Monday, May 25, 2009
Fisher Of The Fed On Monetizing Debt
His bigger concern these days would seem to be what he calls "the perception of risk" that has been created by the Fed's purchases of Treasury bonds, mortgage-backed securities and Fannie Mae paper.A difficult trick, since that is what we are doing.
"I think the trick here is to assist the functioning of the private markets without signaling in any way, shape or form that the Federal Reserve will be party to monetizing fiscal largess, deficits or the stimulus program."
It conjures up images of Argentina. ... He has just returned from a trip to China, where "senior officials of the Chinese government grill[ed] me about whether or not we are going to monetize the actions of our legislature."Fisher is quoted on the role of the ratings firms, past low rates, weak regulation, and the dangers of monetizing the debt. This is from his Kennedy School speech:
Throughout history what the political class has done is they have turned to the central bank to print their way out of an unfunded liability. We can't let that happen. That's when you open the floodgates. So I hope and I pray that our political leaders will just have to take this bull by the horns at some point. You can't run away from it.We're running, but it's like those nightmare running sequences. We run and run, and we can't get anywhere. WSJ notes:
Voices like Mr. Fisher's can be a problem for the politicians, which may be why recently there have been rumblings in Washington about revoking the automatic FOMC membership that comes with being a regional bank president.The next election should be interesting!
A careful reader may develop the theory that although Mr. Fisher volunteered to wear the Fed Inflation Hawk suit, his differences with FOMC policy are not that great. He states that inflation is not a risk, that deflation is a risk, and that the FOMC as a whole just will not tolerate inflation, which is a position that other Fed governors have not espoused recently.
So I think this is another strategic appearance of the Fed Inflation Hawk.
The text of Fisher's February 23rd Kennedy School speech is here. On April 8th Fisher gave a speech in Japan. On April 17th Fisher gave a speech in China.
Excerpts From The Japanese Speech:
In light of this, the Federal Reserve has assumed a dramatically proactive and highly innovative role in seeking to restore vibrancy in the credit markets while stemming economic decline. This is an unaccustomed thing for our central bank. Ordinarily, the men and women of the Federal Reserve are the most shy and modest of economic agents. We prefer to move incrementally rather than exponentially, and we have historically treasured conducting our deliberations quietly and away from the public limelight. But confronted with a dysfunctional financial market and an implosion in our economy, in rapid order we have undertaken a series of very visible and widely broadcast initiatives. Over a period of a little more than a year, we:
* Established a lending facility for primary securities dealers, taking in new forms of collateral to secure those loans;
* Initiated so-called swap lines with the central banks of 14 of our major trading partners, ranging from the Bank of Japan to the European Central Bank and the Bank of England to the Banco de México to the Monetary Authority of Singapore and the Korean Central Bank, to provide these foreign central banks with the capacity to deliver U.S. dollar funding to financial institutions in their jurisdictions. We also have put in place swap agreements with four of our counterparts—the Bank of Japan, the European Central Bank, the Bank of England and the Swiss National Bank—to enable the Federal Reserve to provide up to 10 trillion yen, 80 billion euro, 30 billion in sterling and 40 billion in Swiss franc liquidity to U.S. financial institutions as a reciprocal prophylactic measure;
* Created facilities to backstop money market mutual funds;
* Initiated new measures in cooperation with the Treasury and the Federal Deposit Insurance Corp. to strengthen the security of certain banks;
* Undertook a major program to purchase commercial paper, a critical component of the financial system;
* Began to pay interest on bank reserves;
* Announced we stood ready to purchase up to $100 billion of the direct obligations of Fannie Mae, Freddie Mac and the Federal Home Loan Banks, then increased that sum to $200 billion;
* Announced we would buy $500 billion in mortgage-backed securities backed by Fannie, Freddie and Ginnie Mae, then increased that sum to $1.25 trillion;
* Announced, and just recently fleshed out, a new facility to support the issuance of asset-backed securities collateralized by student loans, auto loans, credit card loans and loans guaranteed by the Small Business Administration, a facility which we have since stated we were prepared to expand significantly to other types of securities and beyond our originally planned $200 billion to $1 trillion; and
* Began the process of purchasing up to $300 billion of longer-term Treasury securities over the next six months to help improve conditions in private credit markets.
And, in a series of steps, the FOMC reduced the fed funds rate to between zero and one-quarter of 1 percent, a process which I supported once it became clear that the immediate inflationary tide was ebbing. Simultaneously, at the request of the 12 Federal Reserve Banks, and again in a series of steps, the Board of Governors lowered the rate we charge banks to borrow from our discount windows, so as to lower the cost of credit to the economy.
All of this has meant expanding the Federal Reserve’s balance sheet. As of today, the total footings of the Federal Reserve have expanded to roughly $2 trillion—more than a twofold increase from when we started in 2008. It is clear that we will grow our balance sheet even more as we complete our programs of purchasing longer-term Treasuries, expanding our holdings of mortgage-backed paper and purchasing larger amounts and different forms of asset-backed paper.
Fisher then goes on to address concerns raised by all of this innovation and asserts that the Fed will not tolerate inflation, and launches into an outright sales pitch for T-Bills:
And yet, let me remind you that over the past year since we began in earnest the process of using the new tools I have just articulated, the dollar has appreciated 17 percent against the euro and 29 percent against the British pound. Among the major currencies, the dollar has depreciated against only one currency, Japan’s, and by 2.4 percent.You may or may not find that credible. I see no beginnings of an attempt to grapple with reality in Congress.
Here are some numbers for you to contemplate: If a Japanese investor had purchased a three-month U.S. Treasury bill in March 2008 and rolled it over every three months until the end of this past month, the return would have been slim to none—about –1.4 percent. That is hardly inspiring. But, had that same investor purchased and rolled over a three-month euro-area central government bond, the investment would have resulted in a loss of 16 percent. A Chinese investor investing in euro bonds would have had the same experience. A Korean investor investing in the same manner would have earned a return of 21 percent in euros but would have earned a 42 percent return in won terms had he invested in three-month Treasury bills.
As to the future, the underlying math becomes more complex: The net new supply of Treasury debt is predicted to expand by $2.5 trillion in the current fiscal year, versus $788 billion in the last fiscal year and only $145 billion in fiscal year 2007. All things being equal, this would result in a move upward in yield and downward in price, providing negative returns absent any foreign exchange factor. But all things are not equal. For starters, the problems facing the largest competitive currency, the euro, are perhaps even more substantial than those confronting the United States. I will point to Spain and Ireland as examples of euro-area economies that led the European pack on the upside and now are cascading rapidly downhill. In the case of Japan, you are as aware as anybody of the economic and fiscal and political predicament you are faced with; I will say no more. My point is that demand for Treasuries and other official paper of U.S. government issuers will be determined by their attractiveness relative to alternatives, and they may well be judged more, rather than less, attractive under most reasonable future scenarios.
Moreover, both the fate of budget imbalances and the potential for total returns earned by investing in U.S. securities depend on the efficacy of the fiscal policies Congress has advanced. These policies are designed to jump-start the economy while laying the groundwork for permanent structural reform. Time will tell if they achieve this multipurpose goal. If they do, they will engender economic growth and concomitant confidence in the fixed-income and equity markets for private securities. In addition, tax flows will be restored and confidence boosted in the path of deficit reduction envisioned by the current administration in its budget projections. If these policies don’t jump-start the economy, then I am confident that the reaction within fixed-income markets will force those with the power to tax and spend, the Congress, to readjust their fiscal policies.
Excerpts From The Chinese Speech:
The men and women who operate our businesses and create and sustain employment have assumed an uncharacteristic defensive crouch. Confronted by dyspeptic financial markets, they are doing the best they can to preserve their margins by cutting costs (most significantly, the cost of labor), and running tight inventories, rationalizing supply lines, deferring all but the most necessary capital expenditures and, in general, avoiding risk. The result is an American economy in stasis. Presently, nothing is being ventured, and nothing is being gained.Fisher then repeats the list of steps the Fed has taken, and moves on to discuss the risks (this part of the speech closely parallels the Japanese speech):
Of course, not helping matters is the implosion of our export markets, which are vital to the growth of an economy positioned to sell high-value-added goods and services—as well as agricultural and other basic goods—to others. The World Bank is predicting that global trade will contract by 6.1 percent in 2009. The WTO is forecasting a 9 percent contraction. This will be the first time since the 1940s that we have witnessed such a deep and synchronized retrenchment of global economic activity, and this makes tougher the task of growing the U.S. economy.
This expansion of our balance sheet has given rise to concerns that we may be:Fisher then moves on to give virtually the same sales pitch for Treasuries as in Japan. This post is long enough, so I will end. But I really want to address some of Fisher's comments in his February speech at the Kennedy School.
1. Planting the seeds of future inflation; and
2. Setting the stage for a demise of the dollar.
First, with regard to the potential inflationary consequences of our actions: Our assignment is to conduct monetary policy so as to engender sustainable, noninflationary job growth. Presently, the risk is deflationary job destruction. We have undertaken measures to counter that risk. And we seek to do so in a way that will not ignite the embers of either a future destructive inflation or a debasement of our currency.
I have a reputation for being the most “hawkish” participant in the deliberations of the Federal Open Market Committee. I do not particularly like ornithological nomenclature—I would rather be considered a wise owl (and I certainly do not wish to be anybody’s pigeon). But I have a record that substantiates that “hawkish” reputation, having voted five times against monetary accommodation during the commodity-driven price boom of 2008. I consider inflation an evil spirit that rots the core of economic prosperity and must never, ever be countenanced. But it is clear to me that in this environment, inflation is unlikely to present a serious threat given the pervasive bias in the U.S. economy toward wage cuts and freezes, rising unemployment, the widespread loss in wealth that has resulted from both the housing and equity market corrections, continually declining consumption and business investment, and the anemic condition of the banking and credit system, all of which reinforce downside price pressures in a global economy groaning with excess capacity.
For as far ahead as I trust my forecasting ability (that is to say, the next couple of years), the problem with regard to maintaining price stability most certainly is not inflation.
With regard to the fate of the dollar and the willingness of others to continue purchasing dollar-denominated debt, we realize that by purchasing Treasuries in volumes and of durations that are atypical, we are at risk of being perceived as monetizing the fiscal largesse of our Congress. And we are acutely aware that by intervening in the mortgage-backed securities and other markets that we are at risk of being perceived as blurring the lines between fiscal and monetary policy. We realize that this may give rise to some apprehension among large holders of Treasuries and agency paper such as your government and others in the Asian-Pacific region.
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