/235712-it-s-a-solvency-problem-not-a-liquidity-problem.)
Therefore, individuals, banks and businesses, and governments can issue all the debt they want and the Federal Reserve, the European Central Bank, the United States government, or the European Union can step in and solve any discomforting situations that arise through bailouts and loose monetary policy.
However, debt does matter! And, defaults should not just fall on individuals and families. Foreclosures and bankruptcies are very common into the world today.
Yet, governments continue to try and sweep solvency issues “under-the-rug” when it comes to banks and businesses…and to governments.
The only time we really hear about problems of this sort within these institutions is the weekly list of bank closings overseen by the FDIC. But, this information tends to end up on the fifth or sixth page of the business section of the newspaper and rarely, if ever, gets into the radio or television news. Maybe this news, week-after-week, is too boring. However, the FDIC is closing three to four banks a week and they have been doing this for more than a year. Still there are nearly 900 banks on the FDICs list of problem banks, and this does not include a thousand or more banks that are sliding into this problem bank list but have not reached the “statistical” test of being on the list.
This has to be the case within the sector of non-financial businesses. How many small- to medium-sized firms are still on the brink of insolvency? My guess is…a lot. It seems like every week there are more and more empty spaces in the strip malls and other business buildings.
And, then there are the state and local governments. The municipal bond market is in a mess!
In the banking week ending November 19, 2010, the Federal Reserve reports that the average yield on State and Local bonds was 4.72 percent. In the same week 30-year U. S. Treasury bonds yielded 4.30 percent. And, State and Local bonds are not taxed.
WHEN HAVE YOU SEEN AN INTEREST RATE RELATIONSHIP LIKE THIS BEFORE?
Now we get into sovereign debt. Let me just start listing the problems: Greece, Ireland, Portugal, Spain, Italy, France…
Need I say more?
And, what about the United States? On September 30, 2009, the Gross Federal debt outstanding was almost $12 trillion; the Federal debt held by the public was about $8 trillion on that date. And, what if the Gross Federal debt more than doubles over the next ten years as I have been predicting? How acceptable will the debt of the United States government be in the world?
DEBT MATTERS!
Why isn’t debt included in the models the policy makers use? We can’t continue to operate under the assumption that debt doesn’t matter and that all we need to do, policy wise, is throw more spaghetti against the wall.
People, other than individuals, families, small businesses, and small banks, must come to realize that there is a penalty for taking on too much debt. That penalty is default followed by bringing one’s books under control. People must learn that the solution to issuing debt is not issuing more debt!
Tuesday, January 12, 2010
The Problem with Debt
The economy is recovering. The areas that seem to show the most life are those sectors that have had sufficient debt relief so as to be able to move forward. The big banks are moving out in a very robust fashion, just how robust we will begin to hear this week. The auto industry seems to be moving ahead, albeit a little more slowly than the big banks. And, there are other areas that show signs of moving forward, the health industry and firms in the information technology industry.
The big cloud hanging over all of this is the debt that still is outstanding in many sectors of the economy. The problem with debt is that it just won’t go away. Regardless of any adjustments made to who owes what to whom, if there is debt outstanding, someone has to pay for it in some fashion.
The big banks were saved, but who picked up the tab for the bailout? The taxpayer did, or, at least the taxpayer has footed the bill pending a potential Obama tax on the banks to “recover” some of the bailout monies.
Who saved the auto industry and subsequently holds the IOU for the rescue? A large part of the financial restructuring came at the expense of those that had provided credit or equity funds to the car companies. And, the federal government also paid a share.
If homeowners got relief from their mortgage and consumer debt, who would pay the bill? Shareholders of the bank, holders of mortgage-backed securities, and the federal government. (You might check out this little piece by Peter Eavis in today’s Wall Street Journal: http://online.wsj.com/article/SB20001424052748704081704574652660161217386.html#mod=todays_us_money_and_investing.)
And, what about the debt that is related to commercial real estate lending? Shareholders of banks, holders of commercial mortgage vehicles, and the federal government.
Then we move to the financial problems of the states. Recent information points to the fact that 36 states in the United States are having financial problems and these could lead to deficits in the state budgets of around $350 billion this year and next. Where is the money going to come to pay for these shortfalls? States have already attempted to sell off properties, outsource functions to the private sector, and even turn some things over to the federal government.
Part of the problem here is that the tax base in most states has collapsed as unemployment and under-employment have risen, as property values have fallen, and as business earnings have collapsed. Rating agencies have begun to lower credit ratings on some states. The best guess is that ratings will drop on many other states before the year is over.
And, what about local and municipal governments? Same problems.
And, then, what about the federal government? Without totaling up the bill for the problems mentioned above, let alone the escalation of wars here and there all over the world, health care reform, and some kind of energy bill, many expect federal deficits over the next ten years to total $15 to $18 trillion!
Who is going to purchase all or almost all of this debt? China?
What I find scary is that our “friends” are voicing concern in different ways. For example, the Financial Times this morning carries the opinion piece of Gideon Rachman titled “Bankruptcy Could Be Good for America”: http://www.ft.com/cms/s/0/a8486284-fee9-11de-a677-00144feab49a.html. The point Rachman makes is that the Brics, Brazil, Russia, India, and China all went through economic reform before they “broke out” into their current ascendency. Brazil’s reform came in the 1990s, Russia defaulted in the late 1990s, India embraced economic reform in 1991, and China moved to a new mindset in the early 1990s. “Those much discussed emerging powers, the Brics, all needed a fiscal crisis to set them on the road to economic reform and national resurgence. America may one day be lucky enough to experience its very own national fiscal crisis.”
Even if we print money to pay for the federal debt, as the Federal Reserve has done over the last year or so, (the monetary base rose 23% from December 2008 to December 2009, and rose by 101% over the previous 12 months) someone, somewhere will pay this debt in terms of a reduction in purchasing power.
Need I mention that since January 1961 the purchasing power of one dollar has dropped to roughly $0.15. Inflating the United States government out of its debts has a long, post-World War II history.
Might this process of “printing money” continue?
Seems like a lot of people believe that it will. For one there is the problem of rising long term interest rates. More and more worry is being expressed about the expected increases. Why? Well most analysts believe that the Federal Reserve has helped to keep long term interest rates lower than they would have been in order to provide liquidity to the financial markets and to support the mortgage market. On January 6, 2010, the Fed held on their balance sheet $777 billion in U. S. Treasury securities, $160 billion in Federal Agency debt securities, and $909 billion in Mortgage-backed securities.
This totals $1.846 trillion in securities held by the central bank! The concern is that in the last week of August, 2008, the Fed had provided only $741 billion in funds to the banking system through some kind of market or auction based transaction.
How much affect these purchases have had on keeping long term interest rates lower than they would have been is currently being debated. What is not in question is that, sooner or later, interest rates are going to begin to rise, first because the Fed’s artificial support will be removed, but rates will rise as the economy begins to improve, further pressure will be put on rates as issuers of bonds race to place debt before the rise takes place (See “Rate Rise Fears Spark Rush to Issue Bonds: http://www.ft.com/cms/s/0/6f46f226-fef2-11de-a677-00144feab49a.html), and as inflationary expectations are incorporated into bond yields.
How fast will the Fed allow interest rates to rise because rising interest rates will slow down economic recovery. Also, the Fed has created another problem by keeping short term interest rates so low. Not only have these low rates created arbitrage possibilities for domestic investment, borrow short term money in the 35 to 65 basis point range and invest in 10-year government bonds at 3.50% to 3.80% but also for the international carry trade. It is argued that the Fed cannot allow rates to go up too fast or big financial institutions and other investors will get trapped in losses that will not help the economic recovery.
The point of all this discussion is that any “exit” strategy that the Fed is planning to reduce the securities held on its balance sheet from current levels to even a level of $1.0 trillion, let alone the $741 billion mentioned above, is already in jeopardy. And, many are arguing that in the face of such overwhelming future deficits, the Fed will be forced to print even more money than it has over the last 17 months.
The problem with debt is that debt, once issued, really does not go away. Someone has to pay for it!
The big cloud hanging over all of this is the debt that still is outstanding in many sectors of the economy. The problem with debt is that it just won’t go away. Regardless of any adjustments made to who owes what to whom, if there is debt outstanding, someone has to pay for it in some fashion.
The big banks were saved, but who picked up the tab for the bailout? The taxpayer did, or, at least the taxpayer has footed the bill pending a potential Obama tax on the banks to “recover” some of the bailout monies.
Who saved the auto industry and subsequently holds the IOU for the rescue? A large part of the financial restructuring came at the expense of those that had provided credit or equity funds to the car companies. And, the federal government also paid a share.
If homeowners got relief from their mortgage and consumer debt, who would pay the bill? Shareholders of the bank, holders of mortgage-backed securities, and the federal government. (You might check out this little piece by Peter Eavis in today’s Wall Street Journal: http://online.wsj.com/article/SB20001424052748704081704574652660161217386.html#mod=todays_us_money_and_investing.)
And, what about the debt that is related to commercial real estate lending? Shareholders of banks, holders of commercial mortgage vehicles, and the federal government.
Then we move to the financial problems of the states. Recent information points to the fact that 36 states in the United States are having financial problems and these could lead to deficits in the state budgets of around $350 billion this year and next. Where is the money going to come to pay for these shortfalls? States have already attempted to sell off properties, outsource functions to the private sector, and even turn some things over to the federal government.
Part of the problem here is that the tax base in most states has collapsed as unemployment and under-employment have risen, as property values have fallen, and as business earnings have collapsed. Rating agencies have begun to lower credit ratings on some states. The best guess is that ratings will drop on many other states before the year is over.
And, what about local and municipal governments? Same problems.
And, then, what about the federal government? Without totaling up the bill for the problems mentioned above, let alone the escalation of wars here and there all over the world, health care reform, and some kind of energy bill, many expect federal deficits over the next ten years to total $15 to $18 trillion!
Who is going to purchase all or almost all of this debt? China?
What I find scary is that our “friends” are voicing concern in different ways. For example, the Financial Times this morning carries the opinion piece of Gideon Rachman titled “Bankruptcy Could Be Good for America”: http://www.ft.com/cms/s/0/a8486284-fee9-11de-a677-00144feab49a.html. The point Rachman makes is that the Brics, Brazil, Russia, India, and China all went through economic reform before they “broke out” into their current ascendency. Brazil’s reform came in the 1990s, Russia defaulted in the late 1990s, India embraced economic reform in 1991, and China moved to a new mindset in the early 1990s. “Those much discussed emerging powers, the Brics, all needed a fiscal crisis to set them on the road to economic reform and national resurgence. America may one day be lucky enough to experience its very own national fiscal crisis.”
Even if we print money to pay for the federal debt, as the Federal Reserve has done over the last year or so, (the monetary base rose 23% from December 2008 to December 2009, and rose by 101% over the previous 12 months) someone, somewhere will pay this debt in terms of a reduction in purchasing power.
Need I mention that since January 1961 the purchasing power of one dollar has dropped to roughly $0.15. Inflating the United States government out of its debts has a long, post-World War II history.
Might this process of “printing money” continue?
Seems like a lot of people believe that it will. For one there is the problem of rising long term interest rates. More and more worry is being expressed about the expected increases. Why? Well most analysts believe that the Federal Reserve has helped to keep long term interest rates lower than they would have been in order to provide liquidity to the financial markets and to support the mortgage market. On January 6, 2010, the Fed held on their balance sheet $777 billion in U. S. Treasury securities, $160 billion in Federal Agency debt securities, and $909 billion in Mortgage-backed securities.
This totals $1.846 trillion in securities held by the central bank! The concern is that in the last week of August, 2008, the Fed had provided only $741 billion in funds to the banking system through some kind of market or auction based transaction.
How much affect these purchases have had on keeping long term interest rates lower than they would have been is currently being debated. What is not in question is that, sooner or later, interest rates are going to begin to rise, first because the Fed’s artificial support will be removed, but rates will rise as the economy begins to improve, further pressure will be put on rates as issuers of bonds race to place debt before the rise takes place (See “Rate Rise Fears Spark Rush to Issue Bonds: http://www.ft.com/cms/s/0/6f46f226-fef2-11de-a677-00144feab49a.html), and as inflationary expectations are incorporated into bond yields.
How fast will the Fed allow interest rates to rise because rising interest rates will slow down economic recovery. Also, the Fed has created another problem by keeping short term interest rates so low. Not only have these low rates created arbitrage possibilities for domestic investment, borrow short term money in the 35 to 65 basis point range and invest in 10-year government bonds at 3.50% to 3.80% but also for the international carry trade. It is argued that the Fed cannot allow rates to go up too fast or big financial institutions and other investors will get trapped in losses that will not help the economic recovery.
The point of all this discussion is that any “exit” strategy that the Fed is planning to reduce the securities held on its balance sheet from current levels to even a level of $1.0 trillion, let alone the $741 billion mentioned above, is already in jeopardy. And, many are arguing that in the face of such overwhelming future deficits, the Fed will be forced to print even more money than it has over the last 17 months.
The problem with debt is that debt, once issued, really does not go away. Someone has to pay for it!
Wednesday, November 4, 2009
Building an Exit Strategy at the Federal Reserve--Part Two
Yesterday, I discussed what I saw as the reasoning behind the strategy the Federal Reserve is building to reduce the massive amount of excess reserves that it has injected into the banking system. The basic strategy seemed to be logical and reasonable and consistent with the way that economists usually think. That is, the arguments of economists always contain the assumption: “all other things held constant.” In other words, this is the plan, given that nothing else changes.
In the proposed strategy the Federal Reserve is developing, what is missing that might be crucial to the success of this strategy?
How about the fiscal deficits that the government is in the process of producing?
The deficit for the fiscal year ending this fall recorded the largest deficit in United States history: $1.4 trillion. And, some projections for the next ten years place the cumulative federal deficits around $15 trillion, more or less.
The Gross Federal Debt rose by 11.6% in fiscal 2008 and the estimates published by the government for fiscal 2009 and fiscal 2010 are 22.3% and 15.4%, respectively. The federal debt held by the public rose 15.2% in fiscal 2008 and is projected to increase by 35.4% and 21.9% in the following two years.
A lot of debt is going to be created by our government in the upcoming future and the assumption is that the public is going to absorb greater increases in the amount of debt they hold than ever before in peacetime!
The increases in debt over the past seven years have been of epic proportions. Carmen Reinhart and Kenneth Rogoff, in their informative new book “This Time is Different”, state of this buildup: “Were the United States an emerging market, its exchange rate would have plummeted and its interest rates soared. Access to capital markets would be lost…” They continue, “Over the longer run, the U. S. exchange rate and interest rates could well revert to form, especially if policies are not made to re-establish a firm base for long-term fiscal sustainability.”
Why do the exchange rates of nations that exhibit such fiscal irresponsibility decline?
The answer to this is that, sooner or later, the central banks of these nations have to become active in supporting the placement of the debt and this results in the monetization of that debt.
The question then arises, “Can the Federal Reserve reduce the amount of excess reserves it has injected into the banking system given the market pressures that surround the problem of the placing of the federal debt that is going to be created?”
Let’s look what seems to happening right now.
Some have argued that the Federal Reserve’s policy of “buying everything in sight” has created an asset bubble. The result has been that the prices in many different asset classes now move together: the movements in these asset classes now possess a high positive correlation rather than a zero or negative correlation. Thus, investors can achieve very little diversification across markets. And, as a consequence, the market volatility indexes have risen to remarkable highs.
The extremely low target interest rates, the quantitative easing, and the massive flows of capital into the United States resulting from the accumulation of foreign exchange reserves by foreign central banks keep Treasury bond prices high, prices of mortgage-backed securities high, United States equity prices high, and global asset prices high. (A bubble you say?)
To support the bond market and the market for mortgage-backed securities, that is, to keep interest rates low, the Fed has continued to pump reserves into the banking system. The reserve balances that commercial banks hold at Federal Reserve banks jumped $236 billion from September 30 to October 28 so that they totaled $1.080 trillion on this latter date. Excess Reserves held by commercial banks rose by around $190 billion from the end of August to the end of September, to around $1.0 trillion.
If these security prices are artificially high (and interest rates artificially low) due to Federal Reserve support, what will happen when the economy picks up activity and the Fed has to back off its underwriting of low interest rates? What will happen if this “backing off” coincides with the need of the Federal Reserve to “exit” from its excessively loose policy?
As I wrote earlier, the proposed exit strategy that the Federal Reserve is exposing to the public seems “logical and reasonable” given that “all other things are held constant.” Unfortunately, policy makers do not work in a world in which “all other things are held constant.”
Again, the policymakers are faced with the problem of dealing with the aftermath of earlier policy actions. As I have argued, the irresponsible fiscal policy of the early 2000s and the excessively low interest rates maintained by the Federal Reserve during this time (supported by both Greenspan and Bernanke) created the environment for the financial collapse of 2007-2008. The Bernanke Federal Reserve faced this collapse, to accumulating accolades, by throwing everything it could against the wall to see what would stick. (The lesson Bernanke learned from his research on the First Great Contraction was that in order to avoid a great contraction one had to leave nothing on the table for if one is going to err one must err on the side of excessive ease.)
Now we are faced with the problem of dealing once again with the left-over’s of previous fiscal and monetary policy. We are once again faced with a situation in which there are no “good” policies that are painless. As Reinhart and Rogoff conclude from their massive study of “Eight Centuries of Financial Folly”, pain cannot be avoided once financial folly has been committed.
Let me close once again as I closed my post yesterday: the Fed is in a delicate position. They cannot get out of this situation by “throwing everything it can against the wall.” Let’s just hope that they can find a way to get out of their conundrum with the least amount of negative consequences.
In the proposed strategy the Federal Reserve is developing, what is missing that might be crucial to the success of this strategy?
How about the fiscal deficits that the government is in the process of producing?
The deficit for the fiscal year ending this fall recorded the largest deficit in United States history: $1.4 trillion. And, some projections for the next ten years place the cumulative federal deficits around $15 trillion, more or less.
The Gross Federal Debt rose by 11.6% in fiscal 2008 and the estimates published by the government for fiscal 2009 and fiscal 2010 are 22.3% and 15.4%, respectively. The federal debt held by the public rose 15.2% in fiscal 2008 and is projected to increase by 35.4% and 21.9% in the following two years.
A lot of debt is going to be created by our government in the upcoming future and the assumption is that the public is going to absorb greater increases in the amount of debt they hold than ever before in peacetime!
The increases in debt over the past seven years have been of epic proportions. Carmen Reinhart and Kenneth Rogoff, in their informative new book “This Time is Different”, state of this buildup: “Were the United States an emerging market, its exchange rate would have plummeted and its interest rates soared. Access to capital markets would be lost…” They continue, “Over the longer run, the U. S. exchange rate and interest rates could well revert to form, especially if policies are not made to re-establish a firm base for long-term fiscal sustainability.”
Why do the exchange rates of nations that exhibit such fiscal irresponsibility decline?
The answer to this is that, sooner or later, the central banks of these nations have to become active in supporting the placement of the debt and this results in the monetization of that debt.
The question then arises, “Can the Federal Reserve reduce the amount of excess reserves it has injected into the banking system given the market pressures that surround the problem of the placing of the federal debt that is going to be created?”
Let’s look what seems to happening right now.
Some have argued that the Federal Reserve’s policy of “buying everything in sight” has created an asset bubble. The result has been that the prices in many different asset classes now move together: the movements in these asset classes now possess a high positive correlation rather than a zero or negative correlation. Thus, investors can achieve very little diversification across markets. And, as a consequence, the market volatility indexes have risen to remarkable highs.
The extremely low target interest rates, the quantitative easing, and the massive flows of capital into the United States resulting from the accumulation of foreign exchange reserves by foreign central banks keep Treasury bond prices high, prices of mortgage-backed securities high, United States equity prices high, and global asset prices high. (A bubble you say?)
To support the bond market and the market for mortgage-backed securities, that is, to keep interest rates low, the Fed has continued to pump reserves into the banking system. The reserve balances that commercial banks hold at Federal Reserve banks jumped $236 billion from September 30 to October 28 so that they totaled $1.080 trillion on this latter date. Excess Reserves held by commercial banks rose by around $190 billion from the end of August to the end of September, to around $1.0 trillion.
If these security prices are artificially high (and interest rates artificially low) due to Federal Reserve support, what will happen when the economy picks up activity and the Fed has to back off its underwriting of low interest rates? What will happen if this “backing off” coincides with the need of the Federal Reserve to “exit” from its excessively loose policy?
As I wrote earlier, the proposed exit strategy that the Federal Reserve is exposing to the public seems “logical and reasonable” given that “all other things are held constant.” Unfortunately, policy makers do not work in a world in which “all other things are held constant.”
Again, the policymakers are faced with the problem of dealing with the aftermath of earlier policy actions. As I have argued, the irresponsible fiscal policy of the early 2000s and the excessively low interest rates maintained by the Federal Reserve during this time (supported by both Greenspan and Bernanke) created the environment for the financial collapse of 2007-2008. The Bernanke Federal Reserve faced this collapse, to accumulating accolades, by throwing everything it could against the wall to see what would stick. (The lesson Bernanke learned from his research on the First Great Contraction was that in order to avoid a great contraction one had to leave nothing on the table for if one is going to err one must err on the side of excessive ease.)
Now we are faced with the problem of dealing once again with the left-over’s of previous fiscal and monetary policy. We are once again faced with a situation in which there are no “good” policies that are painless. As Reinhart and Rogoff conclude from their massive study of “Eight Centuries of Financial Folly”, pain cannot be avoided once financial folly has been committed.
Let me close once again as I closed my post yesterday: the Fed is in a delicate position. They cannot get out of this situation by “throwing everything it can against the wall.” Let’s just hope that they can find a way to get out of their conundrum with the least amount of negative consequences.
Thursday, September 17, 2009
It's the Dollar, Stupid!
“A nation’s exchange rate is the single most important price in its economy.” Paul Volcker
The value of the United States dollar is heading to the lows it reached in the summer of 2008. My belief is that the value of the dollar will reach these lows in the fall and then proceed to even lower levels in 2010.
The reason given for the current decline? The U. S. economy is getting stronger and the recession (Bernanke) is “very likely over.” In other words, uncertainty and, consequently, the financial market’s perception of risk are declining. A simple measure of the risk the financial market perceives is the interest rate spread between Baa-rated bonds and Aaa-rated bonds. The near term peak, 338 basis points, in this spread occurred in November 2008, a time when all hell was breaking lose in the financial markets. In recent weeks this spread has narrowed to about 120 basis points, a level that has not been seen since January 2008, one month after the current recession is said to have begun.
Financial markets are relatively calm and so market participants can direct their attention to some of the longer term issues that still have to be addressed in the world.
Of particular interest is the economic policy stance of the United States and not just the recent reprieve from economic collapse. The crucial elements? First, there is the massive amount of government debt that is projected to accumulate over the next ten years: maybe $10 trillion in additional debt; maybe $15 trillion; maybe more. Second, there is the Federal Reserve balance sheet that currently shows over $2 trillion in assets, substantially more than the $840 billion in asset the Fed held as late as August 2008.
This is a tremendous cloud hanging over the financial markets!
We know that the value of the United States dollar rose in late 2008 because of the crisis in world financial markets. Almost everyone concerned contends that this move came about as financial market participants moved to what they considered to be less risky assets, and that move brought them to U. S. Treasury securities and the U. S. dollar. This concern over risk was exhibited in the Baa-Aaa spread.
But, now with the strengthening of the U. S. economy and other economies around the world and with the calming of the financial markets, investors are moving their money out of dollar denominated assets. And, they are once again focusing upon the fundamentals of the economic policy of the United States government.
And what are the fundamentals? Just looking at the numbers one would have a difficult time telling the difference between what the Bush 43 administration did and what the Obama administration is doing. During the Bush 43 administration, there were massive increases in the federal debt and the Federal Reserve kept interest rates extremely low for an extended period of time. Now in the Obama administration we are seeing massive increases in the federal debt and the Federal Reserve is keeping interest rates extremely low for an extended period of time.
This is not a financial mix that participants in international financial markets like.
Let’s take a look at the historical record. We start during the Nixon administration because until August 1971 the value of the dollar was fixed in value relative to other currencies. But, once the value of the dollar began to fluctuate we saw some very consistent behavior in the currency markets. During the Nixon administration the gross federal debt increased at an 8.5% annual rate. The value of the dollar declined by 12.7% during this time period.
In the period between 1978 and 1992, the gross federal debt rose at a 12.6% annual rate. The value of the dollar only declined by 4.6%, but we must remember that during this time there was the period that Paul Volcker was the chairman of the Board of Governors of the Federal Reserve System and short term interest rates were pushed above 20%. As a consequence, the value of the dollar actually rose during the early part of the period even though the federal debt was continuing to increase. However, it was all downhill for the value of the dollar after 1985.
The exception to the other periods of time examined here was the 1992 to 2000 period. During that time the gross federal debt rose at a miserly annual rate of 3.6% and the value of the dollar actually rose by 16% during this period. By the end of the Clinton administration, the federal budget was actually showing a surplus.
Now we get back to Bush 43. During the 2001 to 2009 period the gross federal debt rose at an 8.5% annual rate. From January 2001 through to January 2009, the value of the dollar declined by 23.0%! (Through one stretch, the value of the dollar actually declined by more than 40%.)
With substantial budget deficits forecast into the foreseeable future, the Obama administration is causing the gross federal debt to continue to increase at annual rates that are relatively high by historical standards. The result? Since January 20, 2009, the value of the dollar against major currencies has declined by about 10.5%; the value of the dollar against the Euro has declined by more than 12%
I don’t believe that the current declines in the value of the dollar are just a result of the strengthening of the United States economy. To me, the fall in the value of the dollar is just a continuation of the market’s response to the general economic and fiscal policies of the latter part of the 20th century. Since at least 1971, the United States government has consistently deflated the value of the dollar.
In 1971, President Richard Nixon, as he embraced deficit spending, said that we had all become Keynesians. Unfortunately, he was right then and I fear that he is still right about the policy makers now in charge in Washington! Because of this I cannot see any long term relief in sight for the dollar. The debt of the federal government will continue to increase at a very rapid pace and the value of the dollar will continue to decline.
The value of the United States dollar is heading to the lows it reached in the summer of 2008. My belief is that the value of the dollar will reach these lows in the fall and then proceed to even lower levels in 2010.
The reason given for the current decline? The U. S. economy is getting stronger and the recession (Bernanke) is “very likely over.” In other words, uncertainty and, consequently, the financial market’s perception of risk are declining. A simple measure of the risk the financial market perceives is the interest rate spread between Baa-rated bonds and Aaa-rated bonds. The near term peak, 338 basis points, in this spread occurred in November 2008, a time when all hell was breaking lose in the financial markets. In recent weeks this spread has narrowed to about 120 basis points, a level that has not been seen since January 2008, one month after the current recession is said to have begun.
Financial markets are relatively calm and so market participants can direct their attention to some of the longer term issues that still have to be addressed in the world.
Of particular interest is the economic policy stance of the United States and not just the recent reprieve from economic collapse. The crucial elements? First, there is the massive amount of government debt that is projected to accumulate over the next ten years: maybe $10 trillion in additional debt; maybe $15 trillion; maybe more. Second, there is the Federal Reserve balance sheet that currently shows over $2 trillion in assets, substantially more than the $840 billion in asset the Fed held as late as August 2008.
This is a tremendous cloud hanging over the financial markets!
We know that the value of the United States dollar rose in late 2008 because of the crisis in world financial markets. Almost everyone concerned contends that this move came about as financial market participants moved to what they considered to be less risky assets, and that move brought them to U. S. Treasury securities and the U. S. dollar. This concern over risk was exhibited in the Baa-Aaa spread.
But, now with the strengthening of the U. S. economy and other economies around the world and with the calming of the financial markets, investors are moving their money out of dollar denominated assets. And, they are once again focusing upon the fundamentals of the economic policy of the United States government.
And what are the fundamentals? Just looking at the numbers one would have a difficult time telling the difference between what the Bush 43 administration did and what the Obama administration is doing. During the Bush 43 administration, there were massive increases in the federal debt and the Federal Reserve kept interest rates extremely low for an extended period of time. Now in the Obama administration we are seeing massive increases in the federal debt and the Federal Reserve is keeping interest rates extremely low for an extended period of time.
This is not a financial mix that participants in international financial markets like.
Let’s take a look at the historical record. We start during the Nixon administration because until August 1971 the value of the dollar was fixed in value relative to other currencies. But, once the value of the dollar began to fluctuate we saw some very consistent behavior in the currency markets. During the Nixon administration the gross federal debt increased at an 8.5% annual rate. The value of the dollar declined by 12.7% during this time period.
In the period between 1978 and 1992, the gross federal debt rose at a 12.6% annual rate. The value of the dollar only declined by 4.6%, but we must remember that during this time there was the period that Paul Volcker was the chairman of the Board of Governors of the Federal Reserve System and short term interest rates were pushed above 20%. As a consequence, the value of the dollar actually rose during the early part of the period even though the federal debt was continuing to increase. However, it was all downhill for the value of the dollar after 1985.
The exception to the other periods of time examined here was the 1992 to 2000 period. During that time the gross federal debt rose at a miserly annual rate of 3.6% and the value of the dollar actually rose by 16% during this period. By the end of the Clinton administration, the federal budget was actually showing a surplus.
Now we get back to Bush 43. During the 2001 to 2009 period the gross federal debt rose at an 8.5% annual rate. From January 2001 through to January 2009, the value of the dollar declined by 23.0%! (Through one stretch, the value of the dollar actually declined by more than 40%.)
With substantial budget deficits forecast into the foreseeable future, the Obama administration is causing the gross federal debt to continue to increase at annual rates that are relatively high by historical standards. The result? Since January 20, 2009, the value of the dollar against major currencies has declined by about 10.5%; the value of the dollar against the Euro has declined by more than 12%
I don’t believe that the current declines in the value of the dollar are just a result of the strengthening of the United States economy. To me, the fall in the value of the dollar is just a continuation of the market’s response to the general economic and fiscal policies of the latter part of the 20th century. Since at least 1971, the United States government has consistently deflated the value of the dollar.
In 1971, President Richard Nixon, as he embraced deficit spending, said that we had all become Keynesians. Unfortunately, he was right then and I fear that he is still right about the policy makers now in charge in Washington! Because of this I cannot see any long term relief in sight for the dollar. The debt of the federal government will continue to increase at a very rapid pace and the value of the dollar will continue to decline.
Sunday, July 5, 2009
Deficits and the Declining Value of the Dollar
One of the questions that has arisen from the posts I have put up over the last several months has to do with my statement that the international financial community doesn’t like government deficits and tends to believe that a lack of fiscal discipline will result in an increased monetization of the debt. The feeling that the central bank of such a country cannot, in the longer run, overcome the fiscal imprudence of its national government and act independently of that government has resulted, time and again, in a decline in the value of the currency of the country being examined. The dollar is no exception.
Let’s look at the following information.
Average Yearly Increase in Gross Federal Debt (in billions of dollars)
Nixon/Ford $49.5
Carter $90.2
Reagan $258.6
Bush 41 $359.3
Clinton $232.1
Bush 43 $541.1
Now let’s look at the decline in the value of the dollar from the start of an administration to the end of that administration. I will use the trade weighted index of the United States dollar versus major currencies. The series begins in January 1973. Up until August 1971 the United States had a fixed exchange rate. At that time President Nixon announced that he was allowing the dollar to float in foreign exchange markets and was taking the United States off of the gold standard.
He also announced that “We are all Keynesians now!” meaning that he was going to stimulate the economy with budget deficits (so that he could get re-elected) and to protect against inflation he was freezing wages and prices. He created the Cost of Living Council and the Committee on Interest and Dividends to administer these controls as well as controls on interest rates. As can be seen from the above figures, the Gross Federal Debt increased by an average of almost $50 billion every year during the Nixon/Ford years. This compares with those spendthrifts John Kennedy and Lyndon Johnson who introduced Keynesian economic policies to the United States and who only increased the Gross Federal Debt by an average of less than $10 billion per year.
Change in the value of the dollar (as measured against major foreign currencies).
Nixon/Ford - 1.0 %
Carter - 10.4 %
Reagan - 5.7%
Bush 41 - 1.9 %
Clinton + 16.6%
Bush 41 - 21.6%
Note that the only administration to see a rise in the value of the dollar over the past forty years was the Clinton administration. Note, too, that the only break in the continued increase in the Gross Federal Debt outstanding was during the Clinton administration. As you may recall, the last four years it was in office, the Clinton administration ran budget surpluses.
Also, one can remember the accolades received by Paul Volcker, when he was the Chairman of the Board of Governors of the Federal Reserve System, for bringing inflation under control. Volcker was Chairman from August 1979 until August 1987. Volcker did bring inflation under control and early on this effort was reflected in a rise in the value of the United States dollar. The value of the dollar reached a short term bottom in July 1980 and then, accompanying the decline of inflation in the United States, the dollar rose in value by 55 percent to peak out on March 1985. However, even Volcker could not hold out against the massive deficits that the Reagan administration was piling up and the value of the dollar fell from that peak by 31 percent through the month at Volcker left his position at the Fed. Even someone as strong as Paul Volcker could not fight against the increasing deficits that were being posted by the Reagan administration. The value of the dollar closed lower at the end of the Reagan years than it was at the start.
The only conclusion one can draw from these data is that participants in international financial markets do not like the currency of countries that lack discipline over their fiscal affairs. This, of course, has very strong implications for the Obama administration. With the possibility that the Gross Federal Debt is on a trajectory in which the debt will increase in the $1.0 trillion range per year, at least for the near term, the implications seem clear. There will be continued pressure on the value of the United States dollar in the upcoming years.
The specific argument for this relationship is that increased federal deficits will result in increased monetization of the debt. Increased monetization of the debt will result in an increased rate of inflation. An increased rate of inflation will cause the value of the currency to decline. So, the question being posed by skeptics right now is “where is the inflation?” The time seems more right for deflation rather than inflation.
In the short run it is hard to argue against this logic. The only thing one can fall back on to answer this question is the fact that when budget deficits increase and there is no relief from substantial increases in the debt of the country, participants in international markets tend to sell the currency. What we have seen in the past is that any inflation that results from the massive increase in the debt outstanding can come in many forms that are not all registered in the computed price indices like the Consumer Price Index. Something like the CPI is an estimate, a guess at what is happening to prices. The important thing to remember about massive increases in debt is that they have to go somewhere and where ever they go they will have large consequences. We hope that we can measure these consequences and measure them in a timely manner. However, that does not always happen.
And, where else are we seeing action? India has now joined China and Russia and Brazil in calling for a discussion at the upcoming G-8 conference of the place of the United States dollar in the world’s monetary system. China is tired of continuing to support its currency against the United States dollar. Given the likelihood of a further decline in the value of the dollar, China faces the need to buy more and more dollars and invest in more and more securities from the United States. This, in the longer run, is not in China’s best interest. Nations, other than England and those from the Eurozone, are getting tired of the United States abusing its privilege of having the only reserve currency in the world. Although nothing is going to be done to change the monetary system at this time, this talk is going to get stronger and stronger. And, if the value of the dollar continues to decline in the future, the arguments are going to resonate more and more with others in the world. The basic approach to fiscal policy in the United States over the past 50 years has not been the most productive one in terms of maintaining a sound dollar currency.
Let’s look at the following information.
Average Yearly Increase in Gross Federal Debt (in billions of dollars)
Nixon/Ford $49.5
Carter $90.2
Reagan $258.6
Bush 41 $359.3
Clinton $232.1
Bush 43 $541.1
Now let’s look at the decline in the value of the dollar from the start of an administration to the end of that administration. I will use the trade weighted index of the United States dollar versus major currencies. The series begins in January 1973. Up until August 1971 the United States had a fixed exchange rate. At that time President Nixon announced that he was allowing the dollar to float in foreign exchange markets and was taking the United States off of the gold standard.
He also announced that “We are all Keynesians now!” meaning that he was going to stimulate the economy with budget deficits (so that he could get re-elected) and to protect against inflation he was freezing wages and prices. He created the Cost of Living Council and the Committee on Interest and Dividends to administer these controls as well as controls on interest rates. As can be seen from the above figures, the Gross Federal Debt increased by an average of almost $50 billion every year during the Nixon/Ford years. This compares with those spendthrifts John Kennedy and Lyndon Johnson who introduced Keynesian economic policies to the United States and who only increased the Gross Federal Debt by an average of less than $10 billion per year.
Change in the value of the dollar (as measured against major foreign currencies).
Nixon/Ford - 1.0 %
Carter - 10.4 %
Reagan - 5.7%
Bush 41 - 1.9 %
Clinton + 16.6%
Bush 41 - 21.6%
Note that the only administration to see a rise in the value of the dollar over the past forty years was the Clinton administration. Note, too, that the only break in the continued increase in the Gross Federal Debt outstanding was during the Clinton administration. As you may recall, the last four years it was in office, the Clinton administration ran budget surpluses.
Also, one can remember the accolades received by Paul Volcker, when he was the Chairman of the Board of Governors of the Federal Reserve System, for bringing inflation under control. Volcker was Chairman from August 1979 until August 1987. Volcker did bring inflation under control and early on this effort was reflected in a rise in the value of the United States dollar. The value of the dollar reached a short term bottom in July 1980 and then, accompanying the decline of inflation in the United States, the dollar rose in value by 55 percent to peak out on March 1985. However, even Volcker could not hold out against the massive deficits that the Reagan administration was piling up and the value of the dollar fell from that peak by 31 percent through the month at Volcker left his position at the Fed. Even someone as strong as Paul Volcker could not fight against the increasing deficits that were being posted by the Reagan administration. The value of the dollar closed lower at the end of the Reagan years than it was at the start.
The only conclusion one can draw from these data is that participants in international financial markets do not like the currency of countries that lack discipline over their fiscal affairs. This, of course, has very strong implications for the Obama administration. With the possibility that the Gross Federal Debt is on a trajectory in which the debt will increase in the $1.0 trillion range per year, at least for the near term, the implications seem clear. There will be continued pressure on the value of the United States dollar in the upcoming years.
The specific argument for this relationship is that increased federal deficits will result in increased monetization of the debt. Increased monetization of the debt will result in an increased rate of inflation. An increased rate of inflation will cause the value of the currency to decline. So, the question being posed by skeptics right now is “where is the inflation?” The time seems more right for deflation rather than inflation.
In the short run it is hard to argue against this logic. The only thing one can fall back on to answer this question is the fact that when budget deficits increase and there is no relief from substantial increases in the debt of the country, participants in international markets tend to sell the currency. What we have seen in the past is that any inflation that results from the massive increase in the debt outstanding can come in many forms that are not all registered in the computed price indices like the Consumer Price Index. Something like the CPI is an estimate, a guess at what is happening to prices. The important thing to remember about massive increases in debt is that they have to go somewhere and where ever they go they will have large consequences. We hope that we can measure these consequences and measure them in a timely manner. However, that does not always happen.
And, where else are we seeing action? India has now joined China and Russia and Brazil in calling for a discussion at the upcoming G-8 conference of the place of the United States dollar in the world’s monetary system. China is tired of continuing to support its currency against the United States dollar. Given the likelihood of a further decline in the value of the dollar, China faces the need to buy more and more dollars and invest in more and more securities from the United States. This, in the longer run, is not in China’s best interest. Nations, other than England and those from the Eurozone, are getting tired of the United States abusing its privilege of having the only reserve currency in the world. Although nothing is going to be done to change the monetary system at this time, this talk is going to get stronger and stronger. And, if the value of the dollar continues to decline in the future, the arguments are going to resonate more and more with others in the world. The basic approach to fiscal policy in the United States over the past 50 years has not been the most productive one in terms of maintaining a sound dollar currency.
Thursday, March 26, 2009
Has the Monetization Really Started?
Headlines on the Wall Street Journal website Thursday afternoon, “Treasurys Climb After Solid Auction.” (See http://online.wsj.com/article/SB123807273254847621.html#mod=testMod.)
Success!
The issue Thursday was a seven-year note sale of $24 billion and this capped the issuance of $98 billion in Treasury offerings this week. The day before, Wednesday, the auction of five-year notes was “tepid” and the market was nervous at the beginning of the day.
But, something else happened on Wednesday. The Fed began its planned purchases of existing securities. In fact, the Fed bought securities that matured between February 29, 2016 and February 15, 2019. Gosh, that’s right in the range of the new issue that sold so well on Thursday. Imagine!
Primary dealers offered the Fed a total of $21.9 billion in Treasury securities that matured in this time period and the central bank bought back $7.5 billion of them. Apparently, this will be the procedure that the Fed will follow in upcoming weeks as the indication is that they will purchase outstanding securities on a regular basis.
The Fed is expected to buy roughly $12 billion of Treasury securities every week until they exhaust the planned $300 billion in purchases as announced last week. Friday, March 27, they are going to be purchasing at the short end of the yield curve with dates running from March 2011 to April 2012. Planned are three purchases next week, with some maturity dates expected to run from August 2026 through February 2039.
One of the prominent explanations for the intermediate-term purchases is that the Fed thinks it will help keep mortgage rates down since most 30-year mortgages have an average life of about seven years. If choosing this maturity just happens to provide liquidity to the market so that the Treasury has an easier time of placing its new issues, well so be it!
So, it looks as if we are on our way.
Where?
To the land of Oz?
We are starting to see the Fed get serious about monetizing the debt. The talking is over and the direct impact on the market is now under way. At $12 billion in purchases every week, this means that for the next 25 weeks or so, the Fed will be entering the Treasury market acquiring more securities. And, this doesn’t include the provision to purchase mortgage-backed securities in large dollar amounts.
On the other side, as we saw with the $98 billion in new issues this week, the “recovery program” will be providing plenty of additional debt to the market during this period of time. Relieving primary dealers of outstanding issues will certainly “grease the wheels” for the Treasury in terms of the additional debt issue that will need to be placed.
So now we are seeing the future. The Wizard is waving his magic hand. Monetizing the government debt! Providing a scheme whereby private interests can make tons of money buying up “legacy assets”! And, a new regulatory scheme to keep the “bad guys” under control! It is a wonder land with a whole new geography.
It’s ironic. Last September, I remember feeling as if the world had changed, shifted, and would not be the same again. The specific time—a Tuesday evening--when I learned that AIG was being nationalized. I just felt different.
I feel that way again. The rules have changed. Maybe better said, the old rules are no longer applicable and we really don’t know what the new rules are—but we know that they will be different.
Will all this work and restore the banking system and speed the economy on to recovery? No one really knows. I guess we are all waiting for a “tipping” point. But the tipping point can mean different things to different people. The administration sees the tipping point producing a recovery. Critics of the administration see the tipping point creating a whole new cycle of inflation.
And, what if no tipping point appears? Well, that will just mean that a greater effort will be put into the attempt to spur the financial system and the economy along.
The most specific thing going right now is what the Federal Reserve is doing. They are purchasing the debt of the government and they are going to continue to do it for a substantial period of time. For today, we see that this effort has helped the Treasury Department place $24 billion of that debt. And, the Fed’s actions will probably continue to ease the placement of the additional new debt in the future.
What we need to look for, in my estimation, is what happens to the value of the dollar in foreign exchange markets. When the Federal Reserve initially announced this program the value of the dollar fell. When this policy of regularly purchasing Treasury securities up to the $300 billion proposed becomes excessive in the minds of currency traders, the value of the dollar will begin to decline again. My guess is that this will happen sooner rather than later.
Success!
The issue Thursday was a seven-year note sale of $24 billion and this capped the issuance of $98 billion in Treasury offerings this week. The day before, Wednesday, the auction of five-year notes was “tepid” and the market was nervous at the beginning of the day.
But, something else happened on Wednesday. The Fed began its planned purchases of existing securities. In fact, the Fed bought securities that matured between February 29, 2016 and February 15, 2019. Gosh, that’s right in the range of the new issue that sold so well on Thursday. Imagine!
Primary dealers offered the Fed a total of $21.9 billion in Treasury securities that matured in this time period and the central bank bought back $7.5 billion of them. Apparently, this will be the procedure that the Fed will follow in upcoming weeks as the indication is that they will purchase outstanding securities on a regular basis.
The Fed is expected to buy roughly $12 billion of Treasury securities every week until they exhaust the planned $300 billion in purchases as announced last week. Friday, March 27, they are going to be purchasing at the short end of the yield curve with dates running from March 2011 to April 2012. Planned are three purchases next week, with some maturity dates expected to run from August 2026 through February 2039.
One of the prominent explanations for the intermediate-term purchases is that the Fed thinks it will help keep mortgage rates down since most 30-year mortgages have an average life of about seven years. If choosing this maturity just happens to provide liquidity to the market so that the Treasury has an easier time of placing its new issues, well so be it!
So, it looks as if we are on our way.
Where?
To the land of Oz?
We are starting to see the Fed get serious about monetizing the debt. The talking is over and the direct impact on the market is now under way. At $12 billion in purchases every week, this means that for the next 25 weeks or so, the Fed will be entering the Treasury market acquiring more securities. And, this doesn’t include the provision to purchase mortgage-backed securities in large dollar amounts.
On the other side, as we saw with the $98 billion in new issues this week, the “recovery program” will be providing plenty of additional debt to the market during this period of time. Relieving primary dealers of outstanding issues will certainly “grease the wheels” for the Treasury in terms of the additional debt issue that will need to be placed.
So now we are seeing the future. The Wizard is waving his magic hand. Monetizing the government debt! Providing a scheme whereby private interests can make tons of money buying up “legacy assets”! And, a new regulatory scheme to keep the “bad guys” under control! It is a wonder land with a whole new geography.
It’s ironic. Last September, I remember feeling as if the world had changed, shifted, and would not be the same again. The specific time—a Tuesday evening--when I learned that AIG was being nationalized. I just felt different.
I feel that way again. The rules have changed. Maybe better said, the old rules are no longer applicable and we really don’t know what the new rules are—but we know that they will be different.
Will all this work and restore the banking system and speed the economy on to recovery? No one really knows. I guess we are all waiting for a “tipping” point. But the tipping point can mean different things to different people. The administration sees the tipping point producing a recovery. Critics of the administration see the tipping point creating a whole new cycle of inflation.
And, what if no tipping point appears? Well, that will just mean that a greater effort will be put into the attempt to spur the financial system and the economy along.
The most specific thing going right now is what the Federal Reserve is doing. They are purchasing the debt of the government and they are going to continue to do it for a substantial period of time. For today, we see that this effort has helped the Treasury Department place $24 billion of that debt. And, the Fed’s actions will probably continue to ease the placement of the additional new debt in the future.
What we need to look for, in my estimation, is what happens to the value of the dollar in foreign exchange markets. When the Federal Reserve initially announced this program the value of the dollar fell. When this policy of regularly purchasing Treasury securities up to the $300 billion proposed becomes excessive in the minds of currency traders, the value of the dollar will begin to decline again. My guess is that this will happen sooner rather than later.
Subscribe to:
Comments (Atom)
