In a 1951 letter from then F_E_D chairman McCabe to Senator O'Mahoney with regard to currency debasement and the F_E_D's independence from the Treasury...
I agree with you entirely that the Soviet dictators would like to bring about our economic collapse and, as you know, inflation is perhaps the greatest force for arraying the various sectors of a capitalistic economy against each other. John Maynard Keynes stated in his 'Economic Consequences of the Peace' (1919): 'Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency...Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of Society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.'
...
Confidence of the public in Government securities as well as in other forms of liquid savings is inextricably bound up with public confidence in the value of the dollar. With the large overhand of such liquid savings, and considering among other things the heavy maturities of savings bonds coming up next year, it is extremely important that confidence in the dollar be firmly established by Government policies that destroy the inflation threat at its roots. Continuation of too easy money policies will make it next to impossible to engender confidence in the sustained real value of Government securities. (***Think China and Japan here and who is the largest holder now of US public debt, hint... it starts with an F and ends with a D****)
The interest cost on the public debt should be as low as is consistent with economic stability.Interest rates should be high enough, however, so that the debt will be bought and firmly held by the investing public and will not need the support of an undue amount of money creation.... We should also keep in mind that interest rates on short-term Government securities also decline in periods of recession as they did in the 30's and more recently in 1949. I am old fashioned enough to believe that history will repeat itself and that over a period of years interest rates will fluctuate with changing economic conditions.
The Federal Reserve has always tried to avoid conflict with the Treasury. The record over the years shows patience, compromise and much sacrifice of basic convictions to this end. I am still hopeful that a basis of mutual understanding and agreement can be reached. If not, we will have no defensible alternative save but to do what, in our considered judgment, is for the best interests of the country, in accordance with our statutory responsibilities. We can, of course, always go to the Congress that created us and to whom we report and appeal for a redefinition of our responsibilities.
-------------------------------------------
More from 1951 from F_E_D Governor and the man which the building housing the F_E_D is named after, Marriner Eccles:
We favor the lowest rate of interest on government securities that will cause true investors to buy and hold these securities. Today’s inflation. . . is due to mounting civilian expenditures largely financed directly or indirectly by sale of Government securities to the FederalReserve.... The inevitable result is more and more money and cheaper and cheaper dollars.
-------------------------------------------
From Fed Governor Martin, 1951:
Unless inflation is controlled, it could prove to be an even more serious threat to the vitality of our country than the more spectacular aggressions of enemies outside our borders. I pledge myself to support all reasonable measures to preserve the purchasing power of the dollar.
-------------------------------------------
Letter from Henry Truman to Governor McCabe:
"We must combat Communist influence on many fronts.. . . If the people lose confidence in government securities all we hope to gain from our military mobilization, and war if need be, might be jeopardized.”
I hope the Board will. . . not allow the bottom to drop from under our securities. If that happens that is exactly what Mr. Stalin wants.
----------------------------------------------
My, my, how times have changed, I wonder if the fundamentals of what was said above have changed?
While Central Banks around the world, at least the important ones, undertake brave new strategies such as the ECB's new bond buying program, there are at least a few out there who seem to understand that you can't get rid of debt by adding more debt and the simple fact is, when you print, you cause inflation as the money is worth less. Being a victim of one of the worst hyper-inflationary economies of modern times, Germany still remembers and still seems to have a sane voice in all of this as was noted in an interview today between the TeleGraph and the Bundesbank's Jens Weidmann.
While we're on the F_E_D, we'll look at a few other things, what worked, what didn't and why.
You may recall this last post from Friday, "Panic?" in which a former F_E_D Governor, Kevin Warsh, who knows, has served with and holds Bernie in high regard, said of the last week's policy action: It looks like panic when we are in an economic environment that doesn't warrant panic. He continued to talk about the most difficult part of Central Banking is always the exit, policy is easy to enter, difficult to exit (in fact he said for Central Bankers, "EXIT" is a 4-letter word) so in his opinion, Bernie must be very frightened by something.
If you reference this post "The History of QE", you'll see what the 4 F_E_D programs have been, when they were started, what they were and what effect they had. In a quick study, QE-1 started with MBS (like now), however the market didn't respond well to QE-1 initially which was $600 billion in MBS purchases. The S&P went on to lose -21%, even as the Obama administration introduced a $787 billion dollar stimulus package in February of 2009 (about 4.5 months after QE-1 started). By March 18th, the F_E_D added additional asset purchases to QE-1 of an additional $100bn in MBS and for the first time in Bernie's tenure, the purchase of $300 bn in long dated treasuries, this got the market moving.
QE-1 ended with the market moving higher, it only started to top after the end and before the 2010 Jackson Hole speech telegraphing QE-2, but QE-2 lost price momentum at least 5 months before it ended, the difference? QE1 was open ended, QE-2 had a fixed amount on a fixed schedule.
QE3 has the benefit of being open ended, but as QE-1 didn't originally respond well to MBS purchases only and only responded well in the market any way after treasuries were added, it's worth noting QE3 as of now is an Agency Backed MBS purchase program, although there was language that left the door open to other assets.
Other differences between QE1, 2, Twist and Twist 2... At each of the announcements when QE was first understood to either be coming or explicitly announced, the market was depressed and at regional lows, the market now on the other hand is the opposite, many would say that is because QE-3 has already been discounted or priced in to the market, which wouldn't be the best thing for those looking for a liquidity high.
Additionally the dividend yield when QE1 started for the S&P-500 was 4%, it is now half that at 2%. The P/E (Price to Earnings ratio) was 10 back then (stocks were fairly cheap), now it is nearly 15% at 14.9x-stocks are no longer cheap, at least not compared to the 2008/2009 period. Furthermore P/E's are expected to rise as input costs and the lack of demand for manufactured products is going to further constrain earnings and therefore the P/E ratio, even if stocks stayed exactly where they are now.
This doesn't mean one thing or the other will happen, it's merely pointing out the facts. Many think that money will move toward hard assets like housing as Bill Gross tweeted last week, "Buy a house!", Gold of course is the old standby, oil and commodities in general have also been frequently cited, the common theme is a hard, tangible asset. While gold inflation would have some effect on manufacturing of high end electronics, it wouldn't have the same inflationary cost to manufacturers who are already suffering world wide with high input (material) costs. In addition the consumer is suffering from high gas and food inflation leaving less discretionary income to buy goods and products. As mentioned last week, we already see manufacturers are laying off employees, capacity utilization is down, inventories are up and there are no new orders to drive demand. Inflation seems to be the metric that is key to the unemployment problem. The F_E_D doesn't consider food and gas as they consider them volatile and transitory, but everyone uses it every day.
I'm sure you've already put it together, however consumers are very sensitive to inflation and thus spending may be curbed, manufacturers are very sensitive to inflation and need consumers spending and need to work through inventories and have real demand before they even consider hiring, they aren't using what they have now as capacity utilization has fallen. The F_E_D's policies don't sterilize QE3, therefore money is created and inflation rises just as we saw with QE 1 and 2, in fact most would say it was those programs that killed the emergence of Emerging markets as the US exported inflation to those countries. Unless there's a very different reason for QE3, (we know it has never shown any success in lowering unemployment and marginal success with the economy as a whole and in many cases did more damage than good) it would seem there's a circle of trouble ahead for the program, consumers, manufactures, those looking for work or trying to keep it and finally the economy more broadly. Unless...the reason is something else altogether, banks, investment banks and Wall Street made a killing off QE (remember the earning reports from the BOFA's and Citi's in which they didn't have single day with trading losses the entire quarter?). I have always wondered if QE was more about capitalizing banks so there wouldn't be another Bear Stearns of Lehman, rather than the stated purpose because as the stated purpose goes, the dollars would be much more effective if they just handed them out to citizens to spend however they see fit.
Today as anyone could have predicted, the Bank of Japan announced it would consider additional easing, this just being days after QE-3, of course it is a direct result as the dollar vs the Yen makes Japanese exports more expensive. With the Chinese market going down the drain quickly for Japan (see pictures of Toyota and Honda dealerships burnt or Chinese returning their newly purchased Japanese cars. The situation for Japan is getting worse by the day and they're probably closing in on a trade war with China so YES, expect the BOJ and Central bank after Central bank announce similar measures as well as currency market interventions as countries try to support their currency vs the $USD. Oh, the market didn't have any reaction to the BOJ easing which in the past has sent the market immediately higher. You may recall the chart of what the S&P would look like (from the F_E_D) if it weren't for the build up period 24 hours before the f-O-m-c announcement, the SPX would be much lower, the point being, in effect by going all in, Bernie may have taken that 24 hour edge and more broadly any surprise edge out of the game.
Well today is an escalation of a dispute over two small islands that Japan recently bought that has set China ablaze with anti-Japanese sentiment (hatred would even be too soft a word) and extreme nationalism, China who is currently Japan's largest creditor, is actively considering dumping the $230bn in Japanese bonds they hold which would take an already shaky Japanese economy and probably make the European troubles look insignificant. If China started dumping Bonds of mass economic destruction, every Japanese creditor would all rush for the exits at the same time and who exactly would be the buyer ? The Bank of Japan? I think they might be the only available buyer-talk about inflation! Even if the US could afford to step in, we certainly wouldn't want to get mixed up in taking sides on a new form of warfare that Germany first used against Greece just several months back and see China start dumping UST's. However the other side of that coin is if this were to happen, Japan may be forced to sell US Treasuries, whether out of spite for the US not coming to their aid or out of pure necessity to buy up their own debt. This is why I try to keep you informed on the basics of fundamental events such as the dust up over two small islands and how that could end up right here on American shores with a spike in inflation.
Also today John Taylor was back in the mix with the "Taylor Rule" which Bernanke either misunderstood or misused, but he was called to task on the very rule that the F_E_D uses/used to set the F_E_D Funds Rate by none other than a Congressman at the semi-annual testimony Ben gives. The Congressman called Ben out and explained the rule, which Ben disagreed with, ok so call it a draw or give the benefit of the doubt to the chairman who uses the rule to set policy. A day or so later, none other than John Taylor (not of Duran Duran-don't ask how I know that), but of the Taylor rule, verified that Bernie was mis-using the rule and the Congressman was right.
Given that Bernie holds Taylor's ideas in such high regard that they are used or misused to set F_E_D policy. Given the F_E_D has revised their outlook on unemployment and inflation as of last week, the Zero Interest Rate Policy (ZIRP) that Bernie said will remain in effect at least until mid-2015, is wildly at odds with the Taylor Rule, based on the revised numbers from the F_E_D, the Taylor rule wouldn't just end ZIRP, it would start tightening policy and raising rates now, by mid-2015 rates should be over 2%, not still at ZIRP.
I once posted the link to the San Francisco F_E_D's virtual game, "You be the Chairman". It was a really neat game in which you set policy, rates, etc and saw how the economy reacted, if you however followed what Bernie has done thus far and what he had promised to do up until the time I was playing the game, the US was basically on fire and you were fired as the Chairman, but it wasn't a quick move that ended in disaster, it was quarter after quarter of deterioration and you could fix it, but if you stuck with their policy it kept getting worse and ended in some ridiculous hyper inflation and huge unemployment. I know it's just a game, but we are in uncharted waters as is the F_E_D.
***Update***
As I finish up this post, trying to be careful to separate opinon, historical fact and actual evidence, news breaks and I'm awake at 12:30 a.m. to bring it to you. Japan just announced thy will expand their Asset Purchase Program by 10 trillion Yen, bringing the new total Asset Purchase program to 80 trillion Yen, the assets in focus are JGBs and T-Bills (Japan buys a lot of asset classes, including ETFs). Japan's current total public debt, One Quadrillion Yen (I feel like Doctor Evil from Austin Powers even saying that number).
That was enough to get a little rise out of the market, lets see how long it holds...
And the AUD/JPY
Should be interesting tomorrow-I mean today, remember nimble, Japanese policy interventions have a reputation for a very short half-life.
No comments:
Post a Comment