A Minsky Moment?

John Plender wrote in yesterday's Financial Times,  "Complacent investors face prospect of a Minsky moment."  

One observation is hard to quarrel with, to wit,  "It is historically atypical in that the central banks have been encouraging market participants through quantitative easing to take on more risk to help stave off a perceived deflationary threat. This was, in a sense, a perpetuation of the asymmetric policy pursued by the Federal Reserve before the crisis." we have seen the Greenspan Put on the stock market, the Bernanke Put on the housing market, and are we now seeing the Powell Put on the current bubbles?

Financial assets have grown rapidly relative to the stock of physical capital and certainly some bubbles have been inflated, most notably the growth of unicorns.

On the the hand, he claims hat that "Since the Trump tax changes (sic) are unlikely to have more than a modest impact on potential output, the economy, already close to full employment, could run into capacity constraints."  This is unduly pessimistic.  The Paul Ryan/ GOP/Trump tax cuts have dramatically reduced the cost of equity and, for well capitalized companies, for corporate investment in real capital.  Reducing marginal individual tax rates improves incentives to work.  The limit on state and local tax deductions reduces the tax incentive to drive prices up in the most expensive markets in the nation.

The supply side tax changes combined with the administration's deregulation initiatives has accelerated economic growth after the slowest economic recovery in a century.  Growth, the first real wage rate rises since the 1990s, and the improved incentives have increased labor force participation by attracting workers who have given up or face disincentives to taking paying employment.  Workers on disability have reentered the workforce.  Yes the unemployment rate is the lowest in forty-nine years, but the prime age employment ratio is still below its level at the beginning of the 2007-9 recession even though it is eleven years later.

Not only did the 2017 tax act create supply side incentives for the real economy (which Mr. Plender judges too weak), but it also reduced the tax incentive to over lever.  It limited corporations' ability to deduct interest expense and the lower corporate marginal corporate tax rates reduce debt's tax subsidy.  The debt binges by Netflix and Amazon among others is their last hurray.  

Citing Dr. Doom (Henry Kaufman), Plender worries that "the 10 largest financial institutions held about 10 per cent of US financial assets. Today the figure is about 80 per cent."  While that may reduce the liquidity of financial markets, but it also makes the banking sector more stable.  Canada with similar concentration for a century or more has not had a banking crisis since the 1840s.  A shift of capital raising from the financial markets to the commercial banks by itself would increase the potential for economic growth.  A key initiative by the Republicans with some bipartisan support is to reduce the regulatory burden of smaller banks that are not a systemic threat and shifting the emphasis from regulation to capital.

Five Things to Get the U.S. Economy Moving

Buying Back Corporate America

Are U.S. corporations pulling up the drawbridge? Finding an alternative to dividends? or Overlevering themselves? 

The Economist argues that share buybacks may be encouraging shorttermism and that by "reducing the number of shares outstanding, buy-back schemes can also artificially boost a firm’s earnings per share."  Based on its survey, buyback activity "in the S&P 500 index" reached $500 billion in 2013, "close to the high reached in the bubble year of 2007:" that is a third of U.S. corporate cashflow. Furthermore, the Economist notes that "buy-backs have usurped dividends as the main way listed American firms give money back to their owners, accounting for 60% of cash returns last year." 

James McIntosh stresses the levering that buybacks are driving and warns investors, in this September 9th video,  that equity markets may seem calm but the cashflow, and debt raising seem ominously like 2007: the calm before the storm. Mackintosh, the FT's investment editor, charts the close relationship among buybacks, debt raising, and cashflow. Corporate share repurchases have been converting cashflow surpluses into deficits which firms are financing with ever more debt.  The result is more levered balance sheets.

Was Janet Yellen's goal in driving down interest rate to relever corporate balance sheets?




 

Are Treasuries Turning?

The bull market in US Treasuries is three decades old. 

 

Michael Mackenzie, US markets editor, tells Long View columnist John Authers in this January 25th video (5m 10sec) that this could be about to change.   The rise in equities as a harbinger of a strengthening economy suggests bond yields are set to rise.  

Fed's Forecast to 2014

MarketWatch.com columnist columnist Chuck Jaffe visits Mean Street to discuss how the Federal Reserve, by keeping interest rates low for several years, is pushing savers to risky territory (1/30/2012):

Tom Hoenig Nominated to Be the Vice Chair of the FDIC

Wow!

I do not know to what party Dr. Thomas Hoenig belongs, but he has been great on the FOMC (the Federal Open Market Committee that determines monetary policy.)  President Obama has nominated him to be the number two official at the Federal Deposit Insurance Corporation (FDIC) which guarantees bank deposits.  The FDIC also is one of the agencies that examines banks for soundness.

Tom Hoenig has been a staunch critic of the "Too Big to Fail" syndrome in American bank supervision.  He has been seemingly a Cassandra warning of the bubble in farmland prices.  Hopefully his arms will not be chained when he raises them to prays for policies to address the problem. 

On the FOMC, Hoenig has voted for raising rates.  Knowing that we are creating new bubbles rather than stimulating new investment in real projects creating real jobs, he has dissented from the prevailing majority.  What business owner in its right mind would invest in a risky business project when there is free money to lever up holdings of financial assets made risk free by the Bernanke put?  Why subsidize investment banking bonuses? And he has not kept quiet.  As Michelle Lucci pointed out over a year ago, "Kansas City Federal Reserve Bank President Thomas Hoenig has been recently speaking publicly about his desire for an increase in the federal funds rate, sooner rather than later, and also about his concern for community banks and the drag on earnings from commercial real estate loans."

Scott Canon at the Kansas City Star warns "Hoenig is ... a provocative selection to join [the FDIC's] board of directors."  Three cheers for President Obama on this one.  Even Ron Paul should be cheering. He would be available should a President Cain need a Fed Chairman.

Risks and opportunities for Brazil

Brazil's central Bank has cut interest rates from high levels.   Two weeks before Brazil's next interest rate decision it remains unclear whether the central bank will cut rates again.  In this FT video from October 7 2011, Zeina Latif, Latin America chief economist with RBS in São Paulo, explains to Jonathan Wheatley, deputy emerging markets editor, why although the crisis in Europe looks like an opportunity to cut rates there are multiple risks involved. (5m 24sec)

Good Bye Reserve Currency?

It was a bit of a shock to read James Politi writing in the Financial Times that the, "World Bank sees end to dollar’s hegemony."  The shock was not that the dollar will lose its status as the sole reserve currency in the long run, but that the source of the forecast was the World Bank.  The lead author of the report of the World Bank report was Mansoor Dailam.  He sees a "multi-currency system" with the euro, the renminbi, and the dollar playing roles.  Dr. Dailam argued the "shift will be driven by the increasing power and strength of emerging market economies, with six countries – Brazil, China, India, Indonesia, Russia and South Korea – accounting for more than half of global growth in 14 years."  From now to 2025, the World Bank pegs emerging economies as growing 4.7% and the developed economies barely hitting a 2.3% growth rate.

The FT quotes the report as saying, “The current predominance of the US dollar would end sometime before 2025 and would be replaced by a monetary system in which the dollar, the euro and the renminbi would each serve as full-fledged international currencies.”

Our favorite hawk, Federal Reserve Bank of Kansas City President Thomas Hoenig, spoke with Bloomberg in London.   On Bloomberg Television's "The Pulse," Maryam Nemazee asks Hoenig about the Fed's quantitative easing strategy, recent revelations on the Fed's lending during the financial crisis, the U.S. job market and banking regulations. 

China, Monetary Policy, and the U.S.

The U.S., still the monetary linchpin of the global economy, is fighting its unemployment with monetary and fiscal stimulus rather than addressing the dislocations created by the housing bubble.   This repeat of its policy mistakes in the wake of the high tech bubble is destabilizing the world economy.  The emerging world has led global economic growth over the past decade with China, Brazil, and India the main powerhouses.   Super loose monetary policy in Europe, Britain, and especially the U.S. has flooded them with foreign exchange reserves which have threatened to over inflate their economies.

The People's Bank of China's Governor, Zhou Xiaochuan (on the left in Bloomberg photographer Tomohiro Ohsumi's picture) sees fighting asset bubbles as well as inflation in his job description.   The central bank has raised its reserve requirements for the third time this year, according to the Aaron Back and Tom Orlik in the Wall Street Journal: "China's central bank said Friday it will raise the share of deposits banks must hold in reserve by half a percentage point, the third increase this year, as inflationary pressures remain in the spotlight."  At the time of the Bank's November reserve requirement increase, Bloomberg News reported, "China ordered banks to set aside larger reserves for the second time in two weeks, draining cash from the financial system to limit inflation and asset-bubble risks in the world’s fastest-growing major economy."  This enforced increase in banks' liquidity restricts their ability to expand loans.

Nor is this the only monetary policy tool being used.  The central bank raised interest rates in February.   Indeed, "[t]he PBOC raised the reserve requirement ratio six times last year, and benchmark lending and deposit rates three times since October. The previous reserve ratio increase took effect Feb. 24."  In November, Qu Hongbin, co-head of Asian economic research at HSBC Holdings Plc in Hong Kong, told Bloomberg  the bank “decided to fight forcefully” against the impact of America's loose monetary policy.

Gordon Chang, author of "The Coming Collapse of China," talks about China's economy and currency policy. Chang, speaking with Betty Liu on Bloomberg Television's "In the Loop," also discusses Federal Reserve Chairman Ben S. Bernanke's November speech in Frankfurt.






Below Keith McCullough, chief executive officer of Hedgeye Risk Management and a Bloomberg Television contributing editor, to Bernanke's defense of quantitative easing (see above.) What does this mean for for U.S.-China relations? McCullough speaks with Betty Liu on Bloomberg Television's "In the Loop."




J

The "B" in BRIC is Brazil and Henrique Meirelles is Brazil's Banker

My four favorite central bankers are Thomas Hoerner, Glenn Stevens, Mark J. Carney and Henrique Meirelles.

Henrique Meirelles is the president of Brazil's Central Bank. In this video he has tea with the Economist and says there's no room for complacency despite Brazil's impressive economic performance.

The Voice Crying Out In the Wilderness

Maria Anastasia O'Grady normally writes about Latin America.  She is the Wall Street Journal's Americas columnist.  Perhaps her experience with Latin American inflationist policies and monetary proflicacy made her the appropriate person to interview Tom Hoenig, the one hawk on the Federal Open Market Committee, the only member who seems to think loose money sinks economies.  Ms O'Grady explains this is in part because Tom Hoernig learned bank supervision in the the 1970s in the mid-west when the energy and farmland bubbles burst in the late 1970s and early 1980s.  He saw the effect on the local economies, businesses, employment, and growth.  He is no stranger to the human costs of bubbles.

Yet our policy makers are once again pursuing a policy of negative real policy rates (i.e., the federal funds rate is set below what inflation is expected to be.  Investing in T-Bills is a guaranteed mug's game.  it would seem new bubbles are on the way. "But if it happens the fault won't lie with one stubborn voice of dissent, crying out in Missouri."

It is refreshing to hear Hoenig tell us that "'Monetary policy has to be about more than just targeting inflation. It is a more powerful tool than that. It is also an allocative policy, as we've learned. In other words, when we kept interest rates unusually low for a considerable period we favored credit and the allocations related to it over savings, and we created the conditions that I think facilitated a bubble."

Here Is One Investor Who Thinks Fighting Bubbles Is In Dr. Bernanke's Job Description!

Many still think Alan Greenspan walked on water.  Jeremy Grantham is not one of them.  The good Dr. Greenspan seemed to think that preventing bubbles was neither part of his job nor realistically feasible. Having suffered thorough the aftermaths of the high tech bubble and the housing bubble, has thinking on Constitution Avenue changed?  unfortunately not.  Pauline Skypala writes that "Mr Grantham sees Ben Bernanke, chairman of the Federal Reserve, following the same path as his predecessor." He and his firm have identified thirty two bubbles over the last ninety years. 

As to his own business, the investment business, does it add value?  "The business is a zero-sum game, he points out, and 'we collectively add nothing but costs'. Costs have grown because there is no fee competition, due to the agency problem and the information advantage the agent has over the client. Growing complexity has increased the client’s dependence on the industry."

Greece and the Fed's Exit Strategy Move Bank Stocks

U.S. banks have $176 million dollar exposure to the sovereign debt of the PIGSs (Portugal, Ireland, Greece, and Spain.)

Michael Corkery in the Wall Street Journal's "Deal Journal" asks, "So just what is the exposure of U.S. banks to debt in these four nations? 'Overall, we believe that the direct risk of the large U.S. banks to Ireland, Greece, Portugal and Spain is modest,' writes Barclays analyst Jonathan Glionna in a research note.


"Barclays analysts estimate the 10 largest U.S. financial institutions have a total of $169 billion of their loans tied up in the four troubled Euro nations. That is about about 19% of those banks’ combined Tier 1 capital, or the cash cushion that banks keep to absorb bad loans. Looking at the combined exposure of the 10 largest banks and the other 63 U.S. banking firms that supply cross border information to the Federal Institutions Examination Council, the total exposure is $176 billion. By country, the overall exposure of those 73 banks is $82 billion to Ireland, $68 billion to Spain, $18 billion to Greece and $9 billion to Portugal."


Alistair Barr reports on the effect of this and the Fed's exit stretegy on Market Watch. 







Speaking of PIGS, the UK's debt is starting to smell of bacon to use Ian Bremmer and Nouriel Roubini's phrase. Sara Schaefer Muñoz reports that British banks have a heavy exposure to UK soverign debt.  What about the Yanks?

Dr. Hoenig, the Hawk: We Need More of Them

Dr. Thomas Hoenig, President of the Kansas City Federal Reserve Bank, has been known as a monetary policy hawk in the past. If he has been part of the Federal Open Market Committee's consensus supporting negative real interest rates, he is a dove no longer. He told the American Economics Association (AEA) meetings, “Experience both in the US and internationally tells us that maintaining large amounts of stimulus over an extended period risks creating conditions that lead to financial excess, economic volatility and even higher unemployment at some point in the future.” Amen!

Hoenig vs. Bernanke

Hoenig and our current Fed Chairman, Ben Bernanke offered opposing views of history at the AEA meetings.

As George Santayana taught us, "Those who cannot learn from history are doomed to repeat it." So at issue is what role monetary policy played in creating the real estate bubble that caused the so called Great Recession of 2007-9. To Hoenig and to me it is clear that the over-expansion of credit that inflated the bubble had as its root cause the Fed's war against the paper dragon of deflation. Negative real interest rates in 2002-2005 and much too low rates in 2006 subsidized the creation of ever more esoteric securities which was the stuff from which Wall Street's leverage binge was made.  Negative real interest rates inflate investment bankers' profits and bonuses, misdirect productive resources into speculation, cause a dangerous correlation of returns, and subsidize the ever increasing financial roundabout production we saw during the recent bubble. Short term interest rates are the price for the raw materials with which investment banks create leverage in securities markets and financial engineers manufacture designer securities.Subsidize the raw materials and increase the supply.

Bernanke is a better student of the Great Depression of the 1930s than of the recent bubble. As John Cassidy relates, that Ben Bernanke "[r]ather than conceding that he and his predecessor, Alan Greenspan, made a hash of things between 2002 and 2006, keeping interest rates too low for too long, he said the Fed’s policies were reasonable and the main cause of the rise in house prices was not cheap money but lax supervision." Cassidy is moved to wonder in the Financial Times whether Ben Bernanke is "Decended From the Bourbons?" recalling "Talleyrand’s quip about the restored Bourbon monarchs: 'They have learned nothing and forgotten nothing.'”

Requiem for the Dollar

Constantine the Great created the solidus, a gold coin that held its value well enough to be a monetary standard for seven hundred years.  The Bretton Woods monetary system survived a quarter century.  The U.S. dollar is worth maybe 5% of its 1900 value.

Jim Grant, the sage of the bond market, writes in the Wall Street Journal a lengthy, witty, thoughtful, and ultimately depressing "Requiem for the Dollar. "  He tells us, "To give modernity its due, the dollar has cut a swath in the world. There's no greater success story in the long history of money than the common greenback. Of no intrinsic value, collateralized by nothing, it passes from hand to trusting hand the world over. More than half of the $923 billion's worth of currency in circulation is in the possession of foreigners."

Yet like all great schemes it has its limits.  "But now the world is losing faith, as well it might. It's not that the dollar is overvalued—economists at Deutsche Bank estimate it's 20% too cheap against the euro. The problem lies with its management. The greenback is a glorious old brand that's looking more and more like General Motors."  Ouch!  Take away my membership in the American Economics Association before you compare me to Rick Wagnoner!

The strength of the dollar is of both economic and geopolitical significance. 

Stable monetary values make economic calculation easier and facilitates prosperity.  Unstable money gives incentives to speculate and invest capital and human energy into unproductive activities.  Diverting human and financial capital form productive activity makes society poorer.  It is one of the two legs of Robert Mundell's "policy mix," which not only won him a Nobel Prize, but also is the foundation of Supply-Side Economics as Brian Domitrovic demonstrates in his new book, The Econoclasts: The Rebels Who Sparked the Supply-Side Revolution and Restored American Prosperity." 

Our current international financial system has no anchor in the real economy.  We have floating exchange rates that float whithersoever the whims of speculators send them.  Wallace and Sargent demonstrated three decades ago that floating exchange rates have no equilibrium.  The result is uncertainty in trade, profits for banks, and the diversion of many clever folk into speculation.

President Obama's new realism (see "Is there an Obama Doctrine?" in the Economist) seems to say that we as a superpower will assert our selfs, if we can afford it.  With such an anemic dollar it is hard to say we will afford much!

Henrique de Campos Meirelle On Brazil's Success Through the Financial Crisis

Henrique de Campos Meirelles is the Governor of Banco Central do Brasil. Maybe Ben Bernanke could learn a thing or two from this interview with the economist:

Where There Is a Way, Is there a Will?

Not too long ago George Melloan asked on the Opinion pages of the Wall street asked a troubling question:

"Federal Reserve Chairman Ben Bernanke assured readers of this page (“The Fed’s Exit Strategy,” July 21) that he has the tools to prevent the huge reserves he’s pumped into the banks from generating an inflation that would abort an economic recovery.

"But does the Fed have the guts to use those tools?"

Yes, Virginia, the Fed Does Have An Exit Strategy

It seems literally Providential that Dr. Ben Bernanke was chairing the Board of Governors when the financial crisis hit. He, as a young researcher at Princeton, demonstrated how the financial crises in the 1930s were the missing link that converted the mild cyclical downturn of 1929 into the Great Depression.

In today's Wall Street Journal (see also below), he explains the Fed's exit policy. I have a very big worry about what he says. He argues the Fed has plenty of tools to fight inflation. He never mentions asset price bubbles.

The Wall Street Journal accuses him, in a former stint as a Governor, of being at the housing bubble's birthing. He helped support the intellectual case for not fighting the emerging bubble. At the December 9th, 2003 Board meeting he argued that the Fed could continue its negative real interest rate policy. His focus was on consumer price inflation and the output gap.

There are two problems with the Chairman's perspective: If a bubble allocates resources in the real economy, there will be cyclical unemployment that reflects these structural distortions. This unemployment will require a longer period of adjustment than ordinary cyclical unemployment. Thus the output gap will underestimate the economy's inflationary potential. Secondly preventing a bubble is just as important as preventing consumer price inflation.

Some of the comments share my concern. I particularly appreciated Avery Goodman's comment (reproduced below.)


The Fed’s Exit Strategy by Ben Bernanke (WSJ: July 20, 2009)

The depth and breadth of the global recession has required a highly accommodative monetary policy. Since the onset of the financial crisis nearly two years ago, the Federal Reserve has reduced the interest-rate target for overnight lending between banks (the federal-funds rate) nearly to zero. We have also greatly expanded the size of the Fed’s balance sheet through purchases of longer-term securities and through targeted lending programs aimed at restarting the flow of credit.

These actions have softened the economic impact of the financial crisis. They have also improved the functioning of key credit markets, including the markets for interbank lending, commercial paper, consumer and small-business credit, and residential mortgages.

My colleagues and I believe that accommodative policies will likely be warranted for an extended period. At some point, however, as economic recovery takes hold, we will need to tighten monetary policy to prevent the emergence of an inflation problem down the road. The Federal Open Market Committee, which is responsible for setting U.S. monetary policy, has devoted considerable time to issues relating to an exit strategy. We are confident we have the necessary tools to withdraw policy accommodation, when that becomes appropriate, in a smooth and timely manner.
The exit strategy is closely tied to the management of the Federal Reserve balance sheet. When the Fed makes loans or acquires securities, the funds enter the banking system and ultimately appear in the reserve accounts held at the Fed by banks and other depository institutions. These reserve balances now total about $800 billion, much more than normal. And given the current economic conditions, banks have generally held their reserves as balances at the Fed.

But as the economy recovers, banks should find more opportunities to lend out their reserves. That would produce faster growth in broad money (for example, M1 or M2) and easier credit conditions, which could ultimately result in inflationary pressures—unless we adopt countervailing policy measures. When the time comes to tighten monetary policy, we must either eliminate these large reserve balances or, if they remain, neutralize any potential undesired effects on the economy.

To some extent, reserves held by banks at the Fed will contract automatically, as improving financial conditions lead to reduced use of our short-term lending facilities, and ultimately to their wind down. Indeed, short-term credit extended by the Fed to financial institutions and other market participants has already fallen to less than $600 billion as of mid-July from about $1.5 trillion at the end of 2008. In addition, reserves could be reduced by about $100 billion to $200 billion each year over the next few years as securities held by the Fed mature or are prepaid. However, reserves likely would remain quite high for several years unless additional policies are undertaken.

Even if our balance sheet stays large for a while, we have two broad means of tightening monetary policy at the appropriate time: paying interest on reserve balances and taking various actions that reduce the stock of reserves. We could use either of these approaches alone; however, to ensure effectiveness, we likely would use both in combination.

Congress granted us authority last fall to pay interest on balances held by banks at the Fed. Currently, we pay banks an interest rate of 0.25%. When the time comes to tighten policy, we can raise the rate paid on reserve balances as we increase our target for the federal funds rate.

Banks generally will not lend funds in the money market at an interest rate lower than the rate they can earn risk-free at the Federal Reserve. Moreover, they should compete to borrow any funds that are offered in private markets at rates below the interest rate on reserve balances because, by so doing, they can earn a spread without risk.

Thus the interest rate that the Fed pays should tend to put a floor under short-term market rates, including our policy target, the federal-funds rate. Raising the rate paid on reserve balances also discourages excessive growth in money or credit, because banks will not want to lend out their reserves at rates below what they can earn at the Fed.

Considerable international experience suggests that paying interest on reserves effectively manages short-term market rates. For example, the European Central Bank allows banks to place excess reserves in an interest-paying deposit facility. Even as that central bank’s liquidity-operations substantially increased its balance sheet, the overnight interbank rate remained at or above its deposit rate. In addition, the Bank of Japan and the Bank of Canada have also used their ability to pay interest on reserves to maintain a floor under short-term market rates.

Despite this logic and experience, the federal-funds rate has dipped somewhat below the rate paid by the Fed, especially in October and November 2008, when the Fed first began to pay interest on reserves. This pattern partly reflected temporary factors, such as banks’ inexperience with the new system.

However, this pattern appears also to have resulted from the fact that some large lenders in the federal-funds market, notably government-sponsored enterprises such as Fannie Mae and Freddie Mac, are ineligible to receive interest on balances held at the Fed, and thus they have an incentive to lend in that market at rates below what the Fed pays banks.

Under more normal financial conditions, the willingness of banks to engage in the simple arbitrage noted above will tend to limit the gap between the federal-funds rate and the rate the Fed pays on reserves. If that gap persists, the problem can be addressed by supplementing payment of interest on reserves with steps to reduce reserves and drain excess liquidity from markets—the second means of tightening monetary policy. Here are four options for doing this.

First, the Federal Reserve could drain bank reserves and reduce the excess liquidity at other institutions by arranging large-scale reverse repurchase agreements with financial market participants, including banks, government-sponsored enterprises and other institutions. Reverse repurchase agreements involve the sale by the Fed of securities from its portfolio with an agreement to buy the securities back at a slightly higher price at a later date.

Second, the Treasury could sell bills and deposit the proceeds with the Federal Reserve. When purchasers pay for the securities, the Treasury’s account at the Federal Reserve rises and reserve balances decline.

The Treasury has been conducting such operations since last fall under its Supplementary Financing Program. Although the Treasury’s operations are helpful, to protect the independence of monetary policy, we must take care to ensure that we can achieve our policy objectives without reliance on the Treasury.

Third, using the authority Congress gave us to pay interest on banks’ balances at the Fed, we can offer term deposits to banks—analogous to the certificates of deposit that banks offer their customers. Bank funds held in term deposits at the Fed would not be available for the federal funds market.

Fourth, if necessary, the Fed could reduce reserves by selling a portion of its holdings of long-term securities into the open market.

Each of these policies would help to raise short-term interest rates and limit the growth of broad measures of money and credit, thereby tightening monetary policy.

Overall, the Federal Reserve has many effective tools to tighten monetary policy when the economic outlook requires us to do so. As my colleagues and I have stated, however, economic conditions are not likely to warrant tighter monetary policy for an extended period. We will calibrate the timing and pace of any future tightening, together with the mix of tools to best foster our dual objectives of maximum employment and price stability.
—Mr. Bernanke is chairman of the Federal Reserve.

Avery Goodman's Comment:

Dear Mr. Bernanke,

There is nothing that I would like better than to see you proved correct. But, all the evidence shows otherwise.

The primary dealers of the Fed have received huge wads of almost-free-cash, in one way or another, as a part of your balance sheet expansion, as well as the fact that you have traded Treasuries for toxic waste held by the banks. So far, the cash you've handed out is not being used to fund productive industry in America. Instead, it is being used to fund speculation.

These primary dealers appear to be making loans mostly to client-speculators including hedge funds, and, also, supplying their own trading divisions. Since speculation thrives in time of volatility, price instability has resulted. The markets, in turn, have become Fed-driven, rather than free and independent,

We have seen an explosion in prices, as well as the overall level of speculation in the stock, oil, gold, silver, and commodities markets. A new bubble in asset prices is now being formed, and it has every prospect of eventually exceeding the previous one. We have seen little actual improvement in the U.S. economy, however.

Oil, in particular, has roared back in price, even though it is in serious oversupply. This is because people are buying everything that tends to rise in inflationary times. The wild speculative buying impairs the potential for the economy to recover.

Meanwhile, the dollar is currently in a free-fall, and the Chinese, Russians, Indians and even the Brazilians are threatening to settle trades in other currencies. Gold and silver, in contrast, are soaring into the stratosphere. Foreigners clearly do not have confidence in your policies.

You had better make it very crystal clear, when you testify, that you intend to take very strict and affirmative action to reduce the Fed balance sheet back to $900 billion or less, or this situation will continue to deteriorate.

I would love to be proven wrong. However, the result of your easy money policies has been rampant speculation. This speculative activity is being encouraged by, or directly participated in, by the big banks you have bailed out. We are now seeing a falling dollar, rising stock, gold, silver, and commodity prices, and a continuing hollowing out of the American economy.

It would have been better to allow the insolvent banks to fail, while allowing the FDIC to do its job of replacing whatever deposit money was lost. There would have been no repeat of the Great Depression, because of the existence of the safety net provided by FDIC insurance. The market share lost by the failed banks would have eventually shifted to their competitors, who would become bigger.

Instead, the Federal Reserve has attempted to micro-manage the economy in a manner similar to the Politburo of the old Soviet Union. This has brought us ever higher levels of moral hazard. Such policies are unwise, but since you apparently intend to continue to pursue them, I wish you the best of luck. You, and we, are going to need it.

Xinjiang Is more Important than a New International Moneary System for China's Hu Jintao

The drama at the G-8 meeting in Italy came when China's Hu Jintao deserted the conference before it began.

Richard McGregor and Kathrin Hille explain Mr. "Hu, the president and communist party head, convened an emergency meeting of the leadership, the nine-member inner-circle of the Politburo, hours after arriving home on Wednesday from his truncated G8 trip to Italy.

The management of the crisis is a high-profile test for Mr Hu, who must satisfy the demands of hardliners within the party for a tough response, with an eye on the sensitivities of Muslim countries offshore.

China has blamed Sunday’s violence in Urumqi, which left 156 people dead and more than a thousand injured, on Xinjiang’s indigenous Muslim population, the Uighurs."

Thus it was Mr. Hu's surrogate that delivered China's call for a less dollar dependent international monetary system.

As George Parker, Guy Dinmore, Krishna Guha, and Justine Lau tell it "China attacks dollar’s dominance:" (FT: July 9 2009)

"China has launched its highest-profile criticism of the dominant role of the US dollar as a global reserve currency at a meeting of the world’s biggest economies.

"Dai Bingguo, Chinese state councillor, raised the issue on Thursday when he joined the leaders of four other emerging economies for talks with the leaders of the Group of Eight industrialised nations – including US President Barack Obama."

China has already taken concrete moves toward a reduced reliance on the greenback:

"China moves to cut reliance on dollar"

By Richard McGregor in the Financial Times, July 3 2009, Page 19


China has taken another step towards internationalising its currency and reducing reliance on the US dollar with the announcement of new rules to allow select companies to invoice and settle trade transactions in renminbi.

The regulations released by the People's Bank of China, the country's central bank, will allow approved companies to settle transactions through financial institutions in Shanghai and other cities in southern China.

Offshore, the trial scheme will allow transactions to be settled in renminbi in Hong Kong and Macao, the two self-governing territories on China's southern borders, and later in a limited fashion in south-east Asia as well.

Importers and exporters will be able to place orders with authorised Chinese companies, and settle payment for them, in renminbi.

Although it has no short-term implications for the full convertibility of the renminbi, the announcement adds to the volley of political signals Beijing has sent recently over its dissatisfaction with the US dollar.

"To many minds in China the US dollar's time is almost up, the eurozone suffers from political paralysis and a too-conservative central bank, while two decades of economic stagnation and a shrinking population do the yen no favours," said Stephen Green, of Standard Chartered, in Shanghai.

"For them, the renminbi is an obvious, and imminent, replacement."

Far from being a replacement for the dollar as a freely-traded reserve currency, the move has been justified by the PBoC initially as assisting exporters buffeted by the greenback's fluctuating value.

"Companies in China and neighbouring countries are facing relatively large risks of exchange-rate fluctuations because of big swings in the US dollar, the euro and other major currencies used for settlements," the PBoC statement said.

The rules have also been expressly drafted to ensure that the new regime is not used to circumvent China's capital controls, by requiring supporting documentation for transactions.

"Domestic settlement banks should take effective measures to know the nature and purpose of their clients' trading," the central bank said.

The announcement of an offshore role for the renminbi chimes with China's call earlier this year for a new reserve currency.

He Yafei, a vice-foreign minister, said in Beijing yesterday that China supported reserve currency diversification in the future and that it would be "normal" for the issue to be raised at the G8 talks.

The volume of trade conducted under the new rules is expected to be small initially, but over time it should increase demand for the renminbi.


Copyright The Financial Times Limited 2009