Fed Gets Aggressive After Months of Holding Back

ECONOMIC SCENE

By DAVID LEONHARDT

Published: November 3, 2010

For much of the last year, there were three basic camps on what theFederal Reserve should be doing.

Tim Shaffer/Reuters

Fed Chairman Ben Bernanke.

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Matthew Staver/Bloomberg News

Thomas Hoenig, president of the Kansas City Fed.

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One focused on the risks of the Fed’s taking more action to help the economy. This camp — known as the hawks, because of their vigilance against inflation — worried that the Fed could be sowing the seeds of future inflation and that any further action might cause global investors to panic.

Another camp — the doves — argued instead that the Fed had not done enough: inflation remained near zero, and unemployment near a 30-year high.

In the middle were Ben Bernanke and other top Fed officials, who struggled to make up their minds about who was correct. For months, they came down closer to the hawks and did little to help the economy. On Wednesday, they effectively acknowledged that they had made the wrong choice.

The risks of inaction have turned out to be the real problem.

The recovery has not been as strong as the Fed forecast. Businesses became more cautious about hiring after the European debt crisis in the spring. State governments began cutting workers around the same time, and the flow of federal stimulus money began to slow. Since May, the economy has lost 400,000 jobs.

Now — six months later, with Congress unlikely to spend more — the Fed is getting more aggressive. (And, yes, the idea that the doves are the advocates for aggression is indeed a bit odd.) Having long ago reduced its benchmark short-term interest rate to zero, the Fed will again begin buying bonds, as it did last year, to reduce long-term interest rates, like those on mortgages. Lower rates typically lead to more borrowing and spending by households and businesses.

Of course, the risks of taking action have not gone away. The new policy could eventually cause inflation to spike. All else equal, a policy that encourages more spending will cause prices to rise. And if investors begin to think that a dollar tomorrow will be worth much less than one today, they may refuse to lend money at low interest rates, undercutting the whole point of the bond purchases. Separately, the Fed, like any bond buyer, could end up losing money on the purchases, worsening the federal budget deficit.

What’s striking about the last six months, however, is how much more accurate the doves’ diagnosis of the economy has looked than the hawks’.

Early this year, for example, Thomas Hoenig, president of the Kansas City Fed and probably the most prominent hawk, gave a speech in Washington warning about the risks of an overheated economy and inflation. Mr. Hoenig suggested that the kind of severe inflation that the United States experienced in the 1970s or even that Germany did in the 1920s was a real possibility.

When he gave the speech, annual inflation was 2.7 percent. Today, it’s 1.1 percent.

The doves, on the other hand, pointed out that recoveries from financial crises tended to be weak because consumers and businesses were slow to resume spending. Around the world over the last century, the typical crisis caused the jobless rate to rise for almost five years, according to research by the economists Carmen Reinhart and Kenneth Rogoff. By that timetable, the unemployment rate would rise for a year and a half more.

Perhaps the clearest case for more action came from within the Fed itself. In June, an economist at the San Francisco Fed published a report analyzing how aggressive monetary policy should be, based on past policy and on the current levels of unemployment and inflation.

As a benchmark, it looked at the Fed’s effective interest rate, taking into account the actual short-term rate as well as any bond purchases to reduce long-term rates. Because the short-term rate was zero and the Fed bought bonds in 2009, the report judged the effective interest rate to be below zero — about negative 2 percent.

And what should the effective rate have been, based on the economy’s condition? Negative 5 percent, the analysis concluded. In other words, the Fed wasn’t buying enough bonds.

All the while, global investors have continued to show no signs of panicking. If anything, as the economy weakened over the summer, investors became more willing to lend money to the United States, viewing its economy as a safer bet than most others.

After the Fed’s announcement on Wednesday, many of the hawks who warned about inflation earlier this year repeated those warnings anew. The Cato Institute, citing a former vice president of the Dallas Fed, said the new program would “sink” the economy. Mr. Hoenig provided the lone vote inside the Fed against the bond purchases.

It’s always possible that the critics are correct and that, this time, inflation really is just around the corner. But there is still no good evidence of it. The better question may be whether the Fed is still behind the curve.

Some economists are optimistic that it has finally found the right balance. Manoj Pradhan, a global economist at Morgan Stanley, pointed out that bond purchase programs lifted growth in Europe and the United States last year — and a broadly similar approach also helped end the Great Depression. “There are no guarantees,” Mr. Pradhan said, “but the historical precedents certainly suggest it will work.”

Others, though, wonder if the program is both too late and too little. “I’m a little disappointed,” said Joseph Gagnon, a former Fed economist who has strongly argued for more action. The announced pace of bond purchases appears somewhat slower than Fed officials had recently been signaling, Mr. Gagnon added, which may explain why interest rates on 30-year bonds actually rose after the Fed announcement.

One thing seems undeniable: the Fed’s task is harder than it would have been six months ago. Businesses and consumers may now wonder if any new signs of recovery are another false dawn. And although Mr. Bernanke quietly credits the stimulus program last year with being a big help, more stimulus spending seems very unlikely now.

Unfortunately, in monetary policy, as in many other things, there are no do-overs.

http://www.nytimes.com/2010/11/04/business/04leonhardt.html?src=me&ref=business

Fed to Spend $600 Billion to Speed Up Recovery

Andrew Harrer/Bloomberg News

The Federal Reserve building in Washington.

By DAVID E. SANGER and SEWELL CHAN

Published: November 3, 2010

WASHINGTON — The Federal Reserve, getting ahead of the battles that will dominate national politics over the next two years, moved Wednesday to jolt the economy into recovery with a bold but risky plan to pump $600 billion into the banking system.

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Bernanke Explanation of Fed Action (washingtonpost.com)

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• The Fed Discusses the Rationale for Its Securities Action(November 4, 2010)

• Economix Blog: Will Additional Fed Action Help the Economy?(November 3, 2010)

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Richard Drew/Associated Press

At the New York Stock Exchange on Wednesday, all eyes were on the Federal Reserve.

A day earlier, Republicans swept to a majority in the House on an antideficit platform, virtually guaranteeing that they would clash with the Obama administration over the best way to nurture a fragile recovery.

The action was the second time in a year that the Fed had ventured into new territory as it struggles to push down long-term interest rates to encourage borrowing and economic growth. In a statement, the Fed said it was acting because the recovery was “disappointingly slow,” and it left the door open to even more purchases of government securities next year.

The Fed is an independent body, its policy decisions separated from the political pressures of the day. But it acted with a clear understanding that the United States, like many other Western countries, seems to have taken off the table many of the options governments traditionally use to give their economies a kick, particularly deficit spending.

The Republicans regained control of the House for the first time in four years in part by attacking the stimulus plan — begun by the Bush administration and accelerated byPresident Obama — as a symbol of government spinning out of control, contributing to a dangerously escalating national debt.

This political reality has left Washington increasingly reliant on the Fed to take action, though its chairman, Ben S. Bernanke, has said the Fed cannot fix the problem alone.

But in stepping in so aggressively, the Fed is taking risks. The action not only expands the Fed’s huge portfolio ofTreasury bonds, it makes it a target of a Congress whose new members include some who are hostile to the Fed’s independent role.

On Wall Street, analysts said the move appeared to be a balancing act that met expectations and stock prices rose.

Ordinarily the Fed’s main tool for spurring economic growth is to lower short-term interest rates. But those rates are already near zero. With no more room to go, it has to find another route to stimulate demand.

That route is to buy government bonds, which increases demand for them and raises their prices, pushing long-term interest rates down. “Easier financial conditions will promote economic growth,” Mr. Bernanke predicted in an essay for Thursday’s Washington Post.

Representative Mike Pence of Indiana, the outgoing chairman of the House Republican Conference, said shortly after the announcement that the Fed was overstepping its bounds. “Diluting the value of the dollar by continually increasing the supply of money poses an incalculable risk,” he said. “Instead, Congress needs to embrace progrowth fiscal policies to stimulate our economy rather than masking our fundamental problems by artificially creating inflation.”

In making that argument, Mr. Pence and his allies are replaying a dispute that permeated Washington in the mid-1930s, when the economy was crawling out of the Great Depression. Conservative Democrats pushed Franklin D. Roosevelt to cut back on spending, and argued for tight monetary policy. Many economists argue that the result was a second downturn just before the outbreak of World War II, but others say the conditions today differ in so many ways that the comparison is misleading.

While the Fed step was telegraphed to the markets in recent weeks, most experts had expected $300 billion to $500 billion in purchases of Treasury debt. Still, the pace — $75 billion a month for eight months — disappointed some investors.

The Fed said it would also continue an earlier program, announced in August, of using proceeds from its mortgage-related holdings to buy additional Treasury debt, at a rate of about $35 billion a month, or $250 billion to $300 billion by the end of June.

So in total, the Fed will buy $850 billion to $900 billion, just about doubling the amount of Treasury debt it currently holds.

If the Fed’s bet is right, lower long-term rates should ripple through the markets, pushing down rates for mortgages and corporate bonds. That could encourage homeowners to refinance into cheaper mortgages, though it would not help the millions of Americans facing foreclosure. It could push businesses to make investments instead of sitting on piles of cash.

In a sign of its willingness to do even more, the Federal Open Market Committee, the central bank’s policy arm, left open the possibility of even more purchases beyond June, saying it would “adjust the program as needed to best foster maximum employment and price stability.”

Only one committee member dissented, for reasons that are similar to the complaints that some Republicans are likely to raise. Thomas M. Hoenig, an economist who is president of the Federal Reserve Bank of Kansas City, said he believed the decision could create more risk for the financial system by enticing too much borrowing.

There are other risks, as well. The actions are likely to further drive down the dollar. That could worsen trade and exchange-rate tensions that have threatened to unravel cooperation among the world’s biggest economies.

Moreover, the Fed is exposing itself to the risk that the assets it has acquired could shrivel in value when interest rates eventually rise. That could reduce the amount of money the central bank turns over to the Treasury each year, and expose the Fed, already vulnerable for its failure to prevent the 2008 financial crisis, to even more criticism.

On Wednesday, the standoff between the parties was on display as the two sides argued over tax cuts and the desirability of government investment to create jobs.

It was this impending gridlock that might have pushed Mr. Bernanke to move, said Laurence H. Meyer, a former Fed governor. “Bernanke has said that fiscal stimulus, accommodated by the Fed, is the single most powerful action the government can take for lowering the unemployment rate, when short-term rates are already at zero,” Mr. Meyer said. “He has nearly pleaded with Congress for fiscal stimulus, but he can’t count on it.”

But Leonard J. Santow, an economic consultant, said he feared that the Fed was reacting to one mistake — the failure of fiscal policy — by adding another. “The main problem is on the fiscal side, and there is nothing wrong with the Fed chairman making budget recommendations and admitting there is not a great deal left for monetary policy to achieve when it comes to stimulating the economy,” he said.

One of the main questions raised by the Fed’s action was whether it had waited too long. While economists disagree on that, the Fed’s announcement completed a U-turn. Earlier, speculation was that the Fed would gradually raise interest rates and tighten the supply of credit, as it would normally do after a recession..

But this downturn and its painful aftermath have been anything but normal. Markets were set back in the spring by the European debt crisis. By late summer, as continuing high unemployment, slow growth and low inflation became clear, Mr. Bernanke became convinced that the Fed needed to act again.

http://www.nytimes.com/2010/11/04/business/economy/04fed.html?src=me&ref=business

Emerging-Market Countries Criticize Fed Decision

Emerging-Market Countries Criticize Fed Decision
By BETTINA WASSENER
Published: November 4, 2010

HONG KONG — Policy makers in emerging markets criticized the Federal Reserve on Thursday for its decision to pump more money into the U.S. economy, a measure that they fear could escalate the worrisome influx of cash into fast-growing economies.

Officials from countries like Brazil and Thailand threatened more measures to curb the flood of money that has pushed up currency values and fueled concerns that asset price bubbles might be in the making.

The unusually sharp backlash against the Fed’s action underscores the disagreement among some of the largest economies in the world over appropriate economic policy and is likely to overshadow a gathering of leaders of the Group of 20 top economies in Seoul at the end of next week.

The Brazilian foreign trade secretary, Welber Barral, said the Fed’s policies would impoverish “those around them and end up prompting retaliatory measures,” according to Reuters. In South Korea, the Finance Ministry said it would consider ways to limit capital flows.

While some inflows, particularly long-term investments, are welcome ways of bolstering economic development, the capital influxes into emerging market stocks, bonds and property have increased rapidly in recent months, totaling more than $2 billion a day, according to estimates by DBS in Singapore.

Analysts and policy makers are concerned that the Fed’s injection of more liquidity into the U.S. economy — through purchases of Treasury securities to the tune of $600 billion — could lead to yet more inflows as investors seek higher returns.

“As long as the world exercises no restraint in issuing global currencies such as the dollar — and this is not easy — then the occurrence of another crisis is inevitable, as quite a few wise Westerners lament,” Xia Bin, an adviser to the central bank of China, wrote in a newspaper managed by the People’s Bank of China.

In Thailand, Finance Minister Korn Chatikavanij said the central bank governor had “confirmed discussions with central banks of neighboring countries, which are ready to impose measures together, if needed, to curb possible speculative money flowing into the region,” according to Reuters.

Norman Chan, chief executive of the Hong Kong Monetary Authority, warned that the Fed’s new measures — informally known as QE2, denoting the second round of what is called quantitative easing — added to the risk of asset bubbles, including a bubble in the city’s housing sector.

“For emerging markets, QE2 means a guarantee of the ‘low for longer’ scenario through the first half of 2011, which suggests inflows into emerging markets will continue, if not strengthen,” Richard Yetsenga and Pablo Goldberg, analysts at HSBC, said in a note on Thursday. “The tide generated by the liquidity from abroad is bigger than whatever wall emerging market countries can put up.”

Misgivings about the Fed action appeared confined to emerging markets, but Germany’s economy minister, Rainer Brüderle, also weighed in. “I view that not without concern,” Reuters quoted Mr. Brüderle as saying. It said he added that measures were needed to stimulate growth in the United States and that it was not enough to add liquidity alone.

The French economy minister, Christine Lagarde, said Thursday that some emerging countries’ angry reactions to the Fed’s latest round of easing highlighted the need for an overhaul of the global monetary system. Asked about some emerging countries’ reactions, Ms. Lagarde said: “It confirms the imperative need to forge tools for monetary calm,” according to Reuters.

The president of the European Central Bank, Jean-Claude Trichet, said he did not think the U.S. was pursuing a weak dollar policy, Reuters reported from Frankfurt.

Mr. Trichet said he had “no indication that would change my trust” that the Federal Reserve, the U.S. Treasury and President Barack Obama “aren’t playing a tactic of a weak dollar,” Mr. Trichet said. “I have no reason to think that.”

While the United States argues that China in particular should allow its currency to appreciate more rapidly, China and other emerging markets are loath to do so. They argue that the additional round of quantitative easing by the Fed is hurting the value of the dollar artificially while prompting more cash to flow into emerging nations as investors seek the higher interest rates in such countries.

Although finance ministers who gathered at a preparatory meeting in South Korea last month pledged to refrain from weakening their currencies and to let the markets exert more influence in setting foreign exchange rates, a concrete agreement on current account limits, proposed by the U.S. Treasury secretary, Timothy F. Geithner, is likely to prove elusive.

Many emerging-market countries and Japan have been intervening in the foreign exchange markets in an effort to slow the rise in the values of their currencies, which they fear could harm export industries by making exported goods and services more expensive for overseas consumers.

Partially as a result of currency inflows, the yen is up 15 percent against the U.S. dollar this year. The Thai baht is up 11 percent, and the South Korean won has gained 5 percent.

Some countries have also already announced or signaled steps to discourage capital inflows. Brazil and Thailand, for example, raised taxes last month on foreign investment in government bonds, a step designed to deter excessive inflows.

Capital controls have so far not been “too Draconian,” said Yougesh Khatri, senior Southeast Asia economist at Nomura, in a conference call from Singapore on Thursday. But the risk is that such measures might escalate in the longer term, he added, while more foreign exchange intervention is likely.

The Hang Seng index in Hong Kong rose 1.6 percent Thursday, while the Nikkei 225 index in Japan played catch-up after a public holiday, gaining 2.2 percent.

The Kospi in South Korea edged up 0.3 percent, while the Straits Times index in Singapore was up 0.5 percent by late afternoon.

http://www.nytimes.com/2010/11/05/business/global/05global.html?_r=1&src=me&ref=business

High unemployment in Fed cross-hairs

November 5, 2010 - 7:06AM

The United States faces the prospect of high unemployment for some time as the Federal Reserve embarks on a risky and unproven course to bring back solid economic growth.

All eyes will be on the October labour market report on Friday, expected to show a dip in job creation and an unemployment rate stuck at 9.6 per cent for the third consecutive month.

The Federal Reserve announced on Wednesday it would inject an additional $US600 billion ($A598.12 billion) into the struggling economy, through the purchase of new Treasury debt from financial institutions at a rate of around $US75 billion ($A74.76 billion) a month.

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Fed chairman Ben Bernanke said the extraordinary action was necessary because the central bank has a duty to help promote increased employment and sustain price stability.

Though the current low level of inflation was "generally good" it poses the risk of morphing into deflation, a dangerous cycle of falling prices and wages, Bernanke said in an opinion article published Thursday in the Washington Post.

But it was the suffering job market that spurred the stimulus move, known as "quantitative easing."

Bernanke said that in the panel's review of economic conditions, "we could hardly be satisfied."

"Unfortunately, the job market remains quite weak; the national unemployment rate is nearly 10 per cent, a large number of people can find only part-time work, and a substantial fraction of the unemployed have been out of work six months or longer," he said.

"The heavy costs of unemployment include intense strains on family finances, more foreclosures and the loss of job skills."

The Fed action came a day after Tuesday's nationwide congressional and local elections that handed big victories to Republicans, who have called for less government interference in the US economy.

Republicans won control of the House of Representatives and whittled the majority of President Barack Obama's Democrats in the Senate.

At the top of voters' complaints was persistently high unemployment more than a year after the recession officially ended, along with massive federal spending to rescue the economy from recession that has produced record deficits.

The government's weekly snapshot on unemployment trends reinforced the picture of a depressed labour market treading water.

Initial unemployment claims rose more than expected in the week ending October 30, up 4.6 per cent from the prior week, the Labor Department reported.

"Unfortunately, there is nothing in the data that suggests the employment sector is on the cusp of entering a prolonged hiring expansion.

"Instead, the stability suggests that employment growth is going to be slow and sluggish for the foreseeable future," said Jeffrey Rosen at Briefing Research.

Andrew Gledhill at Moody's Analytics noted that businesses remained anxious about economic conditions and were being cautious about payroll decisions, while layoffs were still climbing at a rate consistent with minimal job growth.

"The stalled labour market will not significantly break out of this trend until the second half of next year," Gledhill said.

"Even once widespread hiring resumes, it will take considerable job creation to restore employment to its pre-recession level; we forecast that won't occur until 2013."

AFP

http://www.smh.com.au/business/world-business/high-unemployment-in-fed-crosshairs-20101105-17g4d.html

The Fed turns on printing press: The Implications

The Fed turns on printing press
Sewell Chan, Washington
November 5, 2010

IN ITS latest move to help the economy, the Federal Reserve is about to restart its monetary printing press - or rather, the electronic equivalent.

The Fed announced that it intended to buy $US600 billion in long-term Treasury securities through June. It also signalled that it could make more purchases after that if unemployment remained too high and inflation too low.

The Fed is prohibited under law from directly lending to the Treasury Department, which issues government debt. So the Fed buys government securities on the open market from ''primary dealers'', a network of 18 institutions, including Goldman Sachs and Morgan Stanley, that constantly trade in such securities.

While monetary policy is set at the Fed's headquarters in Washington, it is carried out in Lower Manhattan, at the Federal Reserve Bank of New York, which buys and sells Treasury securities and other assets on the Fed's behalf.

In typical recessions, when the Fed pumps money into the economy, it buys assets, like government bonds, and creates an equivalent amount in liabilities - reserve deposits that commercial banks keep at the Fed. Those deposits, which now exceed $US1 trillion, along with currency in circulation, now $US961.4 billion, make up what economists call the monetary base - in essence, the raw material from which money is created and made available to consumers and businesses.

If banks were quickly start quickly using the reserves to make loans, the supply of money, now $US8.7 trillion by one estimate, could grow rapidly and lead to inflation even as the amount of reserves remained constant.

The supply of money includes not just currency, but also things like bank deposits, savings accounts and money market funds.

For now, that seems highly unlikely. Banks say there is not much demand for loans.

NEW YORK TIMES

Fed's $600bn gamble risks throwing away America's biggest asset

Fed's $600bn gamble risks throwing away America's biggest asset


Apparently, there's been an election in the US. The BBC tells us that America's wholly unsurprising verdict on the past two years is frightfully important and signals the end of the Obama dream, whatever that may have been; it was never entirely clear.

By Jeremy Warner, Assistant Editor
Published: 7:35PM GMT 03 Nov 2010

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The Fed is taking a massive gamble with America's long term future by blindly pursuing further monetary stimulus Photo: EPA

Barely able to disguise his horror at the result, Mark Mardell, the Beeb's North America editor, solemnly pronounced that the hope Obama raised when elected president had turned out to be "too audacious for the times".

It didn't seem to occur to him that Obama's drubbing was not so much a case of haplessly falling victim to economic circumstance but was in fact largely down to incoherent legislative experiment, blind disregard for the deficit and chronic mishandling of the economy. Americans had reasonably expected better.

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Obama's punishment will make little if any difference to the mess the US economy finds itself in and in any case is something of a sideshow against the latest high risk policy initiative the Federal Reserve is visiting on an already battered nation. The Hill can't act, but the Fed still stands ready and willing at the roulette wheel.

The fresh $600bn (£372bn) infusion of quantitative easing announced on Wednesdaymay or may not provide a lift for beleaguered domestic demand – both Goldman Sachs and HSBC have said much more is needed to escape a real or imagined liquidity trap – but one thing it certainly does do is further debauch the currency. Never before has dollar hegemony been so much under threat.

By flooding the world economy with yet more freshly minted dollars, America further undermines faith in the greenback as an internationally reliable store of value and is thereby squandering an economic and geo-political asset of huge importance to the nation's history.

The dollar's reserve currency status means that America can borrow at will in its own currency from the rest of the world, and at favourable rates to boot. This privilege is being recklessly thrown away. Every time the Fed prints more dollars to fight the domestic recession, it further devalues that debt. The lenders are understandably getting restless.

As is now becoming steadily more apparent, dollar hegemony was a major underlying cause of the crisis, for it allowed America to go on an unrestrained borrowing binge; the developing world is ever more minded to think its demise part of the solution.

The Fed is taking a massive gamble with America's long term future by blindly pursuing further monetary stimulus; it may take time, but the dollar's all powerful reign on the world stage is drawing to a close.

And they wonder why US business remains in a state of paralysed shock. Policy seems hell bent on destruction.

In Obama's defence, it is usually said that the economic legacy he inherited was so poisonous that it was never likely to be easily fixed, and there is no doubt much truth in this contention.

But rather than focusing like a lazer on the economic catastrophe unfolding before him, Obama instead embarked on a wildly ambitious, disruptive and divisive legislative programme that has succeeded only in heaping further uncertainty on already damaged economic confidence.

If ever more mountainous public debt were not deterrent enough to investment and trade, the clutter of futile reform emerging from the White House would have frightened even the most loyal of American investors into inaction.

Stripped of his political authority, Mr Obama can only look hopelessly on as the newly enthused "Reds" suck the lifeblood out of health and financial reform. Hard won at near fatal political and economic cost, much of the president's legislative programme may end up neutered to death.

A Republican House cannot overturn these bills, which have already been passed into law, but it can render them toothless by influencing the fine print and more importantly, refusing to fund them. "Defunding" Obama's legislation is readily justified in pursuit of the small state Republicans aspire to.

Unfortunately, the Republican opposition seems as bereft of a credible plan to put public debt back on a sustainable footing as the White House. The political stalemate makes it most unlikely one will be found any time soon. Any long term fix requires a combination of tax rises, pension and medicare reform. There's no cross party support for any of these things.

The political class has no strategy for rolling back debt in a growth friendly way, while the blunt instrument of ultra loose monetary policy has called into question the dollar's international standing and therefore the nation's ability to refinance itself.

Larry Summers – who departs as the President's economic adviser in January – puts it like this: "For how much longer", he asks, "can the world's top borrower carry on being the world's top power?" It's a good question.

http://www.telegraph.co.uk/finance/comment/jeremy-warner/8108660/Feds-600bn-gamble-risks-throwing-away-Americas-biggest-asset.html