9 August 2011 – The Aleph Blog

Debt Junkies

Posted on 9 August 2011 by David Merkel

Our problems today stem from too much debt, both personal and governmental.? When enough of the populace is overindebted, they become conservative in spending.? When corporations see that, they become conservative as well, and cut back on production.? The same is true with governments.? As governments get more indebted, people begin to think they won’t spend as much in the future, which is a reasonable assumption.

But what do the pundits suggest?? Borrow more.? If you only would borrow more, and allocate the money to our favored projects, things would improve.? But that is more of the “hair of the dog that bit you” reasoning.? More debt does not solve the problem of too much debt.

In general, the more of the economy that we hand off to the government, economic growth will be less.? The government rarely grows anything, except itself.

I realize in the short-run that reductions in the growth of debt, much less reductions in debt will be viewed negatively by many.? The question becomes whether you want a solution, or you want to continue the disease, and hope for a miracle.

This problem is not limited to the US.? It extends to the Eurozone and China, and indirectly to the rest of the developed and semi-developed world.? In the Eurozone, the ECB and EFSF buy the debts of the weakest nations in order to back the Euro.? Imagine the Fed buying Puerto Rican and Californian bonds.? Ugly, and I hope the Fed does not become more imaginative.? It is too speculative already.

The Eurozone is transforming what was a fringe problem into a core problem and CDS spreads of Germany and France are greater than those of the UK, which has its own currency.? If the Eurozone were a nation, it would be in roughly the same shape as the US, which means not good.

As for China, the government forces loans that are not economic on the banks.? There are many projects that seem to have no economic purpose, but might have political purpose.? Why build ghost cities?? Why build a highway to Xingjang, and plan a model city there?? For the latter it is to control the Uighurs; for the former, I am not sure, aside from distorting GDP statistics.

China also has its issues with owning US debt.? They have to own US debt to keep their currency cheap for exporting.? This is just another way that China discriminates against their consumers in favor of exporters who are political cronies.

Coming back to the US, the Fed encouraged more debt todayby saying that financing rates would remain low for two years.? That may push up asset prices, and allow the highest quality borrowers to borrow more, but is useless in stimulating the economy, because credit spreads do not respond to the Fed when the economy as a whole is overlevered.

The world is led by debt junkies who think that debt doesn’t matter.? They are leading us to a greater crisis where the only thing that does matter is debt, and for political reasons, some governments will not be willing to pay in full.

Redacted Version of the August 2011 FOMC Statement

Posted on 9 August 2011 by David Merkel

June 2011	August 2011	Comments
Information received since the Federal Open Market Committee met in April indicates that the economic recovery is continuing at a moderate pace, though somewhat more slowly than the Committee had expected.	Information received since the Federal Open Market Committee met in June indicates that economic growth so far this year has been considerably slower than the Committee had expected.	Shades down their view of GDP again.? I think they need to hire better modelers.
Also, recent labor market indicators have been weaker than anticipated.? The slower pace of the recovery reflects in part factors that are likely to be temporary, including the damping effect of higher food and energy prices on consumer purchasing power and spending as well as supply chain disruptions associated with the tragic events in Japan.	Indicators suggest a deterioration in overall labor market conditions in recent months, and the unemployment rate has moved up.	Shades down their view of employment further.? Wishful thinking regarding transitory factors disappears? Japan does not have that big of an impact on US employment, nor do food and energy prices, which have been going up for some time. (See 2 boxes below.)
Household spending and business investment in equipment and software continue to expand.? However, investment in nonresidential structures is still weak, and the housing sector continues to be depressed.	Household spending has flattened out, investment in nonresidential structures is still weak, and the housing sector remains depressed. ?However, business investment in equipment and software continues to expand.	Shades down their view of household spending, otherwise similar.
	Temporary factors, including the damping effect of higher food and energy prices on consumer purchasing power and spending as well as supply chain disruptions associated with the tragic events in Japan, appear to account for only some of the recent weakness in economic activity.	New sentence that takes back part of their wishful argument from last month.? They were grasping at straws.
Inflation has picked up in recent months, mainly reflecting higher prices for some commodities and imported goods, as well as the recent supply chain disruptions.	Inflation picked up earlier in the year, mainly reflecting higher prices for some commodities and imported goods, as well as the supply chain disruptions.	Basically the same.
	More recently, inflation has moderated as prices of energy and some commodities have declined from their earlier peaks.	What evidence do they have that overall inflation is declining?? I don?t see it; this is more grasping at straws.
However, longer-term inflation expectations have remained stable.	Longer-term inflation expectations have remained stable.	Basically the same.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.? The unemployment rate remains elevated; however, the Committee expects the pace of recovery to pick up over coming quarters and the unemployment rate to resume its gradual decline toward levels that the Committee judges to be consistent with its dual mandate.	Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. ?The Committee now expects a somewhat slower pace of recovery over coming quarters than it did at the time of the previous meeting and anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate.	Shades down their view of the recovery overall.? The misplaced optimism is declining.
Inflation has moved up recently, but the Committee anticipates that inflation will subside to levels at or below those consistent with the Committee’s dual mandate as the effects of past energy and other commodity price increases dissipate. ?However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.	Moreover, downside risks to the economic outlook have increased. The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee’s dual mandate as the effects of past energy and other commodity price increases dissipate further.? However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.	Shades down their views on inflation, but for little good reason.
To promote the ongoing economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent.	To promote the ongoing economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent.	No change.
The Committee continues to anticipate that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate for an extended period.	The Committee currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.	Defines the ?extended period to be 2 years.
The Committee will complete its purchases of $600 billion of longer-term Treasury securities by the end of this month and will maintain its existing policy of reinvesting principal payments from its securities holdings.	The Committee also will maintain its existing policy of reinvesting principal payments from its securities holdings.	No real change.
The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.	The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.	No change
The Committee will monitor the economic outlook and financial developments and will act as needed to best foster maximum employment and price stability.	The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability. It will continue to assess the economic outlook in light of incoming information and is prepared to employ these tools as appropriate.	The Fed doesn?t have any good tools left.? All they can work with are the bad tools, and work they will.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen.	Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen.	Note dissenters below.
	Voting against the action were: Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser, who would have preferred to continue to describe economic conditions as likely to warrant exceptionally low levels for the federal funds rate for an extended period.	They would have preferred the old language not specifying how long the extended period would be at minimum.? This is a pretty weak dissent; there is a lot more to be objected to in our monetary policy.

Comments

The FOMC defines the ?extended period to be 2 years.? Short-intermediate part of the Treasury curve flattens.? Long end goes on a speculative tear.? Hope the FOMC likes that, but it will only allow high quality borrowers to borrow more cheaply, not average people and small businesses. The Fed?s policy can?t bring down credit spreads, not that it should.
Still engages in wishful thinking regarding inflation, thinking that it is declining.? Points at energy and commodities, but that?s not the largest part of what drives inflation.
Finally shades down its views on GDP and employment growth.
The Fed ends much of its wishful thinking regarding transitory employment factors? Japan does not have that big of an impact on US employment, nor do food and energy prices, which have been going up for some time.
The key variables on Fed Policy are capacity utilization, unemployment, inflation trends, and inflation expectations.? As a result, the FOMC ain?t moving rates up, absent increases in employment, or a US Dollar crisis.? Labor employment is the key metric.
The hawks finally flew with a weak dissent, objecting to specifying how long the extended period would be at minimum.
The Fed is not shrinking its balance sheet anytime soon.
The Fed is out of good policy tools, so it will use bad policy tools instead.

Questions for Dr. Bernanke:

How big is the effect on employment from higher food and energy prices on consumer purchasing power and spending as well as supply chain disruptions associated with the tragic events in Japan?
Couldn?t increased unemployment be structural, after all, there is a lot more competition from labor in emerging markets?
Isn?t stagflation a possibility here?? I mean, no one expected it in the ?70s either.
Could we end up with another debt bubble from keeping short rates so low?
If the Fed ever does shrink its balance sheet, what effect will it have on the banks?
Is it possible that you don?t really know what would have worked to solve the Great Depression, and you are just committing an entirely new error that will result in a larger problem for us later?