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(What’s Left of) Our Economy: The Fed’s Dangerous Can-Kick

21 Monday Sep 2015

Posted by Alan Tonelson in (What's Left of) Our Economy

≈ 2 Comments

Tags

China, debt, Federal Open Market Committee, Federal Reserve, Financial Crisis, Great Recession, inflation, interest rates, Janet Yellen, Jobs, leverage, monetary policy, recovery, unemployment, yield, {What's Left of) Our Economy

Reverberations continue from the Federal Reserve’s decision last Thursday to keep the short-term interest rate directly controlled by the central bank at the so-called zero bound – after strong hints most of the spring and well into the summer that the financial crisis-born policy of super easy money would finally start coming to an end. Most of the commentary has focused on the incredibly convoluted rationale for delay presented by Fed Chair Janet Yellen at a press conference held following the “stand pat” announcement. That’s entirely understandable, as I’ll explain below. What worries me even more, though, is how the kinds of financial stability threats that triggered the 2007-08 crisis have apparently dropped off the Fed’s screen completely.

It’s not necessary to believe that the U.S. economy is performing well to be puzzled by the Fed decision – which was nearly unanimous. That’s because the Fed majority itself clearly believes it’s performing well. Here’s how Yellen described the recovery from the Great Recession:

“The recovery from the Great Recession has advanced sufficiently far, and domestic spending appears sufficiently robust, that an argument can be made for a rise in interest rates at this time. We discussed this possibility at our meeting.” A little later, Yellen emphasized, “You know, I want to emphasize domestic developments have been strong.”

The Chair did spotlight areas of continued economic weakness, including sluggish wage growth that was contributing to overall inflation rates remaining well below the levels characteristic of a truly healthy economy; the stubbornly high number of Americans who remained out of the workforce, which takes much of the sheen off of the major reduction seen in the headline unemployment rate; and weakening economies in China and elsewhere abroad, which roiled stock markets in the United States and overseas in August.

But she persisted in describing weak prices as mainly due to “transitory” factors, like the depressed global energy picture and the strong dollar (which makes imported goods bought by Americans cheaper). More important, Yellen repeatedly emphasized points like “I do not want to overplay the implications of these [and other] recent developments, which have not fundamentally altered our outlook. The economy has been performing well, and we expect it to continue to do so.” 

Moreover, and most important, the record makes clear that most of the voting members of the Fed’s leadership – the Open Market Committee – “continue to expect that economic conditions will make it appropriate” to raise interest rates “later this year.” All of which inevitably and justifiably has raised the question of why, if most Fed policymakers remain confident that the U.S. and even world economies will remain on a course encouraging enough to warrant slightly tighter monetary policy by year end (i.e., in three months), all except one decided that the conditions of these economies are too fragile now to withstand rates even the slightest bit higher than their current emergency, mid-crisis levels.

Nor is this question answered adequately by Yellen’s claim that it’s crucial not to raise rates too early because such actions could snuff out the recovery’s momentum. Indeed, the Chair herself stated that she buys one of the most compelling reasons to hike sooner rather than later – because the delay between the approval of a monetary policy decision like a rate hike and the appearance of its effects on the economy means that inflation could overheat if the Fed waits too long to step on the brakes.

As a result of these contradictory messages, it’s hard to avoid the conclusion either that the Fed is genuinely confused about the real state of the economy and how it can strengthen it; or that despite its expressed confidence, it still believes that even the kind of minimal rate hike it’s been telegraphing – which Yellen further has intimated will still leave monetary policy “highly accommodative for quite some time” – could bring the recovery to its knees. No wonder investors are confused, too – and increasingly nervous.

And this is only the set of problems on which the economic and financial chattering classes are concentrating. The problem they’ve overlooked for now is even more disconcerting: The Fed’s latest statements about the future of its super-easy money policies contain no mention of the big reason to be genuinely scared of super-easy money policies: They’ve shown a strong tendency to encourage reckless financial practices that tend to end in oceans of tears.

The reason should be pretty obvious, especially since it played out just a few short years ago and nearly blew up the American and global economies. When money is for all intents and purposes free and in glut conditions, incentives to use it responsibly vanish. After all, by definition, it’s no longer precious: If you lose some in a bad investment, you feel confident that more will be easy to get.

At very best, then, nothing like market forces exist to discipline lending and investing, and thereby increase the odds that credit will be used in productive ways that bring the greatest, most durable benefits to the entire economy and society. In fact, too many investors will view the strongest incentives as those fostering a thirst for yield – which drives them into ever riskier assets simply because safer choices offer so little return. At worst, borrowers take on amounts of debt that become ruinous whenever interest rates do finally rise – and threaten the entire financial system and economy.

The Fed’s reluctance to raise rates may in fact stem in part from fears about that latter scenario. It’s true that the economy is less leveraged these days than it was during the previous bubble decade. But that doesn’t mean there’s not a lot of bad, vulnerable debt out there – including that wracked up by the federal government. Worse, precisely because the longer the Fed waits, the more dubious debt will accumulate, the more painful any rate hikes are bound to be.

What’s genuinely sobering about can-kicking by the Fed is that the central bank is structured to be insulated from politics and its obsession with short-run gratification. If the Fed is so reluctant to bite this bullet, and impose some near-term costs on the economy to place it on a sounder footing, where will America’s adult supervision come from?

 

(What’s Left of) Our Economy: America’s Foreign Creditors Curbing their Enthusiasm?

18 Tuesday Nov 2014

Posted by Alan Tonelson in (What's Left of) Our Economy

≈ 9 Comments

Tags

China, credit, foreign holdings, interest rates, Japan, national debt, Treasuries, yield, {What's Left of) Our Economy

That geek’s delight, the Treasury Department’s newest monthly report on international capital flows into and out of the United States, just came out this afternoon, and the data for September showed something that hasn’t happened since last June: The U.S. Treasury debt holdings of China, Japan, foreign governments and central banks overall, and all foreign purchasers, went down on a monthly basis. All four categories of U.S. creditors hadn’t decreased their holdings on net since June, 2013.

These declines aren’t yet anywhere near big enough to endanger the nation’s ability to borrow heavily to finance its expenses and living standards. In fact, total foreign holdings of U.S. official debt, along with the holdings of most major creditors, remain near record highs. Further, these modest September declines followed substantial foreign net purchases in August. The massive monetary easing program announced by the Bank of Japan at the end of October could significantly change the global picture all by itself. And no one should forget that Americans still hold about two-thirds of all the debt issued by the federal government.

But for now, the September figures add to evidence that willingness abroad to finance American over-spending is waning. For example, between December, 2013 and this past September, total foreign holdings of U.S. Treasury debt rose by 4.62 percent. That’s higher than the 1.42 percent increase during the same period between 2012 and 2013. But it’s less than half the 9.37 percent jump between December, 2011 and September, 2012.

Foreign government holdings of Treasury debt have followed the same pattern. From last December to September, 2014, they rose by 2.10 percent. During the same period the year before, they fell a bit (by 0.43 percent). But from December, 2011 through September, 2012, their holdings grew by 9.32 percent.

Finally, America’s two largest foreign creditors, China and Japan, respectively, have become more reluctant to hold Treasury securities as well. From December, 2013 to September, 2014, Chinese holdings fell by 0.30 percent, after rising by 6.01 percent during the previous comparable period. From December, 2011 to September, 2012, they increased by only 0.15 percent – but they still rose.

Japan’s changes look less dramatic. During the September-December periods of 2011 to 2012, and 2012 to 2013, its Treasury holdings increased by a robust 6.65 percent and 6.02 percent, respectively. During this latest such period, the grew more slowly, but the rate was still 3.26 percent. Yet nearly half the increase occurred between December and January alone.

The strongest reason not to overreact to signs of diminished foreign appetite for U.S. Treasury debt is that overall global demand for this debt remains healthy – as evinced by its historically strong prices and low yields, and by the recent surge in thd dollar. Indeed, I remain as confident about this continuing demand as when I wrote about it earlier this year.

But it’s inarguable that the foreign holdings numbers now look somewhat different. If overseas investors remain more standoffish creditors, their American counterparts and possibly the Federal Reserve will need to do even more heavy lifting to keep the national credit card humming. Which means they’ll have to assume more of the risk, too.

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Current Thoughts on Trade

Terence P. Stewart

Protecting U.S. Workers

Marc to Market

So Much Nonsense Out There, So Little Time....

Alastair Winter

Chief Economist at Daniel Stewart & Co - Trying to make sense of Global Markets, Macroeconomics & Politics

Smaulgld

Real Estate + Economics + Gold + Silver

Reclaim the American Dream

So Much Nonsense Out There, So Little Time....

Mickey Kaus

Kausfiles

David Stockman's Contra Corner

Washington Decoded

So Much Nonsense Out There, So Little Time....

Upon Closer inspection

Keep America At Work

Sober Look

So Much Nonsense Out There, So Little Time....

Credit Writedowns

Finance, Economics and Markets

GubbmintCheese

So Much Nonsense Out There, So Little Time....

VoxEU.org: Recent Articles

So Much Nonsense Out There, So Little Time....

Michael Pettis' CHINA FINANCIAL MARKETS

New Economic Populist

So Much Nonsense Out There, So Little Time....

George Magnus

So Much Nonsense Out There, So Little Time....

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