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Is A Shift In Fed Policy Coming?
From The Daily Capitalist
The Wall Street Journal is running a piece tonight (Monday) on a possible shift in Fed policy (Fed Mulls Symbolic Shift) which I don't believe they would run unless they have some insider tipping them off. The article is authored by Jon Hilsenrath who has been writing about deflation and the efficacy of Keynesian stimulus. As I pointed out, he is a good reporter, but his articles mirror the conventional wisdom which, unfortunately, has been mostly wrong.
However I will assume Mr. Hilsenrath has pretty good connections as a Journal reporter so I will take his piece seriously. Here is the gist of the article:
Federal Reserve officials will consider a modest but symbolically important change in the management of their massive securities portfolio when they meet next week to ponder an economy that seems to be losing momentum.
The issue: Whether to use cash the Fed receives when its mortgage-bond holdings mature to buy new mortgage or Treasury bonds, instead of allowing its portfolio to shrink gradually, as it is expected to do in the months ahead. Any change—only four months after the Fed ended its massive bond-buying program—would signal deepening concern about the economic outlook. If the Fed's forecast deteriorates significantly, it could also be a precursor to bigger efforts to pump money into the economy.
The article notes the disagreements among the Fed presidents about inflation, deflation, and the direction of the economy. The inflation hawks, chief among them being Thomas Hoenig of the Kansas City Fed, would probably like to increase the Fed Funds rate soon. Charles Plosser (Philadelphia), James Bullard (St. Louis), and my favorite, Richard Fisher (Dallas) have been favorable to quantitative easing by allowing the Fed to continue to buy toxic debt ("quantitative easing"). None of these Fed presidents seem to understand the causes of deflation or inflation as being something that they create through money supply manipulations.
But James Bullard has come up with another twist.
Dr. Bullard released a paper last week about the dangers of deflation ("Seven Faces of 'The Peril'"). I should tell you that he rose from the research department to president of the St. Louis Fed, which makes him a bit of a policy wonk.
Dr. Bullard says we can stop deflation by buying U.S. Treasurys (this form of "quantitative easing" is also called "monetizing debt"). He says ZIRP (zero interest rate policy) encourages deflation and violates the Taylor Rule (the Fed must keep short-term interest rates at a fixed bandwidth above or below "equilibrium" which is some theoretical balance between the rate of interest and inflation expectations). He says ZIRP loses its effectiveness, creates expectations of lower prices, and increases the likelihood of deflation.
Bullard's solution is to monetize federal debt, but to only do it 'just right':
The experience in the U.K. seems to suggest that appropriately state contingent purchases of Treasury securities are a good tool to use when infl?ation and infl?ation expectations are ?too low.? Not that one would want to overdo it, mind you, as such measures should only be undertaken in an effort to move infl?ation closer to target. One very important consideration is the extent to which such purchases are seen by the private sector to be temporary or permanent. We can double the monetary base one day, and return to the previous level the next day, and we should not expect such movements to have important implications for the price level in the economy. Base money can be removed from the banking system as easily as it can be added, so private sector expectations may remain unmoved by even large additions of base money to the banking system. In the Japanese quantitative easing program, beginning in 2001, the BOJ was unable to gain credibility for the idea that they were prepared to leave the balance sheet expansion in place until policy objectives were met. And in the end, the BOJ in fact did withdraw the program without having successfully pushed infl?ation and infl?ation expectations higher, validating the private sector expectation. The U.S. and the U.K. have enjoyed more success, perhaps because private sector actors are more enamored with the idea that the FOMC and the U.K.?s Monetary Policy Committee will do ?whatever it takes? to avoid particularly unpleasant outcomes for the economy.
Let me translate this for you:
- He and other Fed presidents are worried about a Japan-style deflation where they had declining prices and asset values and almost zero growth for "a decade" (actually almost 20 years at 0.6% average GDP).
- Nothing they (the Fed) have done so far works. Chairman Bernanke and others assumed that all they had to do was ZIRP and inflation would appear, the economy would rebound, and things would be just fine. It hasn't worked.
- Chairman Bernanke has no clue why deflation is occurring and neither do the other Fed presidents. He still assumes, through some neo-Classical, Monetarist econometric formula, they can manipulate the economy to their will. If they could do this they would already have done so.
- Japan, Bullard says, did everything wrong: ZIRP didn't work and fiscal stimulus left them with huge national debt. He is absolutely right about this. However he believes they went into deflation because (i) no one expected inflation to occur because of ZIRP and that (ii) they didn't try hard enough with quantitative easing.
- He believes, with absolutely no evidence, that quantitative easing helped in the UK and in the U.S. in that it prevented inflation expectations from being "too low."
- Monetizing federal debt, he says, will convince us that the Fed 'really means it this time' and that we can expect inflation for sure.
Bullard released this paper for a reason and that is to frame the debate about what they are all really concerned about: a sinking economy that will keep unemployment high. Continued high unemployment is not politically acceptable to Congress and the Administration, and the Fed will face tremendous pressure in the next several months as negative data continues to come in.
Most Fed presidents fear unemployment more than they do deflation. I believe they will keep ZIRP for the foreseeable future and that they will also engage in more "quantitative easing."
Monetizing debt has been a taboo among central bankers because it is a one-way ticket to high inflation. But, Dr. Bullard thinks that is what the Fed should do. That is why I believe we are eventually headed for stagflation.
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they are broker across the pond...
http://www.telegraph.co.uk/finance/personalfinance/7903432/Average-household-bill-higher-than-average-salary.html
The Fed can do what it thinks is best however the reality is that the World has too much structural excess capacity especially on the labor side with the most efficient transportation system that we have ever known. Free markets will seek the most efficinecy in all areas of land, labor and capital. This is what is taking place. Currency valuation changes have not made up the difference in the values of international exchange. All of the twiddling the Fed wants to do will have little impact on the upside.
There is no such thing as excess labor, as that implies that there are no longer unmet human needs where the labor could be applied.
Just because labor (along with capital) has been mal-invested in services and industries that are no longer needed is not the same thing as there being too much of it in general. In the case of the housing bubble for instance, what happened was an unnatural distortion in the demand for housing labor. What is happening now, is that labor has to find some other way to produce value.
As you point out, the markets have no need for inefficient labor. I'll point out that this flaw is structural only due to the Fed's market distortion. It is not structural in the sense of being part of the free market.
So, you are saying there are too many people?
'fraid to ask what the solution to that problem is...
There is absolutely no doubt that one big problem is too many people globally.
There are numerous possible solutions including many that are benign and respectful of human rights. Unfortunately in history such benign solutions have not been the most commonly exercised.
Cue Mako...
Ironically, there may be too many people globally but there are too few domestically. Much has been written on how the west is failing to sustain populations. Ironically, our entire economic system is based on perpetual growth and there are only two ways to get there. One is to get everyone to buy more stuff. The other is to make more people. Many of our problems are a result of not enough people to pay for yesterday's promises, which of course were too big to begin with. We have painted ourselves into a demographic corner for the last 40 years and now the chickens are coming home to roost. It's really quite obvious in hindsight.
There is a third way...a wave of immigration would reinvigorate the US economy. Immigrants are go-getters or they wouldn't be moving. Raise immigration limits to 10 million a year from the current 1 million a year. Add a 10% VAT tax, with no exceptions, and leave the income tax levels where they are.
Immigrants are NOT innovators, only a tiny portion of them are. You cannot start a good business with an 8th grade education. Simply importing more third world peasants does absolutely nothing but drive down wages. If they have no real capital (which they overwhelmingly do not), they will not create any jobs whatsoever. I don't even need poor foreigners in the same country as I to make money off them, there are emerging market mutual funds for that!
The only thing this would do is turn the country into an overpopulated dump full of poor foreigners, in the face of resource limits it means nasty collapse. There are limits to growth, population can't increase indefinitely.
the average adult in the U.S. reads between the 8th and 9th grade reading levels
1 in 5 adults read at or below the 5th grade level
http://www.pfizerhealthliteracy.com/physicians-providers/policy-quiz.html
1 in 5 adults unemployed
http://www.dailyfinance.com/story/careers/what-is-the-real-unemployment-rate/19556146/
US ranks 18 out of 36 in education
http://www.upi.com/Top_News/2008/11/19/US-slipping-in-education-rankings/UPI-90221227104776/
effects of immigration economic net positive
http://www.utexas.edu/lbj/uscir/respapers/ii-oct97.pdf
type of immigrant can be controlled
http://travel.state.gov/visa/temp/types/types_1286.html
US ranks 178 out of 239 in population density
http://en.wikipedia.org/wiki/List_of_countries_and_dependencies_by_population_density
10-year-old Perry Chen, prodigy in the making
http://www.sdentertainer.com/features/10yearold-perry-chen-prodigy-making/
10% VAT would collect $60 billion a year from tourists alone, $1.4 trillion a year altogether
http://www.bea.gov/newsreleases/industry/tourism/2009/tour209.htm
http://global-economy.suite101.com/article.cfm/gdp_estimates_for_richest_countries_in_2009
Nearly half of US households escape fed income tax
http://finance.yahoo.com/news/Nearly-half-of-US-households-apf-1105567323.html?x=0&.v=1
10 million immigrants would close the gap on a 5 miilion home shadow inventory
http://www.dailymarkets.com/economy/2010/07/27/us-housing-market-still-shaky-despite-may%E2%80%99s-home-price-improvement/
Yes indeed! But of course more people living at a US level of consumption just means environmental catastrophe and resource depletion would occur even sooner. Ironic - our crony "capitalism" requires such expansion merely to survive, but continuing that route will cause global catastrophe.
Those who know basic deductive logic might be able to expound on this combination of factors.
And it also tends to suggest why the US elites have been so gung-ho on immigration, legal, illegal and otherwise, regardless of the massive public opposition to it. (Perhaps the elites don't actually serve the existing public?!?! Shocked, shocked I say!)
Don't worry about Mother Nature. She will kick our ass and keep on trucking if we don't innovate food production and out of fossil fuels. Instead of educating a wave of foreigners and sending them home, why not keep them in the US? They are the future innovators.
the UN & the Rockefellor/Ford etc foundations are saying exactly that. Read the UNs Agenda 21 and related for the 'solution to that problem'.
Why not simply nullify federal taxes? This is essentially the same thing, no? I guess monetizing the debt looks more prudent somehow and is easier to swallow. Helluva soft-shoe act we're watching.
Cancelling federal taxes would be transparent and would largely benefit the middle class and smaller companies that can't game the system. The rich already game the system to pay minimal taxes so it wouldn't benefit them. Semi-stealthy monetizing benefits the connected elites who get prior notice and can adjust their investments, tax arrangements and general posturing to get the most benefit.
You don't think the Fed is looking out for the little guy, do you?
Well put.
I have never met anyone who has decided to buy say, a car or washing machine, today because they thought the price would be higher in a year. And I don't think the reverse is true today. People aren't spending money today not because they think the price will drop further, but because 1)they don't have the money 2)they think the might not have the money in near future (might lose their job, etc.) Coupled with the implosion of the shadow banking system and I don't think expectations have anything to with deflation occuring in the near future.
I have made a number of purchases of durable goods and machinery in the last two years expressly because I expect a wave of inflation soon. At this instant I am pondering some other purchases based on the possibility prices might slide further, but I definitely plan to do my buying within the year as I believe that whatever deflation we may now be in won't last and will soon be replaced with stagflation or even hyperinflation.
Many episodes of hyperinflation, particularly those in Argentina, were preceded by a short bout of deflation.
This is just my opinion, not investment advice.
Isn't that the root of hyper-inflation? Succinctly, its the point in time where enough folks with real cash lose confidence and try to all-in on hard assets?
This occurred to me less than a month ago.
I am just a curious bystander, so would be interested what others think.
Cooter
Where's Mako? Well he says "current credit system 1945-2007 RIP".
I agree. Which are you: distracted and polishing brass on the Titanic or out on the water singing songs with Molly Brown?
Martin Armstrong pointed out that the Black Plague made human capital valuable again. We have millions unemployed and on food stamps with no hope in sight. History won't be bashful when she teaches humanity the same lesson as before.
Well, if you were around as an adult in the late 70's-early 80's you would have.
But in order for inflation expectations to have a meaningful impact on peoples spending habits, inflation/expectations would have to be high, probably over 4-5%. Of course the fed would be perfectly content to leave inflation at 5% for an extended period of time.
Seems this Bullard is concerned more with inflation as a monetary phenomenon rather than stimulating demand. A dangerous fellow, he is.
Uh, I was around in the 1970s. I remember it well. The difference, of course, is that my salary was actually going up along with prices in the 1970s. Ok, it lagged a little, but I was confident that we would survive. This time, I am much less confident and learning to live on less. If the spectre of inflation rears it's ugly head, I will move out of cash, but not into consumer durables.....
"Seems this Bullard is concerned more with inflation as a monetary phenomenon rather than stimulating demand. A dangerous fellow, he is."
+10
No sooner do be begin to get one set of "financial experts" on the verge of being educated by reality's hammer than another baloney salesman appears on the scene.
Kinda discouraging.
Tic tock...you could replace Bernanke and I would sleep better at night!
Something so basic as deflation, the answer is so simple everyone misses it entirely:
Bend over, it will only hurt real bad for 3-5 years as all assets reset to true value and all the bad debt is destroyed via default or "some form of payment"...maybe chickens or pigs but I can assure this much...even gold bugs don't wish for that scenario...
God Bless this Planet...she needs it...we need it
deflation is what gets political parties ousted from power. and i mean both parties, in this case.
The Fed will not allow deflation and debt resets to occur. That would require TPTB to take haircuts they are loath to do. The Fed controls the money for the benefit of the few and not the many. Do not forget that.
Succint article; the ZIRP, this is discount window access? ..and in general the re-pricing of risk due to Fed buying of unpriceable assets. Dr. Bullard suggests that this policy hides the interest rate inside the investment function? To which he concludes that raising the expectation of inflation would what, make more irrelevant? How does the Taylorfunction work, yes, I'll google it... I though inflation was dependant on there being a robust velocity, but apparently that is in serious decline.
Actually, I'm surprised the Federal Reserve Banks are attempting to stimulate the economy, I thought they were primarily responsible for the stability of the money supply and prices. I thought that was the rationale behind having the TBTF as adjuncts to make the difference between Fed funds and Real rate..anyway,
It blows me away that those people simply do not understand the effect of too much debt. Cripling amounts of debt are not even an issue with them. They seem to believe that debt levels can be infinite with zero effect.
Of course, when debt creation is your mandate, what else would you think?
All signs in fact point to debt deflation.