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Sunday, January 16, 2011

The Limits Of Monetary Policy

Fisher of the Dallas Fed gave an excellent speech this week on that topic. You can read it here.
...the key to correcting the underperformance of the American economy and American job creation does not rest with the Federal Reserve. It is in the hands of those who make fiscal and regulatory policy.

The Fed has reduced the cost of business borrowing to the lowest levels in decades. It has seen to it that liquidity is widely available to banks and businesses. It has kept the economy from deflating and it has kept inflation under control. This has helped raise the economic tide. Recent data make clear that the risks of a double-dip recession and deflation have ebbed and that economic growth and job creation are beginning to flow. Yet the ships of job-creating investment remain, for the most part, tied to the docks—or worse, choose to sail for foreign ports where tax and regulatory conditions are more favorable, very much in the same way that Ohio, Michigan, New York and California businesses and workers have navigated to Texas.

I don’t believe this has much to do with the Fed. None of my business contacts, large or small, publicly held or private, are complaining about the cost of borrowing, the lack of liquidity or the availability of capital. All express concern about taxes, regulatory burdens and the lack of understanding in Washington of what incentivizes private-sector job creation. All are stymied by a Congress and an executive branch that have appeared to them to be unaware of, if not outright opposed to, what fires the entrepreneurial spirit. Many have begun to feel that opportunities for earning a better and more secure return on investment are larger elsewhere than here at home.
Deflating the dollar has only limited ability to stimulate the economy. Also, deflating the dollar will drive costs up and reduce real incomes for more than half the population, which is not a stimulus.

The US produces almost all the natural gas we consume, and you can see the effect of QE2 in the cost curves for natural gas vs. petroleum. Fisher is taking a minority position in the FOMC. He believes we have reached the end of debt monetization. His viewpoint will not prevail this year.

But we are reaching the end. Our ability to make the US economy grow will depend not on the Fed, but on DC.

Readers might also want to look at Mauldin's recent commentary. Mauldin gets a bit sharp:
So, Liesman asked Bernanke about one minute into the clip (link below) about the little
snafu that, following QE2, both interest rates and commodity prices have risen. How can that be
a success? Ben’s answer (paraphrased):

“We have seen the stock market go up and the small-cap stock indexes go up even more.”

Really? Is it the third mandate of the Fed now to foster a rising stock market? I wonder
what the Fed’s target for the S&P is for the end of the year? That would be an interesting bit of
information. Are we going to target other asset classes?
Of course, the Fed did target other asset classes. That has been the entire goal of their huge asset buying program.

Comments:
“We have seen the stock market go up and the small-cap stock indexes go up even more.”

Rising stock prices help.

"A collapse in U.S. stock prices certainly would cause a lot of white knuckles on Wall Street. But what effect would it have on the broader U.S. economy? If Wall Street crashes, does Main Street follow? Not necessarily." - Ben Bernanke, October 2000

Falling stock prices don't hurt.

Stock booms help but stock busts don't hurt. It therefore stands to reason that anything the Fed does to enhance the frequency and/or amplitude of the boom/bust cycles is a good thing! And what's the best way? Bubbles! Woohoo!

MONSTER Sarcasm Sunday!!! We're turning this economy into a giant mud pit!
 
He's right, of course. Cultural factors are also huge: the dysfunctionality of public education, the hostility toward manufacturing, the siphoning-off of too much talent by the legal and financial industries, etc etc.
 
Also, despite the low rates, many small and mid-market businesses ARE having difficulty getting badly-needed financing. Indeed, several Business Development Companies are doing a nice business filling some of the financing gaps left by banks, but their aggregate capacity is small in comparison with the size of the economy.

Here's something I'd be interested in your thoughts on, MoM: I wonder if many banks have lost or weakened the human infrastructure needed for small and mid-market lending....there has been so much focus on housing loans, which have been largely routinized and automated, and on a small number of very large loans to major companies, that maybe there is now and insufficient number of loan officers who have the experience, and are granted the discretion, to do broad-based business lending.
 
For the long term, we need to get the Fed out of the "full employment" business and give it one goal: stability of the currency. As long as we have a fiat currency (and I see no other practical way) those charged with maintaining the currency must have that as their first and overriding concern.

How to define stability? I think that the target should be maintaining an index (of equal parts earning, consumer prices, and consumer durable prices) constant with the shortest time horizon three years and the longest thirty years.
 
njcommuter,

I think stability is an illusion.

The more our economy appears to be stable the more leverage is applied by speculators to leverage up "sure things".

The GDP of the USA is just 2% of the global derivatives market.

It's like balancing a bowling ball on the top of a needle.

Are we overconnected?

Davidow’s premise that “no large, tightly connected system can be made safe” has several far-reaching and dramatic examples. For one there was the financial collapse of 2008 that was in his estimation driven primarily by excess speculation. “In 2000 value of derivatives is $60 trillion,” he noted. “By 2007 over the counter $600 trillion. What are you really hedging?”
 
That's why the Fed shouldn't try to stabilize the whole economy, nor to guarantee prosperity, nor to worry about week-to-week horizons. It should keep the value of the currency stable, which is to say it--and the USA--should keep faith with all who use it. Just that. No more. All the rest is the outcome of other policy.
 
David - I wrote a really long answer to your question about commercial lending. Blogger burbed and ate it.

I will try to reproduce it.

NJCommuter:
The ECB's only mandate is a stable currency, yet it is buying bonds just like the Fed.

I do not know that an explicit change in the Fed's mandate would have altered its conduct at all. Currencies move because of economic developments. They are not only influenced by monetary policy.

Indeed, that is the entire point of the speech.

If we shove our debt levels up past the 85% mark, we are assured of a very nasty future devaluation - regardless of what the Fed does at that time.
 
I don;t understand Mauldin's surprise. QE2 didn't make anyone or any company creditworthy that wasn't creditworthy before. I might be swayed to think some raw materials companies have benefited and therefore could be more creditworthy, but they are also the biggest target of regulators.

It'll take another generation or two before we get significant relaxation of an extreme regulatory environment; the regulatory environment has been used as a jobs program for the last two generations and they will not give up their positions. A glut of lawyers only tends to make the regulatory agencies more hostile. (Government makes work for idle hands.)
 
MoM:

The stability of which I write is the stability of wages and prices in the currency, not its stability relative to other currencies. Those are outside the control of the central bank. They do affect the domestic monetary situation, but tinkering with the domestic currency to adjust for them only helps to hide long-term trade problems.

The central bank can only control one variable, and the variable that it, uniquely, can best control is the value of the currency relative to an aggregate of prices and wages.

With that held constant over the near term, other fluctuations indicate the results of other policies.
 
NJCommuter - ok, that's theory.

In practice, an economy that imports a good deal of its energy and consumer necessities (some foods, medicines, appliances, clothing, many cars, etc) is not going to see price stability if our currency is dropping sharply relative to many others.

In particular, an economy with as big a trade deficit as ours is going to see sharp escalation in prices when it devalues its currency. Petroleum, in particular, feeds right through the economy and raises a broad spectrum of prices.
 
John Hussman, in his post today, observed that raising stock prices in the near term simply "borrows" returns from future time periods.

Should be obvious, but to many people...possibly including some senior government and Fed officials...apparently is not.
 
I think it is. Recent speeches by various Feds have stressed "bridge" financing etc. Plosser today was supposed to be talking about needing to split fiscal and monetary policy.

They're still trying to goose this, but it is increasingly evident that the doubts are growing.

Anyone who looks at the split between high-end consumer spending and lower half spending this holiday season can see that the Fed is running into natural limits.
 
Electrolux and Steelcase recently announced moving to Mexico. ENER and Evergreen Solar after taking huge taxpayer funded subsidies are packing up and off shoring their production. The U.S. will train 3,000 Offshore IT Workers (http://www.informationweek.com...) and more in Armenia. GE will partner with China and share highly technical aircraft technology. And so it goes. I now live in one big free trade zone.
 
The trend has been replacing labor with automation and software, PERIOD!!! While endless discussion focus upon various economic theories nobody discuses the impact of technology on job creation in the United States. Dean Baker still believes that its 1934 and all we need to do is have the government generate demand/jobs via spending or others that believe jobs would be plentiful if regulatory rules were ended and corporate taxes reduced. Nobody seems to have noticed the leap in manufacturing and software development and how it impacts job creation other than some Disney approach that technology somehow creates more jobs or different jobs or higher value jobs, HOW ABOUT FEWER JOBS!
Sooner or later economic theory needs to get beyond money velocity,data collection,credit,demand etc. We need less people to produce products then we did 10 years, 20 years or 30 years ago and it all adds up to a different economic mix but for some reason technology impacts cannot be given its proper role within the job picture probably a result of our inability to understand the nature of and rate of change that has taken place.
 
less people to produce products means that fewer people will be able to BUY products. I wonder when that fact will sink in.
 
Teri,

"less people to produce products means that fewer people will be able to BUY products. I wonder when that fact will sink in."

Me too.

Theory: Retail Salespersons: Job Outlook

"Employment is expected to grow about as fast as average."

Reality: All Employees: Retail Trade
 
And therein is the other side of the coin. Life with a part time or seasonal job is not easy. You are less likely to buy a home or have much in the way of investments. It leads to a feeling of instability.

I am wondering though if it really is such an awful thing for people to be retiring at 62. They are on reduced benefits for the duration. They can work at a part time job, which is likely all they can find at that age. And no matter how much you push at it, if someone doesn't have a job and can at least get some money by retiring, that's what they will do. I am convinced that companies will lay off older workers in higher numbers than younger ones and will continue to do so despite the laws. It's one thing to have people work longer if they are in a position they can do so. I'd bet a lot of these early retirement folks aren't lucky enough to have that choice.
 
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