A group of conservative economists have written a scathing rebuke of Ben Bernanke and the Fed. Their general premise is that the Fed’s QE2, the printing of money (which by the way is how regular easing works), is no substitute for pro-growth policies. What these agenda-driven economists either do not realize, or refuse to acknowledge for political reasons (I’m betting on the latter) is that the Fed is not making the claim that QE2 or any of its policies are substitutes for pro-growth policies. Mr. Bernanke is trying to buy time until pro-growth policies are put into place and the glut of homes on the markets (foreclosed or otherwise).
In today’s Wall Street former Fed vice chairman Alan Blinder writes a spirited defense of Ben Bernanke (with which I agree) and of Keynesian policies (with which I do not agree in principle). Mr. Blinder responds to Mr. Bernanke’s critics by stating:
“The Fed's plan is to purchase about $600 billion of additional U.S. government securities over about eight months, creating more bank reserves ("printing money") to do so. This policy is one version of quantitative easing, or "QE" for short. And since the Fed has done QE before, this episode has been branded "QE2."”
“Here's the first Economics 101 question: When central banks seek to stimulate their economies, how do they normally do it? If you answered, "by lowering short-term interest rates," you get half credit. For full credit, you must explain how: They create new bank reserves to purchase short-term government securities (in the U.S., that's mostly Treasury bills). Yes, they print money”.
“But short-term rates are practically zero in the U.S. now, so the Fed wants to push down medium- and long-term interest rates instead. How? You guessed it: by creating new bank reserves to purchase medium- and long-term government securities. “
“That sounds pretty similar to garden-variety monetary policy. Yet critics are branding QE2 a radical departure from past practices and a dangerous experiment.”
“The next charge is that QE2 will be inflationary. Partly true. The Fed actually wants a bit more inflation because, now and for the foreseeable future, inflation is running below its informal 1.5% to 2% target. In fact, there's some concern that inflation will dip below zero—into deflation. The Fed, thank goodness, is determined to stop that. We don't want to be the next Japan now, do we?”
“But might the Fed err and produce too much inflation? Yes, it might, leaving us with, say, 3% inflation instead of 2%. Or it might err in the opposite direction and produce only 1%. Neither outcome is desirable, but each is quite tolerable. To create the fearsome inflation rates envisioned by the more extreme critics, the Fed would have to be incredibly incompetent, which it is not.”
“Finally, there's that old hobgoblin: consistency. Critics tell us that QE2 won't give the U.S. economy much of a boost but will lead to rampant inflation. Both? How does that work? “
“If buying Treasurys is a weak policy tool, a view with which I have some sympathy, then it shouldn't be very inflationary. There is no magic link between growth of the central bank's balance sheet and inflation. People, businesses and banks have to take actions—like spending more, investing more, and lending more—to connect the two. If they don't, we will get neither faster growth nor higher inflation, just more idle bank reserves.”
I agree with Mr. Blinder on all of this, but he loses me with the following:
“Somehow, additional government spending actually reduces employment—even when the economy has huge amounts of spare capacity and unused labor desperate for work; even when the central bank will prevent interest rates from rising to "crowd out" private spending. Really?”
Does Mr. Blinder really believe that there are huge amounts of “spare capacity? I don’t believe that. I believe that much of the spare capacity is really spare capacity. I think it is superfluous, unneeded, at least not given the current structure of the U.S. economy. This is not to be confused with the current state of the U.S. economy. The state of the U.S. economy is not likely to improve much until the structure of the U.S economy changes.
No longer can the U,S. economy rely on high-tech start-ups with no business plan. Nor can it rely on cheap lending irresponsible lending standards to drive housing prices and home building. U.S. leaders are going to have to institute policies which promote business activity, expansion end hiring. Without that, look for the Fed to do whatever it takes to keep the U.S. economy in a semi-alive state. Now matter your political beliefs structural changes need to occur,’’
Americans need to realize two things.
1) There is no going back to the years of the 1990s or early 2000s.
2) There is no need for the U.S. economy to be in its current doldrums. Let home prices reset. Let wages and benefits adjust (unfortunately low, at least initially).
Our trading partners are critical of Fed policy. Not just because it may weaken the U.S. dollar and ruin their exchange rate party, but also because structural changes to the U.S. economy could (if done right) make U.S. consumers less willing to purchase cheap foreign goods.
We will have to wit until next year to see if the new Congress is willing to make the necessary and possibly painful changes to make the economy healthy, long-term. I will be watching and waiting as well, but I will not be doing much writing. I am taking a hiatus for health reasons. Happy Holidays and Happy New Year to everyone.
Monday, November 15, 2010
Tuesday, November 9, 2010
Out of the Mouths of Governors
Yesterday, Fed Governor Kevin Warsh became a voice of sanity crying in the wilderness. Writing in the Wall Street Journal (and later in the day reiterating in a speech) Mr. Warsh railed against policies which focus on short-term fixes and a return to irresponsible consumer behavior. Mr. Warsh stated:
“The prevailing theory has it that U.S. policy makers should not deny our foregone fate. We should accept smaller improvements in output and employment and productivity. We should resign ourselves to the new normal and conduct policy accordingly. That is the last best hope, they argue, to preserve the remaining vestiges of a golden age that is no more.
I reject this view. I consider this emerging ethos to be dangerous and defeatist and debunked by America's own exceptional economic history. Our citizens are not unwitting victims of some unavoidable fate. The current period of subpar growth and high unemployment is real, but it need not persist. We should not lower our expectations. We should improve our policies.
Broad macroeconomic policies have not changed direction in the past several years. But change they must if we are to prosper. We can no longer afford to tolerate economic policies that are preoccupied with the here and now. Chronic short-termism in the conduct of economic policy has done much to bring us to this parlous point.
Policy makers should be skeptical of the long-term benefits of temporary fixes to do the hard work of resurrecting the world's great economic power. Since early 2008, the fiscal authorities have sought to fill the hole left by the falloff in demand through large, temporary stimulus—checks in the mail to spur consumption, temporary housing rebates to raise demand, one-time cash-for-clunkers to move inventory, and temporary business tax credits to spur investment.
These programs may well have boosted gross domestic product for a quarter or two, but that is scarcely a full accounting of their effects. These stimulus programs did little to put the economy on a stronger, more sustainable trajectory. Sound fiscal policy must do more than reacquaint consumers with old, bad habits.
Policy makers should take notice of the critical importance of the supply side of the economy. The supply side establishes the economy's productive capacity. Recovery after a recession demands that capital and labor be reallocated. But the reallocation of these resources to new sectors and companies has been painfully slow and unnecessarily interrupted. We are feeling the ill effects.
Fiscal authorities should resist the temptation to increase government expenditures continually in order to compensate for shortfalls of private consumption and investment. A strict economic diet of fiscal austerity has greater appeal, a kind of penance owed for the excesses of the past. But root-canal economics also does not constitute optimal economic policy.
The U.S. would be better off with a third way: pro-growth economic policy. The U.S. and world economies urgently need stronger growth, and the adoption of pro-growth economic policies would strengthen incentives to invest in capital and labor over the horizon, paving the way for robust job-creation and higher living standards.
Pro-growth policies include reform of the tax code to make it simpler, more transparent and more conducive to long-term investment. These policies also include real regulatory reform so that firms—financial and otherwise—know the rules, and then succeed or fail. Regulators should be hostile to rent-seeking by the established, and hospitable to the companies whose names we do not know. Finally, the creep of trade protectionism is anathema to pro-growth policies. The U.S. should signal to the world that it is ready to resume leadership on trade.
The deleveraging by our households and businesses is not a pattern to be arrested, but good prudence to be celebrated. Larger, more liquid corporate balance sheets and higher personal saving rates are the reasonable and right responses to massive government dissaving and unpredictable government policies. The steep correction in housing markets, while painful, lays the foundation for recovery, far better than the countless programs that have sought to subsidize and temporize the inevitable repricing. It is these transitions in our market economy—and the adoption of pro-growth fiscal, regulatory and trade policies—that lay the essential groundwork for greater, more sustainable prosperity.
Monetary policy also has an important role to play. However, the Federal Reserve is not a repair shop for broken fiscal, trade or regulatory policies. Given what ails us, additional monetary policy measures are poor substitutes for more powerful pro-growth policies. The Fed can lose its hard-earned credibility—and monetary policy can lose its considerable sway—if its policies overpromise or under deliver.
Last week, my colleagues and I on the Federal Open Market Committee (FOMC) engaged in this debate. The FOMC announced its intent to purchase an additional $75 billion of long-term Treasury securities per month through the second quarter of 2011. The FOMC did not make an unconditional or open-ended commitment. I consider the FOMC's action as necessarily limited, circumscribed and subject to regular review. Policies should be altered if certain objectives are satisfied, purported benefits disappoint, or potential risks threaten to materialize.
Lower risk-free rates and higher equity prices—if sustained—could strengthen household and business balance sheets, and raise confidence in the strength of the economy. But if the recent weakness in the dollar, run-up in commodity prices, and other forward-looking indicators are sustained and passed along into final prices, the Fed's price stability objective might no longer be a compelling policy rationale. In such a case—even with the unemployment rate still high—we would have cause to consider the path of policy. This is truer still if inflation expectations increase materially.
The Fed's increased presence in the market for long-term Treasury securities poses nontrivial risks that bear watching. The prices assigned to Treasury securities—the risk-free rate—are the foundation from which the price of virtually every asset in the world is calculated. As the Fed's balance sheet expands, it becomes more of a price maker than a price taker in the Treasury market. If market participants come to doubt these prices—or their reliance on these prices proves fleeting—risk premiums across asset classes and geographies could move unexpectedly.
Overseas—as a consequence of more-expansive U.S. monetary policy and other distortions in the international monetary system—we see an increasing tendency by policy makers to intervene in currency markets, administer unilateral measures, institute ad hoc capital controls, and resort to protectionist policies. Extraordinary measures tend to beget extraordinary countermeasures. Heightened tensions in currency and capital markets could result in a more protracted and difficult global recovery.
Responsible monetary policy in the current environment requires attention not only to near-term macroeconomic conditions, but also to corollary risks with long-term effects. Should these risks threaten to materialize, however one gauges the probabilities, I am confident that the FOMC will have the tools and conviction to adjust policies appropriately. “
Bravo, Mr. Warsh! Some of us have been of similar opinions, but have been marginalized by those who believe that blind optimism and an inflated stock market will heal all wounds. This is not the case. Poor polices and consumer and business irresponsibility got is into this mess. Fundamentally sound polices, a resetting of asset prices (especially home prices) and a reallocation of labor and resources will get us out of this.
Some pundits are viewing Mr. Warsh’s comments as some kind of heresy at the Fed. Come on folks, this is orchestrated Fed jawboning at its best. The Fed knows it can’t fix what ails the economy. It can only keep thing going until better policies are implemented. Imagine the economy as a ship with a breached hull. The Fed is the damage control crew manning the pumps keeping the ship afloat until the repair crew back at the dry dock (Capitol Hill) can make structural repairs. Make no mistake; the economy is still broken,
Is it me or is it ironic that our trading partners who have active policies to maintain favorable exchange rates to promote their exports are angry with the U.S. for managing our currency. I am not advocating a weak dollar policy at all, but the irony here does not escape me.
Speaking of our trading partners they were all over today’s 10-year auction, buying a record 56.5% of the deal. Some believed the auction to be weak because the bid-to-cover was soft, but with foreign central banks willing to buy 10-year treasury notes at yields under 2.60% in an attempt to keep the dollar from weakening further, I would not be worried about a lack of demand in the markets. The treasury has yet to weigh on with its QE2 purchases. Mark my words, this time next year we will be looking at 10-year rates in the low 3.00% area and Fed Funds still effectively 0.00% (up to 0,25%).
“The prevailing theory has it that U.S. policy makers should not deny our foregone fate. We should accept smaller improvements in output and employment and productivity. We should resign ourselves to the new normal and conduct policy accordingly. That is the last best hope, they argue, to preserve the remaining vestiges of a golden age that is no more.
I reject this view. I consider this emerging ethos to be dangerous and defeatist and debunked by America's own exceptional economic history. Our citizens are not unwitting victims of some unavoidable fate. The current period of subpar growth and high unemployment is real, but it need not persist. We should not lower our expectations. We should improve our policies.
Broad macroeconomic policies have not changed direction in the past several years. But change they must if we are to prosper. We can no longer afford to tolerate economic policies that are preoccupied with the here and now. Chronic short-termism in the conduct of economic policy has done much to bring us to this parlous point.
Policy makers should be skeptical of the long-term benefits of temporary fixes to do the hard work of resurrecting the world's great economic power. Since early 2008, the fiscal authorities have sought to fill the hole left by the falloff in demand through large, temporary stimulus—checks in the mail to spur consumption, temporary housing rebates to raise demand, one-time cash-for-clunkers to move inventory, and temporary business tax credits to spur investment.
These programs may well have boosted gross domestic product for a quarter or two, but that is scarcely a full accounting of their effects. These stimulus programs did little to put the economy on a stronger, more sustainable trajectory. Sound fiscal policy must do more than reacquaint consumers with old, bad habits.
Policy makers should take notice of the critical importance of the supply side of the economy. The supply side establishes the economy's productive capacity. Recovery after a recession demands that capital and labor be reallocated. But the reallocation of these resources to new sectors and companies has been painfully slow and unnecessarily interrupted. We are feeling the ill effects.
Fiscal authorities should resist the temptation to increase government expenditures continually in order to compensate for shortfalls of private consumption and investment. A strict economic diet of fiscal austerity has greater appeal, a kind of penance owed for the excesses of the past. But root-canal economics also does not constitute optimal economic policy.
The U.S. would be better off with a third way: pro-growth economic policy. The U.S. and world economies urgently need stronger growth, and the adoption of pro-growth economic policies would strengthen incentives to invest in capital and labor over the horizon, paving the way for robust job-creation and higher living standards.
Pro-growth policies include reform of the tax code to make it simpler, more transparent and more conducive to long-term investment. These policies also include real regulatory reform so that firms—financial and otherwise—know the rules, and then succeed or fail. Regulators should be hostile to rent-seeking by the established, and hospitable to the companies whose names we do not know. Finally, the creep of trade protectionism is anathema to pro-growth policies. The U.S. should signal to the world that it is ready to resume leadership on trade.
The deleveraging by our households and businesses is not a pattern to be arrested, but good prudence to be celebrated. Larger, more liquid corporate balance sheets and higher personal saving rates are the reasonable and right responses to massive government dissaving and unpredictable government policies. The steep correction in housing markets, while painful, lays the foundation for recovery, far better than the countless programs that have sought to subsidize and temporize the inevitable repricing. It is these transitions in our market economy—and the adoption of pro-growth fiscal, regulatory and trade policies—that lay the essential groundwork for greater, more sustainable prosperity.
Monetary policy also has an important role to play. However, the Federal Reserve is not a repair shop for broken fiscal, trade or regulatory policies. Given what ails us, additional monetary policy measures are poor substitutes for more powerful pro-growth policies. The Fed can lose its hard-earned credibility—and monetary policy can lose its considerable sway—if its policies overpromise or under deliver.
Last week, my colleagues and I on the Federal Open Market Committee (FOMC) engaged in this debate. The FOMC announced its intent to purchase an additional $75 billion of long-term Treasury securities per month through the second quarter of 2011. The FOMC did not make an unconditional or open-ended commitment. I consider the FOMC's action as necessarily limited, circumscribed and subject to regular review. Policies should be altered if certain objectives are satisfied, purported benefits disappoint, or potential risks threaten to materialize.
Lower risk-free rates and higher equity prices—if sustained—could strengthen household and business balance sheets, and raise confidence in the strength of the economy. But if the recent weakness in the dollar, run-up in commodity prices, and other forward-looking indicators are sustained and passed along into final prices, the Fed's price stability objective might no longer be a compelling policy rationale. In such a case—even with the unemployment rate still high—we would have cause to consider the path of policy. This is truer still if inflation expectations increase materially.
The Fed's increased presence in the market for long-term Treasury securities poses nontrivial risks that bear watching. The prices assigned to Treasury securities—the risk-free rate—are the foundation from which the price of virtually every asset in the world is calculated. As the Fed's balance sheet expands, it becomes more of a price maker than a price taker in the Treasury market. If market participants come to doubt these prices—or their reliance on these prices proves fleeting—risk premiums across asset classes and geographies could move unexpectedly.
Overseas—as a consequence of more-expansive U.S. monetary policy and other distortions in the international monetary system—we see an increasing tendency by policy makers to intervene in currency markets, administer unilateral measures, institute ad hoc capital controls, and resort to protectionist policies. Extraordinary measures tend to beget extraordinary countermeasures. Heightened tensions in currency and capital markets could result in a more protracted and difficult global recovery.
Responsible monetary policy in the current environment requires attention not only to near-term macroeconomic conditions, but also to corollary risks with long-term effects. Should these risks threaten to materialize, however one gauges the probabilities, I am confident that the FOMC will have the tools and conviction to adjust policies appropriately. “
Bravo, Mr. Warsh! Some of us have been of similar opinions, but have been marginalized by those who believe that blind optimism and an inflated stock market will heal all wounds. This is not the case. Poor polices and consumer and business irresponsibility got is into this mess. Fundamentally sound polices, a resetting of asset prices (especially home prices) and a reallocation of labor and resources will get us out of this.
Some pundits are viewing Mr. Warsh’s comments as some kind of heresy at the Fed. Come on folks, this is orchestrated Fed jawboning at its best. The Fed knows it can’t fix what ails the economy. It can only keep thing going until better policies are implemented. Imagine the economy as a ship with a breached hull. The Fed is the damage control crew manning the pumps keeping the ship afloat until the repair crew back at the dry dock (Capitol Hill) can make structural repairs. Make no mistake; the economy is still broken,
Is it me or is it ironic that our trading partners who have active policies to maintain favorable exchange rates to promote their exports are angry with the U.S. for managing our currency. I am not advocating a weak dollar policy at all, but the irony here does not escape me.
Speaking of our trading partners they were all over today’s 10-year auction, buying a record 56.5% of the deal. Some believed the auction to be weak because the bid-to-cover was soft, but with foreign central banks willing to buy 10-year treasury notes at yields under 2.60% in an attempt to keep the dollar from weakening further, I would not be worried about a lack of demand in the markets. The treasury has yet to weigh on with its QE2 purchases. Mark my words, this time next year we will be looking at 10-year rates in the low 3.00% area and Fed Funds still effectively 0.00% (up to 0,25%).
Saturday, November 6, 2010
Jobs - The Long and Winding Road
Better than expected employment data. No spin here, the numbers were truly better than expected. The Nonfarm Payrolls report indicates a gain of 151,000 jobs. The service industry led the way. There were 28,000 new jobs added to the retailing sector, 46,000 jobs were added to the Professional and Business Services sector. The economy also added 35,000 temporary workers. Manufacturing, information, financial activities, leisure & hospitality and government all reduced the number of workers employed. Pending home sales unexpectedly fell as moratoriums on foreclosures and tighter lending standards are creating headwinds.
In normal times a report of 151,000 new jobs would induce yawns around the street. However, we are not living in normal times (unless this is the new normal). That being said, 151,000 new jobs is lifting the spirits of market participants this morning (to say nothing of those who actually found employment). There is still a long way to go before the jobs lost since the recession began in December 2007 have been replaced. Thus far, over 1,000,000 jobs have been added this year. However, that still leaves the economy down just under 7,000,000 jobs since the recession began.
The real question is: Where are nearly 7,000,000 jobs (accounting for population growth we need to add even more) going to come from without the economic activity provided by an over-stimulated economy? That is the challenge. Critics have pointed fingers at the banks for their reluctance to lend to anyone who does not have excellent credit. These critics correctly point out that many people who can get credit do not need credit at this time. However, what incentives do banks have to lend to higher-risk borrowers when they have difficulty securitizing such loans and cannot simply sit on such loans as they would soon run out of lendable capital and incur huge amounts of risk? There is also no way banks can help borrowers who are upside down on their homes (owe more than the homes worth). Home prices will have to drop further to unfreeze the housing market.
Jobs are the key, people. Without jobs there can be no economic recovery, at least not the kind most people expect or desire. The problem is how to replace millions of jobs which would not have existed previously if not for two asset bubbles (tech then housing). I asked a friend who is a senior strategist at a major investment bank if he had any ideas about how the economy can replace millions of jobs which appear superfluous at this time. Unfortunately he is just as perplexed as the rest of us. He did suggest that NAIRU may come back into vogue.
NAIRU stands for Non-Accelerating Inflation Rate of Unemployment. This is the unemployment rate below which inflation rises. This is a way of determining “full employment.” In may short 22-year career in the fixed income markets, I have was around when full employment was considered to be around 6.00%. I remember when it as believed to be below 5.00%. Where is it now? I wish I knew, but I would not be surprised if it was above 7.00%.
What about this great stock market recovery? Thank Ben and Bernakettes for the soaring stock market. Strength in the equity markets (and the weakening dollar) is directly related to Fed policy. So much so that one pundit stated that he believes that market participants prefer continuous accommodative Fed policy than economic strength. If the Fed decides that it managing inflation is now the top priority, the stock market could be in for a violent correction. Fortunately for equity investors Helicopter Ben is at the controls. The money will be falling like WKRP turkeys at Thanksgiving.
There are critics who, following yesterday’s jobs report, are questioning the Fed’s decision to launch QE2. I am not a fan of QE. I believed from the beginning that if home prices were permitted to fall in early 2008 when, bargain hunters could have still obtained credit, the recession may have been more shallow and shorter-lived. However in the wake of the financial crisis, the Fed was left with little choice but to provide a record level of monetary accommodation. To of you equity bulls who are now criticizing the Fed for being too pessimistic and not understanding the recovery story: The only reason for your soaring stock markets is Fed policies, including QE2.
This is not to say that I am in favor of QE2. I would prefer a bloodletting which changes the business mindset in this country to one which favors long-term strength. However, as long as we live in a CNBC culture and equity wonks are considered experts while experts from other areas of the business are considered worriers, clueless and obstructions to growth, we will continue to live for the short-term boom while our trading partners steal our position of prominence and standard of living sinks into mediocrity.
In normal times a report of 151,000 new jobs would induce yawns around the street. However, we are not living in normal times (unless this is the new normal). That being said, 151,000 new jobs is lifting the spirits of market participants this morning (to say nothing of those who actually found employment). There is still a long way to go before the jobs lost since the recession began in December 2007 have been replaced. Thus far, over 1,000,000 jobs have been added this year. However, that still leaves the economy down just under 7,000,000 jobs since the recession began.
The real question is: Where are nearly 7,000,000 jobs (accounting for population growth we need to add even more) going to come from without the economic activity provided by an over-stimulated economy? That is the challenge. Critics have pointed fingers at the banks for their reluctance to lend to anyone who does not have excellent credit. These critics correctly point out that many people who can get credit do not need credit at this time. However, what incentives do banks have to lend to higher-risk borrowers when they have difficulty securitizing such loans and cannot simply sit on such loans as they would soon run out of lendable capital and incur huge amounts of risk? There is also no way banks can help borrowers who are upside down on their homes (owe more than the homes worth). Home prices will have to drop further to unfreeze the housing market.
Jobs are the key, people. Without jobs there can be no economic recovery, at least not the kind most people expect or desire. The problem is how to replace millions of jobs which would not have existed previously if not for two asset bubbles (tech then housing). I asked a friend who is a senior strategist at a major investment bank if he had any ideas about how the economy can replace millions of jobs which appear superfluous at this time. Unfortunately he is just as perplexed as the rest of us. He did suggest that NAIRU may come back into vogue.
NAIRU stands for Non-Accelerating Inflation Rate of Unemployment. This is the unemployment rate below which inflation rises. This is a way of determining “full employment.” In may short 22-year career in the fixed income markets, I have was around when full employment was considered to be around 6.00%. I remember when it as believed to be below 5.00%. Where is it now? I wish I knew, but I would not be surprised if it was above 7.00%.
What about this great stock market recovery? Thank Ben and Bernakettes for the soaring stock market. Strength in the equity markets (and the weakening dollar) is directly related to Fed policy. So much so that one pundit stated that he believes that market participants prefer continuous accommodative Fed policy than economic strength. If the Fed decides that it managing inflation is now the top priority, the stock market could be in for a violent correction. Fortunately for equity investors Helicopter Ben is at the controls. The money will be falling like WKRP turkeys at Thanksgiving.
There are critics who, following yesterday’s jobs report, are questioning the Fed’s decision to launch QE2. I am not a fan of QE. I believed from the beginning that if home prices were permitted to fall in early 2008 when, bargain hunters could have still obtained credit, the recession may have been more shallow and shorter-lived. However in the wake of the financial crisis, the Fed was left with little choice but to provide a record level of monetary accommodation. To of you equity bulls who are now criticizing the Fed for being too pessimistic and not understanding the recovery story: The only reason for your soaring stock markets is Fed policies, including QE2.
This is not to say that I am in favor of QE2. I would prefer a bloodletting which changes the business mindset in this country to one which favors long-term strength. However, as long as we live in a CNBC culture and equity wonks are considered experts while experts from other areas of the business are considered worriers, clueless and obstructions to growth, we will continue to live for the short-term boom while our trading partners steal our position of prominence and standard of living sinks into mediocrity.
Wednesday, November 3, 2010
Pushing on a Slinky
Pushing On a Slinky
As expected the Fed launched QE2. Not quite as expected the Fed announced only $600 billion in U.S. treasury securities purchases between now and June 2011. That works out to about $75 billion per month. The Fed will also reinvest the proceeds from QE1 it will receive during that time to bring the total in the $850 billion to $900 billion range. This is a far cry from the $1 trillion to $2 trillion in new capital many were expecting. Notably nearly absent from QE2 purchases was very long end of the curve (longer than 10 years). Some dealers, such as Goldman Sachs, voiced opinions calling for asset purchases on the extreme long end of the curve. Instead the Fed chose to keep the average duration of the bonds it purchases to the five to six year range spreading purchases nearly evenly from two years to ten years out. The Fed also left the possibility of further easing open.
Aside from keeping rates low, possibly for the next year or two as far as Fed Funds are concerned, and weakening the dollar what has the Fed accomplished? Probably not much, but what it did accomplish will probably keep the economy out of a double dip recession. Some people have described QE2 as pushing on a string (as it would have almost not effect on the recovery). I like it to pushing on a Slinky. When on pushes on a Slinky motion is transferred, but not very efficiently. There is much absorbing of the motion by the spring. The economy will absorb much of this QE because the Fed can keep borrowing rates lower, but it cannot make lenders lend, borrowers borrow or investors invest in mortgage-backed securities.
What about inflation. Sure, the weak dollar could cause food and energy prices to rise, but since the demand curve for such commodities is relative inelastic, they will only hinder consumer spending further. When is housing making a comeback? When home prices fall far enough to where people have enough money saved to make a 10% or 20% down payment. When are jobs coming back? When U.S. labor costs (including taxes and health care) are low enough that businesses can add U.S. workers instead of new equipment or moving jobs overseas. In other words, low rates, high unemployment and sluggish growth will be with us for a very long time.
Stay away from LIBOR-based floaters. Coupons on these bonds and preferreds promise to remain at or near there floors. There will be better times to buy that kind of structure. Most TIPS are rich too. Buy only the 1.25%due 7/15/20 and only in moderation for hedging purposes. Ladder one’s portfolio two-years to 10-years (as I have been saying for a while and how the Fed is doing). Adding some step up bonds for the purpose of increased yield and cushion against rising rates could also be a good idea.
Nonfarm Payrolls on Friday, I can hardly wait.
As expected the Fed launched QE2. Not quite as expected the Fed announced only $600 billion in U.S. treasury securities purchases between now and June 2011. That works out to about $75 billion per month. The Fed will also reinvest the proceeds from QE1 it will receive during that time to bring the total in the $850 billion to $900 billion range. This is a far cry from the $1 trillion to $2 trillion in new capital many were expecting. Notably nearly absent from QE2 purchases was very long end of the curve (longer than 10 years). Some dealers, such as Goldman Sachs, voiced opinions calling for asset purchases on the extreme long end of the curve. Instead the Fed chose to keep the average duration of the bonds it purchases to the five to six year range spreading purchases nearly evenly from two years to ten years out. The Fed also left the possibility of further easing open.
Aside from keeping rates low, possibly for the next year or two as far as Fed Funds are concerned, and weakening the dollar what has the Fed accomplished? Probably not much, but what it did accomplish will probably keep the economy out of a double dip recession. Some people have described QE2 as pushing on a string (as it would have almost not effect on the recovery). I like it to pushing on a Slinky. When on pushes on a Slinky motion is transferred, but not very efficiently. There is much absorbing of the motion by the spring. The economy will absorb much of this QE because the Fed can keep borrowing rates lower, but it cannot make lenders lend, borrowers borrow or investors invest in mortgage-backed securities.
What about inflation. Sure, the weak dollar could cause food and energy prices to rise, but since the demand curve for such commodities is relative inelastic, they will only hinder consumer spending further. When is housing making a comeback? When home prices fall far enough to where people have enough money saved to make a 10% or 20% down payment. When are jobs coming back? When U.S. labor costs (including taxes and health care) are low enough that businesses can add U.S. workers instead of new equipment or moving jobs overseas. In other words, low rates, high unemployment and sluggish growth will be with us for a very long time.
Stay away from LIBOR-based floaters. Coupons on these bonds and preferreds promise to remain at or near there floors. There will be better times to buy that kind of structure. Most TIPS are rich too. Buy only the 1.25%due 7/15/20 and only in moderation for hedging purposes. Ladder one’s portfolio two-years to 10-years (as I have been saying for a while and how the Fed is doing). Adding some step up bonds for the purpose of increased yield and cushion against rising rates could also be a good idea.
Nonfarm Payrolls on Friday, I can hardly wait.
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