Fed head Ben Bernanke, at his first-ever news conference on Wednesday, slammed the door shut on any new QE3 pump-priming. The $600 billion QE2 program to purchase bonds will end on target at the end of June, and that will be that. Mr. Bernanke also suggested that the Fed’s “extended period” for the near-zero federal funds target rate could end in a couple of meetings. Perhaps these announcements suggest a bit-less-easy monetary policy. Perhaps.
But Mr. Bernanke had no defense of the sinking dollar, or the inflation it brings, or the drop in middle-class living standards it causes. So it’s little surprise that gold prices surged $24 to $1,526 during the Fed chairman’s press conference. Silver jumped sharply as well. The markets clearly don’t see any King Dollar shift by the Fed.
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Mr. Bernanke just doesn’t get that inflation-sensitive market-price indicators — like rising gold, oil, and commodity indexes, and the falling dollar exchange rate — are trying to signal higher future inflation. Instead of listening to markets, he is determined to fight them. This is a losing battle. Instead of a market-price rule (anchored by gold) we have some sort of Bernanke fine-tuning rule. It’s not working.
While Mr. Bernanke slightly downgraded the central bank’s economic outlook and slightly upgraded its inflation concern, the Fed still holds out “hope” that the sluggish 2 percent first-quarter GDP will give way to 3 percent or more growth later this year, and that the commodity-based bulge of inflation will come back down as commodity prices somehow sink. This seems to be a triumph of hope over experience.
With the CPI running about 6 percent annually in the first quarter, the real inflation-adjusted fed funds rate is deeply negative. Under similar circumstances in Europe, Jean-Claude Trichet raised the ECB target rate by a quarter of a percent last month. By that benchmark and others, the Fed’s so-called return to normalcy is way behind the curve.
Look, the economic emergency dating back to the fall of 2008 has long been over. And the alleged deflation threat has completely dropped off the radar screen. In the absence of these risks, the Fed’s ongoing emergency policies — including the zero target rate and the $600 billion QE2 — make no sense at all and should be withdrawn.
I recall how President Reagan often argued in the 1980s not simply that a strong dollar was in the nation’s interest, but that a great country, by necessity, needs a strong and reliable currency. Link to gold — that was Reagan’s argument. Paul Volcker and then Alan Greenspan (during the first three of his four Fed terms) essentially agreed with Reagan. The 20-year collapse of gold prices that ensued was associated with a remarkable non-inflationary prosperity and a huge stock market rally that generated unbelievable volumes of new wealth for investors and entrepreneurs.
Today, this hard-money thinking is nowhere to be found in official Washington. Yes, the Fed can produce new money. But no, it can’t produce new jobs and growth in any permanent sense. What does? Limited spending, flat tax rates, minimal regulation, and stable money.
Now where’s the next great American leader to revive and restore this pro-growth model?
– Larry Kudlow, NRO’s Economics Editor, is host of CNBC’sThe Kudlow Report and author of the daily web blog, Kudlow’s Money Politic$.
Well stated Mr. Kudlow. The man is as mysterious as Obama in why he does as he does.
Having said that, one of my retirement accounts is a 403(b) of which is funded by employer with 7% of gross pay. I keep it tied to CPI +3%, so there is no risk of loss of capital, as I invest in stocks with my own funds in a 401(a)
I have had the 403(b) tied to CPI +3% for 12 years, and have obviously always retained 100% capital and interest. As unfortunate as inflation is at this time, I will at least be making double digit gains on my retirement at a time when the balance is very significant to begin with. To bad most people don't have this type of account as well.
"Mr. Bernanke just doesn’t get that inflation-sensitive market-price indicators
are trying to signal higher future inflation"
He gets it fine. Commodity traders are indeed betting on high future inflation.
There just isn't the remotest sign they are right about a particular of it.
These are the same people who gave us $145 oil in the summer of 2008, right before the biggest
deflationary smash since the 1930s.
They cried that the Fed was too loose to cut rates in the fall of 2007, when the real estate market
and GDP had already rolled over, and bid prices to the moon in response. Which promptly blew up on them.
"Look, the economic emergency dating back to the fall of 2008 has long been over.
And the alleged deflation threat has completely dropped off the radar screen."
Somebody forgot to tell that to the US financial sector. It has reduced its total debt
by $3 trillion in that period. In the 4th Quarter of 2010, the annual rate for the US financial
sector was to pay down debt at an $856 billion annual rate. At the close of that year, the balance
sheet of the sector as a whole was $1.36 trillion smaller than at the close of 2009.
Yes that rate of debt destruction was slower than the peak rate of early 2009, but it is still
not net new debt creation, which is normal. All the looseness by treasury and Fed has done no more
than offset the epic tightness of the private financial sector.
The asset backed securities market has collapsed; it is half its size at the bubble top.
No net new mortgage has been written in this country in 3 straight years.
Expecting inflation from those things is perverse. Yes the market does expect such inflation -
just as it did in late 2007 and early 2008. Why? Focus on policy makers and nobody paying any
attention to the rest of the financial system.
Mr Kudlow, please review the state of the private financial sector and its actions and retrenchment since 2008, along with the still elevated credit losses causing that retrenchment. And rethink.
Bernanke is not a dove. He is a student of Friedman and a monetarist, and he knows what he is doing.
JasonC,
I'm not sure what your point it is, as you never addressed Kudlow's main thesis -that onset of significant inflation due to the Fed's monatary policies. And as far as corporate debt is concerned (or for that matter any debt), inflation makes it far easier to pay off one debts. The Fed's policies essientially are forcing corporations and mid size businesses to spend thier cash (some $2 trillion if you believe Wall St)by significantly devaluing the dollar. The Fed may just get its way if current corporate spending numbers are accurate. But, in the end, both Wall St and Main St will find themselves with double digit inflation. We've been down this path before circa 1975-1979.
JPK - my point it is decidely more like 1936 than it is like 1976, out there.
The Fed is not the only entity that effectively creates new broad money by expanding its balance sheet. All financial sectors do so. If the Fed being easy causes other sectors to strongly expand their debts, then yes we get inflation. But when they don't, we don't.
In 1976, 77, 78, and 79, the change in total debt of all sectors in the US, financial and non financial, was to increase by 15-20% of GDP, per year. Specifically, 14.7%, 18.5%, 20.3%, abnd 18.9% in those years.
When the Fed added $42.5 billion to its balance sheet (over 4 years), the rest of the system used that base money to lend it out up to reserve limits and then some, and total debt increased $2.1 trillion, or 50 times the change in the size of the Fed's own sheet.
In the last 2 years, instead, total debts have *decreased*, by 6% of GDP in 2009, and a modest 4.4% increase in 2010, net a reduction of $180 billion or 1.5% of GDP, in total debts outstanding.
The price level rose in the 70s because total debts *nearly doubled*. In the last 2 years, instead they *haven't moved*.
All the net debt issuance by the Treasury, and all the money expansion by the Fed, has been entirely matched by *contraction* of the private financial system.
In the 10 years up to the bubble top, it was entirely normal for the private financial system to increase its balance sheet size by $2 trillion per year. From net new mortgage financing, from issuance of asset backed securities making every firm's receivables into cash, from expanding finance companies, as well as growth at all the commercial banks.
All of that was *shut off* at the end of 2008.
The Fed's additions to reserves are not being lent out again, not 50 times over as in the late 1970s, not 20 times over, not 10 times over. They are merely matching the extinguishment of debt by private firms, especially in the financial sector.
Bank of America has 40% of its entire assets in cash. Before the crisis, a normal figure for that would be 15%.
Everyone scrambled to pay off their debts; nobody but the Treasury is borrowing anything.
You might think with rates so low and the prospect of price increases, everyone would be borrowing hand over fist to buy speculative assets. Some operators no doubt are, but not in the aggregate, not remotely. Instead the public and corporations both, have decided that debt is a sin and they don't want to have any. More soberly put, leverage levels at the top of the bubble were dangerously high and lots of people got burned by them, and everyone is deleveraging in consequence.
This is emphatically not what happened in the late 1970s.
And Bernanke knows this, even if the average journalist or pundit does not. He is watching what the whole financial system is doing - they are only watching more policy makers are doing, because the private sector does not exist to journalist or politicians.
There isn't any large broad inflation, because the conditions for it do not exist. Yet if you like, perhaps simply. I expect CPI to move only 2-3% a year - certainly not the 7-10% a year seen in the late 1970s.
Why aren't banks lending? Because mainstreet isn't paying them back for their existing loans, first off. Loan losses are running 2.5% of loan book, 5 times normal levels. And because the banks are not reserve constrained - needing the Fed to expand narrow money before they can expand broad money - instead they are capital constrained. They can't take the risks involved in expanding broad money, full stop. Not until they earn back losses or raise new capital.
In short, the damage to the financial system from the 2008 crisis has not yet healed, contrary to Kudlow's statement that it is long over. It isn't over, and private finance remains extremely tight due to the damage it caused.
JasonC,
I think I get your points. You are correct in that from a total debt (private and public) this is far different than 1975-79. I was focusing on public debt, the M-supply and the trillions the Fed has added to its blance sheets since 2008 (going back to Paulson).
You do make a good point in bringing up the lack of recovery in real estate, as well as the lack of business activity during this recovery. In that respects, you are correct in pointing not using the late 1970s as an analog. In a way that does underscore my original point. The Fed's inflationary monetary policies, which made sense 3 years ago have not worked (if the intention of Bernecke was to recover positive GDP growth and its attendent jobs). The fact that private firms and families haven't begun spending and borrowing at a pace comparable to say 2004-05 should at least give him pause. In the mean time, Gold has almost doubled in price (as has crude oil and other commodities) since late 2008. Energy and food, while being volatile, are necessities. And the inflation in these areas is siphoning off billions of dollars that would otherwise be spent or saved elsewhere. While, it wasn't energy that popped the real estate bubble in 2008, energy and food costs and a flight from the dollar worldwide will sap this recovery. By the time inflation spreads to other areas (esp wages), it will be too late to do anything other than react. I agree with Kudlow in that respects - Bernecke is playing with fire. I hope you are right; otherwise, the next 2 years could be very rough.
One last thing: I would begin to worry about our banks. Most of our large banks hold large amounts of mortgages, which continue to lose value every month. Perhaps this is why many banks are keeping such large cash reserves. I always thought it was a mistake for both the WH and Congress not to address this problem once it became apparent that TARP II didn't stop the fall in real estate prices. I would have thought by now, real estate would be on the recovery. I could be that when the dust settled that there is way too much inventory in both residential and commerical properties. Our population is aging, and the demand for both residential and commerical properties will never regain its former high levels. If that's the case, deflation is not totally out of the question.
JPK - you write "inflation in these areas is siphoning off billions of dollars that would otherwise be spent or saved elsewhere." In the case of oil that is true, in the case of food it is not. One, food prices are only about 5% higher than in mid 2008. Two, the US is a large net exporter of food and agricultural products generally. Higher food prices marginally help the terms of trade. As a large oil importer, the opposite is true for higher fuel prices; those are a drag on GDP.
Oil is a bigger sector anyway. It takes about a $35 increase in the price of oil to move the terms of trade enough to subtract 1% from GDP. At the top in 2008, oil was $145 a barrel; we are 1% of GDP lower in expense that that figure. But right after in the smash, it fell as low as $35, and nearly stabilized around $70 after that. We are about 1% of GDP higher in oil prices right now - largely due to Libya and the middle east unrest generally - than that $70 level.
The oil price certainly matters, and we should certainly be doing more both to resolve the serial crises in the middle east, and to lift dumb regulation in the US preventing domestic oil development, and for that matter other efficient fuels we have in abundance (coal and natural gas). We aren't due to green pieties on the left, not monetary anything.
As for citing gold, as you and Kudlow both do, I think it is about as reliable a predictor of future broad inflation as the price of McMansions in California, or Florida condos, were 5 years ago. It is simply the latest asset price bubble in a hot item people are chasing for momentum reasons. At least we won't have widespread problems when those stop going up like real estate gave us, because there are fewer people involved, it is a much smaller market, and fewer borrow to play (though futures markets aren't exactly 100% down).
You acknowledge that real estate remains depressed due to oversupply. But you don't seem to notice that such oversupply is incompatible with the idea we face near term high inflation. The supply of housing swamped demand for it once the prices rose enough, because houses could be and were produced for much less than those high speculative prices.
Why was that possible? Because wages, raw materials, etc did not double or quadruple in price in line with house or oil prices.
Remember the Fed did tighten from 2005 to late 2007 (by some measures, until early 2008). M1 did not budge in that period, and short rates hit 5.25% and remained there for a year. Many at the time thought even that rate was low, and continued to bet on high inflation. But it was not low - it was high enough to stomp the real estate market flat.
I deny however that the Fed's policies since late 2008 "have not worked". They have. We faced the real possibility of a deepening systemic financial crisis of the sort we haven't seen in this country since the 1930s, and that was averted. GDP is growing again. Unemployment, though always a lagging indicator, is falling again.
In fact the major problem at the moment is to wean the private economy from fiscal stimulus, which remains far too generous for this stage of the cycle. GDP troughed in the 2nd quarter of 2009. It is 7 quarters since then. By the time QEII ends this summer, the recovery will be 2 years old and the previous GDP level will have been clawed back and a bit to spare.
There isn't any excuse for continuing to run a deficit of 10% of GDP this late into a recovery. That is where greater discipline is needed at the present time.
In short the Fed is not the problem. They have done a solid job - not perfect, but solid. The congress has not. It is slow as usual, and can only agree on unsound popular policies that defy arithmetic.
Stop bashing the Fed, and focus instead on getting rid of the federal budget deficit in a timely manner. That is my prescription.
Bernanke thinks he can fine tune the economy with his monetary buttons. He can't, and like Greenspan before him he's created yet another bubble after trying to recover from a previous bust. The arrogance and incompetence of Fed money mandarins is breathtaking.
Private Joker - The Fed didn't invent bubbles, and free speculators merrily create them at all times and in all places. And always will, wherever at liberty to do so.
I've been reading the monograph "A History of Interest Rates" recently. 11 financial crises per century is the average, as far back as we have records detailed enough to describe them.
The arrogance that is breathtaking is the glib ingraditude of populists and radicals toward American financial capitalism, which in fact has created most of the wealth any of them have ever touched...
@JasonC: Let me do the math for you. Actually, let me let Walter Bagehot do it:
"If a merchant have £50,000 all his own, to gain 10 per cent on it he must make £5,000 a year, and must charge for his goods accordingly; but if another has only £10,000, and borrows £40,000 by discounts (no extreme instance in our modern trade), he has the same capital of £50,000 to use, and can sell much cheaper. If the rate at which he borrows be 5 per cent, he will have to pay £2,000 a year; and if, like the old trader, he make £5,000 a year, he will still, after paying his interest, obtain £3,000 a year, or 30 per cent, on his own £10,000. As most merchants are content with much less than 30 per cent, he will be able, if he wishes, to forego some of that profit, lower the price of the commodity, and drive the old-fashioned trader--the man who trades on his own capital--out of the market."
-- Walter Bagehot, Lombard St.
What applies to merchants applies even more so to bankers, so combining low interest rates with small capitalization requirements creates ever more leverage in the financial markets until the system collapses of its own weight, as in 2001 and 2008.
You are correct that his happens naturally in any financial system, but I think you are incorrect when you assume low-interest rates and cheap money don't dramatically accentuate these cycles in ways that are devastating to the economy.
In 2001 and 2008, I was running two small startup companies that were attempting to raise capital to fund product development. The financial shenanigans in the market, and the distorting effects of low-interest rates and government-subsidized markets like housing which redirect capital to the wrong parts of the economy, made this process more difficult.
Efficient capital markets are a requirement for a economy, but they ultimately don't really create wealth. They make the management of existing wealth more efficient, via mechanisms like arbitrage, efficient and liquid trading markets, etc., which is a good thing.
@Jason C. How can you talk about overall deleveraging when all that is happening is debt is moving from the private to the public sector? This is not deleveraging and through devaluing the dollar is this not actually causing inflation? And so yes, the fed is causing inflation by easing too much as usual. Also doesn't QE have the effect of distorting markets by allowing easing to go on longer than normally markets would allow due to rising treasury bond yields? So what we have here is just the government trying to inflate away their debt, or deal with it by printing money and buying their own debt?
"How can you talk about overall deleveraging when all that is happening is debt is moving from the private to the public sector?"
Because it is a huge change from trend in net debt creation. It is normal for debt to grow as the economy grows. Debt is not a sign of negative net worth, just one way asset values are financed. Total asset values have increased 7.5% a year nominal since WW II. It is normal for total debts outstanding to rise that fast or faster.
Faster, because credit intermediation grows with time, with more hands between the final creditor and the final debtor. Financial sector debts have on average grown twice as fast as the economy or total assets, as a result.
The present behavior of the total debt series is 3.5 standard deviations below its post war mean.
The present behavior of financial sector debts is more like 6 standard deviations below that means and the last time it happened was the 1930s.
None of which is a sign of inflationary anything.
As for the dollar, it bottomed right after Bear Stearns failed. It is higher today than in early 2008. It has moved 20% in either direction several times in that span, including 2 very sharp appreciations that pundits and the press pretend never happened.
We don't run a fixed exchange rate system anyway, making talk of "devaluation" rather misplaced. The dollar has no fixed international value to change. It floats.
"the fed is causing inflation by easing too much as usual"
Inflation is low and moderate at the moment, and has been all decade. Asset prices have bubbled and popped, and commodities are the favorite speculative plaything of the whole period (though real estate was bigger still until 2007), but the broad price level has increased about a third in the last decade. Which is normal for the entire post WW II period - slightly under that normal actually.
Would it be nice if inflation instead of creeping at 2-3% were unitarily zero? Perhaps. But it is minor matter either way, nothing unusual, and decidedly not the inflation problem of the 1970s that the entire populist right apparently thinks is happening.
"QE have the effect of distorting markets"
Every economic action by anyone "distorts" markets. The question for money supply is not whether to have one, or whether it should ever change (it should and it should grow, the whole economy does and money supply needs to), but always how much, and when.
And that is a matter of gauging the amount of money supply growth that roughly maintains the purchasing power of dollars, without unduly restricting available credit for no reason.
The value of each dollar could be increased by reducing the number in existence, but why should it? Where is it written that the interests of those currently holding dollar balances or long dollar loans are more important than the interests of new borrowers? Nowhere.
The Fed judges such things pragmatically and empirically. If they didn't, private bankers would. In fact, right now the degree of overally monetary tightness is being set more by those bankers than by the Fed.
"So what we have here is just the government trying to inflate away their debt"
Hardly. Every move the Fed has made it has made to accomodate the private financial sector especially the needs of the banks. It wasn't the debt of banks that traded through zero in late 2008. The US treasury didn't need help from the Fed; it was able to place everything it wanted at tiny rates on the same days major banks couldn't raise intermediate term money at 12 and 14%.
In 2008, the banks all borrowed from the Fed. From the second quarter of 2009 they paid it back, and if the Fed hadn't redeployed the money as it came back in, the US money supply would have collapsed at twice the peak rates seen in the early 1930s. So instead it rolled over the funds into mortgage securities, basically swapped with the banks again. The banks lost ownership of $1 trillion in mortgage bonds (paying 4.5% BTW) and got in return $1 trillion in reserve cash at their Fed branch (paying only 0.25% BTW).
The banks did this to become more liquid. When their own debts were trading at double digits in the secondary market, it made no sense to lend out at prime or mortgage rates, especially to deadbeats defaulting at 3% annual rates (aka "mainstreet"). Instead they are paying down debt with a will and stockpiling safe cash. Doing so has improved their credit standing enough that their own debt is back to trading around 5-6%. Which still hardly makes lending on mortgages paying 4.75% but losing 2.5% a year in credit losses terribly attractive, but has been enough to modestly revive loans to corporate business, at least.
The Fed is trying to get the private financial system functioning again. It is still quite deeply broken, I think most here have little concept how badly. When Bank of America is trading at its tangible book value and can earn twice as much paying down long term debt as lending to Americans on mainstreet, we are emphatically not out of the woods yet.
Yes, we all know the libertarian ideology that private anything is always flawlessly perfect and government anything is always mucked up, but the reality of 2008 and early 2009 was that private financial actors ran screaming from the prospect of other private firms controlling the allocation of capital, and instead handed over everything to the US treasury. When T-bill auctions at a rate of 0 were oversubscribed 4 times, major bank debt was offered at 14% with no takers. That wasn't the Fed's doing; private capital abdicated in panic, because it did not trust the men in the private financial system to "not get took".
We have come through the worst of that successfully, but it took the Fed to do it. Libertarian dreams of how well it all would have worked without any policy other than letting things fail, was tried the week Lehman went down and it failed utterly. Dogmatics are not a substitute for empirical reality.
We will be out of the woods when private finance is growing its sheet again instead of shrinking them, and that will happen when mainstreet pays its debts instead of mailing in the keys.
Not a minute before.
You do not need to like any of this for it to be true.
It's not too often that the comments are more substantive than the commentary, particularly for someone who is usually as spot on as Larry Kudlow.
When I was in business school back in the 1970's, Keynsianism ruled and Monetarism was the new kid on the block. I could never fully grasp Keynesianism because it was never explained how, if the ratchet effect was so great for wealth creation, why not just keep doubling or tripling down on the bet to ensure prosperity for all. The basic premise of monetarism, that in the long run the real money supply should track the real growth of goods and services in the economy (no more and no less) at least made sense, even if actually measuring both the real money supply and the growth of the economy were non-trivial technical issues.
It is ironic that just as Nixon may have said "we are all Keynesians now" in the early 70's, today there is a growing sense that the assertion that "We are all Monetarists now" would not be too far off the mark.
It should never be forgotten that economics is still rightfully described as a social science. Unlike the hard sciences, the social sciences, (in spite of the psuedo-scientific pretensions of objectivity among too many the old school leftists who dominate academia), are never very far removed from moral judgementalism.
Adam Smith considered himself first and foremost a moral philosopher.
I lived for almost the whole decade of the 70's in what started out as a friendly, peaceful, reasonably prosperous and racially integrated working class neighborhood in Buffalo, New York. During that time, I saw first hand the deleterious effects of the "Great Society" inexorably play themselves out in real time. Like millions of others, it was the real social pathologies (not racism) that ultimately drove my family out of the city and into the suburbs.
It was also during the 70's that Milton Freidman, who had already convinced me of the fundamental correctness of monetarist theory, created and starred in "Free to Choose" on PBS.
Maybe I'm simply projecting my own experiences, but I find it amazing that so few public intellectuals acknowledge how revolutionary and influential that short 10 episode television series was, or how important Milton Friedman has been to the evolution of cultural, political and economic thought in this nation, much less his influence on movers and shakers throughout the world over the past forty or so years.
Modern Libertarianism in the Milton Friedman mode is alive and well and is just coming of age in our lifetimes.
Even if Ben Bernanke doesn't make the slightest misstep over the next year or two, the sovereign debt crisis will not disappear from the radar. Its interlinked moral dimensions of crony capitalism (defacto socialism), an unsustainable social safety net (rooted in a widely held free lunch fantasy), an unstable and rapidly changing international order, and the continued degradation of societal norms that guide individuals to make good moral choices, will force the hand of both public policy makers and a growing cohort of private citizens of good faith and good judgment to seek a coherent and sustainable new course.
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