Since the end of December 2010 (the banking week ending December 29, 2010) the Federal Reserve has injected almost $200 billion in new reserve balances into the banking system. (See my post of December 18: http://seekingalpha.com/article/253787-fed-s-liquidity-machine-full-speed-ahead.)
Since the end of December 2010 (the banking week ending December 29, 2010) cash assets at commercial banks have risen by more than $280 billion!
Since the end of December 2010 (the banking week ending December 29, 2010) cash assets at foreign-related banking institutions in the United States have risen by more than $175 billion!
In addition, trading assets at these foreign-related banking institutions have risen by $33 billion and a catch-all asset account has risen by $12 billion. (This catch-all account includes things like loans to foreign banks, loans to nonbank depository institutions and loans to nonbank financial institutions.)
All together these accounts at these foreign banking organizations have risen by about $220 billion in the last six weeks, about $30 billion more than the total assets of these foreign-related banking institutions have increased. One could argue that the foreign-related banking institutions are doing pretty well by the quantitative easing that the Federal Reserve is conducting. These foreign-related organizations seem to be doing a lot of trading!
During this same time period the total assets of large domestically chartered commercial banks in the United States have declined slightly.
The total assets of small domestically chartered commercial banks rose by about $30 billion.
Also, during this time period cash assets at the largest 25 domestically chartered banks rose by more than $72 billion and the cash assets at all other domestically chartered banks rose by $38 billion.
Thus, the Fed's QE2 is getting the cash out into the banking system. However, almost two-thirds of the cash seems to be going to foreign-related organizations and not to domestically chartered commercial banks!
Is this what was supposed to have happen?
Over the past 14-week period, cash assets in the banking system have risen by almost $300 billion. Again, over two-thirds of the increase (about $205 billion) came in the cash assets of the foreign-related banking institutions. All of the increase in cash holdings at the largest 25 banks came after December 29, 2010, while cash assets holdings in the rest of the banking system fell in the period before December 29 before rising in the last 6-week period.
One would think that this distribution of cash would not bode well for domestic lending. And, in fact, bank lending was abysmal over the past 6-week period and the last 14-week period.
Since the end of the year, loans and leases at the largest 25 domestically chartered banks in the United States dropped dramatically by about $50 billion, much of this coming in consumer lending although loan amounts were down across the board. Loans and leases held roughly constant in the eight weeks that preceded December 29 at these large banks.
In the rest of the banking system the declines in the loan portfolio came primarily before the end of the year. After falling by about $60 billion in November and December, loans at these institutions rose slightly in the first six weeks of 2011. Notable decreases came in both residential lending and in commercial real estate loans, each declining by a little more than $20 billion over the last 14-week period.
One interesting thing also appeared in the recent statistics. The securities portfolio of the banking system declined over the latest 14-week period by a little less than $40 billion.
However, there were huge differences in the behavior of the largest banks and the smaller banks.
The largest banks REDUCED their holdings of securities by about $96 billion; $67 billion of the total were in U. S. Treasury and Agency securities.
The rest of the domestically chartered commercial banks INCREASED their holdings of securities by almost $60 billion with a $63 billion increase in their holdings of U. S. Treasury securities.
The larger banks got out of securities as interest rates rose through November, December, and January. The smaller banks increased their securities. Is this bad timing on the part of the smaller banks?
So, here we are with the Federal Reserve pumping reserves into the banking system like crazy.
But, two-thirds of it is going to foreign-related banking institutions?
And, commercial bank lending continues to contract?
What is wrong with this picture?
I am feeling such a disconnect between Ben Bernanke’s view of the world and what seems to be going on in the world. When Mr. Bernanke speaks I really wonder what planet he is on…it certainly doesn’t seem to be the one that I am on.
Also, I am getting tired of Mr. Bernanke putting the blame for all his troubles on the backs of others. He began this practice in the early 2000s and it continues on today. He doesn’t accept the fact that some of the mistakes of the past are his. As Stephen Covey has said, if all the blame for the problems one faces is “out there”…that’s the problem!
Showing posts with label the Federal Reserve. Show all posts
Showing posts with label the Federal Reserve. Show all posts
Monday, February 21, 2011
Thursday, April 30, 2009
Long Term Bond Yields and the Fed
The Federal Reserve is trying to hold down long term interest rates. The reason? To stimulate economic activity and encourage credit flow and especially mortgage lending. But, we have a problem. The Financial Times puts out headlines stating that “Rising bond yields present fresh challenge for the Fed.”
Long term bond rates have been rising lately. Yesterday, the 10-year Treasury hit 3.096%, a territory not breached since November 24, 2008. Last time I looked today, this yield was at 3.134%. The same was true for 20-year Treasuries topping 4.00% yesterday and today.
The Fed has been engaged in an effort to purchase longer term United States Treasury issues on a continuous basis as well as Federal Agency issues and mortgage-backed securities. It has made purchases in sizable amounts weekly. Now, the Fed seems to be losing its grip on yields in the long term end of the market.
The rationale given for this slippage? The record amounts of debt the United States government has to sell.
It is true that there are and will continue to be record amounts of debt issued by the United States government coming to the market now and for as far as we can see in the future. The supply issue may have some effect in the short run, but let me provide another possibility for the rise in rates in the longer term end of the yield curve.
The argument about whether or not the central bank can significantly impact yields in the longer term end of the yield curve has been going on for almost the entire length of my professional career. First, people think that the central bank can, and should, conduct open market operations so as to lower long term interest rates in order to spur on the economy. Then, research is produced that indicates that the Fed cannot achieve a significant reduction in long term yields through open market operations. A little later, some others think that it would be a good idea for the central bank to conduct open market operations to reduce long term interest rates. This is followed by another round of research indicating that the central bank cannot achieve this goal. Now, we are back at the point where policy makers believe that the Fed should attempt to keep long term interest rates low.
My reading of history is that the Federal Reserve cannot control, for any length of time, yields on long-term Treasury issues!
My reading of history also causes me to believe that the supply of Treasury securities cannot impact, for any length of time, the yields on long-term Treasury issues!
I am one that believes that long-term Treasury yields are determined by the appropriate expected real rate of interest and the expected rate of inflation. Since the expected real rate of interest does not change over short periods of time, the general movement in longer-terms interest rates will be determined by changes in expected inflation. And, expected inflation is dependent upon what the financial markets believe the Federal Reserve will be doing with respect to the monetization of the federal debt.
This, of course, has been a big fear in the financial markets. With all of the projected government debt coming down the road, many market participants believe that the Federal Reserve will have no choice but to monetize large portions of this debt. As more and more of the debt is monetized the probability that inflation will rise increases. And, this expectation gets built into long term interest rates.
If this is true, then the central bank faces a real dilemma. When the Federal Reserve attempts to keep long term interest rates low, it can cause a rise in inflationary expectations and this will create upward pressure on long term interest rates. If the Fed monetizes more of the debt to keep interest rates at the lower level, inflationary expectations will become even greater, putting even more upward pressure on long term interest rates. And, as long as the central bank continues to keep these long term yields below where the market wants them, the more damaging will be the consequences in the future.
In all my experience, I have not seen the Federal Reserve succeed in keeping long term interest rates below where the market wants them to be. I don’t expect them to succeed in their present efforts.
And, what about inflationary expectations? I believe that we can provide evidence from other markets that confirm this recent sensitivity to the increasing pressure on the monetary authorities to monetize the government debt. I am not concerned with the absolute levels of expected inflation, just the direction in which the spread has moved.
The spread between the 10-year government bond yield and the rate on 10-year inflation indexed government bonds is often used as an indicator of movements in inflationary expectations. The spread remained relatively constant from January 2009 through March. However, in April the spread has increased by 2 ½ times the January figure. This spread now is at a level we have not seen since early October 2008, right after the fall crisis hit. Market participants seem to be increasingly worried about what the Fed is going to have to do.
Furthermore, every time we see this spread increasing we tend to see a decline in the value of the United States dollar against the Euro and against other major currencies. Relative currency valuations are highly dependent upon changes in what central banks are expected to do because their actions can affect relative rates of inflation. If investors believe that the central bank in your country is going to monetize its government’s debt more rapidly than that of another country, the value of your currency will decline relative to that of the other country.
In this respect, the value of the United States dollar has declined over the past two days and tends to drop every time there is a rise in yields on longer term Treasury bonds. This would indicate that some of the same things affecting the yields on long term bonds are also affecting the value of the currency.
A final piece of evidence in support of this idea is that the market also responded to the minutes released yesterday by the Federal Reserve’s Open Market Committee. In those minutes the Fed stated that “the economic outlook has improved modestly since the March meeting…” It also noted that household spending “has shown signs of stabilizing while businesses have cut inventories, investments and staffing” implying that if consumer spending does stabilize or even increase, businesses will have to restock their shelves in order to support this spending which would be positive for economic recovery. Both of these statements foresee a stronger economy in the future, reinforcing the earlier fears of the market.
Long term Treasury yields were low because there was a flight to quality and because inflationary expectations were low. Unless there is another major shock to the system, I believe that the flight to quality is over and is in the process of being reversed. In addition, I believe that the Fed will continue to monetize the debt in increasing amounts for the Fed also emphasized in the minutes released yesterday that they will “stay the course” in the fight against an economic collapse. For both of these reasons, I feel that pressure will continue for long term Treasury yields to rise and for the value of the dollar to fall.
Long term bond rates have been rising lately. Yesterday, the 10-year Treasury hit 3.096%, a territory not breached since November 24, 2008. Last time I looked today, this yield was at 3.134%. The same was true for 20-year Treasuries topping 4.00% yesterday and today.
The Fed has been engaged in an effort to purchase longer term United States Treasury issues on a continuous basis as well as Federal Agency issues and mortgage-backed securities. It has made purchases in sizable amounts weekly. Now, the Fed seems to be losing its grip on yields in the long term end of the market.
The rationale given for this slippage? The record amounts of debt the United States government has to sell.
It is true that there are and will continue to be record amounts of debt issued by the United States government coming to the market now and for as far as we can see in the future. The supply issue may have some effect in the short run, but let me provide another possibility for the rise in rates in the longer term end of the yield curve.
The argument about whether or not the central bank can significantly impact yields in the longer term end of the yield curve has been going on for almost the entire length of my professional career. First, people think that the central bank can, and should, conduct open market operations so as to lower long term interest rates in order to spur on the economy. Then, research is produced that indicates that the Fed cannot achieve a significant reduction in long term yields through open market operations. A little later, some others think that it would be a good idea for the central bank to conduct open market operations to reduce long term interest rates. This is followed by another round of research indicating that the central bank cannot achieve this goal. Now, we are back at the point where policy makers believe that the Fed should attempt to keep long term interest rates low.
My reading of history is that the Federal Reserve cannot control, for any length of time, yields on long-term Treasury issues!
My reading of history also causes me to believe that the supply of Treasury securities cannot impact, for any length of time, the yields on long-term Treasury issues!
I am one that believes that long-term Treasury yields are determined by the appropriate expected real rate of interest and the expected rate of inflation. Since the expected real rate of interest does not change over short periods of time, the general movement in longer-terms interest rates will be determined by changes in expected inflation. And, expected inflation is dependent upon what the financial markets believe the Federal Reserve will be doing with respect to the monetization of the federal debt.
This, of course, has been a big fear in the financial markets. With all of the projected government debt coming down the road, many market participants believe that the Federal Reserve will have no choice but to monetize large portions of this debt. As more and more of the debt is monetized the probability that inflation will rise increases. And, this expectation gets built into long term interest rates.
If this is true, then the central bank faces a real dilemma. When the Federal Reserve attempts to keep long term interest rates low, it can cause a rise in inflationary expectations and this will create upward pressure on long term interest rates. If the Fed monetizes more of the debt to keep interest rates at the lower level, inflationary expectations will become even greater, putting even more upward pressure on long term interest rates. And, as long as the central bank continues to keep these long term yields below where the market wants them, the more damaging will be the consequences in the future.
In all my experience, I have not seen the Federal Reserve succeed in keeping long term interest rates below where the market wants them to be. I don’t expect them to succeed in their present efforts.
And, what about inflationary expectations? I believe that we can provide evidence from other markets that confirm this recent sensitivity to the increasing pressure on the monetary authorities to monetize the government debt. I am not concerned with the absolute levels of expected inflation, just the direction in which the spread has moved.
The spread between the 10-year government bond yield and the rate on 10-year inflation indexed government bonds is often used as an indicator of movements in inflationary expectations. The spread remained relatively constant from January 2009 through March. However, in April the spread has increased by 2 ½ times the January figure. This spread now is at a level we have not seen since early October 2008, right after the fall crisis hit. Market participants seem to be increasingly worried about what the Fed is going to have to do.
Furthermore, every time we see this spread increasing we tend to see a decline in the value of the United States dollar against the Euro and against other major currencies. Relative currency valuations are highly dependent upon changes in what central banks are expected to do because their actions can affect relative rates of inflation. If investors believe that the central bank in your country is going to monetize its government’s debt more rapidly than that of another country, the value of your currency will decline relative to that of the other country.
In this respect, the value of the United States dollar has declined over the past two days and tends to drop every time there is a rise in yields on longer term Treasury bonds. This would indicate that some of the same things affecting the yields on long term bonds are also affecting the value of the currency.
A final piece of evidence in support of this idea is that the market also responded to the minutes released yesterday by the Federal Reserve’s Open Market Committee. In those minutes the Fed stated that “the economic outlook has improved modestly since the March meeting…” It also noted that household spending “has shown signs of stabilizing while businesses have cut inventories, investments and staffing” implying that if consumer spending does stabilize or even increase, businesses will have to restock their shelves in order to support this spending which would be positive for economic recovery. Both of these statements foresee a stronger economy in the future, reinforcing the earlier fears of the market.
Long term Treasury yields were low because there was a flight to quality and because inflationary expectations were low. Unless there is another major shock to the system, I believe that the flight to quality is over and is in the process of being reversed. In addition, I believe that the Fed will continue to monetize the debt in increasing amounts for the Fed also emphasized in the minutes released yesterday that they will “stay the course” in the fight against an economic collapse. For both of these reasons, I feel that pressure will continue for long term Treasury yields to rise and for the value of the dollar to fall.
Thursday, December 18, 2008
The Declining Dollar
The decline in the value of the dollar has gotten increasing headlines since the Federal Reserve Board of Governors released its new monetary policy efforts on Tuesday. Many short run reasons are being given for the recent decline in the value of the dollar, especially against the Euro and the Yen.
The most intriguing explanation for the decline, however, is a longer term reason. In this explanation, analysts argue that the decline in the value of the dollar is just a continuation of the trend which began in early 2002 and continued through until early August 2008.
The story that accompanies this explanation is that a series of events in 2001 and 2002 convinced international markets that the United States government had forfeited any discipline it had established over its fiscal and monetary policies. First, there was the huge Bush (43) tax cut that moved the government’s budget from one of surplus to one of deficit. This was followed by the war on terror and the Iraq invasion which exacerbated the amount of the budget deficit.
In addition to this the Greenspan Federal Reserve cut the target Federal Funds rate to very low levels, around 1% or so, for a period of about two years. Mr. Greenspan’s concern, apparently, was fear of an extended recession following the burst of the dot.com bubble in the stock market. The result was the creation of the housing bubble as well as smaller bubbles in other areas of the economy, including commodity prices.
As a consequence of these actions, massive amounts of debt were created. Fortunately for the United States…at the time…was that over 50% of this debt…both private and public debt…was financed outside of the United States…large amounts being placed in China, India, and the middle east…although as we found out…banks all over the world acquired huge quantities of mortgage-backed debt.
The interesting thing that was learned from this period is that consumer inflation (as measured by the Consumer Price Index) could be kept in check while inflation ran rapid in asset prices (particularly in housing prices and commodity prices at this time). The monetary authorities concentrated on consumer prices and did nothing with respect to asset prices.
The thing is that “self-reinforcing expectations” can get built into asset prices leading to a massive increase of financial leverage. Consumer credit can be expanded for purchases of the items individuals purchase, but this credit expansion cannot match the possibilities for increase that exist as asset prices go up substantially, year-after-year.
Foreign exchange rates capture the relative expectations of people that operate in these markets. The specific ‘relative expectations’ that are relevant here pertain to how market participants judge how the economies of different countries are expected to perform. Performance in this instance relates to the state of the economy, performance of government’s in terms of their conduct of their economic policies, and expected inflation.
In this respect, Paul Volcker, former Chairman of the Board of Governors of the Federal Reserve System, has stated that the price of a country’s currency is the most important price in its economy. The value of a country’s currency is, in a real sense, the “grade card” of the country’s economic and monetary policy, relative to the rest of the world.
Thus, as the value of the United States dollar fell more than 40% from early 2002 to August 2008, participants in international financial markets were indicating a belief that the government of the United States was showing little or no discipline over its budget and this was connected with an extremely “loose” monetary policy. To these market participants, the United States would have to “pay the piper”, sooner or later.
As the story continues, when the financial markets fell apart in September, the United States dollar became the “quality” asset in the world and investors flocked to the dollar as they repatriated assets from all over the globe in order to invest in U. S. Treasury securities. As a consequence of this rush to quality the value of the United States dollar rose.
This latter movement has apparently come to an end. There seems to be a number of short-run reasons for the recent decline in the value of the United States dollar…one of them being a move on the part of foreign investors to get back into their own currencies to dress up their year-end balance sheets.
But, there is another reason given for the drop in the value of the dollar and this is connected with the decisions of the Federal Reserve that were announced on Tuesday and the projected rise in the deficit of the federal government. For all intents and purposes, the target Federal Funds rate is now approximately zero. In addition, the Fed said that it would buy financial assets, long term U. S. Treasury issues and mortgage backed bonds and so forth in order to flood the financial markets with liquidity. And, they warned, they will continue to do this for as long as necessary…whatever “necessary” means. On top of this, the Obama team seems to be talking about adding roughly $1.0 trillion in expenditures to the federal budget to get the United States economy going again.
One can easily draw from this the assumption that the world will be flooded with dollars…millions and millions of dollars. How should one react to this in terms of the value of the dollar?
One could argue that this is exactly what world financial markets have been predicting would happen since early in 2002. (They did not, and could not, predict precisely the path of the collapse.) This is exactly the reason why the United States dollar has declined by about 40% since then!
The problem is that there are no “good” decisions left for the United States. This is the dilemma that must be faced when discipline in lost. When one sees the consequences of a lack of discipline, one does what one needs to do in order to get one’s life back in order. Getting discipline back into one’s life is a matter of one step at a time.
In terms of priorities…getting the economy going and avoiding a cumulative collapse is number one. Until this is accomplished, we may just have to see the value of the dollar continue to decline.
The most intriguing explanation for the decline, however, is a longer term reason. In this explanation, analysts argue that the decline in the value of the dollar is just a continuation of the trend which began in early 2002 and continued through until early August 2008.
The story that accompanies this explanation is that a series of events in 2001 and 2002 convinced international markets that the United States government had forfeited any discipline it had established over its fiscal and monetary policies. First, there was the huge Bush (43) tax cut that moved the government’s budget from one of surplus to one of deficit. This was followed by the war on terror and the Iraq invasion which exacerbated the amount of the budget deficit.
In addition to this the Greenspan Federal Reserve cut the target Federal Funds rate to very low levels, around 1% or so, for a period of about two years. Mr. Greenspan’s concern, apparently, was fear of an extended recession following the burst of the dot.com bubble in the stock market. The result was the creation of the housing bubble as well as smaller bubbles in other areas of the economy, including commodity prices.
As a consequence of these actions, massive amounts of debt were created. Fortunately for the United States…at the time…was that over 50% of this debt…both private and public debt…was financed outside of the United States…large amounts being placed in China, India, and the middle east…although as we found out…banks all over the world acquired huge quantities of mortgage-backed debt.
The interesting thing that was learned from this period is that consumer inflation (as measured by the Consumer Price Index) could be kept in check while inflation ran rapid in asset prices (particularly in housing prices and commodity prices at this time). The monetary authorities concentrated on consumer prices and did nothing with respect to asset prices.
The thing is that “self-reinforcing expectations” can get built into asset prices leading to a massive increase of financial leverage. Consumer credit can be expanded for purchases of the items individuals purchase, but this credit expansion cannot match the possibilities for increase that exist as asset prices go up substantially, year-after-year.
Foreign exchange rates capture the relative expectations of people that operate in these markets. The specific ‘relative expectations’ that are relevant here pertain to how market participants judge how the economies of different countries are expected to perform. Performance in this instance relates to the state of the economy, performance of government’s in terms of their conduct of their economic policies, and expected inflation.
In this respect, Paul Volcker, former Chairman of the Board of Governors of the Federal Reserve System, has stated that the price of a country’s currency is the most important price in its economy. The value of a country’s currency is, in a real sense, the “grade card” of the country’s economic and monetary policy, relative to the rest of the world.
Thus, as the value of the United States dollar fell more than 40% from early 2002 to August 2008, participants in international financial markets were indicating a belief that the government of the United States was showing little or no discipline over its budget and this was connected with an extremely “loose” monetary policy. To these market participants, the United States would have to “pay the piper”, sooner or later.
As the story continues, when the financial markets fell apart in September, the United States dollar became the “quality” asset in the world and investors flocked to the dollar as they repatriated assets from all over the globe in order to invest in U. S. Treasury securities. As a consequence of this rush to quality the value of the United States dollar rose.
This latter movement has apparently come to an end. There seems to be a number of short-run reasons for the recent decline in the value of the United States dollar…one of them being a move on the part of foreign investors to get back into their own currencies to dress up their year-end balance sheets.
But, there is another reason given for the drop in the value of the dollar and this is connected with the decisions of the Federal Reserve that were announced on Tuesday and the projected rise in the deficit of the federal government. For all intents and purposes, the target Federal Funds rate is now approximately zero. In addition, the Fed said that it would buy financial assets, long term U. S. Treasury issues and mortgage backed bonds and so forth in order to flood the financial markets with liquidity. And, they warned, they will continue to do this for as long as necessary…whatever “necessary” means. On top of this, the Obama team seems to be talking about adding roughly $1.0 trillion in expenditures to the federal budget to get the United States economy going again.
One can easily draw from this the assumption that the world will be flooded with dollars…millions and millions of dollars. How should one react to this in terms of the value of the dollar?
One could argue that this is exactly what world financial markets have been predicting would happen since early in 2002. (They did not, and could not, predict precisely the path of the collapse.) This is exactly the reason why the United States dollar has declined by about 40% since then!
The problem is that there are no “good” decisions left for the United States. This is the dilemma that must be faced when discipline in lost. When one sees the consequences of a lack of discipline, one does what one needs to do in order to get one’s life back in order. Getting discipline back into one’s life is a matter of one step at a time.
In terms of priorities…getting the economy going and avoiding a cumulative collapse is number one. Until this is accomplished, we may just have to see the value of the dollar continue to decline.
Friday, June 6, 2008
The Bermuda Triangle?
Is the United States flying into a period of economic turmoil that one can only describe as a Bermuda Triangle? Financial institutions are not out-of-the-woods yet in terms of cleaning up their balance sheets. The economy has surprisingly remained stronger than expected, yet there are layoffs in the airline industry, the car industry, the housing industry, and other industries that are bound to contribute to future weakness. And, there is talk within central banking circles that interest rates may need to be raised in upcoming months.
Furthermore, there seems to be some uncertainty among the pilots flying the monetary ship in the United States. After leading the Federal Reserve through a period of historically massive reductions in the Fed’s target Federal Funds rate, the introduction of major innovations in the way the Fed conducts its monetary policy, and after intervening into areas of the financial sector in ways that are reminiscent of the Great Depression (of which he is a major academic scholar), Chairman Bernanke has stated that maybe the Federal Reserve better look out after the decline in the value of the United States dollar.
But, now several other members of the Federal Reserve leadership have expressed doubts about how the Federal Reserve has acted in recent months. On June 5, Jeffrey Lacker, the president of the Federal Reserve Bank of Richmond has come out and expressed concerns about the Federal Reserve lending to major securities firms. Charles Plosser, the president of the Federal Reserve Bank of Philadelphia has also spoken out defining more clearly the boundaries of what the Federal Reserve System can and should do. Both raised concerns about whether or not the Fed should actually be doing these things.
But, these are not the only voices that have expressed concern. Two other presidents of Federal Reserve banks have expressed similar thoughts. Gary Stern, president of the Federal Reserve bank of Minneapolis, discussed, in April, the expansion of the Fed’s authority, while Thomas Hoenig, president of the Kansas City Federal Reserve bank discussed the threat of moral hazard in the financial system due to the Fed’s actions.
On the other side, Ben Bernanke, vice chairman of the Board of Governors of the Federal Reserve System, Donald Kohn, and Timothy Geithner, president of the Federal Reserve Bank of New York, have defended the recent actions taken by the Fed.
I cannot remember a time when there has been so much discussion, in public, about what the Federal Reserve is doing or has done by the individuals within the Federal Reserve System that have responsibility for making the policy decisions that the Fed executes. The Federal Reserve does no usually “wash its dirty linen” for the whole world to see. Just what is going on here?
One final point: the timing of the departure of Governor Frederic Mishkin to return to his teaching position at this time raises a question mark. This is a very delicate time for the Federal Reserve System because the departure of Mishkin will reduce the number of openings in the ranks of the Governors to four…out of seven. This, of course, is not Mishkin’s fault because the administration has made appointments for the other three positions. It is just that the Democratically controlled confirmation process has held up the confirmation on these other three appointments for over a year. But, Mishkin’s resignation is tremendously awkward at this time. I don’t want to make too big a point out of this, but the timing, given the internal debate within the Fed and with the shortage of Governors on the Board, the timing of the departure is curious.
But, let’s return to the other points mentioned above. First, the condition of the financial system. Foreclosures remain high and will probably continue to rise. Bankruptcies have increased and probably will increase. Charge offs of credit card debt are high and rising. There remains the question about further charge offs at major financial institutions. And, if the economy is going to get softer, delinquencies and other financial dislocations are going to increase. The question still remains…how stable are the financial institutions of the United States, particularly if short term interest rates need to rise?
Second, the state of the economy, although it has been stronger than expected, shows signs of growing weakness. It is kind of like watching this whole thing evolve in slow motion. The bad news piles up, yet the economy seems to be hanging in there. However, the unemployment figures are up and the impacts of the higher oil and gas prices seem to be spreading to more and more major industries. The unexpected strength in the economy has allowed Chairman Bernanke to express concern about the weakness in the value of the United States dollar, but one really wonders about how much can be done in this election year to actually combat its falling value if the economy gets softer and financial institutions remain in a tenuous state.
Finally, there is the reality that the United States is “out-of-step” with the rest of the world in terms of where it is policy wise. On June 5, the European Central Bank and the Bank of England, both left their target interest rates at their current levels, but, especially Jean-Claude Trichet, the president of the European Central Bank, they both stated that there was a strong possibility that these target interest rates would need to be raised in the future. The focus of these central banks on inflation remains firm in spite of weakening economies. These central banks are earning their reputation for trying to keep inflation in their areas under control.
The direct effect of this effort has been to cause renewed weakness in the value of the United States dollar and a rebound in the price of oil. And, this points up the main dilemma facing the United States government and the Federal Reserve. Policy wise, the United States is in a different place than is much of the rest of the world. The “go-it-alone” attitude of the Bush administration which thumbed its nose to the international community in foreign relations as well as in its economic and financial policies has now left it at odds with much of the rest of the world and isolated it in terms of what it needs to do. Whereas the United States seemingly cannot act to protect the value of the dollar because of the fragility of its economic and financial system, other major players in the world now are indicating that they, in all likelihood, will raise interest rates in the future. If others do raise interest rates this can only put the United States in a more difficult position because if the Fed does need to act to further protect the economy or even if it does not move from the targets it now has, the weakness in the value of the dollar will only continue. The actions of others will place the dollar in a relatively worse position than it is now
Once again, we see the problem of a major nation going off on its own path. Now, when the United States is reaping the consequences of its past actions, the only way others can contribute to helping it resolve its difficulties is to weaken their own discipline and act in a way that is not consistent with the long term welfare of their own people. The future direction of the United States economy and the health of its financial system is heavily dependent upon what others might have to do to maintain the health and welfare of their countries. We have already seen the United States president “beg” for relief on the oil front. Will he also need to “beg” for other relief?
Furthermore, there seems to be some uncertainty among the pilots flying the monetary ship in the United States. After leading the Federal Reserve through a period of historically massive reductions in the Fed’s target Federal Funds rate, the introduction of major innovations in the way the Fed conducts its monetary policy, and after intervening into areas of the financial sector in ways that are reminiscent of the Great Depression (of which he is a major academic scholar), Chairman Bernanke has stated that maybe the Federal Reserve better look out after the decline in the value of the United States dollar.
But, now several other members of the Federal Reserve leadership have expressed doubts about how the Federal Reserve has acted in recent months. On June 5, Jeffrey Lacker, the president of the Federal Reserve Bank of Richmond has come out and expressed concerns about the Federal Reserve lending to major securities firms. Charles Plosser, the president of the Federal Reserve Bank of Philadelphia has also spoken out defining more clearly the boundaries of what the Federal Reserve System can and should do. Both raised concerns about whether or not the Fed should actually be doing these things.
But, these are not the only voices that have expressed concern. Two other presidents of Federal Reserve banks have expressed similar thoughts. Gary Stern, president of the Federal Reserve bank of Minneapolis, discussed, in April, the expansion of the Fed’s authority, while Thomas Hoenig, president of the Kansas City Federal Reserve bank discussed the threat of moral hazard in the financial system due to the Fed’s actions.
On the other side, Ben Bernanke, vice chairman of the Board of Governors of the Federal Reserve System, Donald Kohn, and Timothy Geithner, president of the Federal Reserve Bank of New York, have defended the recent actions taken by the Fed.
I cannot remember a time when there has been so much discussion, in public, about what the Federal Reserve is doing or has done by the individuals within the Federal Reserve System that have responsibility for making the policy decisions that the Fed executes. The Federal Reserve does no usually “wash its dirty linen” for the whole world to see. Just what is going on here?
One final point: the timing of the departure of Governor Frederic Mishkin to return to his teaching position at this time raises a question mark. This is a very delicate time for the Federal Reserve System because the departure of Mishkin will reduce the number of openings in the ranks of the Governors to four…out of seven. This, of course, is not Mishkin’s fault because the administration has made appointments for the other three positions. It is just that the Democratically controlled confirmation process has held up the confirmation on these other three appointments for over a year. But, Mishkin’s resignation is tremendously awkward at this time. I don’t want to make too big a point out of this, but the timing, given the internal debate within the Fed and with the shortage of Governors on the Board, the timing of the departure is curious.
But, let’s return to the other points mentioned above. First, the condition of the financial system. Foreclosures remain high and will probably continue to rise. Bankruptcies have increased and probably will increase. Charge offs of credit card debt are high and rising. There remains the question about further charge offs at major financial institutions. And, if the economy is going to get softer, delinquencies and other financial dislocations are going to increase. The question still remains…how stable are the financial institutions of the United States, particularly if short term interest rates need to rise?
Second, the state of the economy, although it has been stronger than expected, shows signs of growing weakness. It is kind of like watching this whole thing evolve in slow motion. The bad news piles up, yet the economy seems to be hanging in there. However, the unemployment figures are up and the impacts of the higher oil and gas prices seem to be spreading to more and more major industries. The unexpected strength in the economy has allowed Chairman Bernanke to express concern about the weakness in the value of the United States dollar, but one really wonders about how much can be done in this election year to actually combat its falling value if the economy gets softer and financial institutions remain in a tenuous state.
Finally, there is the reality that the United States is “out-of-step” with the rest of the world in terms of where it is policy wise. On June 5, the European Central Bank and the Bank of England, both left their target interest rates at their current levels, but, especially Jean-Claude Trichet, the president of the European Central Bank, they both stated that there was a strong possibility that these target interest rates would need to be raised in the future. The focus of these central banks on inflation remains firm in spite of weakening economies. These central banks are earning their reputation for trying to keep inflation in their areas under control.
The direct effect of this effort has been to cause renewed weakness in the value of the United States dollar and a rebound in the price of oil. And, this points up the main dilemma facing the United States government and the Federal Reserve. Policy wise, the United States is in a different place than is much of the rest of the world. The “go-it-alone” attitude of the Bush administration which thumbed its nose to the international community in foreign relations as well as in its economic and financial policies has now left it at odds with much of the rest of the world and isolated it in terms of what it needs to do. Whereas the United States seemingly cannot act to protect the value of the dollar because of the fragility of its economic and financial system, other major players in the world now are indicating that they, in all likelihood, will raise interest rates in the future. If others do raise interest rates this can only put the United States in a more difficult position because if the Fed does need to act to further protect the economy or even if it does not move from the targets it now has, the weakness in the value of the dollar will only continue. The actions of others will place the dollar in a relatively worse position than it is now
Once again, we see the problem of a major nation going off on its own path. Now, when the United States is reaping the consequences of its past actions, the only way others can contribute to helping it resolve its difficulties is to weaken their own discipline and act in a way that is not consistent with the long term welfare of their own people. The future direction of the United States economy and the health of its financial system is heavily dependent upon what others might have to do to maintain the health and welfare of their countries. We have already seen the United States president “beg” for relief on the oil front. Will he also need to “beg” for other relief?
Monday, May 12, 2008
Defenses of the Current U. S. dollar policy.
Defenders of the current economic policy of the Bush administration are now surfacing. Apparently, enough concern has been raised to cause a need to defend the status quo. There are two arguments for not changing policy at the present time. First, there is the argument that the value of the dollar has bottomed out along with signs that there could be an upturn. The second argument is that the United States is still too important in the world for the dollar to have to play by the same rules as all other nations. We will present these two defenses in turn.
The argument for the strengthening of the dollar is the growing attention that has been given to the weakness in the dollar over the past six years or so. Some analysts have discerned such concern being expressed in recent speeches of Ben Bernanke. The feeling is that the ‘balance is shifting’ from the emphasis on financial market crisis to greater emphasis being placed on what has been happening in the foreign exchange markets. Just the added attention on the foreign exchange market has given people hope.
Another factor in this glimpse of optimism is what is happening in Europe. Last Thursday, the Bank of England and the European Central Bank left their interest where they were. The concern expressed by these leaders is with inflation and they, the leaders of these banks, stated that ‘their mandate’ is to maintain price stability within their domains. Given the recent rise in the price of oil and other commodities, greater concern is being expressed that inflation could get out-of-hand and the need right now is to keep a lid on price pressures. The underlying theme is that these central banks will do what they have to do in order to fight these inflationary trends...but this could cause an economic slowdown in Europe, taking the pressure off the central banks to further raise rates or even to let them fall.
This, of course, is taken as a hopeful sign by those arguing for the stabilizing of the dollar because it would help to change relative interest rates between Europe and the United States, something that has contributed to the weakness in the dollar. Higher short term interest rates in Europe have drawn investors away from the U. S. during the recent period when the Federal Reserve has been dramatically lowering their target for the Fed Funds rate. In addition, the Federal Reserve Open Market Committee, after their latest meeting, announced that their latest reduction in the Fed Funds target may be the last one…at least for a while. [See the post of May 1, 2008, “Where is the Leadership?” http://maseportfolio.blogspot.com/.] This has been taken as a hopeful sign that the yield differential between Europe and the United States will become more favorable to the United States.
Finally, although not noticed at the time, the finance ministers of the G-7 nations called attention to the problems, including that of the dollar, in international currency markets and stated that they could not ignore these going forward. [See my post “Finance Ministers Concerned with the U. S. Dollar”, of April 13 at the above website.] Analysts have now gone back to this and claimed this to be another piece of evidence that the concern over the decline in the value of the dollar has risen on the agenda of world bankers. This, they argue is just another sign that maybe the decline in the value of the dollar is over and that some rise might be expected in the future.
In terms of the second argument, analysts are arguing that, yes, the dollar has declined in value but we needn’t be overly concerned with the decline because the United States is too important in the world for nations and other investors to ‘dump’ the dollar. The United States, they argue is still a great place for people to invest and, in this respect, will continue to be a haven to world investors in this age of uncertainty and changing technologies. Also, just the fact that the United States possesses the major military machine in the world gives it the ability to continue to pay off its debts. Even though China and India are becoming major economic powers in the world, the United States and the dollar will maintain its position and prevail over other currencies [including the Euro] in the foreseeable future.
Essentially, the argument here is that it is in the best interest of other nations [China and India included] to see that the role of the dollar is maintained. And, as long as the United States and the U. S. dollar serve as the lubricant for world trade, there is plenty of incentive to see that the current system continues to work. Others, like the G-7, will do what they have to do to keep things as they are.
There are several responses I would like to make to these arguments.
First, people seem to forget that the United States had a budget surplus as recently as 2001. Why do we think that fiscal discipline is not a viable alternative?
Second, most of the first argument is based on wishful thinking. There has been talk before by Treasury Secretaries and Federal Reserve Chairman about a strong dollar…but nothing ever came of this. The situation in England and Europe may require higher interest rates before lower rates are considered…and the Federal Reserve has only suggested a pause in the lowering of interest rates here. And, what is the G-7 going to do for the dollar if United States policymakers do not show a real commitment on their part.
Third, no country in the world has considered itself ‘too’ important to ignore the rules that other nations play by. Although a ‘go-it-alone’ attitude has prevailed in Washington, D. C. over the past 7 ½ years, it has already come back to haunt us in many different areas. In the early 1990s, Robert Rubin convinced Bill Clinton that the United States could not afford to be out-of-step with the rest of the world and needed to bring the Federal budget under control. Clinton listened to him and by the time he left office, the United States was, fiscally, in very god shape and the dollar was doing quite well. This strength was recognized in world financial markets. We are a part of the world and can play by the rules that everyone else plays by. We only hurt and isolate ourselves if we consider that we are above the rules.
Will we continue on the path suggested by those arguing for little or no change in United States economic policy? Yes, for at least the short run.
First, we have a lame duck administration. There is nothing dramatic that will be done before a new administration comes into office. All that we can expect is efforts to protect the legacy of the current administration.
Second, there is a question as to whether a new administration will accept the economic and financial realities that exist or will they try and enact legislation reflecting the promises they are making to get elected. Before confidence can be restored in the U. S. government, there must be real commitment on the part of a new administration that market participants in international markets can trust.
Third, there is still the lingering financial uncertainty. How fragile is the financial system at this time and how will continuing economic weakness contribute to any future dislocations? Banks and others seem to be working out their problems in an orderly fashion, but will this continue?
Fourth, how will United States citizens respond to more and more foreign ownership of their physical assets? Sovereign wealth funds and other investors will keep investing their dollars in U. S. companies. The use of these dollars in this way has recently increased every year and there is no reason that this will stop. How will the electorate respond in the future to seeing U. S. firms coming more and more under the control of foreign nations and other foreign interests? Globalization is coming home to America.
Finally, will the United States enact an effective energy policy? This, sadly, is still in the distant future.
The future...the dollar may fluctuate around the current range for a while...but, it seems to me that unless things change, the longer term picture contains more weakness in the dollar's value.
The argument for the strengthening of the dollar is the growing attention that has been given to the weakness in the dollar over the past six years or so. Some analysts have discerned such concern being expressed in recent speeches of Ben Bernanke. The feeling is that the ‘balance is shifting’ from the emphasis on financial market crisis to greater emphasis being placed on what has been happening in the foreign exchange markets. Just the added attention on the foreign exchange market has given people hope.
Another factor in this glimpse of optimism is what is happening in Europe. Last Thursday, the Bank of England and the European Central Bank left their interest where they were. The concern expressed by these leaders is with inflation and they, the leaders of these banks, stated that ‘their mandate’ is to maintain price stability within their domains. Given the recent rise in the price of oil and other commodities, greater concern is being expressed that inflation could get out-of-hand and the need right now is to keep a lid on price pressures. The underlying theme is that these central banks will do what they have to do in order to fight these inflationary trends...but this could cause an economic slowdown in Europe, taking the pressure off the central banks to further raise rates or even to let them fall.
This, of course, is taken as a hopeful sign by those arguing for the stabilizing of the dollar because it would help to change relative interest rates between Europe and the United States, something that has contributed to the weakness in the dollar. Higher short term interest rates in Europe have drawn investors away from the U. S. during the recent period when the Federal Reserve has been dramatically lowering their target for the Fed Funds rate. In addition, the Federal Reserve Open Market Committee, after their latest meeting, announced that their latest reduction in the Fed Funds target may be the last one…at least for a while. [See the post of May 1, 2008, “Where is the Leadership?” http://maseportfolio.blogspot.com/.] This has been taken as a hopeful sign that the yield differential between Europe and the United States will become more favorable to the United States.
Finally, although not noticed at the time, the finance ministers of the G-7 nations called attention to the problems, including that of the dollar, in international currency markets and stated that they could not ignore these going forward. [See my post “Finance Ministers Concerned with the U. S. Dollar”, of April 13 at the above website.] Analysts have now gone back to this and claimed this to be another piece of evidence that the concern over the decline in the value of the dollar has risen on the agenda of world bankers. This, they argue is just another sign that maybe the decline in the value of the dollar is over and that some rise might be expected in the future.
In terms of the second argument, analysts are arguing that, yes, the dollar has declined in value but we needn’t be overly concerned with the decline because the United States is too important in the world for nations and other investors to ‘dump’ the dollar. The United States, they argue is still a great place for people to invest and, in this respect, will continue to be a haven to world investors in this age of uncertainty and changing technologies. Also, just the fact that the United States possesses the major military machine in the world gives it the ability to continue to pay off its debts. Even though China and India are becoming major economic powers in the world, the United States and the dollar will maintain its position and prevail over other currencies [including the Euro] in the foreseeable future.
Essentially, the argument here is that it is in the best interest of other nations [China and India included] to see that the role of the dollar is maintained. And, as long as the United States and the U. S. dollar serve as the lubricant for world trade, there is plenty of incentive to see that the current system continues to work. Others, like the G-7, will do what they have to do to keep things as they are.
There are several responses I would like to make to these arguments.
First, people seem to forget that the United States had a budget surplus as recently as 2001. Why do we think that fiscal discipline is not a viable alternative?
Second, most of the first argument is based on wishful thinking. There has been talk before by Treasury Secretaries and Federal Reserve Chairman about a strong dollar…but nothing ever came of this. The situation in England and Europe may require higher interest rates before lower rates are considered…and the Federal Reserve has only suggested a pause in the lowering of interest rates here. And, what is the G-7 going to do for the dollar if United States policymakers do not show a real commitment on their part.
Third, no country in the world has considered itself ‘too’ important to ignore the rules that other nations play by. Although a ‘go-it-alone’ attitude has prevailed in Washington, D. C. over the past 7 ½ years, it has already come back to haunt us in many different areas. In the early 1990s, Robert Rubin convinced Bill Clinton that the United States could not afford to be out-of-step with the rest of the world and needed to bring the Federal budget under control. Clinton listened to him and by the time he left office, the United States was, fiscally, in very god shape and the dollar was doing quite well. This strength was recognized in world financial markets. We are a part of the world and can play by the rules that everyone else plays by. We only hurt and isolate ourselves if we consider that we are above the rules.
Will we continue on the path suggested by those arguing for little or no change in United States economic policy? Yes, for at least the short run.
First, we have a lame duck administration. There is nothing dramatic that will be done before a new administration comes into office. All that we can expect is efforts to protect the legacy of the current administration.
Second, there is a question as to whether a new administration will accept the economic and financial realities that exist or will they try and enact legislation reflecting the promises they are making to get elected. Before confidence can be restored in the U. S. government, there must be real commitment on the part of a new administration that market participants in international markets can trust.
Third, there is still the lingering financial uncertainty. How fragile is the financial system at this time and how will continuing economic weakness contribute to any future dislocations? Banks and others seem to be working out their problems in an orderly fashion, but will this continue?
Fourth, how will United States citizens respond to more and more foreign ownership of their physical assets? Sovereign wealth funds and other investors will keep investing their dollars in U. S. companies. The use of these dollars in this way has recently increased every year and there is no reason that this will stop. How will the electorate respond in the future to seeing U. S. firms coming more and more under the control of foreign nations and other foreign interests? Globalization is coming home to America.
Finally, will the United States enact an effective energy policy? This, sadly, is still in the distant future.
The future...the dollar may fluctuate around the current range for a while...but, it seems to me that unless things change, the longer term picture contains more weakness in the dollar's value.
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