Archive for the ‘politicization of the Fed’ Category

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.

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

Federal Reserve signals inflation-spiral

December 15, 2012

At his press conference this week, Fed Chairman Ben Bernanke committed the Federal Reserve to near-zero interest rates until the US unemployment rate falls below 6.5 per cent. Currently, the unemployment rate stands at 7.7 per cent.

Given the massive expansion of federal spending under President Obama, and given the elimination of many unskilled jobs as a result of technical change and out-sourcing, the natural rate of unemployment in the United States may now be as high as 7 per cent. If this is correct, the Federal Reserve will pay for a 6.6 per cent unemployment rate with inflation rates that increase over time more or less rapidly depending on whether rational  or adaptive expectations determine responses to such monetary expansion.

In any event, Bernanke has announced a revolution in US monetary policy. Henceforth monetary policy will not seek to hold inflation to a maximum of two per cent per annum.  It will allow inflation to rise to whatever rate is necessary to lower unemployment to 6.6 per cent in response to near-zero interest rates.

Some apologists will laud this as a move to a nominal GDP target. But they are Obama-sycophant serpents speaking  with forked tongues.

The real objective of such a shift in Fed policy is socialism.

“The best way to destroy the capitalist system is to debauch the currency.” V.I. Lenin

Bernanke should read Silber’s biography of Volcker

September 30, 2012

Richard L. Silber has written a detailed new biography of Paul Volcker, the former chairman of the Federal Reserve who successfully eliminated the stagflation of the late 1970’s in the United States.  Appropriately, his biography is entitled, Volcker: The Triumph of Persistence.

In response to questions posed by Neil Irwin of The Washington Post (September 30, 2012),  Silber draws important insights for current Fed policy from his in-depth analysis of Paul Volcker’s lasting contribution to price stability in the United States.

“Bernanke gets an A for what he did in 2008.  He did exactly what a central banker, knowing the history of the Great Depression, should have done when confronted with the potential for panic. Open up the floodgates and lend.  But now he should worry about the fallout from remaining too easy for too long, which Volcker maintains is the reason we lost the battle against inflation before.” Neil Irwin, ‘Volcker biographer: Bernanke needs to embrace lessons of  ’70s’, The Washington Post, September 30, 2012

In his response to Irwin’s questions, Silber identifies two major lessons that must be learned from the 1970s:

“The 1970s delivered two important messages.  First, we can’t get a permanent reduction in unemployment by inflating. It doesn’t work.  And second, we’ve got to worry about inflation, even with unemployed resources. Waiting until we see a clear and present danger is too late.” ibid.

Why is inflation such a serious problem?

“He (Volcker) believes that the main problem with inflation is that it undermines trust in government.  We, as citizens, give the government the right to print money, not to abuse that right by inflating. When the government inflates, it breaks its pledge and undermines our trust.  Right now, we need trust in government more than anything else.” ibid.

Is inflation currently a realistic impending problem?

“The big difference today versus the problem Volcker confronted in 1979 is that inflationary expectations were already out of hand back then.  Today, they are still under control, but no one knows how fragile they are.  More importantly, it will be difficult for Ben Bernanke, or whoever follows him, to maintain low expectations of inflation by raising real interest rates – the way Volcker did – when that’s needed.  We have had five years of unemployment, and the American public may not tolerate a central bank that acts preemptively, as it must, to prevent inflation.  The Fed is independent, but it cannot do whatever it wants.” ibid.

I offer these words of distilled wisdom for your consideration.  Unusually, they arrive as a useful warning before, and not after, the impending crisis has  emerged.  As such they are to be treasured.

Fed easy money punishes middle class Americans

September 27, 2012

John Maynard Keynes first noted that labor market equilibrium may be impacted by price inflation.  He noted workers’ strong preference for a 2 per cent wage increase in a 4 per cent inflation environment over a 2 per cent decrease in nominal wages during a period of constant prices. For many years politicians attempted to exploit this illusion by hiking up inflation rates.  Ultimately, the entire process collapsed in 1970’s stagflation, as the Phillips curve became upward sloping in price inflation/rate of unemployment space.

Money illusion has not disappeared, however, from the box of tools of the Federal Reserve. Indeed it is alive and well in the easy money policies emanating from the Fed since September 2008. Indeed, the Fed, under the chairmanship of Ben Bernanke, has becoming increasingly bold in exploiting money illusion. With inflationary expectations not yet rattled by the Fed’s $2 trillion balance-sheet expansion, Bernanke has now committed the Fed to an open-ended round of quantitative easing in the expectation of trading a little extra inflation for a little short-term employment.

These actions hurt the middle class – the group for which the policy is designed – as low interest rates sap their investment returns and as creeping inflation erodes their perceived real living standards.

“The more than five-fold increase in the median income of the American household since 1971, to $50,000 from $9,000, certainly provides the clear appearance of progress.  But after the dollar’s 82% loss of purchasing power over the same period is factored in, the median household income rose just 12%.  This much more modest increase is largely the result of the growing prevalence of two-income households.  The median real income for working men over the same 40-year period rose just 8%.  And thaat improvement only accrued to the ever-shrinking percentage of men fortunate enough to still have full-time jobs – just 67% according to the latest data from the Bureau of labor Statistics, within a percentage point of the lowest level on record since the figure was first recorded in 1948.”  Sean Fieler,  ‘Easy Money Is Punishing the Middle Class’, The Wall Street Journal,  September 27, 2012

As price inflation creeps upwards, from 2 per cent per annum to 4 per cent per annum, the price signals necessary for American workers to compete in the global market-place are dulled and incentives to re-educate and re-adjust are dimmed.  The end result is serious structural unemployment of the kind that now seriously hinders economic recovery in the United States. Ben Bernanke is the worst enemy that working Americans could ever wish to avoid. For he is working on their perceived cognitive deficiencies to gain short-term advantage for his Wall Street friends and cronies.


High-rolling Bernanke empties Fed pockets in the last chance saloon

September 14, 2012

The economy is in the tank, the national debt is out of control, the banks are largely insolvent, the housing market is under-water, and Washington is a dysfunctional political jungle.

So hey guys,  let us live things up in the Eccles Building’s Kit-Kat club!   Let us pour a few cool ones down for B.O. on November 6, and enjoy Ben Bernanke’s generosity as an effusive, big-spending Master of Ceremonies.  And always remember that life is a cabaret, old friends,  life is a cabaret!*

Just keep a half eye open for those shadows in the corner of the club. They just may be National Socialists waiting in the wings for inflation to take its toll. And believe me, my friends, life will then be no cabaret, save for those with a penchant for surviving under dictatorship.

Revelers in the Kit-Kat club had been clamoring all night long for the Master of Ceremonies to refill the punch bowl.  Ever anxious to please, Bernanke responded to the cries, as he had  done twice before. This time, however, he forgot the fruit juice. The punch bowl is over-flowing with 80 per cent alcohol  and the spigots will remain wide open until no one is left standing. Now this is a real cabaret!

Quantitative easing 3 is here to stay. The Fed will buy $40 billion of agency-backed mortgage securities a month indefinitely, funding its outlays through the printing press.  It will keep rates at rock-bottom levels through the middle of 2015 and it will retain such an accommodative policy for a considerable time period after the economy strengthens.

As clearly as Bernanke can make it, without using the dreaded words, the Fed is now dedicated to inflating the US economy out of stagnation.  As surely as history has demonstrated, Bernanke is leading the U.S. economy into stagflation.  Given usual monetary lags, Bernanke will be safely exiled on some offshore island by the time that this calamity hits the large majority of Americans insufficiently skilled to avoid its catastrophic consequences.

As always, the prescient will survive. Yesterday gold jumped 2.2 percent to trade at $1,750 an ounce.

* Musical Cabaret 1972

Hat Tip: The Lex Column, ‘QE3’, Financial Times,  September 14, 2012

Federal Reserve should place itself on auto-pilot

March 29, 2012

A single goal of long-run price stability should be supplemented with a requirement that the Fed establish and report its strategy for setting the interest rate or the money supply to achieve that goal.  If the Fed deviates from its strategy, it should provide a written explanation and testify to Congress.  To further limit discretion, restraints on the composition of the Federal Reserve’s portfolio are also appropriate, as called for in the Sound Dollar Act.” John B. Taylor, ‘The Dangers of an Interventionist Fed’, The Wall Street Journal, March 29, 2012

The history of the Federal Reserve System, since its inception in 1913, has been poor from the standpoint of economic stability. During the 1920s, the money supply grew too quickly, promoting the stock market boom of 1929. Excessive tightening in 1929 induced the Great Crash. Bank failures and a contraction of the money supply through much of the 1930s, played a major role in prolonging the Great Depression in the United States.

Between 1960 and 1980, the Fed intervened unpredictably with stop-go changes in money growth, inducing frequent recessions, high unemployment and fluctuating rates of price inflation. The resulting stagflation of the late 1970s encouraged Paul Volcker to usher in an era of rules-based monetary policy designed to squeeze stagflation out of the U.S. economy.

Between 1980 and 2000, the Fed followed monetary rules that led to low unemployment, low inflation, stable interest rates and stronger economic growth. Unfortunately, after the dot-com collapse of 2000, andthe  September 11, 2001 attack, the Federal Reserve succumbed to populist pressures as Chairman Alan Greenspan seized the controls with uncontrollable zeal. From 2003 through 2012, the Federal Reserve has behaved in a manic fashion, creating the financial crisis of 2008 and plunging the U.S. economy into a 1930s style recession that shows no sign of ending.

The potential stagflation confronting the United States is of immense proportions. Let me focus on reserve balances credited by the Federal Reserve and deposited in  U.S. banks. This is base money,which eventually expands through the money multiplier into the broader M2 money supply (or its equivalent)  that, in turn,  determines the aggregate level of prices across the economy.

Prior to the 2008 panic, reserve balances held steady at approximately $10 billion. In its own post-2008 panic,  including its mindless initial money injections, followed by QE1 and QE2 stimulus injections, the Federal Reserve has  pumped up those reserve balances to $1,600 billion – a 16-fold increase. 

 So far the impact on M2 has been relatively small. But once the recession eases, the scope for expansion in M2 will be dramatic. In the absence of base money contraction,  M2 money balances will soar, inducing significant inflation. The economy will be severely disrupted, most likely  by inflation, or stagflation, but alternatively by a Fed-induced  major recession.

If the Federal Reserve attempts to claw back base money by selling off its enormous portfolio of mortgage securities, long-term interest rates will soar and the housing market will tank. If it sells short term Treasuries, the credit market will dry up and with it, consumer expenditures. If it leaves base money alone, the U.S. will lurch back to double-digit rates of price inflation.

In essence, the Federal Reserve has replaced the entire interbank money market and large segments of other markets with itself.  It determines the interest rate without regard for the demand and supply of money.  In so doing, it has socialized financial markets, replacing decentralized markets with centralized bureaucratic control. Ben Bernanke has morphed into V.I. Lenin as the  autocratic leader of an increasingly socialist country.

Off with his head!

US Federal Reserve joins the long march to socialism

January 9, 2012

The Federal Reserve until recently has jealously guarded its independence from politics by focusing attention exclusively on monetary policy.  Wisely, it has sought to distance itself from fiscal policy which is a central responsibility of the political process.

No longer!  Federal Reserve Governors and senior Federal Reserve policy-makers are now actively urging the fiscal authorities to advance socialism through redistribution policies.

“William Dudley, president of the Federal Reserve Bank of New York, said on Friday that taxpayers and mortgage bond investors should shoulder the cost of reducing borrowers’ loan principal.  Sarah Bloom Raskin, a member of the Federal Reserve’s board of governors, added on Saturday that forcing leading banks to cut mortgage principal as a penalty for poor practices was an option ‘that should stay on the table’ …according to Federal reserve policymakers, the US Congress and the Obama administration should adopt new programmes that make it easier for troubled borrowers to keep their homes and potential homebuyers to obtain loans.”  Shahien Nasipour, ‘Call for US  taxpayers to help borrowers’, Financial Times, January 9, 2012

The Federal Reserve confronts a problem in trying to resuscitate the US housing market (and construction industry) via monetary policy. Its interest rates are already  near-zero,  leaving  the Fed with few options.  An explicit policy of driving up inflation would contravene its own mandate and provoke a political backlash from creditos across the nation. So the Federal Reserve falls back on crude socialism to put the housing market on life support.

In so doing, the Federal Reserve takes a wrong fork in the road. The US housing market suffers not from a deficiency, but from an excess, of political intervention. A sequence of vote-seeking US presidents  and of  vote-seeking US congressmen have intervened shamelessly over four decades to drive up the rate of home ownership among households unfitted by reason of income or imprudence from assuming additional debt. The 2007-8  bubble burst exposed such shameless chicanery. Since then attempts to prop up house prices by government intervention have slowed the rate of market adjustment. That is why the housing market remains in the doldrums.

The medicine required to clear the market is simply to allow average US  house prices to fall to clearing levels as some 4 million excess homeowners are returned to a newly-vibrant rental market. The Federal Reserve has no role to play in this market process, which lies outside its mandate and (evidently) outside the competence of its Governors.

Why should US taxpayers be on the hook for imprudent decisions by would-be homeowners who entered into non-sustainable contracts and for selfish interventions by corrupt politicians who garnered votes by pressuring government agencies to extend loans to the indigent and the reckless.


Barack Obama – true believer in the European welfare state

November 25, 2011

Barack Obama has been President of the United States now a little shy of three years. His policy positions have remained clear and unswerving both when he had workable majorities in the Congress and , since January 2011, when he has not.

Unlike President Clinton, President Obama will not adjust to accommodate changes in electoral preferences. So, if he is re-elected in November 2012, a decisive plurality of voters, as reflected in the Electoral College, will overtly and explicitly endorse his policy platform. This time, there will be no error of calculation. Americans will know precisely what they have chosen, and why they have registered that choice.

“President Obama…is a true believer in the European model of the welfare state.  Everybody who was listening learned that three years ago.  The fact that the European welfare states are crashing is irrelevant ti him; true believers are never rattled by facts, not even facts that slap them in the face like a cream pie.  The opportunity to impose a failing welfare state on America is what drew him to the presidency in the first place.  The congressional elections last year, the Republican rout that Mr. Obama rightly called a ‘shellacking’ of his party, made no impression either.  The results were all about cutting taxes and dismantling government, but not to Mr. Obama.  Those elections were merely a few pebbles on the road to Utopia.” Wesley Pruden, ‘If only pigs really could fly’, The Washington Times, November 25, 2011

Barack Obama is running for re-election on a platform of consolidating forever  the expansion of government during his first two years at 25 per cent of gross domestic product or more, while increasing federal taxes to 28 per cent of gross domestic product or more in order to pay lip-service to debt reduction. That involves almost doubling federal income taxes. And that cannot remotely be achieved on the backs of the top 1 percent alone.

The path that Barack Obama has chosen is unsustainable in the longer-term. Greece, Spain, Portugal and Italy have already demonstrated that. And France is right on the edge. The only country that conceivably can pull it off is Germany, because their population is industrious and frugal.And the German government is already trimming its spending.  A majority of other Europeans and Americans do not share those  Germanic qualities. So they are on the big spenders’ roads to ruin.

Barack Obama, of course, does not care at all about the longer-term. He cares only about the present and the following fours years. By then, wealthy as he and his immediate family will be, he can relocate anywhere across the globe. And allow the United States to go to Hell in a handbasket:

“Everyone knows that unless someone does something, everything will be swallowed by one of those black holes from outer space.  Health care costs, which already consume 3.7 per cent of the gross domestic product, will take almost twice that by the year 2020.  Democrats are determined not to reform any of that.  Who will still be in Washington then?  The distance to 2020 might as well be measured in light years.  Next year is the short run, where Washington measures it all.  In the long-run, as Winston Churchill famously said, there is no long run.” Wesley Pruden, ibid.

Let’s not twist again

September 22, 2011

“Come on let’s twist again like we did last summer

Yea, let’s twist again like we did last year

Do you remember when things were really hummin’

Yea, let’s twist again, twistin’ time is here

Yeah round  ‘n up ‘n down we go again

Yea, let’s twist again, twistin’ time is here.

Chubby Checker Lyrics, 1961”

 Chubby Checker’s  twistin’ time is here again!  On September 21, 2011, The Federal Reserve Open Market Committee  announced its decision to revert to a 1961 policy twist designed to reboot the United States economy.  The stock market saw the policy for what is was worth: the Dow Jones Industrial Average dropped 283.82 points on the news flash.

 Ben Bernanke has done it again! When Bad Ben is about to make a policy statement, sell the U.S. stockmarket short and you will make a packet. That is what happens when progressive socialists occupy positions of authority in a market economy.

To be fair, the problem does not lie entirely with Bernanke and the other six stagflationers on the Federal Reserve Open Market Committee who voted with him, though it surely does not lie with the three dissenters who stood up for price stability and sound money.  The problem lies also with the dual  mandate Congress gave the Fed – to pursue maximum employment and stable prices over the long term. 

 This dual mandate is not required of central banks in the rest of the world, where the pursuit of stable prices is the only mandate imposed.   The current state of economic knowledge does not support the dual mandate, since the goals of maximum employment and price stability often appear to be in conflict. Monetary policy should be restricted to promoting sound money and price stability. Laissez-faire capitalism,  operating under sound money and the rule of law, will do the rest. 

The F-twist, in its 2011 manifestation, involves the Federal Reserve selling off immediately $400 billion of  its  Treasury notes due to mature within three years or less while simultaneously purchasing $400 billion of  Treasury bonds  at the long end of the market – with six to 30 year maturities.  The intent of the F-twist is is to put further downward pressure on longer-term interest rates and to help to make broader financial conditions more accommodative. With long-term interest rates already at historic lows, this policy is unlikely to promote an investment boom across the United States.

The F-twist goes further than this.  The Fed will also invest the principal payments that it receives on its asset holdings into mortgage-backed securities, rather than into U.S. Treasuries.  The objective here is to reduce yet further mortgage rates, thus supporting the housing market.  With mortgage rates already at historic lows, this policy is unlikely to reverse the downward trend in house prices or materially to reduce the foreclosure overhang that is the key symptom of house-market disequilibrium in the United States.

The F-twist clearly worsens the balance sheet of the Federal Reserve. With its balance sheet distorted  by excessive long maturity holdings, should sound money require significant increases in long-term rates of interest, the Fed’s assets could be halved or more as bond prices collapse.  With its balance sheet distorted by holding high risk securitized mortgages, if foreclosures get back on track, significant portions of the Fed’s assets may turn out to be worthless.  Both possibilities render the Fed a hostage to fortune.

If the Fed were restricted to a single mandate of  ensuring sound money, it would more likely acknowledge the evident truth of September 2011. The United States economy is experiencing a capital strike that will continue until President Obama is removed from office, be it in 2012 or in 2016.  Few firms will invest in market development or will hire new employees while uncertainty about the future of the federal debt and question-marks over the direction of progressive socialism hang over the market-place.

Only the political market-place can clear those uncertainties and determine whether the United States will continue on its current trajectory into Second World status, or whether it will recover its exceptionalism and, once again, show other nations a clean pair of economic heels.

Unfortunately no agency of government can twist its way around that epochal  choice. It can only take the economy round ‘n round and up ‘n down again!