Category: Economy

Analysis of the global economy

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Fed’s numerical thresholds are a bad idea

The Fed effectively tied its monetary policy to a balloon bobbing in the wind. Pedro da Costa writes on Reuters:

The Federal Reserve on Wednesday took the unprecedented step of tying its low rate policy directly to unemployment, saying it will keep rates near rock bottom until the jobless rate falls to 6.5 percent. That’s as long as inflation, the other key parameter of policy, does not exceed 2.5 percent.

Both unemployment and inflation are moving targets. Unemployment primarily because results are highly dependent on the participation rate: disheartened job seekers who give up looking for work are excluded from unemployment figures. Likewise, inflation measures are highly subjective. Weightings require constant adjustment because of advances in technology and changes in consumption patterns, while cost of housing estimates, which make up 39 percent of core CPI, seem to have little connection with reality. Scott Sumner points out:

The problem seems to be that, according to the Bureau of Labor Statistics, housing prices did not fall. On the contrary, their data shows housing prices actually rising between mid-2008 and mid-2009, despite one of the greatest housing market crashes in history. And prices did not rise only in nominal terms; they rose in relative terms as well, that is, faster than the overall core CPI. If we take the longer view, the Bureau of Labor Statistics finds that house prices have risen about 8 percent over the past six years, whereas the famous Case-Shiller house price index shows them falling by nearly 35 percent…..

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Ray Dalio Explains The Rare Set Of Circumstances That's Making Him Bearish On Markets | Business Insider

Joe Weisenthal reports on hedge fund guru Ray Dalio’s outlook:

His novel set of circumstances he sees is an economy that faces austerity (due to the Fiscal Cliff, etc.) coupled with a Fed that’s mostly blown its bazooka, and can’t get much more juice out of QE.

  • Yields can’t go down anymore.
  • Austerity is coming.
  • Economy is running out of steam.
  • QE is losing its efficacy.
  • Rate turn probably finally coming late in 2013.

Read more at Ray Dalio Explains The Rare Set Of Circumstances That's Making Him Bearish On Markets – Business Insider.

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Dangers of quantiative easing may be political more than technical

Glenn Stevens, governor of the Reserve Bank of Australia, in an address to the Bank of Thailand today commented on the dangers facing central bank monetary policy:

For the major countries a further dimension to what is happening is the blurring of the distinction between monetary and fiscal policy. Granted, central banks are not directly purchasing government debt at issue. But the size of secondary market purchases, and the share of the debt stock held by some central banks, are sufficiently large that it can only be concluded that central bank purchases are materially alleviating the market constraint on government borrowing. At the very least this is lowering debt service costs, and it may also condition how quickly fiscal deficits need to be reduced. There is nothing necessarily wrong with that in circumstances of deficient private demand with low inflation or the threat of deflation. In fact it could be argued that fiscal and monetary policies might actually be jointly more effective in raising both short and long-term growth in those countries if central bank funding could be made to lead directly to actual public final spending – say directed towards infrastructure with a positive and long-lasting social return – as opposed to relying on indirect effects on private spending.

The problem will be the exit from these policies, and the restoration of the distinction between fiscal and monetary policy with the appropriate disciplines. The problem isn’t a technical one: the central banks will be able to design appropriate technical modalities for reversing quantitative easing when needed. The real issue is more likely to be that ending a lengthy period of guaranteed cheap funding for governments may prove politically difficult. There is history to suggest so. It is no surprise that some worry that we are heading some way back towards the world of the 1920s to 1960s where central banks were ‘captured’ by the Government of the day.

via RBA: Speech-Challenges for Central Banking.

Hat tip to Walter Kurtz at Business Insider.

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Carney broaches dumping inflation target | FT.com

Claire Jones reports that Mark Carney says central banks should consider scrapping inflation targets and target nominal GDP instead — allowing more aggressive measures during a down-turn.

[Mark Carney, next governor of the Bank of England] suggested that a nominal GDP target, where a central bank sets monetary policy based on both inflation and growth, would do more to boost economic output. “For example, adopting a nominal GDP-level target could in many respects be more powerful than employing thresholds under flexible inflation targeting,” he said.

Read more at Carney broaches dumping inflation target – FT.com.

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Republicans Send Fiscal Cliff Counteroffer To Obama – Business Insider

Brett LoGiurato reports that House Speaker John Boehner made a counter-offer in fiscal cliff negotiations. His spokesman Michael Steel issued a brief statement:

“We sent the White House a counter-offer that would achieve tax and entitlement reform to solve our looming debt crisis and create more American jobs. As the Speaker said today, we’re still waiting for the White House to identify what spending cuts the president is willing to make as part of the ‘balanced approach’ he promised the American people. The longer the White House slow-walks this process, the closer our economy gets to the fiscal cliff.”

via Republicans Send Fiscal Cliff Counteroffer To Obama – Business Insider.

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The Fed's interest rate policies are damaging rather than restoring confidence and should be reversed

Vince Foster at The Fiscal Times writes about this Wednesday’s FOMC meeting:

With Operation Twist due to expire at the end of the year and because the Fed is essentially out of short-term bonds with which to finance purchases, it is virtually assured that they will opt for outright purchases financed with printed money……….Now, said Ned Davis Research in a report last week, the Fed is likely to replace Operation Twist with purchases of Treasuries, perhaps in the $45 billion a month range, bringing its total monthly purchases to $85 billion.

Outright purchases of long-term Treasuries are far more expansionary than Operation Twist purchases which are off-set by the sale of shorter-term maturities.

Foster discusses Fed motives, considering that previous QE failed to lower interest rates or lift stock market values.

It has been my contention that the main objective is not to reflate asset prices but rather to stimulate credit creation and the velocity of money. According the Fed’s H.8 Release banks are holding over $2.6 trillion in cash that’s sitting idle on their balance sheet in securities portfolios. Bernanke is trying to flush the banking system out of these bloated securities positions and into extending credit by lowering bond yields to levels where banks can no longer afford to hold them.

Foster points out that negative real interest rates may be discouraging banks from lending, inhibiting the recovery. Also that bank balance sheets — bloated with Treasuries and MBS ($2.6 trillion) purchased as an alternative to lending — are vulnerable to capital losses should interest rates rise.

The Fed’s low-interest-rate policies have created a powder keg while being largely ineffectual in stimulating credit creation and consumption. The safest approach would be to reverse these policies and raise interest rates. Raising long-term rates to sustainable levels would reduce uncertainty and help restore confidence. House prices and stocks may initially fall but this would flush any excess inventory out of the system, giving purchasers and banks confidence that the market really has bottomed. With higher rates and stable collateral, banks will be more willing to lend.

At present we are all sheltering under the shadow of the Fed’s low-interest-rate umbrella, but with a nagging fear as to what will happen when the Fed takes the umbrella away. Fed policies are no longer adding confidence but increasing uncertainty. The sooner the umbrella is removed, the sooner the system will return to normality.

QE is likely to continue — Treasury needs to print money in order to fund the fiscal deficit — but this can still occur at higher rates. The fiscal deficit unfortunately will remain with us for some time — until confidence is completely restored and deflationary effects of private sector deleveraging are consigned to the history books.

Read more at How the Fed Will Affect Economy, Market in 2013 | The Fiscal Times.

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Pettis: Australia should be pessimistic | MacroBusiness

Michael Pettis writes about the latest Australian government White Paper Australia in the Asian Century that projects an average 7% GDP growth rate for China between 2012 and 2025:

This seems to put the Australian government among the most optimistic in the market when it comes to long-term growth expectations for China. I have always assumed that government projections should generally be on the pessimistic side to prepare for unexpected negative shocks (positive shocks can take care of themselves), but apparently not. I am glad to say that my own conversations with Australian government officials lead me to believe that this White Paper may represent the official view of the government, but it does not represent the private views of all Australian government officials…….

Read more at Pettis: Australia should be pessimistic | MacroBusiness.

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IS STATE INTERVENTION IN THE ECONOMY INEVITABLE? | CIS

Peter Boettke teaches economics at George Mason University. He writes that ongoing economic woes demand drastic reduction in state intervention into free markets:

The great expansion of trade and technology in the twentieth and twenty-first centuries has produced a level of material wealth that enabled the cost of government intervention to be offset, and remain largely hidden to many observers. This possibility is not a new phenomenon. Adam Smith pointed out long ago that the power of self-interest exercised in the market economy is so strong that it can overcome a ‘hundred impertinent obstructions with which the folly of human laws too often encumbers its operations.’ But it is important to stress that the great material progress realised over the past 100 years was not caused by the expansion of state invention into the economy but in spite of those interventions. And the tipping point is when the number of ‘impertinent obstructions’ grow from hundreds to thousands so that the market economy can no longer hide the costs of the folly of human laws.

It is important to distinguish between state intervention in the free market and state regulation of free markets. Regulation is essential for orderly functioning of the market place. Compare the early days of stock exchanges to the benefits of current regulation regarding insider trading, market manipulation and stock flotation. State intervention, on the other hand, is disruptive to the orderly functioning of markets — distorting price signals which can lead to massive imbalances. The most obvious recent example of state intervention is the Fed suppression of interest rates in the early 2000s which led to a massive property bubble and global financial crisis in 2008.

Read the entire article at IS STATE INTERVENTION IN THE ECONOMY INEVITABLE? | CIS.

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We warmed to Gough, even as his grand design crumbled

Amanda Vanstone, former Howard government minister, writes on the 40th anniversary of Gough Whitlam’s government.

For a surprisingly long period there was no effective cabinet, then unsatisfactory cabinet process. It was nothing short of economic chaos, a disaster. It was a reminder to everyone that you can have all the great ideas you want about a better world, but if you do not keep the economy on track your government will fall apart.

via We warmed to Gough, even as his grand design crumbled.

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Phoney recovery?

First signs of recovery after a recession are normally rising earnings, initially from corporate cost-cutting but followed up with rising revenues.

With massive central bank pump priming — referred to by Mark Mobius here — this time may be different. Flows of new money from central bank balance sheet expansion are likely to find their way into the stock market — and even the housing market — driving up prices. But consumption is lagging with slow growth in employment and average wages. With lackluster sales growth, earnings are likely to remain sluggish. Which means inflated stock market valuations and high price-earnings ratios as stocks are driven into over-bought territory. Not a solid foundation for a sustained recovery but another rung up the ladder of risk.

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