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Fed’s Bullard: Full of Self-Contradictions
By Dian L. Chu, EconForecast
James Bullard, President of the Federal Reserve Bank of St. Louis was on CNBC Monday, December 20, 2010 mostly defending the Fed’s controversial $600 billion Treasury purchasing program (QE2) announced in Nov.
What struck me as totally self-contradictory were Bullard’s statements regarding the QE2, treasury yield, inflation expectations, and inflation, which I will outline and rebuff below.
Bullard – Higher Treasury Yield = QE2 Success
During the interview, aside from the usual Fed PR spin that QE2 has been 'modestly successful so far', he also states:
“People who see the rise in Treasury yields as a sign the Fed's purchases were not having their desired effect should look at other measures, especially the improvement in the economic outlook and the rise in inflation expectations in the market for Treasury Inflation-Protected Securities (TIPS). These are the ultimate goals of the Fed's policy.”
Bullard – QE2 Unrelated to Rising Commodity Prices
But when Fred Smith, Chairman, President and CEO of FedEx asked whether QE2 was related to the run-up in commodity prices, fuel prices in particular, which has been up 15% in the last 90 days and acted as a tax on American consumers, Bullard had this to say:
“…Is there some independent effect coming from monetary policy other than supply and demand conditions globally…I haven’t seen very much evidence of that, but would like to keep an eye on that.”
So, basically Bullard touts QE2 as building up inflation expectations, driving up treasury yields (thus averting a potential deflationary cycle), which was the goal of the Fed QE2 initiative. Furthermore, Bullard contends that global demand and supply factors are behind the record high prices across almost all commodities, which he believes is unrelated to QE2.
Higher Treasury Yields– Kills Housing et al
First of all, the ultimate goal of the Fed’s securities purchases (QE2), as outlined by Chairman Bernanke in his speech at Frankfurt, Germany on Nov. 19, is to “lower interest rates on securities of longer maturities” to support household and business spending.
On that measure, QE2 has failed miserably. Interest rates, instead of declining, are rising rapidly driven by the bond markets and the bond vigilantes. The 10-year yield was at a low for the year of 2.4% in early October, and has shot up to a seven-month high of 3.56% the week of Dec. 12, before easing back to around 3.34% on Monday Dec. 20. (Fig. 1)
The yield on the U.S. Treasury is used as a benchmark to set interest rates on many kinds of loans including mortgages, and business borrowing rates in the capital market. So, the sharp rise in yields on Treasurys since the QE2 announcement in early November not only kills any flickering recovery sparks in the housing and other related sectors, but also raises the borrowing costs and interest payments of Uncle Sam.
Higher Borrowing Costs for Uncle Sam
The Congressional Budget Office (CBO) on Dec. 14 projects that under current law, debt held by the public will exceed $16 trillion by 2020, reaching nearly 70% of GDP. The CBO also projects the combination of rising debt and rising interest rates to cause net interest payments to balloon to nearly $800 billion, or 3.4% of GDP, by 2020 (Fig. 2).
U.S. Debt Downgrade - More Than a Warning
Now, the U.S. is at a stage where the downgrade of U.S. sovereign debt rating seems closer to reality than ever before. Although most have dismissed the downgrade initiated by China’s Dagong Credit Agency back in July, CNBC reported that this time around the U.S. Treasury Dept. is going to meet with Moody’s and other agencies in January, 2011 to make its case to prevent a downgrade from the current AAA status.
CBO’s debt and interest payment projection assumes that US borrowing cost will remain reasonable. However, a credit downgrade and/or further loose monetary policies along with continued over-spending will only prompt bond markets and bond vigilantes to demand even higher interest rates resulting in much higher interest payment than the current projections, reminiscent of the 80’s when bond yields were in double-digit.
Expectation Drives Inflation
When it comes to inflation expectations, I’m actually in agreement with Bullard that the Fed has been successful in driving it up, which is reflected in the TIPS yield as well as the steepening yield curve (Fig. 3). However, as Bernanke himself puts it:
“The state of inflation expectations greatly influences actual inflation and thus the central bank's ability to achieve price stability.”
Since the Fed hinted at QE2, commodity price inflation has surged at a record pace during the past six months (Fig. 4) The manifestation of Inflation is a combination of many factors including but not limited to expectations, which drives behavior, as well as supply and demand factors.
So, for Bullard to “take credit” for driving up inflation expectations, but ignore its inflationary effect on commodity prices is illogical as well as self-contradictory.
QEs Not Flowing Where It’s Needed Most
The bottom line is this: Unlike China where its central government can mandate banks to actually lend to business and individuals, Fed’s two rounds of QE liquidity did not go to where it’s intended; it is instead trapped on banks, and corporations’ balance sheets.
U.S. banks have been holding about $1 trillion of excess reserves for the last two years, while American corporations are flush with $3 trillion in cash.
What do they use this money for? Banks and institutions with access to the Fed’s cheap money are pumping up commodities and stocks to make their quarters, while corporations, facing higher input costs in the form of runaway commodity prices, are busy engaging in M&A’s (which typically means “job rationalization”), and share buybacks to juice up earnings per share.
Meanwhile, stagnant wage and hiring trends failing to keep pace with skyrocketing food and energy costs for consumers, coupled with higher input costs, such as fuel, hitting companies' bottomline, will only further cut into growth prospects, and even the purchasing power of consumers and their overall standard of living.
QEs = Wealth Redistribution
The concern of deflation is entirely overblown (thanks to Bullard’s research paper warning of a Japanese-style deflation in the U.S.) and the Fed jumped the gun. In a way, the Fed’s QEs are a form of wealth redistribution from taxpayers to banks, institutions and corporations.
The liquidity has created an artificial financial market where a disproportionate minority is benefitting through higher stock and commodity prices (without producing much output and benefit to the real economy); while the majority suffers higher input costs for essential items like food and energy.
Food and energy are some of the things that affect every consumer's daily life and pocket book, but are excluded from the core inflation calculation, a key measure on Fed's watch list. This bias would only further misrepresen true inflation pressures misguiding Fed's future policies, and result in a net loss for the economy over the long haul.
Dian L. Chu, Dec. 21, 2010
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I saw the interview this article references and couldn't agree more with this article's conclusions.
The Fed is crammed full of groupthinking, mutually maturbatory, tightly-wound yo-yos.
My bet is that no matter what rates, markets, currencies or commodities did... these guys would figure out a way to claim that is illustrates how their policy is working just as they planned...
They figure that by the time it becomes apparent that its total bullshit you'll have forgotten about it... moved on to the next circus... and they'll be even richer!
And the media will STILL keep calling on these same guys as "experts"...
That is what you get when people discuss everything but reality.
The guy spoke to cover tracks or infuriate people by showing them while being naked, he can still force them to behave as if he is dressed.
Could this guy come on the screen to tell that the US basically gets its stuff for free, starving people around the world in the process? Once this answered, the rest follows crystal clear.
Boy, it's a good thing all this QE is part of Ben's ongoing natural experiment in economics. Can you imagine the panic if Ben knows exactly what should happen, tells us what is going to happen, we expect it to happen, and then it doesn't happen? If his experiment doesn't work out, I hope he gets a do-over like the TBTFs. Oh, by the way, when will the Chinese, as participants in the experiment, revalue their yuan as Ben said they must do in his speech he gave in Frankfurt?
For over a month, TIPS (the Barclays ETF) fell from $112 to $106 while long bonds yields went up from 3.8% to 4.6% between 3 Nov and 16 Dec 2010. TIPS only started rising last week, when the Fed finally realized there was a big contradiction to the mass-media's "don't worry, yields are up because inflation is up so QE2 is working" theme. Presumably someone was told to prop up TIPS since 16 Dec.
The reason why there are so many holes in their story to justify QE2 is simply because the main objective was never the economy, nor inflation, and definitely not unemployment. Its the banks' profitability they are trying to boost, plus to get people to quickly forget about QE1, which was illegal. You bet Volcker and Hussman were correct - QE1 was illegal. The Fed does not have the legal authority to conduct fiscal policy by buying MBS from Frandie or from the banks.
people who see the rise in treasury yields as a sign the Fed's purchases were not having the desired effect should look at other measures...
WTF, translated: we blatently fucked up so don't look
Since this so-called "Core Inflation" number disseminated by the hedonic propagandists at the BLS is already wildly unrepresentative of the cost of living reality of every American, why bother stopping there? Why not exclude EVERYTHING from the "core inflation" rate reported by the government, and just substitute some randomly lowball number pulled from Bernanke's ass instead? We are already essentially 80-90% of the way toward doing that today.
Every time one hears some lame mainstream pundit or establishment apologist start quoting the "Core CPI" numbers, that person can immediately be dismissed as an honest or intelligent analyst of the true state of our ongoing currency depreciation.
You have to understand that all modern business education revolves around a concept called "Hygene Motivator Theory"
http://www.netmba.com/mgmt/ob/motivation/herzberg/
Inflation is good when it occurs on things you need. Inflation is bad if it occurs on the things you want.
Why? Because it is your responsibility to feed, clothe and house yourself.It is managements' responsibility to purchase or subsidize the motivators (Think I-Pads, Tickets to sporting events, paid time off, etc)
Economists must maintain the fiction that the price of these categories are separate and do not affect each other, whether they believe it or not. "Let them eat cake."="There is no reason housing values should not rise indefinitely"
It's amazing that the FRB is seeing the long end spike which is the beinning of the endgame and they keep saying they aren't responsible?
Aside from our fiscal trainwreck, thanks to our bought and paid for politicians, who would be to blame then??
These jackasses are making noises about their success, yeah right.
Liars.
It's amazing that the FRB is seeing the long end spike which is the beinning of the endgame and they keep saying they aren't responsible?
Aside from our fiscal trainwreck, thanks to our bought and paid for politicians, who would be to blame then??
These jackasses are making noises about their success, yeah right.
Liars.