In order for our current level of debt-fueled prosperity to continue, the rest of the world must continue to use our dollars to trade with one another and must continue to buy our debt at ridiculously low interest rates. Of course the number one foreign nation that we depend on to participate in our system is China. China accounts for more global trade than anyone else on the planet(including the United States), and most of that trade is conducted in U.S. dollars. This keeps demand for our dollars very high, and it ensures that we can import massive quantities of goods from overseas at very low cost. As a major exporting nation, China ends up with gigantic piles of our dollars. They lend many of those dollars back to us at ridiculously low interest rates. At this point, China owns more of our national debt than any other country does. But if China was to decide to quit playing our game and started moving away from U.S. dollars and U.S. debt, our economic prosperity could disappear very rapidly. Demand for the U.S. dollar would fall and prices would go up. And interest rates on our debt and everything else in our financial system would go up to crippling levels. So it is absolutely critical to our financial future that China continues to play our game.
Unfortunately, there are signs that China has now decided to start looking for a smooth exit from the game. In November, I wrote about how the central bank of China has announced that it is “no longer in China’s favor to accumulate foreign-exchange reserves”. That means that the pile of U.S. dollars that China is sitting on is not going to get any higher.
In addition, China has signed a whole host of international currency agreements with other nations during the past couple of years which are going to result in less U.S. dollars being used in international trade. You can read about many of these agreements in this article.
This week, we learned that China started to dump U.S. debt during the month of December. Many have imagined that China would try to dump a flood of our debt on to the market all of a sudden once they decided to exit, but that simply does not make sense. Instead, it makes sense for China to dump a bit of debt at a time so that the market will not panic and so that they can get close to full value for the paper that they are holding.
As Bloomberg reported the other day, China dumped nearly 50 billion dollars of U.S. debt during the month of December…
China, the largest foreign U.S. creditor, reduced holdings of U.S. Treasury debt in December by the most in two years as the Federal Reserve announced plans to slow asset purchases.
The nation pared its position in U.S. government bonds by $47.8 billion, or 3.6 percent, to $1.27 trillion, the largest decline since December 2011, according to U.S. Treasury Department data released yesterday.
This is how I would do it if I was China. I would try to dump 30, 40 or 50 billion dollars a month. I would try to make a smooth exit and try to get as much for my U.S. debt paper as I could.
So if China is not going to stockpile U.S. dollars or U.S. debt any longer, what is it going to stockpile?
It is going to stockpile gold of course. In fact, China has been voraciously stockpiling gold for quite some time, and their hunger for gold appears to be growing.
According to Bloomberg, more than 80 percent of the gold that was exported from Switzerland last month went to Asia…
Switzerland sent more than 80 percent of its gold and silver bullion and coin exports to Asia last month, the Swiss Federal Customs Administration said today in an e-mailed report. It imported most from the U.K.
Hong Kong was the top destination at 44 percent on a value basis, with India at 14 percent, the Bern-based customs agency said in its first breakdown of the gold trade data since 1980. Singapore accounted for 8.6 percent of exports, the United Arab Emirates 7.9 percent and China 6.3 percent.
When China imports gold, most of it goes through Hong Kong. We know that imports of gold from Hong Kong into China are at an all-time record high, but we don’t know exactly how much gold China has accumulated at this point because they quit reporting that to the rest of the world a number of years ago.
When it comes to global finance, China is playing chess and the United States is playing checkers. China knows that gold is a universal currency that will hold value over the long-term. As the paper currencies of the world race toward collapse, China could end up holding most of the real money and that would be a huge game changer when they finally reveal that fact…
The announcement of China’s new gold hoard will send shockwaves through the financial markets, and make China and the Chinese yuan (their national currency) even bigger players at the international table.
International banking expert James Rickards compared it to a game of Texas Hold ‘Em poker:
“You want a big pile of chips. The U.S. has a big pile of chips, Europe has a big pile of chips. The U.S. has 8,000 tonnes [metric tons] of gold, 17 members of the euro system have 10,000 tonnes. China at 1,000 tonnes is not a player, but at 5,000 tonnes, they are a player.”
There are some really good points made in the quote above, but I do take exception with a couple of things. First of all, I believe that China now has far more than 5,000 tons of gold. Secondly, I seriously doubt that the U.S. still actually has 8,000 tons of gold or that Europe still actually has 10,000 tons of gold.
As China (and eventually the rest of the world) moves away from a U.S.-based financial system, the consequences are going to be dramatic.
For instance, right now the average rate of interest that the U.S. government pays on debt is just 2.477 percent. That is ridiculously low and it is way below the real rate of inflation. It is simply not rational for anyone to lend the U.S. government money so cheaply, and at some point we are going to see a dramatic shift.
When that day arrives, interest rates are going to rise dramatically. And if the average rate of interest on U.S. government debt rises to just 6 percent (and it has been much higher than that in the past), we will be paying out more than a trillion dollars a year just in interest on the national debt.
Even more frightening is what a rapidly changing interest rate environment would mean for our banking system. There are four large U.S. banks that each have exposure to derivatives in excess of 40trillion dollars. You can find the identity of those banks right here. Interest rate derivatives make up the biggest chunk of those derivatives contracts. As John Embry told King World News just the other day, when that bubble bursts the carnage is going to be unprecedented…
“Stockman brought up a brilliant point, the fact that we have hundreds of trillions of dollars of interest rate swaps, which are polluting the world’s banking system. If we see growing volatility in interest rates, and I think that’s inevitable with what’s going on, that would cause spasms in the financial system. And if something goes wrong in the derivatives market, Heaven help us because the leverage that is imparted to the banking system through these derivatives is unholy.”
Unfortunately, very few of the “experts” will ever see this crash coming.
Very few of them saw it coming in 2000.
Very few of them saw it coming in 2008.
And very few of them will see it coming this time.
Early warnings of a crash are dismissed over and over (“just a temporary correction”). They gradually numb us about the inevitable. Time after time we forget history’s lessons. Until finally a big surprise catches us totally off-guard. Financial historian Niall Ferguson put it this way: Before the crash, our world seems almost stationary, deceptively so, balanced, at a set point. So that when the crash finally hits — as inevitably it will — everyone seems surprised. And our brains keep telling us it’s not time for a crash.
Till then, life just goes along quietly, hypnotizing us, making us vulnerable, till a shocker like Lehman Brothers upsets the balance. Then, says Ferguson, the crash is “accelerating suddenly, like a sports car … like a thief in the night.” It hits. Shocks us wide awake.
Don’t let the upcoming crash take you by surprise.
Douglas Adams’ brilliant comic farce The Hitchhiker’s Guide to the Galaxy describes Earth as residing in sector ZZ9 Plural Z Alpha, one of “the uncharted backwaters of the unfashionable end of the Western Spiral Arm of the Galaxy” and being inhabited by “ape-descended life forms” who “are so amazingly primitive that they still think digital watches are a pretty neat idea”.
Sometimes when I return to Australia, I feel that I’ve arrived in the planet’s sector ZZ9 Plural Z Alpha. Here the economic debate is so primitive that people still think the economy can be controlled by tinkering with the rate of interest.
Is inflation rising? Then put the rate of interest up one and a half times as fast as inflation is increasing. Is output falling below trend? Then drop the rate of interest by half as much as output has fallen. Then adjourn for drinks.
This formula, known as the Taylor Rule, was all the rage in Central Banks from the early 1990s until the mid-2000s. Economists were so confident that they had economic management nailed that they invented the phrase “The Great Moderation” to describe the Goldilocks state of the economy, and took credit for bringing it about:
The sources of the Great Moderation remain somewhat controversial, but as I have argued elsewhere, there is evidence for the view that improved control of inflation has contributed in important measure to this welcome change in the economy (Bernanke 2004, emphasis added).
Then in late 2007 the world went to hell in a handbasket when the global financial crisis began. Mainstream economists were forced to abandon the belief that getting the rate of interest right was all that was necessary to keep the economy on an even keel. Instead, the rate was dropped to near-zero to in an attempt to stop the economy sinking below the waves.
The USA? A cash rate of 0.13 per cent. Japan? 0.1 per cent. Europe? 0.25 per cent. The UK? 0.5 per cent. No-one asks what the central bank will do to interest rates at its next meeting at one of those more fashionable sectors of this planet, because the conceit that the central bank can fine-tune the economy by varying its interest rate is long dead.
Figure 1: Cash rates around the world.
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But not in Australia. Here, what the Reserve Bank will do to the interest rate at its monthly meeting is big news. And because it’s big news, every month Sky News asks about 20 economists three (and lately four) questions about the RBA rates meeting on the first Tuesday of the month:
1) Do you expect the RBA to move on Tuesday? And if so, in which direction and by how much?
2) Where will the official cash rate likely sit by the end of the calendar year?
3) One thing you’re looking for in the RBA statement?
4) What do you THINK the RBA should do on Tuesday? (we’re asking for your opinion)
The first question I’ve likened to betting on which cockroach will get outside a circle first inChangi prison; it’s just gambling. On the second, I’ve consistently called for rates to be lowered, because in my opinion the main impact of our high cash rate – compared to the USA, Europe, UK and Japan in Figure 1 – has been an overvalued dollar that has decimated Australian manufacturing.
On the third and fourth, since March of last year, I’ve added a call that the RBA to introduce loan to valuation ratio controls to stop a property bubble forming. (Strictly, APRA would make such a call, but if the RBA said jump, APRA would do it.)
My answer to Sky News’ poll in March 2013 was:
1) I think the RBA will hold, but if there is any move it will be down;
2) 2 per cent
3) Realisation that (a) the cash rate is the main factor keeping the Australian dollar overvalued and (b) it has to do something to stop a housing bubble forming if it lowers rates–for example, reintroduce a maximum level for LVRs of say 90%.
But that’s all so yesterday. For last week’s poll, I changed my answers in a rather radical way:
3.5 percent [1 per cent higher than today]
Realisation that they are stuck with 4 competing goals: declining employment, rising inflation, a housing bubble and an overvalued dollar, and whatever they do with rates will stuff up at least 3 of those 4 things
Introduce loan to valuation controls like those in NZ (via APRA), persuade the government to introduce limits on non-resident buying of properties, raise rates by half a percent to help burst the property bubble they’ve allowed to develop.
The answers were partly in exasperation, since the whole idea that all the Reserve Bank can and should do to control the economy is vary the interest rate is nonsense. I felt rather likeFord Prefect, livid at the inability of the Golgafrinchans to design the wheel:
‘And the wheel,’ said the captain . ‘What about this wheel thingy? It sounds a terribly interesting project.’ ‘Ah,’ said the marketing girl, ‘well, we’re having a little difficulty there.’ ‘Difficulty?’ exclaimed Ford. ‘Difficulty? What do you mean, difficulty? It’s the single simplest machine in the entire Universe!’ The marketing girl soured him with a look. ‘All right, Mr Wiseguy,’ she said, ‘you’re so clever, you tell us what colour it should be.’
So I answered that the colour should be “square”. And, by analogy, the interest rate decision is about as useful as a square wheel in controlling the economy. There are at least four factors the RBA should care about, and they’re giving conflicting signs:
The economy: this has been heading down for some time, and is still generally heading down—which indicates that rates should be cut. So tick the ‘down’ box.
Housing: We now have a housing bubble because of the RBA rate cuts since 2012—rate cuts that it didn’t expect to make since against its expectations, the economy has been going down (check Figure 1 again: the RBA was alone in raising rates from 2010 since it falsely thought that the economic crisis was over and inflation was about to rise once more). Since the RBA has been and remains too gutless to introduce prudential controls on mortgage lending—unlike the New Zealanders, who did so in August 2013—then it should put interest rates up to prick the housing bubble. So tick the ‘up‘ box.
The currency: this has been overvalued for the last four years, thanks to our high interest rates, and though it’s fallen it is still above the RBA’s comfort level, let alone where the actual economy needs it to be (around 70 cents in my opinion). So tick the ‘down’ box.
Inflation: though this has been consistently lower than the RBA has expected, it is now potentially moving up because the currency has fallen. So tick the ‘up‘ box.
That gives us two “up” signals and two “down” signals. So what to do? Sit on our hands, or stay in a bath for 5 years, like the captain of the Golgafrinchans.
Bugger that, I thought. The one thing the RBA has done courtesy of its primitive belief that interest rates alone can control the economy is allow a housing bubble to form once more. So let’s prick that – hence my call for a 3.5 per cent rate by June 30 (this month’s question asked for the rate by the end of this financial year).
Of course, if the RBA did that – which it won’t – then the currency would fly back over a dollar for sure. There’s no way I actually thought that would be the rate. But please, let’s stop being digital watch fans, and join the rest of the world in realising that there’s more to managing the economy than tinkering with the rate of interest.
“The relentless credit deluge in America is beyond belief…” Kurt Richebächer bemoaned in 2005. “Credit growth, financial and nonfinancial, in the United States has effectively run riot in the short time since 2000.”
Fast-forward nearly a decade and we have no doubt Kurt would express himself with even greater discontent if he were with us now. From CNN Money this afternoon:
“The CBO projects that under current policies, public debt will reach $21 trillion — or 79% of GDP — by 2024. That would be its highest level in more than 75 years and would leave debt at nearly double its long-term average of 40% of GDP.”
What would Kurt say if he were here today? Probably that a nation, no less than you or I, should earn its money before spending it. And that the U.S. may very well thrive as its public and private debt climbs ever higher… yet it’s probably in spite of indebtedness, not because of it…
…the size of its interest payments is as likely to bring the empire of debt to its knees as anything.
At writing, the national debt sits at $17.3 trillion. The debt limit will need to be raised, according to Treasury Secretary Jacob Lew, lest the U.S. default on some of its obligations. That’s old hat.
What’s more interesting is the interest on the debt. After all, the size of its interest payments is as likely to bring the empire of debt to its knees as anything.
According to the CBO, the U.S. will shell out “only” $233 billion to service its debt this year. That’s a little more than 1% of GDP. At the same time, the federal deficit is set to decline this year and next — to nearly half the amount of 2009′s deficit.
We would humbly posit, however, that digging yourself deeper into a hole isn’t an enviable position… no matter how slowly you dig. This is especially true while interest rates are so low.
What happens when they go back up, as they inevitably will?
The answer, according to the CBO report, is that interest payments will make up the biggest portion of the federal deficit. “By 2024, it will reach $880 billion, or 3.3% of GDP,” reports CNN. That will be 80% of the projected $1.1 trillion deficit a decade from now. That amount rivals what we spend on Medicare alone right now.
It sounds like the end of the road for the ol’ US of A… then again, what do we know? When we produced our film I.O.U.S.A. in 2007, the federal debt was about $9 trillion. Today, it’s nearly double that. If we’ve learned anything, it’s that these things can go on a lot longer than you’d figure. Alas, for all of our uncertainty about the journey’s time frame… the destination is certain.
“For decades,” Dr. Richebächer told us in France two years prior toI.O.U.S.A., “one dollar added to GDP in the United States was tied to $1.40 in additional debt. But all that changed in the 1970s. Since then, the debt-to-GDP growth relationship has skyrocketed. Now for one dollar of additional GDP, there is $4 in additional debt.”
The good doctor might have been engaging in a bit of hyperbole. Comparing the GDP numbers from the Commerce Department with the total credit market debt as reported by the Federal Reserve, it took $3.20 in debt to produce $1 of additional GDP at the time of that interview. But the acceleration since the 1970s is undeniable.
The good news — if that’s what you can call it — is that the upward spiral reversed as the “official” recession ended in mid-2009. We’re now back to $3.44 — the level where it was when Dr. Richebächer died, in August 2007. It’s bad news when you consider that much of that debt has been frittered away on entitlement programs, which have exacerbated the problems they were created to solve.
Ed. Note: In the Daily Reckoning email edition, from which this essay was taken, Dr. Marc Faber followed Addison’s musings with an exploration of some specific instances of government failure. Specifically, schemes like the war on poverty… a decades-long mission to flush $20 trillion down a massive toilet. But these essays are just one benefit of reading The Daily Reckoning email editionbefore it hits the Daily Reckoning website… Readers of the email edition are also treated to several chances to discover real, actionable profit opportunities every single day. So don’t wait. Get the full story by signing up for The Daily Reckoning, for FREE, right here.
Addison Wiggin is the executive publisher of Agora Financial, LLC, a fiercely independent economic forecasting and financial research firm. He’s the creator and editorial director of Agora Financial’s daily 5 Min. Forecast and editorial director of The Daily Reckoning. Wiggin is the founder of Agora Entertainment, executive producer and co-writer of I.O.U.S.A., which was nominated for the Grand Jury Prize at the 2008 Sundance Film Festival, the 2009 Critics Choice Award for Best Documentary Feature, and was also shortlisted for a 2009 Academy Award. He is the author of the companion book of the film I.O.U.S.A.and his second edition of The Demise of the Dollar, and Why it’s Even Better for Your Investmentswas just fully revised and updated. Wiggin is a three-time New York Times best-selling author whose work has been recognized by The New York Times Magazine, The Economist, Worth, The New York Times, The Washington Post as well as major network news programs. He also co-authored international bestsellers Financial Reckoning Dayand Empire of Debt with Bill Bonner.
We previously examined 240 years of US market history for a sense of ‘trend’ or sustainability but some were not satisfied. In order to get a truly long-term perspective, we reach back 1000 years to The Middle Ages and look at how stock prices, interest rates, commodity prices, and gold have changed in a millennia (and most notably how the key historical events have shaped those price changes).
Sometimes, perhaps all too often; investors, traders, economists, and mainstream media anchors miss the forest and see only the trees (growing to the sky or crashing to the floor). To provide some context on the markets, we present the first of three posts of long-term chart series (and by long-term we mean more than a few decades of well-chosen trends) – stock, bond, gold, commodity, and US Dollar prices for the last 240 years…
Investors are betting Bank of England Governor Mark Carney will lead the charge out of record-low interest rates as central banks pivot from fighting stagnation to managing expansions.
Economists at Citigroup Inc. and Nomura International Plc say the strongest growth since 2007 will prompt the U.K. to lift its benchmark from 0.5 percent as soon as this year. Money-market futures show an increase in early 2015. That’s at least three months before the contracts indicate Federal Reserve Chairman Janet Yellenwill raise the target for the federal funds rate. European Central Bank PresidentMario Draghi and Bank of JapanGovernor Haruhiko Kuroda are forecast to maintain or even ease monetary policy.
“Carney and BOE officials will be looking at the domestic recovery, and if that is strong enough, then they will feel comfortable increasing rates before the Fed,” said Jonathan Ashworth, an economist at Morgan Stanley in London and former U.K. Treasury official. “Tightening by the major developed central banks will be gradual, and they will be aware of what everyone else is doing.”
The BOE will lift rates in the second quarter of 2015 and the Fed will increase in 2016, Morgan Stanley predicts.
This wouldn’t be the first time Carney, 48, has broken from the pack. As governor of the Bank of Canada, he abandoned a “conditional commitment” to keep rates unchanged until July 2010, citing faster-than-expected growth and inflation. He delivered a rate increase in June of that year, putting him ahead of other Group of Seven central bankers.
The risk of being first this time is that the divergence pushes up the U.K.’s currency and bond yields, threatening to choke off its economic upswing.
Acting before the Fed — now led by Yellen, who was sworn in today as chairman — “would require a very big stomach for having sterling rise,” former BOE policy maker Adam Posen said in a Jan. 8 interview.
While all economists surveyed by Bloomberg News predict BOE policy makers will leave their official bank rate unchanged when they meet Feb. 6, Carney may seek to quell expectations for increases when he releases new economic predictions Feb. 12.
Investors pushed up Britain’s borrowing costs as consumer spending powered the economy back from recession. The pound has already climbed to the highest level in more than 2 1/2 years against the dollar, and the extra yield investors demand to hold 10-year U.K. government bonds over similar maturity German bunds widened to 1.13 percentage points last month, the most since 2005 based on closing prices. Both may undermine growth.
“There’s no immediate need” to raise rates, Carney said on Jan. 25 at the annual meeting of theWorld Economic Forum in Davos, Switzerland. He added that any eventual increases will be gradual.
With Britain expanding 1.9 percent in 2013, matching U.S. growth, money managers are switching their focus to when key central banks will start tightening policy.
The Fed, which has a dual mandate of price stability and full employment, said last week it probably will keep its target rate near zero “well past the time” that unemployment falls below 6.5 percent, “especially if projected inflation” remains below its longer-run goal of 2 percent.
Joblessness dropped to 6.7 percent in December from 7 percent the previous month; part of the reason for the decline is Americans who are giving up on finding work. Prices rose at a 1.1 percent annual pace in December, according to the Fed’s preferred inflation gauge.
The BOE focuses on achieving price stability in the medium term by meeting its 2 percent inflation goal. Last month was the first time since November 2009 (UKRPCJYR) that price growth cooled to that level after hitting 5.2 percent in September 2011.
Weak inflation prompted the ECB to cut its benchmark to 0.25 percent in November, and Draghi said in Davos the central bank would be willing to act against deflation or unwarranted tightening in short-term money-market rates. The ECB’s Governing Council meets the same day this week as the BOE.
In Japan, nineteen of 36 economists surveyed by Bloomberg last month see the central bank expanding already unprecedented stimulus in the first half of this year as officials aim to drive Asia’s second-biggest economy out a 15-year deflationary malaise.
The yield difference between U.K. and German 10-year bonds widened one basis point to 1.06 percentage points as of 11 a.m. London time, after reaching 1.13 percentage points on Jan. 28.
The pound slid for a fifth day against the dollar after a purchasing-management survey showed manufacturing growth slowed last month. ING Bank NV economist James Knightley said the report, by Markit Economics, remains “consistent with very strong growth,” with domestic demand and export orders both improving. The U.K. currency fell 0.6 percent to $1.6341 as of 12:48 p.m. London time. It reached $1.6668 on Jan. 24, the highest level since April 2011.
“The market is pricing in that the BOE will raise rates first, and the Fed will follow three to six months after,” said Jamie Searle, a strategist at Citigroup in London. “The ECB, if anything, is going in the other direction. This will build on the policy-rate divergence that we’ve already seen, which will lead to an unprecedented decoupling in bond rates.”
Such a split has drawn criticism from emerging markets, some of which have been roiled in the past month after the Fed’s announcement of a reduction in its monthly bond purchases combined with signs of a slowdown in China to unnerve investors.
“International monetary cooperation has broken down,” India central bank Governor Raghuram Rajan told Bloomberg TV India on Jan. 30. Industrial countries “can’t at this point wash their hands off and say we’ll do what we need to and you do the adjustment.”
There’s precedent for the BOE to take action ahead of the Fed. The Monetary Policy Committee raised its benchmark in November 2003 and again three more times before the U.S. central bank boosted the rate on overnight loans among banks in June 2004 for the first time in four years. That action helped push sterling up about 9 percent against the dollar.
Between 2007 and 2011, policy makers in London lagged behind their American counterparts in cutting rates and adopting emergency policy measures in response to the financial crisis.
“Traditionally, Fed and BOE policy are quite closely synchronized, but if current trends are maintained, then there will be more than enough data and evidence to justify a BOE increase,” said Stuart Green, an economist at Banco Santander SA in London.
U.K. mortgage approvals rose in December to the highest level in almost six years as a revival in the housing market bolstered the economic rebound. Consumer confidence has improved, and Chancellor of the Exchequer George Osborne hailed signs of a manufacturing pickup in a speech last month.
“The BOE should welcome the opportunity to have a small normalization from an emergency policy setting which isn’t really justified anymore,” Green said.
Carney’s credibility is under pressure after official data show the U.K. jobless rate fell to 7.1 percent in the three months through November from 8.4 percent in the quarter through November 2011. That’s on the verge of the 7 percent he and colleagues identified last August as a threshold that would trigger a discussion about higher interest rates — something they initially didn’t anticipate would happen until 2016.
The BOE governor has signaled he will revise forward guidance next week, when economists say the central bank also will increase its growth forecasts. Among Carney’s options: setting a timeframe for low rates, changing the unemployment threshold, following the Fed in releasing policy makers’ rate forecasts or introducing a broader range of variables to inform decisions.
Simon Wells, a former Bank of England economist, isn’t convinced the BOE will act before the Fed. Unlike the U.S., the U.K.’s output still is below its pre-crisis peak, while workers face cuts in inflation-adjusted pay and are professing sensitivity to the cost of living. An election in May 2015 and the stronger pound also pose obstacles
“There is more willingness to give growth a chance,” said Wells, currently chief U.K. economist at HSBC Holdings Plc., who doesn’t expect the central bank to raise rates before the third quarter of next year.
Carney does have more flexibility now that inflation is back to the 2 percent target. The risk is if unemployment keeps declining, price pressures may re-emerge, especially if joblessness is dropping because of sluggish productivity. Output per hour slid in the third quarter and may leave the economy less inflation-proof.
“We do not believe the MPC can ignore the data and delay,” said Philip Rush, an economist at Nomura in London, who forecasts a rate increase in August. “Surging job creation is lowering unemployment without a commensurate supply-side improvement, so spare capacity is being rapidly used up. This is what matters to the BOE.”
“Is the falling exchange rate good news or bad news?”
I was on CBC radio yesterday morning for about 5 minutes, talking about the exchange rate.
From this experience, and from previous similar experiences, this is what reporters want to ask:
“Who gains, and who loses, from the fall in the exchange rate? For Canada as a whole, is the fall in the exchange rate good news or bad news?”
And the answer they expect to hear is:
“Exporters gain; importers lose. On the one hand it reduces unemployment; on the other hand it increases inflation.”
I don’t think reporters are alone in looking at it from that perspective. Most non-economists are probably the same. But economists are uncomfortable answering that question. Let me try to explain why:
The exchange rate didn’t just fall. Something, call it X, caused it to fall. So when we ask “Is the fall in the exchange rate good news or bad news?”, what are we really asking? You can’t give a good answer if you are unclear on the question.
We might be asking:
1. “Is X good news or bad news?”
Or, we might be asking:
2. “Given that X happened, should the Bank of Canada take action to prevent the fall in the exchange rate?”
To my mind, that second question is the useful one to ask. Because, even if we think we know what X is, and whether X is good news or bad news, if we can’t do anything about X, that isn’t very useful.
2a. An economist can say something useful about the benefits of two different monetary policies: would it be better for the Bank of Canada to fix the exchange rate, or should it target inflation and let the exchange rate adjust to wherever it needs to keep inflation on target?
2b. Or, an economist can say something useful about whether the Bank of Canada, in this particular case, needs to prevent the exchange rate falling in order to prevent inflation rising above the 2% target.
I decided to answer that second question, in the form 2a. I said it would be better for the Bank of Canada to target 2% inflation than to fix the exchange rate to the US Dollar.
I didn’t really answer 2b. But I think that, in this particular case, the Bank of Canada is right to let the Loonie depreciate, to help bring inflation back up to the 2% target.
My guess is that X is mostly news about Canadian inflation coming in lower than had previously been expected, and the realisation that the Bank of Canada would therefore not be raising interest rates as quickly as had previously been expected. (Note that when Statistics Canada released the December CPI data, on Friday morning, and inflation was just slightly higher than I had expected, the Loonie gained nearly half a cent in the next hour.) And maybe weaker commodity prices are part of X too. And maybe the US recovery, and the prospect of rising US interest rates, is part of X too.
Sometimes, when a reporter asks you a question, it’s best not to answer it, and to answer a different question. Not because you are weaseling out of answering the reporter’s question, but because you think about it differently, and you think the reporter’s question isn’t the right one to ask. (I now have more sympathy for politicians being interviewed, when they appear to duck an apparently straight question!)
Update: by the way, when reporters want to interview an economist, they (or one of the people they work with) will normally want to have a pre-interview discussion first. This is your chance to suggest they re-frame the question in the way you think it should be framed. You can tell them you wouldn’t be able to give a good answer to that question, but you could give a good answer to a different but related question. Because very few reporters have any economics background, they don’t really know what questions to ask. And, from my experience, they seem to be willing to listen to your suggestions, because they are trying to prepare for the interview, as well as help you prepare.
It would be interesting to hear any reporter’s thoughts on interviewing economists. (It must be tough!)
As Federal Reserve Chairman Ben S. Bernanke shuts the door to his office for a final time in two days, he can say he took actions that were the first or the biggest of their kind in the central bank’s 100-year history. Some will probably also be the last.
Bernanke was the first to devise a monetary policy that focused on lowering credit costs by suppressing longer-terminterest rates after the short-term policyrate hit zero. His strategy, involving direct purchases of agency mortgage-backed securities and longer-term Treasury debt, left the Fed with the biggest balance sheet in its history, $4.1 trillion.
He was the first chairman since the Great Depression to use emergency lending powers to rescue businesses in almost every corner of the financial system — from banks, to corporations, to bond dealers. And he might be the last: Congress, leery of the Fed’s sweeping powers, removed the central bank’s ability to loan to individuals, partnerships and non-bank companies.
“He was incredibly creative in the different steps and programs he took to prevent a free fall of the global economy,” said Kristin Forbes, a professor at Massachusetts Institute of Technology’s Sloan School of Management in Cambridge and a member of the White House Council of Economic Advisers under President George W. Bush. “During a crisis, you have to make decisions with highly imperfect information. He was willing to do that.”
The 60-year-old Bernanke leaves a Fed vastly different from the institution he took charge of on Feb. 1, 2006. At that time, the former Princeton University professor had a few goals. He said naming an inflation target would help boost accountability and policy effectiveness. He also wanted to push power out of the chairman’s office down into the policy-making Federal Open Market Committee, in effect, to dilute some of the mystique his predecessor Alan Greenspan created.
Eight years later, Bernanke achieved those goals. The Feddeclared an inflation target of 2 percent in 2012, and the FOMC is more democratic. The Fed chairman encouraged more open debate at policy meetings, allowing colleagues to interrupt the format if they wanted to make a point. Unlike Greenspan, Bernanke voices his policy view last.
Among other Bernanke innovations, central bankers publish their economic forecasts, including their outlook for the policy interest rate they set, four times a year. The chairman holds a press conference quarterly.
The crisis response also transformed the institution in ways that defy any near-term conclusion because nobody knows whether extraordinary actions, like purchasing $1.5 trillion in mortgage debt or creating $2.4 trillion in excess bank reserves, can be retracted, shrunk and unwound successfully.
The Fed is more extended politically as it engages in policies such as suppressing mortgage rates, and the size and influence of its open-market operations have involved it in financial markets as never before.
“The legacy is still open,” said Vincent Reinhart, a former top Fed official and now chief U.S. economist at Morgan Stanley in New York. “We survived. The question is what are the consequences?”
U.S. central bankers meeting today will probably announce a second $10 billion reduction in the pace of monthly bond purchases, bringing them down to $65 billion from an original $85 billion. That means Bernanke’s successor, current Fed vice chairman Janet Yellen, will inherit a balance sheet that is still growing.
Those purchases from Wall Street dealers add to the level of reserves in the banking system, requiring the Fed to plant a huge footprint in money markets to manage them. Yellen’s Fed will need to use new tools such as paying interest on these reserves or pulling them out of the banking system with reverse repurchase agreements. Otherwise, the central bank would have a difficult time stabilizing its policy interest rate as banks dumped reserves into the overnight market. That could lead to higher inflation.
“I think it is very intrusive,” Tad Rivelle, who oversees about $84 billion as chief investment officer for U.S. fixed-income securities at TCW Group in Los Angeles, said of the Fed’s operations under Bernanke. The outgoing chairman’s legacy “will ultimately be negative” as policies used during the crisis and slow recovery lead to future instability, he said.
That instability may be social and political as well as financial, he said. Banks are still wary lenders, so the Fed’s low-rate policies are providing what Rivelle calls “preferential access” to a privileged group of borrowers: the government, corporations and consumers with the highest credit scores.
The bond-buying policy, known as quantitative easing, has helped boost asset prices. The Standard and Poor’s 500 stock index rose 30 percent last year, and home prices rose a projected 11.5 percent in 2013, according to an index tracked by CoreLogic, an Irvine, California, data and analytics company. Yet earnings per hour for private-sector workers have climbed just 2 percent a year on average since 2011 compared with a 3.2 percent gain in 2007, the last year of the previous expansion. Adjusted for inflation, they’ve barely grown at all.
Meanwhile, the Fed’s retreat from quantitative easing is slowing capital flows to emerging markets, roiling local stock markets. The MSCI Emerging Markets Index is down 6.8 percent year-to-date.
The Fed’s rescues under Bernanke also left an expanded safety net around financial institutions and markets that Congress and regulators are busily trying to shrink.
Fed officials, such as Richmond Fed president Jeffrey Lacker, warn that if the perception of government guarantees against financial risk isn’t reduced, it will set the stage for another crisis. Richmond Fed economists estimate that the proportion of the total liabilities of U.S. financial firms covered by an implicit or explicit federal safety net increased by 27 percent over the past 12 years.
Bernanke helped increase the perception of government support by rescuing Bear Stearns Cos. and American International Group Inc. during the crisis. He further contributed to that notion when Goldman Sachs Group Inc. and Morgan Stanley came under speculative attack and he let them convert into banks, which granted them access to backstop credit from the Fed.
The bailouts triggered a backlash, stiffening resolve on Capitol Hill to prevent taxpayer support from helping Wall Street again.
Even one of Bernanke’s predecessors, former Chairman Paul Volcker, was surprised by the actions, which, he said in an April 8, 2008, speech before economists in New York, took the Fed “to the very edge of its lawful and implied powers.”
The 2010 Dodd-Frank Act, the most sweeping rewrite of financial rules since the 1930s, contains the phrase “to end too-big-to-fail” in its preamble, a message to regulators that no bank should be so big and risky that it would have to be saved again. To put a point on it, Congress limited the Fed’s power to lend emergency funds to non-bank corporations to a broad-based facility that could only be accessed by several institutions. The message was that singular bailouts of firms such as Bear Stearns were over.
Bernanke said in a hearing in February that regulators were “moving in the right direction” to end too-big-to-fail with the new tools given to them by the Dodd-Frank Act.
Phillip Swagel, who helped manage the government’s bank bailout fund known as the Troubled Asset Relief Program during the George W. Bush administration, said legislation is only part of the solution.
“We won’t know if too-big-to-fail has been solved until the next crisis,” said Swagel, now an economist at the University of Maryland in College Park. “The tools are there” to take down a troubled bank, he added. “The unknown is the will of the government.”
Among the unresolved questions as Bernanke exits: Can the Fed operate indefinitely with a multi-trillion-dollar balance sheet? Is the flow of credit to the economy constricted with the banking system under intense regulatory scrutiny? Has the economy downshifted to some slower pace of growth that the Fed can’t change?
“This is a Fed that’s intervening in the yield curve, it’s intervening in liquidity markets, it’s intervening in many asset classes,” said Julia Coronado, a former Fed board staff economist who is now chief economist for North America at BNP Paribas in New York.
“The book is still open, the last chapters have yet to be written, and it’s way too soon to say, ‘Ah, this is his legacy,’ because history is the judge, and there’s still a lot of risk.”
So much for the credibility of the CBRT? After the Lira soared, and the USDTRY plummeted by just under 1000 pips yesterday when the Turkish Central Bank announced its “shock and awe” intervention, it has since pared back virtually all gains, and at last check was just over 2.24 having nearly roundtripped in 12 hours. Why the loss of faith? Two reasons: First, as we pointed out yesterday, suddenly the domestic situation in Turkey takes front stage again, with 4.25% added elements of instability, causing the political instability to soar, leading to an even higher probability of a social and political overhaul. Second, as Goldman pointed out overnight, “the CBRT stated that liquidity “… will be provided primarily from one-week repo rate instead of the marginal funding rate in the forthcoming period”. This implies that the effective rate hike is 225bp (to 10.00%; the 1-week repo rate), as the Non-PD lending rate was 7.75% prior to the announcement.”
In other words, when looked at on a corridor basis, the CBRT hiked not by a shocking and awing 425 bps but by precisely the predicted 225 bps!
Which means the central bankers merely went along consensus, and not a basis point above it, which is the worst of all worlds – giving the impression of massive tightening (for domestic political purposes), while in reality not doing all that much.
The Federal Reserve is the primary obstacle to reducing income/wealth inequality. Those who support the Fed are supporting a neofeudal arrangement that widens the income/wealth gap by its very existence.
The issue of income/wealth inequality is finally moving into the mainstream: which is to say, politicos of every ideological stripe now feel obliged to bleat platitudes and express cardboard “concern” for the plight of the non-millionaires with whom they personally have little contact.
While many key drivers of declining income are structural and not “fixable” with conventional policies (globalization of labor and the “end of work” replacement of human labor by robots, automation and software, to name the two most important ones), the financial policies that create wealth/income inequality are made right here in the U.S.A. by the Federal Reserve. We should start addressing wealth/income inequality by eliminating the primary source of wealth/income inequality in the U.S.: the Federal Reserve.
The Fed generates wealth/income inequality in three basic ways: 1. Zero-interest rates (ZIRP) and limitless liquidity creates cheap credit that enables the super-wealthy to buy rentier income streams that increase their wealth.
The closer one is to this gargantuan flood of “free money for cronies,” the wealthier one can become by borrowing from the Fed for near-zero and buying assets that yield returns well above zero. If your speculative bet goes bad, the Fed will bail you out.
2. Zero-interest rates (ZIRP) and limitless liquidity feeds financialization, broadly speaking, the commoditization of debt and debt instruments. The process of commoditizing (securitizing) every loan or debt greatly increases the income and wealth of the financial sector and the state (government), which reaps higher taxes from skyrocketing financial profits, bubbles and rising asset values (love those higher property taxes, baby!).
There is no persuasive evidence that cheap credit enables legitimate wealth creation, while there is abundant evidence that cheap credit fuels speculation, credit bubbles and a variety of financier schemes and scams that create temporary phantom wealth for crony capitalists and impoverishes everyone who wasn’t in on the scam.
The housing bubble was not just a credit bubble; it was a credit bubble enabled by the securitization/financialization of the primary household asset, the home.Those closest to the Fed-enabled flow of credit reaped the gains of this financialization (or were subsequently bailed out by the Fed after the bubble burst), while the households that believed the Fed’s shuck-and-jive (“There is no bubble”) suffered losses when the bubble popped.
This chart of income inequality depicts the correlation between the Fed’s easy-money credit expansion and the extraordinary increase in income inequality.Please note the causal relation between income and wealth; though it is certainly possible to squander one’s entire income, those households with large incomes tend to acquire financial wealth. Those with access to cheap credit are able to buy income-producing assets that add to their wealth.
Financialization is most readily manifested in the FIRE sectors: finance, insurance, real estate.
You can see the results of financialization in financial profits, which soared in the era of securitization, shadow banking, asset bubbles and loosened or ignored regulation:
Here’s how cheap, abundant credit–supposedly the key engine of growth, according to the Federal Reserve–massively increases wealth inequality:the wealthy have much greater access to credit than the non-wealthy, and they use this vastly greater credit to buy productive assets that generate income streams that increase their income and wealth. As their income and wealth increase, their debt loads decline.
The family home is supposed to be a store of wealth, but the financialization of housing and changing demographics have mooted that traditional assumption; the home may rise in yet another bubble or crash in another bubble bust. It is no longer a safe store of value, it is a debt-based gamble that is very easy to lose.
Credit has rendered even the upper-income middle class family debt-serfs, while credit has greatly increased the opportunities for the wealthy to buy rentier income streams. Credit used to purchase unproductive consumption creates debt-serfdom; credit used to buy rentier assets adds to wealth and income. Unfortunately the average household does not have access to the credit required to buy productive assets; only the wealthy possess that perquisite.
As a direct result of Fed policy, the rich get richer and everyone else gets poorer.
3. But that isn’t the end of the destructive consequences of Fed policy: the Federal Reserve has also created a neofeudal society in which debt enslaves the masses and enriches the financial Elites. Put another way, not all wealth is created equally. Compare Steve Jobs, who became a billionaire by developing and selling “insanely great” mass-market technologies that people willingly buy because it enhances their lives, with a crony-capitalist who reaps billions in profits from risky carry trades funded by the Fed’s free-money-for-cronies policy or by selling phantom assets (mortgages, for example) to the Fed at a price far above market value.
Clearly, there is a distinction between those two fortunes: one created value, employment for thousands of people, and tremendous technological leverage for millions of ordinary people. The other enriched a handful of financiers. This financial wealth could not be conjured into existence and skimmed by Elites without the Federal Reserve. This Fed-enabled financial wealth destroys democracy and free markets when it buys the machinery of governance. To the best of my knowledge, Jobs spent little of his time or wealth lobbying Big Government for favors, special laws eliminating competitors with regulatory hurdles, etc.
Much of the debate about wealth inequality focuses on whether the super-wealthy are “paying their fair share” of the nation’s taxes. If we refer to the point above, we see that as long as the super-wealthy can buy the machinery of governance, then they will never allow themselves to be taxed like regular tax donkeys.
Unfortunately, only the top 1/10th of 1% can “afford” this kind of Fed-funded “democracy.” As of 2007, the bottom 80% of American households held a mere 7% of these financial assets, while the top 1% held 42.7%, the top 5% holds 72% and the top 10% held fully 83%.
The income of the top 5% soared during Fed-enabled credit bubbles:
Since all these distortions originate from the Fed, the only solution is to abolish the Fed. Those who have absorbed the ceaseless propaganda believe that an economy needs a central bank to create money and manage interest rates.
This is simply wrong. The U.S. Treasury (a branch of government actually described by the Constitution, unlike the Fed) could print money just as it borrows money. Should a liquidity crisis squeeze rates higher, the Treasury has the means to create liquidity and make it available to the legitimate financial system.
All the Fed’s regulatory powers were power-grabbed from legitimate government agencies defined by the Constitution.
The Federal Reserve is the primary engine of income/wealth inequality in the U.S.Eliminate “free money for cronies,” bailouts of the “too big to fail” banks that own the Fed, manipulation of markets, the purchase of impaired private assets at high prices, and all the other tools of financialization the Fed wields to enforce its grip on the nation’s throat–in other words, abolish the Fed–and the neofeudal structure that feeds inequality will vanish along with the feudal lords that enforced it.
We don’t need to “fix” things as much as remove the obstacles that are blocking the way forward. The Federal Reserve is the primary obstacle to reducing income/wealth inequality. Those who support the Fed are supporting a neofeudal arrangement that widens the income/wealth gap by its very existence.