During my professional career, three things have seemingly dominated the American culture. First, the labor unions; second, the manufacturing industries; and the third was home ownership.
I spent my formative years in Michigan and nothing dominated the newspapers more than the activity of labor unions and the car industry. That was just a part of the society there. Of course, there was the steel industry and in the case of unions there was the coal industry and so on. Nothing is more vivid to me than the role of manufacturing and labor unions in the culture of my youth.
If anything else came close it was the idea of home ownership and the suburban sprawl. It was especially important to put the returning soldiers into homes and to help them live the “true” American life.
These days are gone, but the role they played in this earlier existence still dominates our national life and our political philosophy. Maybe that needs to change. Maybe we need to re-direct our attention.
The manufacturing industries have become a smaller and smaller part of the United States economic machine…for better or worse. The economy has shifted toward information and “information goods”. An “information good” is broadly defined as anything that can be digitized. Besides the computer industry, three other major subcategories in this area are in financial services, higher education, and government. Finance, colleges and universities, and government deal, primarily, with information and “information goods”.
The “new” structure of commerce in the United States is tilted toward the more educated, the more mobile, and the modern urban community. The “old” structure relied more on physical effort, the stationary, and the suburban life.
That is, the driving forces in this new modern world are not cars, and steel, and manual labor.
The thrust of the labor unions has also changed and it seems as if unions have spread into the area of government as the presence of government has grown in the society over the last fifty years. Back in “the good old days”, unions were connected with industry and hard and dangerous jobs and “national” monopolies. International competition was not a threat at that time.
Today, the presence of unions has radically shifted. In the United States most union members are connected with government. This is also the case in the rest of the western, democratic nations. Labor unions are still important in the automobile industry, but the automobile industry is just not as important any more. I have seen figures that indicate that something like 60% of the membership in American labor unions these days is related to government. This move has completely changed not only the location of labor unions in the United States; it has also changed the focus.
The desire to get Americans into their own homes has been present in the country since the country was started. This was felt to be important not only for individuals themselves, but for the substantial positive externalities that were felt to accompany the growth of home ownership.
Today, we may find that renting may become more prevalent in the faster-moving, more educated, “urban” workforce of the 21st century. And, this mobility is becoming more global than just national.
The economic policies of the government have been built around the above factors which, I contend, are not as prevalent as they once were.
Monetary and fiscal stimulus were more effective in an age of “heavy manufacturing” because these industries relied upon fixed capital, huge plants and machinery, and a “local” labor force. When unemployment happened, labor stayed “at home”, both in terms of location, but also in terms of skills because the workers needed to know little else. Monetary and fiscal stimulus put these workers back to work in their old jobs as sales picked up. New investment also was created as the economy rebounded.
The same is not true in the Information Age. “Information” companies do not have huge plants and large machines to maintain. Downsizing and the shifting of the employees occurs incrementally and more rapidly than in the past. People move and re-train and change. Monetary and fiscal stimulus is not so effective because the companies and have “moved on” and do not re-hire people back into their old jobs as did the manufacturing firms. The employees have also “moved on”. Furthermore, these companies do not have large capital investments to undertake that help the economy to re-start.
The labor union issue is surfacing in another way. Labor unions connected with government workers have become very important in recent years and have been very successful in gaining large settlements related to health benefits and retirement. A recent edition of the Economist magazine has covered some of the issues here. The problem: “One California mayor estimates that the effective cost of employing each police officer and fireman is $180,000 a year. That sum is not their take-home pay. For police and firefighters, the big costs occur when they stop working—retirement at 50, combined with inflation-linking, health benefits and lump sums for unused sick leave…California is also shelling out fortunes to retired state and municipal managers; more than 9,000 have retirement incomes of over $100,000 a year.”
And, these pension promises have been subject to “Alice-in-Wonderland accounting.” The Economist presents figures that pension liabilities are estimated to be around $5.3 trillion, compared with $1.9 trillion of assets. “The total shortfall of $3.4 trillion is the equivalent of a quarter of all federal debt.”
So, when it comes to governmental employees, the fighting is not over peanuts. And, this is a worldwide issue as can be noted in the riots taking place in Greece, Italy, Portugal, Spain and France over their government’s retirement and pension payments. And, yesterday it was revealed that the new austerity budget of the British government contains a reduction of 500,000 public sector jobs. “Today, the fight begins,” states the general secretary of the largest government union in the UK.
The role of labor unions in the 21st century society seems to need to be re-addressed going
forward.
Finally, the pressure of the government to achieve high rates of home ownership must be re-visited. We, in the United States, have paid a major price for the emphasis placed on this goal and the resources that were allocated toward its achievement. Payment is still coming due in the area of foreclosures, commercial real estate bankruptcies, and the resolving of government support of Fannie Mae and Freddie Mac. It is very likely that we, the people of the United States, will be paying for this bailout for many years to come.
The whole point of this post is to argue for a change in some of the assumptions behind the economic policies of the leaders of the United States government. The world has changed. Maybe our leaders need to change their outlook as well.
Or, is that too much to ask?
Showing posts with label federal deficits. Show all posts
Showing posts with label federal deficits. Show all posts
Friday, October 22, 2010
Monday, April 19, 2010
The New Way for the Fed to "Exit"?
Has the Federal Reserve begun its exit strategy? Has the Fed already started the “Great Undoing”? It has, but the new exit movement is not taking place in open market operations…or in repurchase agreements. It is occurring with the help of the Treasury Department. Let’s look at the line item on the Fed’s balance sheet titled “U. S. Treasury, supplementary financing account”.
The Federal Reserve defines the U. S. Treasury, supplementary financing account in this way:
“U.S. Treasury, supplementary financing account: With the dramatic expansion of the Federal Reserve's liquidity facilities, the Treasury agreed to establish the Supplementary Financing Program with the Federal Reserve. Under the Supplementary Financing Program, the Treasury issues debt and places the proceeds in the Supplementary Financing Account. The effect of the account is to drain balances from the deposits of depository institutions, helping to offset, somewhat, the rapid rise in balances that resulted from the various Federal Reserve liquidity facilities.”
Thus, this account is a deposit facility of the Federal Reserve similar to the U. S. Treasury, general account, the account that the Treasury conducts its general business from. Thus, it is a factor “absorbing reserve funds”, or, in other words, placing funds in this account removes reserves from the banking system. Hence, it contributes to the “exit” of the Fed from its inflated balance sheet.
I posted a note on this account on February 24, 2010 titled “The Treasury’s Latest Maneuver With the Fed”: http://seekingalpha.com/article/190404-the-treasury-s-latest-maneuver-with-the-fed. In that note I described what was going on in the following way: “On September 17, 2008, the Treasury Department announced something called the ‘Supplementary Financing Program.’ Under this program the Treasury was to issue marketable debt and deposit the proceeds in an account that would be separate from the General Account of the Treasury at the Fed.
In September 2008, this account averaged almost $80 billion. In November 2008 it was above $500 billion. The account dropped to just below $200 billion in January 2009 and remained around that level into September 2009. The figure drops precipitously from there as the issue about the debt limit of the Federal Government had to be dealt with. In January and February 2010, the account averaged just $5 billion.
Now that the Congress has raised the debt limit on the government, the plan has been revived.
The original purpose of the Supplemental Financing Account was to get cash into the hands of those that needed funds and not have to go through the market system which would take more time and, perhaps, a greater amount of trading, to meet the peak liquidity demands in the financial crisis. That is, the Treasury had cash to spend out of this account that could go directly to those that needed the stimulus spending. This program allowed the Treasury to issue securities without going directly to the market and perhaps keeping interest rates from falling.
In the present case, the Treasury says that it is going to keep the cash proceeds from the borrowing on deposit at the Federal Reserve. If this is true, then it seems that what the arrangement is providing is more Treasury securities to the Fed to be used as the central bank reduces the amount of excess reserves in the banking system.”
In recent weeks a lot of activity has taken place in this account. As stated in the post on February 24, 2010, there were $5 billion on deposit in this account.
On March 3, this balance was just under $25 billion. The balance rose to about $50 billion on March 10, around $75 billion on March 17, and near $100 billion on March 24. Again it rose to about $125 billion on April 1, $150 billion on April 8, and $175 billion on April 15.
Obviously, the plan is for this account to increase by $25 billion every week until the Treasury reaches its stated goal of $200 billion in this supplemental financing account.
What impact has this had on bank reserves?
Well, on February 24, factors, other than reserve balances, absorbing reserve funds totaled $1.082 trillion. On April 14, this total was $1.320 trillion, an increase of $238 billion. Reserve balances at Federal Reserve banks declined from $1.246 trillion on February 24 to $1.061 trillion on April 14, a fall of $185 billion.
The latest information we have on excess reserves in the banking system indicates that for the two banking weeks ending April 7, excess reserves averaged about $1.094 trillion, a decline of about $100 billion from the average that existed for the two banking weeks ending February 24 of $1.092 trillion.
Thus, this “maneuver” accomplishes two things. First, it is connected with the issuance of Treasury debt to finance the huge budget deficits of the government. Second, the proceeds of the debt issuance do not stay in the banking system, but are withdrawn and put on deposit at the Federal Reserve so that excess reserves are drained from the banking system.
Therefore, the Federal Reserve, with the help of the Treasury Department, has begun to exit!
One could argue that these reserves are coming out of the banking system willingly. That is, the big concern associated with the “Great Undoing” is that the Fed would take reserves out of the banking system that the commercial banks really wanted to “hang onto.” If this were to take place we might get a replay of the 1937 actions of the Federal Reserve when it took excess reserves out of the banking system that the banks wanted to hold onto which resulted in the contraction of bank lending contributing to the 1937-38 depression.
Removing reserves in this way, with the help of the Treasury, might be a benign way to begin the “undoing” which can then be followed up by more traditional central bank operations using repurchase agreements and outright sales of securities. Also, it takes pressure off the Fed in that open market operations could just focus on the Fed’s holdings of U. S. Treasury securities leaving the Fed’s portfolio of mortgage-backed securities and Federal Agency securities free to just decline by attrition. The Fed has only about $777 billion in Treasury securities in its portfolio and, depending upon how much it needs to reduce the excess reserves in the banking system, would probably not want to be forced to use other other parts of its portfolio in removing these reserves.
So, we observe another financial innovation on the part of the government. Niall Ferguson has argued that, historically, governments have been the biggest innovator when it comes to finance. The reason? Governments have been the largest issuers of debt and have had to be very creative in finding new ways to place debt and to manage debt. Certainly in the last fifty years, governments have shown themselves very adept at coming up with new ways to spend money…and to finance this spending.
The Federal Reserve defines the U. S. Treasury, supplementary financing account in this way:
“U.S. Treasury, supplementary financing account: With the dramatic expansion of the Federal Reserve's liquidity facilities, the Treasury agreed to establish the Supplementary Financing Program with the Federal Reserve. Under the Supplementary Financing Program, the Treasury issues debt and places the proceeds in the Supplementary Financing Account. The effect of the account is to drain balances from the deposits of depository institutions, helping to offset, somewhat, the rapid rise in balances that resulted from the various Federal Reserve liquidity facilities.”
Thus, this account is a deposit facility of the Federal Reserve similar to the U. S. Treasury, general account, the account that the Treasury conducts its general business from. Thus, it is a factor “absorbing reserve funds”, or, in other words, placing funds in this account removes reserves from the banking system. Hence, it contributes to the “exit” of the Fed from its inflated balance sheet.
I posted a note on this account on February 24, 2010 titled “The Treasury’s Latest Maneuver With the Fed”: http://seekingalpha.com/article/190404-the-treasury-s-latest-maneuver-with-the-fed. In that note I described what was going on in the following way: “On September 17, 2008, the Treasury Department announced something called the ‘Supplementary Financing Program.’ Under this program the Treasury was to issue marketable debt and deposit the proceeds in an account that would be separate from the General Account of the Treasury at the Fed.
In September 2008, this account averaged almost $80 billion. In November 2008 it was above $500 billion. The account dropped to just below $200 billion in January 2009 and remained around that level into September 2009. The figure drops precipitously from there as the issue about the debt limit of the Federal Government had to be dealt with. In January and February 2010, the account averaged just $5 billion.
Now that the Congress has raised the debt limit on the government, the plan has been revived.
The original purpose of the Supplemental Financing Account was to get cash into the hands of those that needed funds and not have to go through the market system which would take more time and, perhaps, a greater amount of trading, to meet the peak liquidity demands in the financial crisis. That is, the Treasury had cash to spend out of this account that could go directly to those that needed the stimulus spending. This program allowed the Treasury to issue securities without going directly to the market and perhaps keeping interest rates from falling.
In the present case, the Treasury says that it is going to keep the cash proceeds from the borrowing on deposit at the Federal Reserve. If this is true, then it seems that what the arrangement is providing is more Treasury securities to the Fed to be used as the central bank reduces the amount of excess reserves in the banking system.”
In recent weeks a lot of activity has taken place in this account. As stated in the post on February 24, 2010, there were $5 billion on deposit in this account.
On March 3, this balance was just under $25 billion. The balance rose to about $50 billion on March 10, around $75 billion on March 17, and near $100 billion on March 24. Again it rose to about $125 billion on April 1, $150 billion on April 8, and $175 billion on April 15.
Obviously, the plan is for this account to increase by $25 billion every week until the Treasury reaches its stated goal of $200 billion in this supplemental financing account.
What impact has this had on bank reserves?
Well, on February 24, factors, other than reserve balances, absorbing reserve funds totaled $1.082 trillion. On April 14, this total was $1.320 trillion, an increase of $238 billion. Reserve balances at Federal Reserve banks declined from $1.246 trillion on February 24 to $1.061 trillion on April 14, a fall of $185 billion.
The latest information we have on excess reserves in the banking system indicates that for the two banking weeks ending April 7, excess reserves averaged about $1.094 trillion, a decline of about $100 billion from the average that existed for the two banking weeks ending February 24 of $1.092 trillion.
Thus, this “maneuver” accomplishes two things. First, it is connected with the issuance of Treasury debt to finance the huge budget deficits of the government. Second, the proceeds of the debt issuance do not stay in the banking system, but are withdrawn and put on deposit at the Federal Reserve so that excess reserves are drained from the banking system.
Therefore, the Federal Reserve, with the help of the Treasury Department, has begun to exit!
One could argue that these reserves are coming out of the banking system willingly. That is, the big concern associated with the “Great Undoing” is that the Fed would take reserves out of the banking system that the commercial banks really wanted to “hang onto.” If this were to take place we might get a replay of the 1937 actions of the Federal Reserve when it took excess reserves out of the banking system that the banks wanted to hold onto which resulted in the contraction of bank lending contributing to the 1937-38 depression.
Removing reserves in this way, with the help of the Treasury, might be a benign way to begin the “undoing” which can then be followed up by more traditional central bank operations using repurchase agreements and outright sales of securities. Also, it takes pressure off the Fed in that open market operations could just focus on the Fed’s holdings of U. S. Treasury securities leaving the Fed’s portfolio of mortgage-backed securities and Federal Agency securities free to just decline by attrition. The Fed has only about $777 billion in Treasury securities in its portfolio and, depending upon how much it needs to reduce the excess reserves in the banking system, would probably not want to be forced to use other other parts of its portfolio in removing these reserves.
So, we observe another financial innovation on the part of the government. Niall Ferguson has argued that, historically, governments have been the biggest innovator when it comes to finance. The reason? Governments have been the largest issuers of debt and have had to be very creative in finding new ways to place debt and to manage debt. Certainly in the last fifty years, governments have shown themselves very adept at coming up with new ways to spend money…and to finance this spending.
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!
Monday, January 4, 2010
Following Mr. Bernanke and the Fed into the New Year!
Have you ever noticed that when someone doesn’t have the skills to do a job well that they ask for more control so that they can do the job better next time?
Enter Ben Bernanke into the New Year!
Speaking in Atlanta yesterday, Mr. Bernanke made the following statements about monetary policy in the first decade of this century.
“Stronger regulation and supervision aimed at problems with underwriting practices and lenders’ risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates.”
“When historical relationships are taken into account, it is difficult to ascribe the house price bubble either to monetary policy or to the broader macroeconomic environments.”
So much for that!
At the annual meeting of the American Economic Association we heard that the excessively low interest rates set by the central bank during the 2002 through 2006 period, when Bernanke was a member of the Board of Governors of the Federal Reserve System and the arch-defender of Chairman Alan Greenspan and the low interest rate policy, that the level at which interest rates were set were “appropriately low.”
Imagine that, Mr. Bernanke (now), defending Mr. Bernanke (then). I am truly surprised!
I’m not buying.
Remember, too, that this was a time that large budget deficits were accruing due to the Bush tax cuts and the build up for the Bush war-plan.
Monetary policy and fiscal policy marched hand-in-hand during this period. So much for the independence of the American central bank!
And, how does Mr. Bernanke explain the reaction of the international investment community to this policy stance?
Evidence can be found in the foreign exchange market: the value of the dollar, given most measures of its value, declined by about 40% into the spring of 2008. It seems as if investors did not think that interest rates were set “appropriately low.”
And, this gets me back to my original point: my experience, both in running organizations and in studying those that run organizations, leads me to the conclusion that when people fail to perform their job they ask for more hands-on-control in the areas their job covers. They believe that with greater hands-on-control that they will be able to perform better than they have in the past.
Never, in my experience, have I seen the move to greater control work! Consequently, I don’t expect that giving the Federal Reserve more regulatory control will work at this time either.
And, Mr. Bernanke and the Federal Reserve have an altogether different problem if they “muck up” their exit strategy from the Fed’s inflated balance sheet.
Are they going to save themselves in this area by having greater regulatory control?
I think not!
It is obvious that Mr. Bernanke is going to be re-confirmed as the Chairman of the Board of Governors of the Federal Reserve System, an integral part of the Obama administration.
Investors must remember this going forward. We have huge government deficits in our future. We have a banking system where, at least in the smaller banks, there are still large balances of underwater loans. The wave of home foreclosures does not seem to be over. We have bankruptcies that are still occurring. Unemployment, and under-employment, will continue to remain low for some time into the future. And so on, and so forth.
As a consequence, given past behavior, it is a good bet that Mr. Bernanke is going to err on the side of the politicians that need to get re-elected in 2010 and in 2012.
Investors need to keep this in mind. As we have gone through a period of time when everything the Fed had was thrown against the financial crisis, it seems that the future will include a Fed that errs on the side of keeping things excessively easy. In effect, monetary policy is being conducted with little or no discipline.
Nothing new here for the Bernanke Fed!
The remedy for that, Mr. Bernanke told us yesterday, is to give the Fed greater regulatory control. The assumption is that regulatory control will make up for the lack of discipline elsewhere.
And, you know what can happen when we assume.
Enter Ben Bernanke into the New Year!
Speaking in Atlanta yesterday, Mr. Bernanke made the following statements about monetary policy in the first decade of this century.
“Stronger regulation and supervision aimed at problems with underwriting practices and lenders’ risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates.”
“When historical relationships are taken into account, it is difficult to ascribe the house price bubble either to monetary policy or to the broader macroeconomic environments.”
So much for that!
At the annual meeting of the American Economic Association we heard that the excessively low interest rates set by the central bank during the 2002 through 2006 period, when Bernanke was a member of the Board of Governors of the Federal Reserve System and the arch-defender of Chairman Alan Greenspan and the low interest rate policy, that the level at which interest rates were set were “appropriately low.”
Imagine that, Mr. Bernanke (now), defending Mr. Bernanke (then). I am truly surprised!
I’m not buying.
Remember, too, that this was a time that large budget deficits were accruing due to the Bush tax cuts and the build up for the Bush war-plan.
Monetary policy and fiscal policy marched hand-in-hand during this period. So much for the independence of the American central bank!
And, how does Mr. Bernanke explain the reaction of the international investment community to this policy stance?
Evidence can be found in the foreign exchange market: the value of the dollar, given most measures of its value, declined by about 40% into the spring of 2008. It seems as if investors did not think that interest rates were set “appropriately low.”
And, this gets me back to my original point: my experience, both in running organizations and in studying those that run organizations, leads me to the conclusion that when people fail to perform their job they ask for more hands-on-control in the areas their job covers. They believe that with greater hands-on-control that they will be able to perform better than they have in the past.
Never, in my experience, have I seen the move to greater control work! Consequently, I don’t expect that giving the Federal Reserve more regulatory control will work at this time either.
And, Mr. Bernanke and the Federal Reserve have an altogether different problem if they “muck up” their exit strategy from the Fed’s inflated balance sheet.
Are they going to save themselves in this area by having greater regulatory control?
I think not!
It is obvious that Mr. Bernanke is going to be re-confirmed as the Chairman of the Board of Governors of the Federal Reserve System, an integral part of the Obama administration.
Investors must remember this going forward. We have huge government deficits in our future. We have a banking system where, at least in the smaller banks, there are still large balances of underwater loans. The wave of home foreclosures does not seem to be over. We have bankruptcies that are still occurring. Unemployment, and under-employment, will continue to remain low for some time into the future. And so on, and so forth.
As a consequence, given past behavior, it is a good bet that Mr. Bernanke is going to err on the side of the politicians that need to get re-elected in 2010 and in 2012.
Investors need to keep this in mind. As we have gone through a period of time when everything the Fed had was thrown against the financial crisis, it seems that the future will include a Fed that errs on the side of keeping things excessively easy. In effect, monetary policy is being conducted with little or no discipline.
Nothing new here for the Bernanke Fed!
The remedy for that, Mr. Bernanke told us yesterday, is to give the Fed greater regulatory control. The assumption is that regulatory control will make up for the lack of discipline elsewhere.
And, you know what can happen when we assume.
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.
Subscribe to:
Comments (Atom)
