Thursday, June 16, 2011

Today's links

1--U.S. Economic Confidence Plunges in Early June, Gallup

Excerpt: A sharp deterioration in the jobs outlook and six straight weeks of Wall Street declines sent Americans' confidence in the U.S. economy plunging to an average of -35 during the week ending June 12 -- a decline of nine percentage points from two weeks ago, and six points worse than it was in the same week a year ago. Economic confidence is now approaching a 2011 weekly low...

"Poor" Ratings of Economy Match 2011 Low Point

Nearly half of Americans rated current economic conditions as poor last week -- matching the highest level for "poor" ratings so far in 2011. These ratings are
The sharp drop in economic confidence in early June is consistent with the deterioration in the jobs situation, six consecutive weeks of decline on Wall Street, and fears of a global economic slowdown. Even a recent decline in gas prices to $3.78 a gallon has not been enough to offset the decline in consumer optimism -- possibly in part because overall pump prices remain more than $1 per gallon higher than they were a year ago.three points worse than the previous week and three points lower than a year ago.

2--Gross and Rosenberg: QE3 will see interest rate caps, Credit Writedowns

Excerpt: (Bernanke speech 2002) Because long-term interest rates represent averages of current and expected future short-term rates, plus a term premium, a commitment to keep short-term rates at zero for some time–if it were credible–would induce a decline in longer-term rates. A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years). The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields. If this program were successful, not only would yields on medium-term Treasury securities fall, but (because of links operating through expectations of future interest rates) yields on longer-term public and private debt (such as mortgages) would likely fall as well.....

My understanding about what Gross believes is that the Fed could see QE3 "guaranteeing" a 2 year or 3 year yield at a certain level---say 50 basis points. Moreover, the Fed would not necessarily have to buy any Treasuries to defend this target. Gross understands that the private sector “would do it” for the Fed via the language and confidence in the "guarantee". In fact, I was tipped off last night that “it worked on long bonds in the 40s as his speech indicates.” The same individual also tipped me off that “the helicopter speech has been reemphasized as recently a 8/2010 at Jackson Hole”. So it is clear that Bernanke will do this if the economy is near or in recession....

Despite the talk of financial repression, savvy market participants like Bill Gross know the Fed has this power to ‘artificially’ suppress rates. I would argue it is the knowledge that the Fed is able to do so that has people talking about financial repression. Of course, savers don’t have a ‘right’ to a specific rate of return. But, rates are going to be held below what the market would dictate. if you are a fixed income investor in the United States, the only reason to invest in Treasuries then is to benefit from the price appreciation associated with yield suppression that interest rate caps would involve. A better bet is to find yield elsewhere – in high quality, high dividend shares, in corporate bonds or in government bonds in economies that offer a better yield and macroeconomic backdrop. And this is exactly why Gross is looking elsewhere to get bond yield.

Will this policy be a ‘free lunch’? Raghuram Rajan says no and I agree. Savers are the first casualty. But, more importantly, so are consumer balance sheets. Releveraging is exactly what is desired by these kinds of policies both on the monetary and fiscal side. Larry Summers said it well when he quipped:

that the central objective of national economic policy until sustained recovery is firmly established must be increasing... borrowing and lending.."The jobs crisis is not just about demand"...

My take: the US savings rate will remain low because of the skew in favour of debtors. With private sector debt levels still high, that means future US recessions will be events of extreme levels of private sector deleveraging and public sector deficits

-Gross: Savers to Be Disadvantaged for Years

David Rosenberg is on to this as well. According to Zero Hedge, in reference to the legendary Operation Twist, he noted today:

There is certainly nothing preventing the Fed from targeting the 10-year Treasury-note any more than the Fed funds rate. But the funds rate is already near zero and as such there is no incremental move there that can benefit the economy. But targeting the 10-year note in much the same fashion is probably worth a try....

3--Fed Officials Said to Discuss Adopting Inflation Target Backed by Bernanke, Bloomberg

Excerpt: Federal Reserve officials are discussing whether to adopt an explicit target for inflation, a strategy long advocated by Chairman Ben S. Bernanke and practiced by central banks from New Zealand to Canada, according to people familiar with the discussions.

The talks coincide with Fed efforts to spur growth and reduce unemployment without fueling higher prices. An inflation target could help quiet critics of record monetary stimulus and anchor public expectations for consumer prices should the Fed in coming months try to spur the recovery by keeping interest rates close to zero for longer.

“My sense is that this may be a done deal, though not one likely to be implemented soon, and perhaps not until economic conditions return to closer to normal,” said Laurence Meyer, senior managing director and co-founder of Macroeconomic Advisers LLC and a former Fed governor. “The chairman is obviously for it, and it is hard to find anybody on the FOMC who now is really opposed to it.”

Calls by policy makers for an inflation target have grown in recent months, with Fed bank presidents in Atlanta, Richmond, St. Louis, Philadelphia and Cleveland supporting such a move. Atlanta Fed President Dennis Lockhart said on June 7 said it’s time “to reaffirm in explicit terms the central bank’s commitment to delivering its piece of the package of fundamentals needed to assure a durable and lasting recovery.”

4--Counting the reasons for a higher inflation target, greedgreengrains.blogspot (wonkish)

Excerpt: While Paul Krugman and Greg Mankiw both explain that inflation is no threat, allow me to follow Brad Delong by listing all the reasons I know for why the Fed's current nominal inflation target of two percent (one percent in practice) is too low.

1) To maximize long run stability, the Fed should target a long-run price level, not a long run inflation rate. This way long-run investors can be reasonably assured of a particular long-run real rate of return for any given investment paying nominal dividends. The idea is that the Fed would thereby promise to correct short-run variations in inflation leading to less long-run mis-pricing of expectations and assets. Now, since inflation of the last few years has been well below target, it would therefore help restore pre-recession expectations if the Fed were to pursue higher inflation for at least a few years.

2) A higher inflation target will reduce odds of hitting the zero lower bound in future crises and recessions, thereby reducing odds of liquidity trap situations like the one we are currently in.

3) To aid the current unusually bad economic situation by encouraging spending now while the general price level is low. This is what Krugman has often described as a "commitment to be irresponsible."

4) To accelerate deleveraging of both private and public debts, thereby aiding spending and growth in the short run...

5--What's wrong with inflation targeting?, Joseph Stiglitz, Project Syndicate

Excerpt: Today, inflation targeting is being put to the test — and it will almost certainly fail. Developing countries currently face higher rates of inflation, not because of poorer macro-management, but because oil and food prices are soaring, and these items represent a much larger share of the average household budget than in rich countries. In China, for example, inflation is approaching 8% or more. In Vietnam, it is expected to approach 18,2% this year, and in India it is 5,8% . By contrast, US inflation stands at 3%. Does that mean that these developing countries should raise their interest rates far more than the US?

Inflation in these countries is, for the most part, imported. Raising interest rates won’t have much effect on the international price of grains or fuel. Indeed, given the size of the US economy, a slowdown there might conceivably have a far bigger effect on global prices than a slowdown in any developing country, which suggests that, from a global perspective, US interest rates, and not those in developing countries, should be raised....

Raising interest rates can reduce aggregate demand, which can slow the economy and tame increases in prices of some goods and services, especially nontraded goods and services. But, unless taken to an intolerable level, these measures by themselves cannot bring inflation down to the targeted levels. For example, even if global energy and food prices increase at a more moderate rate than now — for example, 20% per year — and get reflected in domestic prices, bringing the overall inflation rate to, say, 3% would require markedly falling prices elsewhere. That would almost surely entail a marked economic slowdown and high unemployment. The cure would be worse than the disease.

So, what should be done? First, politicians, or central bankers, should not be blamed for imported inflation, just as we should not give them credit for low inflation when the global environment is benign.

Second, we must recognise that high prices can cause enormous stress, especially for poorer people . Riots and protests in some developing countries are just the worst manifestation of this.

Advocates of trade liberalisation touted its advantages; but they were never fully honest about its risks, against which markets typically fail to provide adequate insurance...

Most importantly, both developing and developed countries need to abandon inflation targeting. The struggle to meet rising food and energy prices is hard enough. The weaker economy and higher unemployment that inflation targeting brings won’t have much effect on inflation; it will only make the task of surviving in these conditions more difficult.

6--The inflation obsession, James Galbraith, Foreign Affairs

Excerpt: Should a central bank address a broad agenda of economic growth, price stability, and full employment? Or should it focus single-mindedly on controlling inflation?... In the United States, where federal law stipulates full employment as a policy goal, Republican proposals to require that the Federal Reserve focus only on inflation surface regularly in Congress.

Ben S. Bernanke and his colleagues, each a veteran of the Federal Reserve Bank of New York research staff, make the case for inflation targeting in a book that has the intellectual rigidity of a manifesto....

Since the early 1980s, a handful of countries have formally declared that low and stable inflation should be the overriding objective of monetary policy. These countries, which include New Zealand, Canada, Great Britain, and Sweden, are the main focus of the book. After reviewing these cases, Inflation Targeting uses them as examples to argue that inflation targeting would also enhance American "economic performance in the long term." But the authors have a curious interpretation of this phrase. They do not use it to refer to rising living standards, full employment, declining inequality in pay, or similar recent improvements in American material well-being. Rather, they explicitly deny that monetary policy should be praised for these blessings, since the gains of an expansionary monetary policy are inherently temporary and unsustainable. Economists should therefore not count such gifts among the benefits of a sensible long-term monetary policy.

In other words, America's present affair with full employment is sure to end badly, with an acceleration of inflation leading finally to recession and unemployment. In contrast, the right strategy to fight inflation is to keep unemployment high enough all the time at its "natural" rate, or as low as joblessness can go without sparking inflation. A central bank distracted by the pursuit of economic growth and full employment is to be condemned, while a central bank that achieves price stability at the cost of chronic high unemployment -- as in Germany -- has done its duty....

The case for inflation targeting, as Bernanke and his colleagues present it, rests on a theory -- the natural rate of unemployment mentioned above -- that links monetary policy exclusively to inflation control and denies central banks any important role in determining economic growth or employment. As disciples of the natural-rate doctrine, our authors favor inflation targeting not simply as the better strategy, but as the only strategy consistent with sound economics....

In other words, the countries in question never introduced inflation targets when inflation posed a serious threat, nor did adopting targets reduce the cost of any ongoing inflation battle. In all cases, the declaration of war came after the fighting was over. So why did the central bankers do it? Bernanke and his colleagues are quite honest about the reasons. Inflation targeting in all cases coincided with high unemployment, and its main effect was to excuse central bankers from addressing this crisis. Second, inflation targeting could substitute for the messy practice of money supply targeting, an earlier misguided enthusiasm that Britain had once embraced and that Germany used until the launch of the euro. Third, and in sharp contradiction with the first motive, inflation targeting provided in a few cases some camouflage for central bankers who were actually planning to ease monetary policy in order to fight unemployment. They said one thing to placate conservatives and did another to accommodate the political and economic realities of the hour....

Central bankers, like generals, are often accused of refighting the last war. But as the motives above suggest, this case is somewhat different. First, inflation targeting commits itself in principle to fight the last war -- the war against inflation -- as a way to avoid addressing the present threat -- unemployment. ...

What should the United States do? The Federal Reserve is an independent executive agency under the authority of Congress. It therefore comes under the Humphrey-Hawkins Full Employment and Balanced Growth Act of 1978, which rewrote U.S. economic policy goals to specify that they include, among many things, full employment, balanced growth, and reasonable price stability. In particular, the act set interim targets of four percent unemployment and three percent inflation -- goals that are now, within a few tenths of a percentage point, achieved.

The authors of Inflation Targeting do not discuss the Humphrey-Hawkins Act. If they had the chance, however, they would likely rewrite it and order the Federal Reserve to fight inflation alone. They do not say what would become of the Humphrey-Hawkins goal of "full employment."

7--Inflation Targeting: The Bernanke Way, The Jethro Project

Excerpt: Inflation targeting is a monetary-policy strategy. It was introduced in New Zealand in 1990 and over 20 industrialized and non-industrialized countries use it. Its principal feature is an announced numerical inflation target, a monetary policy that focuses on an inflation forecast (called ‘inflation-forecast targeting) and public transparency and accountability.

Bernanke and his colleagues at the Federal Reserve Bank of New York argued in their book, “Inflation Targeting: Lessons from the International Experience” that inflation targeting is beneficial for the United States economy....

James Galbraith, in his article on “Inflation Obsession: Flying in the Face of the Facts,” notes that in the United States were federal law stipulates full employment as a policy goal, Republican proposals to require the Federal Reserve to focus only on inflation surface regularly in Congress.

Thus, the Bush administration appointed one of the primary proponents of inflation targeting at the helm of the Federal Reserve to quietly implement the Republican proposal of inflation targeting.

The Republicans, including Bernanke and colleagues believe that inflation targeting would enhance American economic performance in the long run. However, Galbraith notes “they do not use it to refer to rising living standards, full employment, declining inequality in pay, or similar recent improvement in the American well-being.” Rather, he notes that they explicitly deny that monetary policy should be praised for expanding the economy....

Bernanke and colleagues illusionary view that controlling inflation would improve economic performance has been debunked; instead of inflation it has created deflation in much of the world and put us in the worse financial crisis since the great depression. It has cause the American middle class to loose a substantial portion of their wealth. Why? Because, in order to control inflation the Federal Reserve maintained a restrictive monetary policy and when exogenous events occur, such as wars or natural disasters, the price of certain goods or services increases, which creates a demand for real money balances. But, since the Federal Reserve is focused on inflation targeting, it failed to increase the stock of money during periods of rising crude oil prices. Therefore, the demand for real money balances exceeded the supply, which meant that the supply of assets exceeded the demand for real assets, such as bonds, housing, and other financial assets.

Thus, the reappointment of Bernanke is a clear indication that the administration does not understand the root cause of the current economic problems and will, more likely than not, continue to disappoint supporters of change.

8--Europe Faces ‘Lehman Moment’ as Greece Unravels, Bloomberg

Excerpt: The European Union’s failure to contain the Greek debt crisis is sending fresh shockwaves through currencies, money markets, equities and derivatives.

The euro lost more than 2 percent against the dollar in the past two days and the cost of protecting corporate bonds soared to the highest level since January, with credit-default swaps anticipating about a 78 percent chance that Greece won’t pay its debts. Equities declined around the world, while a measure of fear in fixed-income markets jumped the most since November.

Market moves suggest heightened concern that authorities won’t be able to keep Greece’s debt troubles from spreading after Moody’s Investors Service said it may downgrade BNP Paribas SA and two other big French banks because of their investments in the southern European nation. The collapse of Lehman Brothers Holdings Inc. in September 2008 caused credit markets worldwide to freeze as investors fled all but the safest government debt.

“The probability of a eurozone Lehman moment is increasing,” said Neil Mackinnon, an economist at VTB Capital in London and a former U.K. Treasury official. “The markets have moved from simply pricing in a high probability of a Greek debt default to looking at a scenario of it becoming disorderly and of contagion spreading to other economies like Portugal, like Ireland, and maybe Spain, Italy and Belgium.”

9--Misc: Q2 GDP Downgrades, Oil Prices decline, CalculatedRisk

Excerpt: Catherine Rampell at the NY Times Economix writes: The Great Growth Disappointment

Second verse, same as the first: The quarter when the economy was supposed to stage its comeback is looking just as bad as its disappointing predecessor.

... after a major bummer of an inflation report, Macroeconomic Advisers, the highly respected forecasting firm, lowered its annualized second quarter G.D.P. forecast to 1.9 percent.

For reference, when the quarter began, Macroeconomic Advisers was expecting 3.5 percent growth

Rampell provides a graph that shows Q2 estimates are tracking the same downward path as Q1 projections. Now it is all about the 2nd half ...

• Oil prices fell sharply today. WTI futures are down to $95.31 per barrel and Brent is down to $113.92.

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