The View From 1776

Barron’s On Fed Monetary Policy

If you are a Barron’s subscriber, read As Stocks Near Records, Why Does the Fed Act as if Times Are Bad?, by Randall W. Forsyth.


Only conspiracy theorists would question why the economy had a head of steam, with a 3.1% annualized real growth rate in the third quarter, ahead of the November elections, only to stall shortly thereafter. To be sure, Superstorm Sandy hurt the quarter’s performance, as did the sharpest cutback in defense spending since the withdrawal from the Vietnam War in the early 1970s. Still, real final sales—GDP less inventory swings—decelerated sharply, to a 1.1% annualized growth rate, from 2.4% in preceding quarter.

Leaving aside the trivial, quarter-to-quarter blips in economic indicators, it’s apparent that the Fed’s money printing has failed to trickle down to the broad economy. The turnover of the money supply—its “velocity”—has fallen, offsetting the increase in the money stock.

As writes Leigh Skene of Lombard Street Research in London:

“In America, for example, the drop in money velocity to almost one-third under the lowest recorded prior to 2012 in this monetary series wiped out 5/8ths of the increase in M2 [the broad money measure, consisting of currency, checking and most savings accounts, including money-market funds] in the past five years.

“Most of the remaining M2 growth created inflation. Worse, excess debt growth increasingly levered asset prices up, creating the biggest asset bubble ever, which widened income disparities. The real incomes of the minority that benefited from microscopic interest rates rose and those of the majority fell. Rising debt burdens and falling real incomes for most people reduced real output growth in the 2000s decade to the second lowest in the 22 decades from 1790, according to Hoisington Investment Management. The 1930s was the lowest decade and the 2010s’ average won’t be higher than third-lowest.”

So, to come back to Paulsen’s point, why does the Fed have its policy throttles on “full speed ahead” if all is well? Or does it only appear so because of the monetary inflation produced by the central bank?

Posted by .(JavaScript must be enabled to view this email address) on 02/01 at 06:41 PM
  1. The fed has committed to its policy of low interest rates until unemployment is below 6.5%.
    Posted by .(JavaScript must be enabled to view this email address)  on  02/01  at  11:23 PM
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  3. Crazy Keynesians keep insisting more debasing of US currency is "needed", and when that doesn't improve the economy their solution is more and more and more...
    Posted by .(JavaScript must be enabled to view this email address)  on  02/11  at  02:53 PM
  4. J. Jay,

    It is thoroughly unclear what point you are trying to make. Are you agreeing Bernanke is ‘stuck in stupid’? Or, are you asserting, as Pelosi so famously and fatuously said, we must pass this pig to find out what is in it (on the presumption we’ll be pleasantly surprised and/or embarrassed by it)? Or, perhaps, you thought your clever one-liner sufficient to both answer and to parry Thomas’ question and premise, but, like so many of your arguments failed to make much of an impression because to vague. You may as well be saying Bernanke is holding the country hostage by keeping interest rates low; which makes greater sense than that he is doing it out of concern for our wellbeing. In truth, however, he can be accused of neither skullduggery nor skillful management.

    The Bernanke policy of keeping interest rates low is not new with this latest pronouncement of a 6.5% unemployment target. In fact, his policies are the result of academic papers written by him well before he became FED Chairman that are notoriously inaccurate predictors of what has happened since. Like Greenspan, Bernanke is an academic without real-world portfolio – and it shows. Bernanke’s overriding fear is deflation; and so focused is he on prevention he is missing opportunities for a robust recovery. Moreover, 6.5% is not his only or exclusive criterion for allowing rates to rise. The full and correct citation is the Fed “will not tighten [the money supply] before inflation goes above 2.5% or unemployment falls below 6.5%”. Thus, the objective is not controlling either unemployment or the money-supply, but something else; and that something is ‘deflation’. Why else would he want to drive inflation above 2.5% except as a cushion against deflation? But then, why also tighten the money-supply should unemployment fall below 6.5% if the real objective is to push inflation higher? We don’t have to guess because he already told us. The reason for it is that falling unemployment is a proxy or indicator of greater economic activity historically presaging a sudden increase in goods, which typically results in prices falling faster than the Fed can react. The result of that, again, would be deflationary; the very thing Bernanke is trying so desperately to avoid.

    Bernanke appears to be obsessed with deflation to the point he will not tolerate even a speck of it despite he must know there is more benefit than downside to it. Consumers are the primary beneficiaries of deflation because falling prices mean a dollar goes further. Moreover, falling prices have been the historical norm of the past two centuries, demonstrating the positive power of deflation. Of course, just because individual goods become cheaper does not mean the market as a whole deflates. As some goods become cheaper, it frees up capital for other uses and drives demand for more, cheaper and better products; and greater consumption of them and the aggregate result of those is market expansion. The inflation we then see (and which CPI reflects) is not so much for a fixed set of goods but of constantly improving and expanding goods, which falling prices on the original and limited goods makes possible. Except for deflation that is more than a few percent and sustained over long periods, the risks from deflation are slight and its negative impacts fall mainly on large investors of the Goldman-Sachs and Warren Buffet variety. Thus, Bernanke’s concern, while touching, mainly serves the interests of super-wealthy capitalists you socialists so love to bash rather than those of the poor, middle-class or country as a whole.

    As one of my sources (Real Clear Markets) points out, Bernanke is unclear as to which unemployment rate he is referencing as his tripwire for policy reversal (come to think of it, he doesn’t tell us which money-supply – M1 ... M6 – he intends tightening either). If this is U6 rather than U3, then we are unlikely to reach that target within our lifetimes. But, even if it is U3 and it only takes another 1.2 points to get there, how long will that take and what are the repercussions of sustained low interest rates. Some astute critics, using the last four years as basis, assert this will not happen sooner than thirty months. A WSJ letter to-the-editor entitled “The Downside of Very Low Interest Rates Over Time” makes the case savings will be negatively impacted (why save if the main attraction for it – interest – is negligible) will be long-term catastrophic for both young adults and retirees (and, by inference, everyone in between). As a policy, it favors borrower-consumers over saver-investors even more than did the low interest-rate policies of Greenspan.

    A prime-rate of zero means the Fed has no more leverage should it need to lower rates further (is a negative prime even possible?). It can still raise rates if necessary, but if lowering is what is needed, it has nowhere to run. If, despite Bernanke’s herculean effort to prevent deflation, it raises its ugly little head any way, he’s got nothing more with which to beat it down … his gun out of ammo.

    Next, we should consider the quantitative effect of easing with rates near zero. When interest rates are high (say in the double digits), consumption will slow because consumers can ill afford buying against credit. In this situation, consumers want rates to go lower so they can keep on spending as before. Money-supply may be ample, but lenders will tend to tighten credit as a response to an increase in defaulters and slow repayment; and will want rates higher to damp the credit demand. Large investors and brokers will likewise prefer rates to go or remain higher (unless they are more consumer than investor, in which case they will be conflicted on this). The Fed (in its wisdom – hopefully) will recognize rates this high are unsustainable, and will do what they can to lower it. A ¼% reduction at this level has a significant effect on credit, but little real effect on savings because returns are still highly attractive. On the other hand, a ¼% reduction when the prime rate is only ¼% has very little stimulus (positive) effect on consumption/borrowing, but a large negative impact on saving/investing. When return on investment (saving) reaches zero, there is far less incentive to save or build toward retirement. Note, I here use the terms ‘negative’ and ‘positive’ in the context of ‘feedbacks’ rather than ‘desirability’.

    The savvy saver will, of course, continue to invest because he knows this is time he cannot make up, but also because this is when bargain investments are to be had. Most savers will not see it that way, however; and will instead see their investments languishing and their money better spent on things than on intangibles and, so, will put off saving until ROIs climb higher. The feedback on savings attributable to a rate increase at this level can be profound. A saver getting 1% on an 18-month CD considering whether to take his money out in order to put it into something riskier at 2% (at best) over the same period may reconsider on learning the rollover CD will now yield a guaranteed 1¼%. A ¼% increase in rate at this level represents a 25% greater investment gain. That same ¼% prime-rate jump when rates are already in the teens represents a less than 2.5% investment gain and is, therefore less attractive to new or renewed investment. Investing may be at historical lows precisely when rates are lowest, but that is precisely when a small Fed rate increase can have its most positive effect of increasing both the number of investors and investment volume. On the flip-side, people paying next to nothing borrowing at 1% have little incentive to buy much more than they are already at ¾% (it’s not like they are resisting temptation hoping for a lower rate, and have already maxed out their credit cards buying junk), so the leveraging effect from lowering the rate further at this level is at its weakest, and far weaker than the same lowering starting from much high rates. Statists love this kind of market despite the poor jobs outlook because consumers are happily consuming regardless of rising personal debt (and to heck with those dastardly, profiteering lenders!). The lesson from this is people are frugal when credit (money) is tight and foolishly profligate when it is loose; and further loosening doesn’t make much of a dent on people already conditioned to spend like there is no tomorrow – which is the situation we are now seeing.

    Source links:[1].pdf – Bernanke policy is narrowly scripted, not presciently beneficial; plus his presentation of targets was incoherent – how soon might the jobless rate fall to 6.5%? ; – according to Fed, it doesn’t expect this to happen anytime sooner than mid-2015 - causes of deflation - no direction to go (with rates) but up - drop-outs not counted in U3?; also – U.S. Unadjusted Unemployment Shoots Back Up - is real-unemployment (hidden) still inching up? - The Downside of Very Low Interest Rates Over Time - Causes of Deflation
    Posted by .(JavaScript must be enabled to view this email address)  on  02/13  at  06:55 AM
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