Archive for the ‘The Fed’ Category



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I COMPLETELY agree with the points made by Bill Gross in this article.  Here is an excerpt and the link:

“Faced with these two decidedly different routes to “level the playing field” it seems obvious that the United States is opting for “Easy Street” as opposed to “Buckle Down Road.” Granted, “The Ben Bernank” as a YouTube cartoon rather hilariously labeled him, has for several months importuned Congress and the Executive Branch to institute substantive reforms, while he attempts to keep the patient alive via non-conventional monetary policy. But very few others are willing to extract their heads from the sand. The President’s debt commission with its insistence on low personal and corporate income tax rates and a mere 15 cent increase in the gasoline tax was one example. The Republicans’ reluctance to advance detailed ideas for budget balancing is another. And the Democrats’ two-year focus on the biggest entitlement program since Social Security – healthcare – as opposed to fundamental reforms to counter our lack of global competitiveness – is perhaps the most grievous example of lost opportunity. Unlike the United Kingdom, where Prime Minister Cameron has championed fiscal conservatism, or even Euroland, which is being forced in the direction of Angela Merkel’s Germanic work ethic, the United States seems to acknowledge no bounds to what it can spend to bolster consumption or how much it can print to support its asset markets. We will more than likely continue to “level the playing field” via currency devaluation and an increasing emphasis on trade barriers and immigration, as opposed to constructive policies to make this country more competitive in the global marketplace.”


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The links below present two opposing conclusions on the second round of quantitative easing (QE2), which began today.

Quantitative easing refers to a process that involves the Fed printing new money to buy long-term treasury bonds.  The practice aims to stimulate demand and prevent deflation by lowering long-term interest rates, but QE also has many other effects.  QE raises the risk of inflation, distorts risky asset prices and disturbs currency markets.  Low US interest rates have created a “carry trade” where investors borrow dollars at superficially low rates and invest abroad.  This does nothing to help the US economy and has the potential to distort foreign asset prices.  Finally, to cap it off, QE supports our current fiscal irresponsibility by keeping the government’s borrowing costs artificially low.

I side with Feldstein on this one.



Also note the international implications:


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Today we find out what the Fed is planning to do about this:

How the mortgage market will react when the Fed halts its MBS purchase program remains a significant question.  I have a hard time believing private sector demand will suddenly rise to offset the Fed’s departure and prevent a noticeable price decline.

‘At the end of March, the Fed is also expected to end its purchases of mortgage-backed securities. At some point later, it will start selling those securities. Earlier this week, aides on Capitol Hill said that in questioning Mr Bernanke lawmakers would probably focus on the end of the support for the housing market, which has shown some signs of stabilisation but continues to struggle because of high foreclosure rates, prices that are still falling, and a glut of unsold homes.

Some economists have warned that the end of the Fed’s mortgage purchase programme could raise mortgage rates and stifle any nascent rebound in the housing market. Supporters of the plan believe that it will only marginally lead to an increase in rates, and is a necessary step towards normalisation of US mortgage markets.

“The question is whether the private markets will be able to pick up the slack,” said one aide, who said that lawmakers would focus on the issue because it is what matters most to voters.’


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I thought this Economist article contained an interesting combination of ideas.  First, it’s astonishing to note that although the level of our trade deficit with China has decreased, over the same period, our trade with China has grown to represent a greater portion of our total trade deficit.  The article presents several plausible explanations of why China’s share of global exports is rising but I am left wondering why the US/China trade relationship has changed so dramatically.

Even more interesting to me is Paul Krugman’s endorsement of currency-adjusting tarriffs as an appropriate response to Beijing’s stubbornly pegged Yuan.  Although I strongly believe China’s subsidized currency has created massive damaging distortions in world trade and capital flows, which are disturbingly ignored in Washington as senators seemingly prefer berating Wall Street “barons” to seeking actual cause,  it is ironic to me that Krugman, the borrow and stimulate Keynesian, doesn’t seem to realize that trade is a two way street.  America has completely lost touch with the reality that wealth is created through parsimony and hard work.  As much as I agree with Krugman’s diagnosis, Greenspan is also on board in spirit (see Greenspan’s March 2009 WSJ piece), I wish Krugman would recognize his part in the problem.

‘China takes an even bigger slice of America’s market. In the first ten months of 2009 America imported 15% less from China than in the same period of 2008, but its imports from the rest of the world fell by 33%, lifting China’s market share to a record 19%. So although America’s trade deficit with China narrowed, China now accounts for almost half of America’s total deficit, up from less than one-third in 2008.

Foreign hostility to China’s export dominance is growing. Paul Krugman, the winner of the 2008 Nobel economics prize, wrote recently in the New York Times that by holding down its currency to support exports, China “drains much-needed demand away from a depressed world economy”. He argued that countries that are victims of Chinese mercantilism may be right to take protectionist action.

Some forecasters, such as the IMF, expect China’s trade surplus to start widening again this year unless the government makes bold policy changes, such as revaluing the yuan. However, Chris Wood, an analyst at CLSA, a brokerage, argues that China is doing more for global rebalancing than America. Rebalancing requires that China spends more and America saves more. Mr Wood argues that China is doing more to boost domestic consumption (for example, through incentives to stimulate purchases of cars and consumer durables, and increased health-care spending) than America is doing to boost its saving. America’s total saving rate fell in the third quarter of last year to only 10% of GDP, barely half its level a decade ago. Households saved more, but this was more than offset by increased government “dissaving”.’


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The Fed’s independence is at risk

By Glenn Hubbard, Hal Scott and John Thornton

Published: August 20 2009 19:55 | Last updated: August 20 2009 19:55

“As leaders gather this week for the annual Jackson Hole symposium on the economy, they should consider the future of the Federal Reserve as lender of last resort. Over many decades and especially in this financial crisis, the Fed has used its balance sheet to be a classic lender of last resort. But its ability to do so depends upon its economic credibility and political independence, attributes the Fed has compromised in this crisis.

As the crisis worsened at the end of 2007, the Fed created new liquidity facilities, some of which involved new recipients, beyond depository institutions, such as investment banks and corporate commercial paper issuers. In addition, in 2008, the Fed made extraordinary “bail-out” loans to avoid the failure of systemically important institutions – a $30bn (£18bn, €21bn) non-recourse loan, with a $1bn deductible, to assist JP Morgan Chase’s acquisition of Bear Stearns and the creation of a two-year $85bn credit facility for AIG. Also, the Fed, in partnership with the Treasury and Federal Deposit Insurance Corporation, guaranteed $424bn of losses on pools of Citigroup and Bank of America bad assets.

These actions have had a big impact on the Fed’s balance sheet. As of June 2009, its total assets had risen to over $2,000bn compared with $852bn in 2006, and only 29 per cent of these assets were Treasury securities, compared with 91 per cent in 2006. Traditional loans by a lender of last resort are sufficiently collateralised to prevent moral hazard for borrowers and reduce risk to the central bank. However, the adequacy of the collateral of these new Fed positions is unclear.

These actions have not only increased the Fed’s risk, the shortage of Treasuries has hampered the Fed’s ability to conduct its central mission – monetary policy. In order to counter the potential inflationary impact of its credit expansion, the Fed requested that the Treasury sell special issues of Treasuries under the Supplementary Financing Program – not to raise revenue but simply as part of the conduct of monetary policy. As of June 3, 2009, the Supplementary Financing Account of the Treasury was about $200bn compared with Treasury holdings of about $475bn, indicating that the Treasury had become a significant player in monetary policy.

Much of the emergency Fed lending was based on Section 13(3) of the Federal Reserve Act, which allows the Fed in “unusual and exigent circumstances” to lend to “any individual, partnership, or corporation,” against “notes” that are “secured to the satisfaction of the Federal Reserve Bank”. Former Fed chairman Paul Volcker, now chair of the president’s Economic Recovery Advisory Board, as well as members of Congress dissatisfied with bailing out the banks, have questioned the Fed’s authority under this section to engage in much of the lending.

Quite apart from the legal issue, the Fed’s assumption of credit risk by lending against insufficient collateral could compromise its independence by: making it more dependent on the Treasury for support in the conduct of monetary policy, as illustrated by the supplemental finance facility; jeopardising the Fed’s ability to finance its own operations and thus require it to seek budgetary support from the government; tarnishing its financial credibility in the event that it incurred big losses; and generally making it more subject to political pressures.

Based on these concerns, the Committee on Capital Markets Regulation has recommended that any existing Fed loans to the private sector that are insufficiently collateralised should be transferred to the federal balance sheet. While the Fed cannot go bankrupt, any Fed losses are ultimately borne by US taxpayers and should be directly and transparently accounted for as part of the federal budget. For the same reason, in the future, only the Treasury should engage in insufficiently collateralised lending.

But rather than reinforcing the Fed’s independence, as our proposal would do, the Obama administration’s reform proposal recommends amending Section 13(3) to require the written approval of the secretary of the Treasury for any emergency extension of credit. This would be a startling expansion of Treasury power over the Fed’s use of liquidity facilities in classic lender of last resort situations – that is, where there was adequate collateral. Instead, the lines of authority should be clear. The Fed should have strengthened authority to loan against adequate collateral in an emergency. And the Fed should have no authority, even with the approval of the Treasury, to lend against insufficient collateral.

The Fed needs authority to lend in a crisis to avoid the chain reaction of failures of financial institutions, which could result in a complete economic collapse. However, this reason to act should not jeopardise the Fed’s credibility and independence. Instead, these goals can be achieved by giving the Fed full authority to lend against good collateral – a traditional power of a central bank – while requiring bail-outs to be undertaken by the government. This change will enhance both the Fed’s credibility and its independence and make our government more accountable.

Mr Hubbard is dean and professor of finance and economics at Columbia Business School. Mr Scott is professor of international financial systems at Harvard Law School. Mr Thornton is chairman of the Brookings Institution. Mr Hubbard and Mr Thornton co-chair and Mr Scott directs the Committee on Capital Market Regulation”


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Ron Paul steams while Bernanke seems to be awaiting the end of a toddler’s temper tantrum.

PS Ron, if inflation is just “an increase in the money supply,” why isn’t everything already 2x as expensive as it was in 2007?

Here’s an older clip where Ron tries to teach Bernanke “Austrian economics” – poor Hayek. (If you are interested in REAL Austrian economics, I suggest “The Use of Knowledge in Society” http://www.econlib.org/library/Essays/hykKnw1.html This is one of my absolute favorites.)

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