Archive for the ‘monetary policy’ Category

The Fed should taper QE3 immediately

July 2, 2013

At his June 19 press conference, Fed Chairman Ben Bernanke outlined the Fed’s plan to start reducing the pace of bond-buying later in 2013 and to end purchases by the middle of 2014. He conditioned this plan on a substantial improvement in the U.S. labor market, leading to an unemployment rate of about 7 per cent by mid-2014 with an increased rate of economic growth.

There can be no realistic expectation that the U.S economy will deliver on these projections. Over the past 12 months, unemployment has fallen from 8.2 per cent to 7.6 per cent. However, there has been no increase in the ratio of employment to population, no decline in the teenage unemployment rate, and virtually no increase in the real average weekly wage for those who are employed.

The Fed assumes that real GDP will grow by 2.5 per cent during the four quarters of 2013. With a growth rate of only 1.8 per cent in the first quarter and a likely greowth rate of only 1.7 per cent in the second quarter, the growth rate will have to jump to more than 3 per cent in the last two quarters to meet this expectation. And that is well nigh impossible.

U.S. exports are declining in response to weakening demand internationally and to a rising dollar. The Obama tax hike in January coupled to the spending sequester continues to drag down aggregate demand. These effects significantly outweigh the small positive effect on GDP from increased residential investment.

Yet, the market has reacted as if the taper is already in place. As bond yields continue to rise, the aggregate economy will respond in a similar fashion. So it makes a great deal of sense for the Fed to accept expectations and to begin the taper immediately. Such a policy would counter the tendency of investors to seek higher yields in high-risk securities. It would allow normal market forces to return, lifting long-term bond interest rates to the traditional 2 per cent above the inflation rate; or even more, given the debt crisis that continues to overhang the U.S. economy.

‘Do well while doing good’ should be the mantra of an independent Fed. Of course, much depends on the meaningfulness of the word ‘independent’.

Hat Tip: Martin Feldstein, ‘The Fed Shoud Start To ‘Taper’ Now’, The Wall Street Journal, July 2, 2013

Lieutenant Ben (Bligh) Bernanke attempts to round Cape Horn

June 29, 2013

In 1787, Lieutenant William Bligh set sail from England on the cutter Bounty, headed first for Tahiti, where he was to pick up breadfruit trees and ferry them to the Caribbean where they might produce food for the growing slave population. To save time, Bligh steered the Bounty to Cape Horn, rather than taking the calmer passage around the Cape of Good Hope.

After a month of unremitting turbulence, during which the Bounty was tossed like flotsam by the waves and gale-force winds, Lieutenant Bligh recognized that he would never round the Horn. Instead, he was forced to change direction and to steer his vessel to the Cape of Good Hope. Though reaching Tahiti, and loading his ship with bread fruit trees, Bligh never reached the Caribbean. Instead, his crew mutinied and set him loose on a long-boat allowing him plenty of time to rue his initial directional decision.

Chairman Ben Bernanke now confronts the dilemma of Lieutenant Bligh. Having pursued a relentless path of monetary expansion, designed to socialize U.S. financial markets, this week he determined to round Cape Horn in order to speed up the path to monetary stability. Immediately, Bernanke confronted the savage turbulence of dangerous financial waters together with gale-force political winds from the Obama administration and Democrats in Congress.

In an uncanny projection of the fate of Lieutenant Bligh, President Obama has assumed the role of the Master’s Mate, Fletcher Christian, in signaling mutiny. Ben Bernanke now has no chance of reappointment to a third term. 2014 is to be the end of the line for this loyal servant of the President. In the mean-time, Ben Bernanke has already blinked. After one month of unremitting turbulence, Chairman Bernanke will adjust the rudder and follow the compass to the more peaceful waters of continued monetary expansion.

However, have no doubt that Fletcher Christian will take him down well before the 2014 elections.

Britain leads the world in bank reform

June 26, 2013

During the 2008 financial crisis, the governments of Britain and the United States failed the test that confronted them. Many of their largest banks had leveraged themselves excessively in mortgage securities and confronted bankruptcy as the U.S. housing market bubble finally burst.

The rational solution to such mis-behavior was to allow the die to fall where it may, specifically to allow insolvent banks to go under and thereby to cleanse an unhealthy financial sector of its least worthy members. The governments led by Prime Minister Gordon Brown (the Scottish cyclops), and President George W Bush (the compassionate conservative) lacked the moral courage to allow free markets to do their work, and introduced the concept of ‘too big to fail’ into the English language.

Since that policy nadir, Britain has forged ahead of the United States with respect to bank reform, as U.S. politicians, from president down to most lowly congressman, have become corporatists, equating the success of an industry with the interests of large companies.

The British government of Prime Minister David Cameron has not succumbed to this fundamental national socialist error, recognizing that the crucial issues lie in the structure of the banks themselves. The government has led the way by concluding that it is not so much that British banks are too big, but that they are too complex.

“Their combination of activities creates conflicts of values, of interests and of objectives. A culture of investment banking that is dominated by trading is incompatible with the requirements of reliable retail banking Central banks have flooded banks with funds to support domestic lending, but the balance sheets of these bans remain dominated by transactions with other financial institutions.” John Kay, Britain is leading the world when it comes to bank reform’, Financial Times, June 26, 2013

The British government gradually has recognized the need for structural change. The Vickers Commission, which reported in 2011, put forward the crucial reform: the separation of retail and investment banking. The Parliamentary Commission on Banking Standards, which reported in June 2013, has proposed criminal sanctions, including jail-time, for bankers who recklessly pursue their own interests ahead of those of the banks they control. Both bodies demand more competition in banking and the government is moving towards the parking of legacy assets in a bad bank. The Bank of England, under the able leadership of Governor Mervyn King, has been the leading source of skeptical thinking on the future of the British financial sector.

In the meantime, under the left-liberal influence of President Barack Obama and the hydraulic Keynesian influence of Ben Bernanke at the Federal Reserve, the American financial sector is returning to its old bad, bonus-boosting habit of excessive leverage, now secure in the knowledge that ‘too big to fail’ is the post-2008 nirvana.

Bernanke has now burst price bubble in long-term Treasuries

June 21, 2013

When socialist bureaucrats are finally done with meddling in financial markets, turbulence is inevitable, as Vladimir Bernanke is now discovering.

Investors who do not understand the nature of a Federal Reserve-driven Treasury price bubble will have experienced severe headaches last night. Those who do not understand the herd instinct, and who hold on to their long-term bond portfolios in coming weeks, in the expectation that the bond market will recover, will wake up six months from now with more than severe headaches.

Inevitably, Bernanke’s signal that the socialist experiment is coming to an end, has hit stocks significantly, with the Dow down 4 per cent or so from its peak in May 2013. However, as long as the real economy does not take a hit – and that is to be determined – stock prices will return. Investors may hold on to their stock portfolios with a degree of confidence.

However, Treasuries are an entirely different matter. Yields on long-term Treasuries will now rise significantly, albeit with a degree of volatility, as QE3 tapers and eventually disappears. If 10-year Treasuries show yields of 5 per cent, say in one year’s time, an investor who bought say $100,000 of those Treasuries at 1.6 percent some months ago, will wake up to find that portfolio valued at $32,000. Only by holding those bonds for ten long years to maturity can such investors avoid that huge loss of capital. And if they do so, they will live in a 1.6 percent per annum yield environment while those who come after them earn 5 per cent per annum.

Suffice it to say that Vladimir Bernanke will not walk the streets safely at night when large-scale government bondholders wake up to the harm that he has wrought.

The bull is throwing Bernanke around like a piece of flotsam

June 20, 2013

I predicted that Ben Bernanke would have a tough time dismounting the market bull. Well, as things go, Bernanke may be quickly thrown by the bull and gored to a nasty exit.

The Dow has lost 500 points in two days.Ten year Treasury yields have risen from 1.6 per cent at the end of May to 2.46 per cent today. Bond prices have fallen accordingly.If this goes on, just watch for the political fall-out. After all the 2014 elections are getting closer by the day.

Thus always ends the fatal conceit. Bernanke may act as though he is the master of the universe. In reality, he is just a piece of helpless flotsam in the rodeo arena.

Ben Bernanke finds difficulty in dismounting the bull

June 19, 2013

Ben Bernanke eagerly mounted the market bull in the wake of the 2008 financial crisis. Using monetary expansion as a device for refueling the market economy, Bernanke and his colleagues at the Federal Reserve have massively increased the magnitude of base money. By purchasing long-term Treasuries and mortgage securities, the Fed has driven long-term interest rates well below their underlying market equilibrium, imposing significant costs on seniors relying on fixed interest receipts to fund their golden years.

Mounting that bull was easy, cheered on as Bernanke was by almost everyone who had suffered capital losses during the financial meltdown. There is, however, no such thing as a free lunch. Sooner or later, those who mount and ride the bull must figure a way how to dismount without imposing a significant setback to a sluggish economy.Bernanke now confronts exactly that quandary in determining when and how to taper the current QE4 monetary expansion.

The eternal problems confronting the bull dismount are timing and political will. The timing to some extent is under his control. The political will lies elsewhere at higher levels in the political system. Bernanke is already learning the import of the second factor. Earlier this week, President Obama strongly hinted that 2014 is the end of the line for this would-be rodeo star. Wall Street has it that Janet Yellen will be Obama’s chosen successor. And she will ride the bull into hyper-inflation if that is what it takes to keep all the bubbles from bursting.

If Bernanke wishes to dismount the bull before he is ejected by the Big Man, he has little wiggle-room available. After all, he has all but promised near-zero rates into mid-2015 and he oversees a Fed balance sheet that has all but quadrupled in five and a half years to some $3.4 trillion.

Interest groups in Washington and on Wall Street are already urging him that it is too soon to dismount, and dangerous to signal any reduction in Fed bond buying in the near to less-near term. The housing recovery may be on its way, they say, but it is fragile indeed. The jobless rate may be falling, but at the pace of a snail. Deflation, they say hovers on the immediate horizon, and would make its dangerous presence felt should QE4 taper out.

My advice to Ben Bernanke is simple. Dismount now, while you still have some control over the bull. Recovery has been fragile over four years of monetary expansion. Much harm has been done to the economy by the manipulation of interest rates and the socialization of risk. Move monetary policy back to neutral and allow the real economy to breathe and adjust to market forces. I know that this asks a lot for a hard-bitten Keynesian such as you. But surely, by now, you understand that we do not live in a Keynesian world.

Hat Tip: ‘Bernanke Rides the Bull’, The Wall Street Journal, June 19, 2013

Ben Bernanke socialism roils U.S. financial markets

June 18, 2013

U.S. financial markets have been increasingly skittish in advance of the Federal Open Market Committee meeting scheduled for Wednesday June 19. Will the Fed or will it not begin to taper its $85 billion monthly purchase of Treasury and federal-agency bonds? When eight males and four females meet to determine whether an extended exercise in socialism will end or will continue, millions of individuals fidget with their wealth portfolios. Traders around the world, who in better free market times considered a wide range of variables, now focus on a single one, Federal Reserve policy.

In bygone days of free markets, stocks tended to move counter to bonds as investors switched from one to the other in order to maximize yield. But in the new world of Bernanke-rigging, they often head in the same direction. That is not good for investors or for capitalism.

Bondholders surely expect bond prices to fall and yields to rise if the Federal Reserve removes its socialist prop. However, they also worry whether the 15,000 Dow may be a Bernanke bubble that will also deflate as the Fed taper begins. Let us follow the money to see how this may occur.

The Fed makes its Treasury bond purchases from the primary ‘dealer’ banks. The proceeds boost the banks’ deposits at the Fed far in excess of legally required reserves. To encourage the banks to hold this base money sao that it will not entrer the credit markets and destroy the value of the dollar, the Fed pays the banks a quarter of a percentage point interest on their deposits.

But it is far from easy to contain $2 trillion in inflationary cash. Many analysts believe that excess deposits are a direct factor in the run-up in stocks since March 2009. Banks have constant dealings in the shadow market with non-bank entities, like money-market, hedge funds and other big money pools. It is a short stretch to imagine these institutions accessing excess bank reserves as collateral to raise money for stock market speculation. Margin debt at the New York Stock Exchange reached a record high of $384 billion in April 2013 – and that means that the stock market is receiving heavy support from borrowed money.

If the Committee of Twelve decides to pull the plug tomorrow, watch out for significant declines both in bond prices and in the Dow and the S & P 500. The enormous quandary now confronting the Fed is a direct consequence of the constructive rationalism of Ben Bernanke and his colleagues at the Fed. Like all socialists, as Friedich von Hayek observed half a century ago, their fatal conceit now threatens the green shoots of a fragile economic recovery.

Hat Tip: George Melloan, ‘How the Fed Turned the Market Skittish’, The Wall Street Journal, June 18, 2013

June 2013 tricky for U.S. investors

June 8, 2013

Investing in financial markets is never simple, because the future is unknown and to some extent unknowable. That is why prudent investors, with sufficient assets, diversify their portfolios across a wide range of assets. June 2013, however, is especially complex. Two key changes in the market environment currently impact on investors’ thinking.

The first is the increasing volatility in the market for government bonds. For several years, holding these assets has proved beneficial, despite, or rather because of their declining yields. Because bond prices move inversely with bond yields, declining yields have manifested themselves in swelling bond values in investors’ portfolios. Declining yields are primarily a consequence of Federal Reserve policy to engage heavily in open-market activity, expanding base money by purchasing long-term government bonds and high-quality mortgage securities. This activity is now in its death throes, and no one knows how much a reversal of this activity will impact government bonds. The market anticipates the likely direction, so bond prices are falling and bond yields are increasing. To dump or not to dump is now the $64,000 question.

The second is the apparent end of the long-period of advance in the price of gold, especially marked since the 2008 financial crisis. From a peak in the region of $1,800 per troy ounce, gold prices have now crashed through the $1,400 per troy ounce barrier. Since gold offers no return other than through price changes, only gold bugs are now confident in retaining this precious commodity in their asset portfolios.

Well stocks are doing well are they not, with the DOW up by 16 per cent so far during 2013. Yes, but how much of that rise is underpinned by a Bernanke bubble, one may legitimately inquire. If Bernanke were to announce tomorrow that Q. E. III is over, just watch how dramatically the Dow and the S & P would sink. Probably not to September 2008 levels, but enough to cause stockholders some sleepless nights.

Certificates of Deposit offer little more than a zero yield, and the money market offers even even less. The realty market is still wobbly and corporate bonds surely would move in sympathy with Treasury bonds. Not much out there for the risk-averse investor.

So portfolio diversification surely is appropriate, with a little less in government bonds and commodities and a little more in stocks and high-quality corporate bonds. Even TIPS are now suspect, because, in the absence of significant inflation, they fare as badly as regular Treasuries in a rising interest rate environment. Still, those nervous about inflation should keep some TIPS in the bag. Those really worried about inflation should perhaps hang on to some gold.

Fundamentally, unease hangs over financial markets because no one fully understands how negatively Bush/Obama socialism will ultimately impact on U.S. economic growth. Growth is lukewarm at best, especially now, four years after the trough of the recession. Is this a short-term downturn, to be overwhelmed eventually by powerful private market forces? Or is it the new norm for an economy that has drifted significantly away from capitalism to a social market economy? That is the $1 million question.

The Bitcoin price bubble

April 4, 2013

The Bitcoin is a virtual currency. The currency was created on July 17, 2010 by an unknown computer scientist with the stock of ‘coins’ growing according to a predetermined algorithm. At its launch, one Bitcoin exchanged for $0.05 (a nickel).

Untethered to any real asset, the Bitcoin’s price is determined purely by speculation on exchanges around the world. In the absence of any government intervention, a buying frenzy has sent the value of the total Bitcoin stock past $1.5 billion. The price of a single Bitcoin has doubled in less than two weeks. Having passed $100 on April 1, 2013, it peaked (so far) at $147 a Bitcoin on April 3, 2013, before falling back to $110.

The Bitcoin currency may grow in accordance with a predetermined algorithm, but it is nothing if not volatile with respect to price. A 2011 spike took the price of a Bitcoin from $2 to over $30 – and back again. Now, in the wake of the Greek Cypriot bank bailout fiasco, Bitcoin’s advocates are pitching the currency as an alternative to authorized currencies that can be devalued or confiscated at the will of political hacks.

All bubbles eventually burst and the Bitcoin will prove to be no exception. A major problem is that governments prefer a monopoly of theft. They do not relish competition in that lucrative activity. So if the Bitcoin gets too big for government’s boots, they will stamp down on it.

Gold, coin and bullion, still remains the preferred asset for those who do not place great faith in government.But do take delivery and hide your holdings from inquisitive government eyes.

Roofs or ceilings?: two Nobel Prize winners offer a lesson to the Federal Reserve

January 29, 2013

In 1945, when millions of Americans returned home after service during World War II, the San Francisco housing market manifested a massive shortage of available housing. The reason for this apparent market dislocation, however, had nothing to do with a failure of market forces. It had everything to do with the socialization of the housing market. The City had imposed a tight ceiling on the rents that could be charged by those who owned the housing stock.

In a 1946 essay, with the catchy title of “Roofs or Ceilings”, two future Nobel Prize winning economists, Milton Friedman and George Stigler exposed the true nature of the problem. If a city desires to secure more roofs over the heads of returning veterans, the best route to do so is to remove the ceiling on rentals. Eventually, San Francisco government saw the light, and the housing shortage immediately disappeared.

Since the 2008 financial crisis, the Federal Reserve has blindly followed the immediate postwar example of the City of San Francisco. It has essentially socialized the market for bank loans by imposing a ceiling on the interest rates that banks can effectively charge when making business loans. As a direct consequence, borrowers desire more loans than in a true market (because interest is too low) and lenders supply fewer loans than in a true market (because interest is too low). The short end of the market always rules. So too few loans are consummated. The economically uneducated (Paul Krugman is a prime example) then rant that the economy is in a liquidity trap.

In reality, the Federal Reserve has chosen ceilings over roofs, thereby imposing severe harm on the economy.It has done so by maintaining a near-zero federal funds rate while ratcheting up its purchases of mortgage-backed and U.S. Treasury securities in order to hold short and long-term rates well below market levels. Effectively the Fed is imposing an interest-rate ceiling on the longer-term market by saying it will keep the short rate unusually low.

There is little economic incentive for lenders to extend credit, especially to risky borrowers, at that rate. The decline in credit availability reduces aggregate demand, which tends to increase the rate of unemployment. This is a classic unintended consequence of such a policy. The policy is a classic form of behavior on the part of Keynesian economists such as Paul Krugman and Ben Bernanke.

Hat Tip: John B. Taylor, ‘Fed Policy is a Drag on the Economy’, The Wall Street Journal, January 29, 2013


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