8 Notes About The Fed

1) Let’s start out with my forecast. I’ve given it before, but it has become the conventional wisdom — at the next FOMC meeting at the end of April, the Fed will cut by 25 basis points. They will make the usual noises about both inflation and economic weakness, as well as difficulties in the financial system, and comment that they have done a lot already — it is time to wait to see the power flow.

The only difficulty is whether we get another blowup in the lending markets that affects the banks. We could see Fed funds below 2% in that case, but absent another crisis, 2% looks like the low point for this cycle. Now all that said, I think the odds of another crisis popping up is 50/50. We aren’t through with the decline in housing prices, and there are a lot of mortgages and home equity loans that will receive their due pain.

2) One interesting sideshow will be how loud the hawks will be opposing a 25 basis point cut. We have comments from voting members Plosser and Fisher already. Price inflation is a real threat to them, and one that is closer to the Fed’s core mission than protecting the financial system.

3) Okay, give the Fed some credit regarding the TSLF, which is now almost not needed. The TAF is another matter — there is continuing demand for credit there. It will be interesting to see when the Fed will stop the the TSLF, and what happens when they try to unwind the TAF. As it seems, some banks still need significant liquidity from the TAF.

4) Indeed, if the Fed is lending to investment banks, it should regulate them. I would prefer they didn’t lend to investment banks, though. Better they should lend to commercial banks that are negatively affected by investment bank failures, and let the investment banks fail. After all, there is public interest in the safety of depositary institutions, but I’m not sure that if the investment banks disappeared, and the commercial banks were fine, that the public would care much. It certainly would teach the investment banks and the investing public a real lesson on overdoing leverage.

5) Okay, so LIBOR rises after it seems that some bankers have been lowballing the rate in an effort to show that they are not desperate for funds. Significant? Yes, the TED spread has widened 12 basis points since then. I’m sure that borrowers with mortgages that float off LIBOR will be grateful for the scrutiny.

Having been in similar situations in the insurance industry regarding GIC contracts, I’m a little surprised that the BBA doesn’t have some requirement regarding honoring the rate quote up to some number of dollars. On the other hand, can’t they track actual eurodollar trading the way Fed funds gets done, and then just publish an average rate?

6) On to the last three points, which are the most controversial. You know that I think the core rate of inflation is a bogus concept. If you are trying to smooth the result, better to use a median or a trimmed mean, rather than throwing out classes of data, particularly ones that have had the highest rates of inflation. Given the inflation that is happening in the rest of the world, I find it difficult to believe that we are the only ones with low inflation, unless it is an artifact of being the global reserve currency.

7) I was quoted at TheStreet.com’s main site regarding the Fed. I think that the Fed is caught between a rock and a hard place, but I am not as pessimistic as this piece.

8) Finally, how do the actions of the Fed get viewed abroad? Given the fall in the US Dollar, not nearly as favorably as the press coverage goes in the US. Do I blame them? No. They sense that they are losing economic value to the US, and that they are implicitly subsidizing us. No wonder they complain.

Comments

[clitosil]

How much pandering do we have to do to the "experts" who tell us we are fools to think that inflation is through the roof? Inflation is obvious to any average person who has to work and support themselves.

[winslow]

David
Agree with all of your comments. I don't know if this period is just a blip in American history or is this really the beginning of a change in world society? The world doesn't look very kindly on the US. One article I read recently called the US "twister", ie, the truth will be twisted whenever needed (not that other countries are any different, but we were supposed to be the "idealistic" leader).

[buyitcheap]

shadowstats.com has a fantastic set of statistics that track the true CPI and peg it at around 7% which feels a lot more realistic.

[billddrummer]

Thank you for your comments. I believe the other central bankers are now noticing what has been true for many years--that because the US dollar is the world's reserve currency, we can export 'real' inflation to other countries through manipulation No wonder the Ugly American has now become the Ugly American Dollar.

If and when decoupling gains momentum, the real inflation we mask will appear. Then the Fed will go on worldside junkets to plead with central bankers not to drop the dollar as a reserve currency. Whether it will work is open to question.

[clitosil]

US government credit quality has already started slipping. Isn't german government spread lower than US government now?

[ussmls7]

The Fed has openly said , it will use all options at all cost, well it has only began, what it did in the commodity markets is a drop in the bucket. now that the 545 is under the control of the G7, we can watch, as our resourses go to the holders of real money.

[gordon]

Why the H can't we like minded readers and David, (one of the best here) bring about pressure on the BLS, to print the real CPI, or change it? For God's sake, why no calls for an investigation? Dragging one of those BLS guys before the camera (once, PBS tv) is like pulling teeth, shoulda seen how evasive he was recently, obviously lying, and told what to say.

[bearfund]

gordon, why bother? Everyone knows the CPI is crap, so it's not like the specific levels actually affect investment decisions. There are four ways in which the CPI matters: the Fed, TIPS, taxes, and Social Security COLAs. All amount to the same thing, taxes that end up in Treasury coffers; on all dollar-denominated asset holders, all TIPS holders, all American taxpayers, and American retirees, respectively. To the extent that your investment decisions are affected by these factors, you're already discounting them for the obvious inadequacies of the CPI. Right?

Thought exercise, then. If the BLS reported the CPI at 11%, the Fed Funds rate would be at 9.5% instead of 2.25%, tax rates would be 70% instead of 35%, and the US military would be off somewhere stealing gold, oil, euros, or lord knows what else from some major power. The Treasury has to get money somehow, because both it and the citizens it serves have been consuming far more than they produce for decades with no sign of stopping. Printing a bogus CPI is probably as good a way as any to achieve the desired outcome, and because most of the people losing by it are complicit in or ignorant or tolerant of the practice, it requires less violence than some of the alternatives. I'm not saying I approve - I'd much rather shut down the whole fractional reserve and central banking system, replace fiat money with gold, and go back to consuming *after* producing, i.e. saving instead of borrowing. Then no one would care about the CPI because most prices would change little. But that's not a "mainstream" view so we're back to where we started, eh?

[elwind45]

I am amazed how long rates are so low compared to real (everyone knows) inflation rates. I dont think the bond market is that far off real inflation. The point is the bond market seems to be signaling we have reached the peak. I feel bond rates would be higher unless bonds are anticipating lower future inflation. Deflation is the true signal? Any future growth would be alot inflationary feeling. Absent a attack on iran, money supply will not be met by equal production increases. The fed will have to drain, drain etc. The 64 dollar question, How much will the EURO drop before europe will defend with higher rates. I believe europe wishes it had already raised rates more. Consider that a falling euro would stimulate a already healthy european economy, and make its central bankers nervous. I would cut rates this time 50 bp, and keep dollar down (until europe breaks) How to break EURO back and not force a worldwide depression?

[User 184146]

Perhaps we need to step back and consider some structural issues. Who allocates scarce capital? Now that capital is becoming scarce can you imagine US credit being allocated by the same folks that brought us the 2007-2009 mortgage debacle, the student loan and credit card fiasco? These are the same folks that brought us the Resolution Trust Corporation from the commercial real estate bust in 1990. Credit has been allocated not based upon the worthiest borrower but based upon the marketing and incentive fees the banks can earn. They have clearly demonstrated their inability to efficiently allocate credit and it seems as if we are going to be relying upon them once again. Unless we revive regulations and oversight of the banking industry eliminating their conflict of interest between their basic credit allocation function and their fee and incentive based marketing operations we can expect the same folks to bring us the next economic disaster. Where are the bank regulators? Where is Congress? Can anybody see beyond the next quarter’s income statement or campaign contribution?

[User 184146]

Perhaps we need to step back and consider some structural issues. Who allocates scarce capital? Now that capital is becoming scarce can you imagine US credit being allocated by the same folks that brought us the 2007-2009 mortgage debacle, the student loan and credit card fiasco? These are the same folks that brought us the Resolution Trust Corporation from the commercial real estate bust in 1990. Credit has been allocated not based upon the worthiest borrower but based upon the marketing and incentive fees the banks can earn. They have clearly demonstrated their inability to efficiently allocate credit and it seems as if we are going to be relying upon them once again. Unless we revive regulations and oversight of the banking industry eliminating their conflict of interest between their basic credit allocation function and their fee and incentive based marketing operations we can expect the same folks to bring us the next economic disaster. Where are the bank regulators? Where is Congress? Can anybody see beyond the next quarter’s income statement or campaign contribution?

[Nepzone]

Major Economic Scenarios


A. Pro Economic Expansionist Governments

In this day and age Governments and politicians seek only to ensure economic expansion (note: In the Clinton Years inflation data was actually manipulated to reflect lower inflation) indifferent to everything else especially Inflation & Speculation.

In some cases Governments actually unbalance the playing field by estalishing Sovereign Funds to enhance their profits and thus competing with the private sector in pushing asset prices and subsequently inflation higher.

B. Flaws of Globalization

Obsessed with growth, Governments expand free trade and encourage globalisation thus opening their countries to greater economic imbalances especially when there are sudden movements in the flow of "hot money" (ie. classic example in the 1997 Asian financial crisis). Just imagine if some countries did not protect their farmers, what would have happened in this current "food inflation crisis"? Free trade have effectively placed some economies at the mercy of others! Thus, has National Security been compromised?

C. Hyperinflation

The factors above have now pushed the world into a hyperinflationary period. The US Fed has EVEN reduced interest rates in the face of severe inflation giving birth and stoking the next bubble. See how twisted Government policies are nowadays! Luckily, we still have a responsible Euro Central Bank.

D. Increasingly Polluted World

Governments in search for economic growth have effectively forgotten the environment.