Dallas Fed's Fisher Says Fed's Duty Is "Not To Monetize" Debt

Tyler Durden's picture

Some stunning remarks from Dallas Fed's Dick Fisher: " Our duty is most distinctly not to monetize - or even
be perceived as monetizing - the debt of fiscally imprudent government
.
Throughout the history of nations, monetizing the budgetary excesses of
governments has proven to be a direct path to economic perdition.
Having already peeked inside that door, I feel strongly that we must
now shut it, lock it and throw away the key."
Well, thanks Dick. You are only $2.6 trillion dollars late.

More comments from Dick:

  • FED'S FISHER SAYS `INFLATIONARY IMPULSES' INCREASING WORLDWIDE
  • FISHER SAYS FED NEAR `TIPPING POINT,' MUST `NORMALIZE' POLICY
  • FISHER SAYS MAYBE FED SHOULD CURTAIL QUANTITATIVE EASING PLAN

What tipping point? The Fed is merely helping Netflix holders cash out at a 1 trillion fed P/E. Everything else is a function of surging global demand for $112 WTI.

Full Speech:

'Is America's Decline Exaggerated or Inevitable?' The Role of Monetary and Fiscal Policy
(With Reference to St. Peter, Calvin Coolidge, Walter Bagehot, Paul Volcker, Winston Churchill and T.R. Fehrenbach)
Remarks before the Society of American Business Editors and Writers 2011 Annual Conference
Dallas, Texas
April 8, 2011

 

In the fall of 2006, I was asked to draw upon
some 30 years of experience in Germany and speak at the American
Academy in Berlin, addressing the question: “Is Germany’s Decline
Exaggerated or Inevitable?”[1]
This was against the backdrop of reforms that had been initiated by
the former German Chancellor Gerhard Schroeder, and carried on by his
successor, Angela Merkel. I argued that Germany’s economic fate and
position as primus inter pares in Europe was at a tipping
point. The answer to the question of whether Germany was fated for
decline or ascent depended upon how Germans would adapt their education
system, labor laws, health care system, financial infrastructure,
corporate governance, tax regime and myriad other changes needed to
advance their economic competitiveness in a world being transformed by
the forces of globalization and cyber-ization. I ended that speech by
saying I was encouraged that changes had been initiated, but drew on
St. Peter and Calvin Coolidge, neither of whom would have considered
themselves economists, to underline the essential ingredient for
success in these critical initiatives. For it was St. Peter who urged,
“Be serious and discipline yourselves.”[2]
And it was Silent Cal who said, “Nothing in this world can take the
place of persistence. …The slogan ‘press on’ has solved and always will
solve the problems of the human race.”

Two weeks ago, I was
back in Germany. My interlocutors there, having been serious,
determined and persistent in implementing change and who are now
sitting rather pretty, turned the question back on me, asking: “Is
America’s Decline Exaggerated or Inevitable?” I thought I would speak
to that question today.

For those of you who are
impatient, the answer is: “It depends.” It depends not upon the
outcome of the conflicts in North Africa and the Middle East, nor upon
the effect of the tsunami and the disruption of nuclear facilities in
Japan, nor upon any of the other pressing issues of the moment that are
the subject of day-to-day angst assiduously reported by your
colleagues in the press.

It depends upon monetary and fiscal policy.

It depends upon whether the United States can get its economic house in order.

It depends, in the end,
upon whether the Federal Reserve, as the nation’s central bank, and the
Congress, working with the executive branch in discharging its duty as
the nation’s fiscal authority, will adhere to the maxims of St. Peter
and President Coolidge-whether each of these institutions has the will
to be serious and discipline itself, and be persistent in pressing on
with their respective duties.

Monetary Policy

I’ll start with the Federal Reserve.

In contemplating future
policy of the Federal Reserve, it is important to remember the
frightful predicament we faced in the fall of 2008. The financial gears
of our economy-the most powerful and important economy in the
world-had ground to a halt. The entire panoply of markets for financial
instruments essential to the daily lives of businesses and individual
citizens-interbank lending, commercial paper, asset-backed lending,
money-market mutual funds and the mortgage markets-seized up. In the
blink of an eye, liquidity and trust in financial counterparties
disappeared. In those darkest of days, a colleague of mine wittily
summed up what had transpired by noting that on the balance sheets of
the most important financial institutions, “nothing on the right is
right and nothing on the left is left.”

We could have an endless
discussion of who was responsible for this so-called black swan
scenario. We would likely agree that it resulted from a combination of
factors, including the speculative excesses that occur when interest
rates remain too low for too long; the consequences of systemically
important bank and financial intermediaries embracing risk-management
tools that are formulaic and dependent upon “quant jocks” rather than
upon common sense and good judgment; the abuses that ensue when
regulatory authorities let down their guard; the comeuppance that
inevitably occurs when policymakers and their advisers are lulled into
complacency with theoretically comforting, but nonsensical, shibboleths
like “efficient markets”; or just the financial tomfoolery that
disturbingly repeats itself at periodic intervals throughout history
when, in the memorable words written in 1856 by the English essayist
Walter Bagehot, “[A]t particular times … people have a great deal of …
money…. At intervals … the money of these people … is particularly large
and craving: it seeks for some one to devour it, and there is [a]
‘plethora’; it finds some one, and there is ‘speculation’; it is
devoured, and there is ‘panic.’”[3]

Regardless of how it came to be, when the Panic
of 2008 occurred, the Fed did what central banks are called to do when
pandemonium strikes: As the lender of last resort, we stepped into the
breach, used the powers given to us by our government to create money
and credit, and deployed the considerable array of tools at our
disposal to calm and restore the financial markets.[4]

The Bernanke-led Federal
Open Market Committee (FOMC) had confidence in the programs we
undertook, for they were well-vetted, disciplined and carefully
considered. We persisted with them even though our actions gave rise to
great consternation and warnings of bleak consequences from an
understandably anxious Congress, skeptical financial pundits and
frightened citizens. Teddy Roosevelt once said, “When people lose
money, they strike out unthinkingly, like a wounded snake, at whoever is
most prominent in the line of vision.”[5]
The Fed-as the nation’s central bank and first responder to a
financial crisis-was front and center in dealing with the panic, and we
felt the sting of a rattled public and its elected representatives.
Still, we “pressed on.”

We now know that the
exigent measures we undertook worked. The end result of the Fed’s
efforts was that the credit markets and the lifeblood of liquidity
needed to conduct commerce and sustain the economy were restored. The
economy responded and began a recovery in the middle of 2009 that is
slowly gaining steam and now appears to be self-sustaining.

Imagine that! A
government agency that (a) devised programs that actually worked, (b)
shut most of them down when they had done their job and (c) made money
for the taxpayer in the process.

This is not to say there
was no cost to what we accomplished. There were trade-offs and
unintended consequences, some of which were distinctly unpleasant.

In saving the system,
for example, it can be argued that we protected imprudent lenders and
investors from the consequences of their decisions; we rescued sinners
and penalized the virtuous.

Postcrisis, the “too big
to fail” financial behemoths that had placed our economy in jeopardy
have ended up with even greater financial power. (And, adding insult to
injury, by the grace of their shareholders, most of their leaders
retain their posts and few, if any, have suffered financial setbacks).
This concentration of power comes at the expense of community and
regional banks, an imbalance that the Federal Reserve and other
authorities must now address through tough-minded, clear-eyed
regulation.

At the individual
citizen’s level, we eased the pain of overextended homeowners with
mortgages by buying up $1.25 trillion in mortgage-backed securities and
driving mortgage rates to historic lows. The Fed’s interventions to
drive interest rates to historically low levels resulted in significant
capital gains for bondholders and equity investors in the most
plain-vanilla securities and mutual funds. Yet, by taking interest
rates to zero and making money cheap and abundant so as to reliquefy
the economy, those who invested the most conservatively-tucking their
savings away in the safest of vehicles, like CDs, money market funds,
and Treasury bills and notes-saw the income earned on their hard-earned
savings dramatically reduced.

I personally fret over
these and other costs, but on net, I believe the Federal Reserve did
what is expected of a responsible central bank: We stemmed a panic and
averted a depression.

While we have wound down
most all of our exigent programs, we remain with a bloated balance
sheet, with footings in excess of $2.4 trillion, roughly triple the
size of our precrisis balance sheet. And the composition of our balance
sheet has changed: We hold about $937 billion in mortgage-backed
securities and over $1.3 trillion in Treasury securities, including
those of longer duration than is typical.

When we buy an
interest-bearing security from the market, we pay the seller of that
security. This expands liquidity in the system. Whereas in the Panic
there was no liquidity, today our large-scale asset purchases have made
for abundant liquidity. Banks have $1.4 trillion in excess reserves
parked in the 12 Federal Reserve Banks; other financial intermediaries
are flush with cash; there is a surfeit of cash on the books of
corporations and nonfinancial businesses, and more is available at
little cost through a robust bond market and a fully recovered stock
market.

Personally, I felt the
liquidity needed to propel our economy forward was sufficient even
before the FOMC opted last November to buy $600 billion in additional
Treasuries on top of the committee’s pledge to replace the runoff of
our $1.25 trillion mortgage-backed securities portfolio. I argued as
much at the FOMC table. I considered the risk of deflation and of a
double-dip recession to have receded into the rearview mirror. In fact,
I gave an interview to my introducer here, Mr. [Brendan] Case, that
was published under his byline in the Dallas Morning News on Aug. 26, 2009, in which I said the recession was over and the long slog of recovery from the Great Recession had begun.[6]
Last November, I felt the problem was not the lack of liquidity in the
economy, but that regulatory and fiscal uncertainty-the handiwork of
fiscal authorities and lawmakers, not the Fed-was inhibiting the
deployment of that liquidity into job creation. I also worried that
these simultaneous programs would have the effect of buying up—of
“monetizing”—the equivalent of most all of the U.S. government’s
issuance of new debt through June of this year, a dangerous course for
any central bank to embark upon.

The majority of my
colleagues on the FOMC felt differently, and the committee voted to
initiate the program now known as QE2. Whether you feel that we are
providing a prudent amount of liquidity, as they do, or too much, as I
do, I think you would be hard-pressed to dispute that there is now
plenty of fuel in the tanks of American businesses to finance expansion
and put unemployed and underemployed Americans back to work.

Having done our job, I see many risks to the Fed overstaying its welcome.

There are perceptional
risks, for example. Our duty is most distinctly not to monetize - or even
be perceived as monetizing - the debt of fiscally imprudent government.
Throughout the history of nations, monetizing the budgetary excesses of
governments has proven to be a direct path to economic perdition.
Having already peeked inside that door, I feel strongly that we must
now shut it, lock it and throw away the key.

There is the risk that
we might breach our duty to hold inflation at bay. Inflationary
impulses are gaining ground in the rest of the world. At the core of
the euro zone, Germany, where unemployment is actually lower than
before the crisis, wage inflation is pressing up against 3 percent.
Retail price inflation in the United Kingdom now exceeds 5 percent,
despite very high unemployment. Reported inflation now exceeds 4.5
percent in China, 6 percent in Brazil and 8 percent in India.

We know from anecdotal
soundings that American businesses, like businesses in other countries,
are doing their utmost to offset with higher prices the surging costs
of inputs such as fuel, other commodities and materials, and
components, parts and processes sourced from abroad. My gut tells me
that this will result in some unpleasant general price inflation
numbers in the next few reporting periods, even though the trimmed-mean
inflation rate we calculate at the Federal Reserve Bank of
Dallas-based on the price movements of 178 personal consumption
expenditure items-while rising, has over the past six months run at a
sedate rate of 1.2 percent.

Given that we still have
significant excess capacity of unemployed workers, extremely subdued
wage growth, strong productivity growth and weak domestic demand, one
might reasonably posit that the general inflationary pressures we are
experiencing presently are transitory. Nonetheless, adding still more
liquidity, or not withdrawing in a timely manner what we already
provided in abundance, would do nothing to quell emerging inflationary
pressures and might well compound them, proving doubly injurious to
savers and the earnings of those who do have jobs.

And there is always the
risk that, having provided so much liquidity, we might unwittingly abet
a resurrection of the tomfoolery so well-described by Bagehot. Some
disturbing practices are beginning to rear their ugly heads again: We
have seen a resurgence of “covenant-lite” loans, with some $24 billion
issued in the first quarter versus $100 billion for all of 2007;
private-equity firms are back in size and turning to leverage to pay
dividends; credit-boom acronyms most thought would never return after
the Panic, such as “payment-in-kind,” or PIK, and “toggle” notes, are
prominent once again; traditionally unleveraged asset managers, such as
insurance companies and pension funds, are turning to leverage and
exotic asset classes to juice returns. These are all signs of the
intoxicating effects of the ambrosia of inexpensive and plentiful
money. Further spiking the punch bowl with accommodative monetary
policy would do nothing to rein them in.

In summarizing the
monetary side of the equation, I would argue that the Federal Open
Market Committee did its job. In the face of great skepticism and
cynicism, we persisted and pressed on with doing what central banks are
supposed to do to pull an economy back from the brink. We reliquefied
the financial markets: Liquidity is no longer scarce. Money is no
longer dear; it is cheap. Job-creating businesses have the financial
means to get on with putting Americans back to work. Continued
accommodation presents significant risks. In my view, no amount of
further accommodation by the Fed would be wise—either by prolonging or
“tapering off” the volume of purchases of Treasuries past June, or
adding another tranche of large-scale asset purchases. Indeed, it may
well be that we should consider curtailing what remains of QE2.

Now, we at the Fed are
nearing a tipping point. Just as we pressed on in doing our duty
through extraordinary, exigent measures, we must now discipline
ourselves to just as persistently normalize our operations in a timely
way.

Fiscal Policy

As for the fiscal side
of the equation, you know the story. I have been harping on this for
years. I spoke of the dangers of what in polite parlance might be
called the fiscal incontinence of Congress when I addressed the
Commonwealth Club of California in May of 2008.[7]
Under both Republican and Democratic leadership, past Congresses have
created a fiscal sinkhole that is so deep and so wide, it threatens to
swallow up our prosperity and render our economy an abattoir. They have
forsaken the most sacred responsibility they have to successor
generations of Americans: Instead of passing the torch to our children,
they have passed them the bill.

Past Congresses have
made promises they cannot keep. Now, the new Congress is embarking on a
corrective course. This is just the beginning of what I expect to be a
long, arduous exercise. Here I evoke St. Peter: Congress, “be serious
and discipline yourselves.” You have no choice but to go through a
painful and gut-wrenching rehabilitation and begin leading a sober life
of living within your means. You must press on with getting your
accounts in order, however politically unpleasant it may be to do so.

This will be a titanic
struggle. Our Congress must find a way to align spending with income
through taxation that (a) does not cut off the incipient economic
recovery, (b) provides a credible path toward bringing their
accounts-including the unfunded liabilities of Medicare and Social
Security-to solvency and (c) respects the fact that in a globalized,
cyber-ized world, those with the ability to create jobs may create them
in places that offer more compelling fiscal and regulatory
environments.

This last point is not
unimportant. Permanent jobs are created by the private sector.
Businesses, large and small, publicly or privately held, have a duty to
earn a return on investment for their shareholders. In a globalized,
cyber-ized world, they need not invest or expand their payrolls in the
United States; they are free to go practically anywhere on the planet.
This is the result of one of our greatest accomplishments as a nation:
We won the Cold War. Before the demise of the Soviet Union and the
death of Mao, we lived in a world of mutually assured destruction;
today, we live in a world of mutually assured competition. This is what
we spent an entire generation of blood and national treasure to
achieve. Now, those with the power to levy taxes and direct spending
must get with it and adjust to the new world as they seek to
incentivize job creation through businesses that, thanks to monetary
policy, now have the financial means to put Americans back to work
right here at home.

There cannot be robust
direct investment in the United States without confidence in the
nation’s ability to reverse its budgetary death spiral, especially the
inexorable accumulation of national debt and unfunded liabilities of
Medicare and Social Security. The need to break the back of that spiral
is as dire now as was the need for Paul Volcker to break the back of
inflation in the 1980s. Those who are leading the charge to restore
fiscal sanity, be they Republican or Democrat, will no doubt recall the
personal vitriol hurled at the then-Fed chairman; they should steel
themselves against it. They should remember that, as a result of his
steadfast determination to press on with exorcising inflation, Mr.
Volcker is today among the most respected living Americans and widely
considered an exemplar for public servants worldwide.

Getting our fiscal house
in order will not be an easy task. But there are worse alternatives.
Resorting to protectionism or capital controls or sustained negative
real interest rates or inflation, in lieu of real fiscal reform, would
be pyrrhic solutions.[8]
Corrupting the independence of the Fed would surely lead the nation to
the same fate that befell Weimar Germany and Peron’s Argentina when
their central banks took to monetizing debt. The nation cannot, must
not, and, in my view, will not go down those sordid paths. Indeed, I
sense we have turned the corner and are on the road to fiscal
redemption, however bumpy it might be.

My German interlocutors
asked why I am encouraged that we would now finally get on with the
business of cleaning up our fiscal house. Central bankers are, after
all, genetically programmed to be sourpusses; we are inherently wary of
the capacity of politicians to be serious and discipline themselves.

My answer is admittedly
emotional. I am the son of immigrants; my parents came to this country
because it is the land of promise. Moreover, I am a naturalized Texan,
and Texans are a persistent people who have always pressed on against
the odds. The great historian of Texas, T.R. Fehrenbach, wrote that
Texans understand that “men who exist get overrun by men who act.”[9]
I believe deep in my heart that this is not unique to Texans—it is a
quintessential American trait. I believe that the people of this great
country will reward those members of Congress who act and will overrun
those who exist only to encumber us with unsustainable debt and an
imbalance of taxes and spending that threatens our prosperity rather
than advances it. So, yes, I am hopeful that our elected leaders will
get on the stick.

Besides, I believe
Winston Churchill had it right: “Americans can always be counted on to
do the right thing … after they have exhausted all other
possibilities.”

Thank you. In the best tradition of central bankers, I would be happy to avoid answering your questions.