FOMC EXPECTATIONS
The FOMC announcement is expected today at 2:15 EST after a two day meeting. It’s widely expected that the Fed will leave the target rate at 0-0.25. Investors will be focused on the Fed’s statement and any changes. Investors should be primarily focused on the Fed’s exit strategy. Unfortunately, after nearly 24 months of ineffective rate cuts it’s hard to imagine why so many care about this meeting.
In his book “Essays On The Great Depression”, Ben Bernanke said: “to understand the great depression is the Holy Grail of macroeconomics.” In his attempt to conquer the world of macroeconomics I believe Bernanke has misinterpreted one of the most important dilemmas of our time. Richard Koo of Nomura Securities believes that the answers to the current credit crisis lie not in the Great Depression, but in the recent Japanese de-leveraging cycle. He also believes Bernanke has misinterpreted that this is a balance sheet recession that cannot be solved with traditional Keynesian approaches. Koo says this experience is different from neo-classical economic experiences, which can be solved with monetary policy because printing money is useless in a balance sheet recession. Demand for loans is non-existent and therefore the added liquidity does little to boost the economy. We’re seeing this in the M1 velocity of money and the Bloomberg chart of the day below. It’s amazing to think that the Fed has been cutting rates for nearly two years and the S&P 500 now sits 40% below the levels it was at when the Fed began cutting rates. How is that for results? Koo recently elaborated:
“Keynesian theory as it stands is critically incomplete, because it fails to see corporate debt minimization as the key driving force behind the economic problem it has set out to explain and solve. Corporate debt minimization, therefore, is the long-overlooked micro-foundation of Keynesian macroeconomics. If Keynes had recognized balance sheet concerns at firms and households as the main cause of the Great Depression, and had indicated in 1936 that fiscal stimulus is effective and essential only when the private sector is paying down debt, his followers in the 1950s and 1960s would not have pushed for aggressive fiscal stimulus. That in turn would have preserved the credibility of deficit spending as the key policy tool for fighting a balance sheet recession all the way to the 1990s.”
This is not to say that Keynesianism is inherently flawed. It just isn’t applicable to the current recession. It’s as if we’re performing brain surgery on a heart attack victim. We have chosen a highly complex and usually effective procedure, but the diagnosis has been wrong from the beginning.
I have been hammering the inflationistas here for months because it is nearly impossible for inflation to run rampant without a pick-up in economic strength and the velocity of money. I have backed off my deflation tilt since the middle of last year, but still believe that deflation has a stronger grip on the economy than inflation currently does and will retain its grip as the second half of the credit crisis takes effect. Bernanke appears to know this, but continues to push on a string with his low interest rate policy. Meanwhile, he has threatened the country with the high probability of rampant inflation years down the road and I believe weakened the long-term strength of the country. It is now evident that his reflation attempts are failing in all the necessary places.
The Bloomberg chart of the day elaborates on the Fed’s string pushing and low probability of a rate increase:
June 23 (Bloomberg) — For evidence that the Federal Reserve is still a long way off raising interest rates, look no further than the U.S. money supply, Westpac Banking Corp. said.
The CHART OF THE DAY shows that while the Fed’s balance sheet has grown, the so-called money-multiplier, the proportion of newly printed money that passes on to consumers, has dropped. M2, a gauge that includes savings and checking accounts, is 4.7 times the base cash supply, down from 9.3 times a year ago.
Of the $2.1 trillion that the Fed is injecting into the financial system, more than half, or 51 cents per dollar, is being posted back at the central bank by financial institutions in the form of excess reserves, a record high, according to Robert Rennie, head of currency research at Westpac in Sydney. That’s likely to ensure that the Fed’s Open Market Committee, which starts a two-day rate-setting meeting today, won’t be concerned about inflation, he said.
“In order for inflation to begin to build you have to have too much money chasing too few assets,” Rennie said today in an interview. “But what the money supply is telling us is that there’s simply not enough within the system to generate inflationary pressures yet.”
There’s a 40 percent chance the Fed will raise its target rate for overnight bank loans by at least a quarter-percentage point to 0.5 percent by December, fed funds futures trading shows. The likelihood was about 36 percent a month ago.
“An important part of money is how it multiplies and this is where we see no signs of green shoots at all,” a team led by Rennie wrote in a report earlier today. “We see the arguments behind current market pricing for the Fed as very thin indeed.”
Today’s FOMC decision is likely to send market participants chasing various asset prices at 2:15:01 EST, but the long-term implications of Bernanke’s decision will be as unimportant as the last 10 rate decisions. His rate cutting policy has had little to no effect on the economy and until we recognize that this is a balance sheet recession that can’t be solved with neo-classical economics we are unlikely to see any sort of fast recovery or inflationary effects.
A bit wonkish TPC….
are you trying to imply that this meeting doesn’t matter at all? I would argue that their exit strategy is incredibly important.
TPC,
I don’t see why you’re being so casual and flippant here. This meeting is entirely significant for the simple reason that the market is looking for direction.
It’s amazing to think that the Fed has been cutting rates for nearly two years and the S&P 500 now sits 40% below the levels it was at when the Fed began cutting rates. How is that for results?
I think you should seriously consider the flaw in this line of thought: The results for what? This is an impossible judgment to make. It could have been down 90%. For Pete’s sake, the entire world financial system almost melted down. The fact that it’s still operating the the whole thing didn’t just collapse is your answer!!
I think you should treat your blog with less flippancy. Seriously, when you get the urge to have knee-jerk “fundamental” insights, check yourself and reconsider. The market is not and never has been fundamental. Value is value because it is not GOLD.
@ AndyD – It’s hard to avoid being wonkish when you write anything with the term “neo-classical economics” in it….
Anonymous & Paul – That is my whole problem. The market is looking for direction and we keep turning to these people who have been wrong every step of the way. Bernanke has been so wrong about this crisis it is unbelievable. Just go back and read his statements from 2007 and early 2008. He had NO clue any of this was going to occur. He saw no housing bubble, no debt bubble, etc. Even an amateur economist like myself was writing about these things and getting very cautious. I was calling for rate cuts in January of 2007 when Bernanke said the sub-prime problems were “well contained”. Then we turn to Hank Paulson for guidance and the TARP when you could easily argue that Paulson did more to cause this crisis than any other single leader on Wall Street. Now we’re relying on Geithner to pull us out of this mess when all of this happened on his watch in his backyard.
Why am I flippant about this meeting? Because I am tired of watching the market hang on Bernanke’s every word while fools like Cramer proclaim that he saved us. Bernanke damn near sank the ship with his reactive approach.
A few things could come out of this meeting: low rates, marginally higher rates and more quantitative easing. The low rate policy has failed. Q easing has failed. Tell me why this meeting matters to the long-term outlook and why Bernanke should be listened to at all? The Fed has been 100% entirely wrong all the way along….
Bernanke inherited this mess though. Do you really think he could have stopped the ball from rolling downhill?
Anonymous – That is true. He did inherit this mess, but he was sworn in in early 2006. The housing bubble was well under way and the sub-prime cracks had already altered the foundation. Bernanke maintained his “well contained” rhetoric until the wheels came off in August 2007. The signs of increased risks were there and he did nothing. This is a classic risk management failure. His reactive approach and lack of risk management is no different than the thousands of mutual fund managers who waited til last October to sell stocks and reduce risk in their portfolios.
Everyone is praising Bernanke for his creative measures in Q4 last year. I commend him for his approach, but we never should have reached that point in the first place. He was simply repairing something that he let get out of control due to his own ignorance.
And to those who say, “no one saw this coming” – that is utter nonsense. The Shillers, Roubini’s and dozens of well known economists and bloggers were banging the table on the risks to the markets for years. There is no risk management or proactive approach in the Fed system. I attribute that almost entirely to Bernanke’s scientific method and academic background. He is not cut out for the job. And this is without even mentioning that he has diagnosed this balance sheet recession almost entirely incorrectly….
Yeah Bernanke had a hand in this whole mess…and I agree that at some point, ppl will realize that this is a non-event because those fools on the Fed Reserve Board are just as lost as any other people. This whole thing is an experiment for them to see if it can fix the ailing economy. If it doesnt, oh well….at least they tried.
I agree TPC. Every few months we have these meetings and every time the markets hang on the statements as if Bernanke is doing something that is beneficial. But as you’ve said, it’s clear that his Fed policies have failed across the board. At what point do we start taking different measures? Thanks for the great insights.
I agree with you TPC well said. How many times did Ron Paul grill Bernanke about his policies when the Helicopter man was on the stand? The Austrians saw this coming from miles away.
tpc — thanks for the great blog — i would however take issue with your interpretation of koo’s assessment. koo, i would say, rather thinks of keynesianism as a special case variant of his two-state “yin-yang” general theory. he really posits that, when balance sheets are ‘normal’, keynesian spending leads to undesirable side effects (eg crowding out, inflation) and monetary policy is optimally effective — but when balance sheets have suffered an asset shock (eg bursting bubble), loan demand goes negative (ie private sector starts paying down loans with income formerly directed to consumption) and monetary policy becomes totally ineffective. however, because the private sector is redirecting income to loan repayment and dumping cash into the banks, the government should be able to borrow cash out of the banks to fund fiscal stimulus in size analogous to the contraction of demand — effecting what amounts to a refinancing of private debt (which gets paid down out of government spending streams) onto the public balance sheet.
in other words, keynesianism “works” — but only in balance sheet recessions. koo i think has recently praised larry summers fairly effusively for his ability to get fiscal policy done — and i’m sure he’ll further recommend much more for coming years, until the private debt monster is transferred to the treasury and private balance sheets repaired.
but there’s a bogey which john hempton brought to my attention — which is that japan was a massive creditor nation with a huge current account surplus. its banking system was deposit-rich even before the bubble burst, which is to say japanese banks typically had more deposits than assets. idle cash was a prominent feature of japanese banking that only became more prominent as time went on.
the united states today is the opposite — massive current account deficits intermediated by the banking system have left US banks heavily dependent on wholesale funding. deposits currently cover only about two-thirds of assets. this means our situation is less analogous to koo’s 1990 japan than to, say, 1998 korea — meaning that we are very likely to see a massive delevering of the banks rather than a long malaise, not because of asset-side losses but liability-side funding difficulties.
the fed has already clearly stepped in to intermediate wholesale funding (CP, interbank) in a massive way, but short of turning all the banks into GSEs for good it doesn’t really resolve how banks are going to put their assets back in line with deposits as our current account imbalance adjusts. your thoughts would obviously be appreciated!
Gaius,
Excellent comments. Much appreciated. If I remember correctly Koo’s work states that monetary policy becomes totally ineffective during a balance sheet recession because consumers seize up and stop borrowing as they attempt to minimize debts. Monetary policy is very effective in the Yang phase and ineffective in the Yin phase. We’ve seen this clearly over the last 20 years as the U.S. pulled the same play from the same playbook during the last 4 or 5 recessions.
Koo advocates strong fiscal policy measures while arguing that monetary approaches are generally ineffective.
I shouldn’t have generalized Keynesian responses as purely monetary. Other than that, I believe we’re on the same page. Thoughts?
TPC,
I don’t think you’re being fair to Bernanke. He could not have come in and immediately tacked hard. It would have completely blown any confidence anyone had in him. You have to ease into a position such as his. It’s a super-tanker, not a fighter jet.
And who gives a damn what Ron Paul says. He reminds me of the opposition parties in European parlimentary systems. All their blather is purely symbolic, since they know it doesn’t have a chance of becoming reality. Governing, however, involves a different calculus.
Sorry, I think you’re wrong. It’s misplaced schadenfreude. Bernanke has understood the situation and guided it pretty well. I don’t blame Lehman on him.
You write:
Today’s FOMC decision is likely to send market participants chasing various asset prices at 2:15:01 EST, but the long-term implications of Bernanke’s decision will be as unimportant as the last 10 rate decisions. His rate cutting policy has had little to no effect on the economy and until we recognize that this is a balance sheet recession that can’t be solved with neo-classical economics we are unlikely to see any sort of fast recovery or inflationary effects.
This is patently wrong. His rate-cutting and the QE has kept the ship from sinking! You have to think that this is not a normative moment, but one in which no one except sovereign powers could have steadied the world.
Schadenfreude? If anything I am upset with his unfortunate response and position. I am far from reveling in it. And I never mentioned Ron Paul so let’s not bring politics and an Austrian vs Keynesian argument into the mix….
As for Bernanke, I don’t see why people are so lenient with him. Bush responds slowly to Katrina and people want to castrate him, but Bernanke responds slowly to the greatest economic crisis of the last 75 years and people cut him a break. He controls the most powerful “independent” arm of the U.S. government and yet we treat him as if he is some unwitting professor driving a tonka truck around. Why is he not more accountable for his mistakes? And to say that Bernanke has “understood the situation and guided it pretty well” is just flat out wrong.
In March of 2007 he said: “At this juncture, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.” Praising him for “saving the economy” in Q4 is like praising the doctor who accidentally slices your femoral artery while performing a bone fracture surgery and then stitches you up and “saves your life”.
There were no signs or risks of inflation in 2007 and 2008 (CPI was at the historical average) yet Bernanke kept rates at 5.25%. Why? Why did he do nothing to get out in front of the crisis? Why was there zero risk management of the U.S. economy? The signs were evident. Plenty of smart people were warning about potential problems in housing and debt markets, but Bernanke was totally blind sided by this crisis. Sure, his response was adequate, but why did this “expert” wait until the patient was on his death bed to be able to diagnose him?
I believe, in 10 years, Bernanke will be seen as a horrible Fed Chief who misdiagnosed these problems and created much larger debt problems at a time when we needed less debt as opposed to more of it.
Paul,
How can you possibly argue that QE has worked when rates have shot up ever since the program began? And how can you say that rate cutting has worked when lending has fallen off a cliff and banks are hoarding record levels of cash? These are all signs that prove your comments 100% wrong. The fact that the economy isn’t decelerating at the same rate as Q4 is not a sign of Bernanke’s success. It just means the rate of decline was unsustainable.
I agreed with TPC. Bernanke should had let the ship(s) sink, there are plenty more ships afloat. It’s our taxpayers’ money being wasted on a ship of fools. We’re going have to be paid for this with the next generation or two. Hello Japan, can we join the ‘lost decade’ party?
we’re on the same page. Thoughts?
yes, i think so too.
my big question is if/how we can avoid an eventual resolution similar to that of 1998 korea — a disorderly sudden-stop delevering event that annihilates all bad businesses and many good, crushes the currency and renders green shoots only from scorched earth.
here’s a better synopsis than i woudl write — but the end result is that when korea’s wholesale funding gave way in november 1997 amid the asian crisis, it experienced capital flight, currency devaluation, banks collapsing for a lack of funding and the IMF ultimately stepped in to refund and prevent complete financial system collapse.
the united states is obviously not korea, and the differences are important. the IMF can’t bail us out, but the dollar (unlike the won) is a traditional safe-haven currency. we’re also the global repository (even now) of excess demand, meaning that many will seek to continue to provide vendor finance and perpetuate our current account imbalance. but how might these things balance against one another? can the fed continue indefinitely to fund the banks? how will the incredible degree of treasury issuance affect the dynamic? will the dollar depreciate? a complex of questions and no one knows, i suspect, the outcome.
gaius,
I’ll take a look at what you wrote later this evening and get back to you. I am not entirely familiar with Korea, but will shoot you a comment on your site or email you.
Best,
TPC
Why hasn’t the QE worked? How do you know what to compare it to? What if the rates would otherwise be 7 or 8%. It’s the same argument you made in the first post–that the economy hasn’t recovered… The question is: relative to what. I am saying that you’re making absolute pronouncements in an inappropriate context. Maybe the economy would hold up better if we did the kind of stimulus that Krugman was calling for, one that was nearly triple what was passed and politically feasible.
Here is what I’m saying: you are making essentially right-wing anti-Keynseian arguments that are used by many right-leaning types that are, to my mind, completely crazy. You cannot have a sound deficit if the economy completely craters. You’d have to not only cut the FED budget in half, you’d have to cut military spending and everything else across the board. You have to sustain the economy as best you can also in order to fight the deficit. But the arguments that you and some on this board are making are the kinds of arguments that I’ve heard for years. Use the crisis to destroy. Let it fail. Other things will come back. It’s magical thinking to my mind. Totemism, precisely the kind of thinking that has taken over the crazy gold bugs.
Other economies understand that if you want to rebuild your economy, you need policy as well as the invisible hand…. and policy dictates that you manage the transition from one economic basis to another.
Jimmy,
No, you’re wrong pal. There aren’t “many other ships.” It’s all one ship. Bernanke has saved it, and the schadenfreude comes from people who don’t believe that he has and are unwilling to admit it. It would require that they change their point of view on matters.
That’s what I think, anyway.
Paul, do u really believe that the Keynes approach has worked? 2 years of this crap and what do we have to show for it? Keyneianism and monetary policy caused all of this and now u and your Keynesian left wing friends think it will get us out??????
Paul,
I never advocated a purely Austrian, Keynesian, Democratic or Republican approach. You’re bringing politics into a debate that never involved politics and it’s clouding your thinking. I never said I disagreed with the fiscal Kenyesian approach and have in fact advocated helping consumers on more than one occasion here at The Pragmatic Capitalist. Perhaps I should have been a bit more clear. Since the post was focused on the monetary policies and today’s Fed meeting I was highly critical of Bernanke’s monetary approach and our general government’s monetary approach. If you read my comments to Gaius you’ll see that more clearly.
I should have been more clear about that in the original post. I did specifically state that I do not condemn Keynesian economics and have said multiple times that there are facets of Austrian economics that are applicable to today’s crisis and facets of Keynesian economics that are applicable. The interest rate tinkering is terribly flawed in my opinion and entirely useless in a balance sheet recession.
Has Bernanke failed? You’re right. It is too early to tell. But if Jim Cramer is right and Ben Bernanke did in fact save the world I will certainly own up to it. But something tells me Cramer is wrong….
fwiw — just my two cents — i think bernanke has run up a pretty mixed bag of results. he clearly has had his core notions about monetarism completely debunked. remember the printing press speech from 2002? he must be aghast and deeply disillusioned about the titanic pile of useless excess reserves, which have done nothing to promote lending in the end — he corrected what friedman always said hoover did wrong in the depression, and for his troubles has seen the entire financial system collapse anyway and the global economy rerun the early 1930s. a lifetime of philosophizing on these issues has come to nothing in its big test; i can think of few iconic books more thoroughly damaged by this crisis than friedman and schwartz’s “monetary history of the united states”.
but he has also been at least party to (though perhaps not designer of — credit paulson and the goldman sachs wunderkinds) some extremely necessary actions — like the all-important intervention into the commercial paper market when the financial system did implode, which essentially saved us from a payments system failure and immediate cascading collapse. they’ve sensibly applied incredible forbearance to the banks’ assets and guaranteed the bank liabilities. it had nothing to do with his academic work, but he did help to do it. some of their stunts have been abortions — MLEC, TALF, PPIP — and others deeply conflicted, but they are flying blind and you have to credit them with creativity.
unfortunately, though, while summers and bernanke have been bailing furiously and the boat is still afloat if listing, they haven’t been able to do much but watch as the securitization colossus was run and has died — and they’ll be fighting that massive deflationary impulse for years. you’d have to call his tenure a failure on its merits, but i’m certain others could have failed more spectacularly still.
of course, we haven’t yet seen them botch the recovery — it IS still too soon, after all.
Paul, there were other recessions right b4 the great depression and they righted themselves without much government meddling. let the bubble deflate instead of trying to patch it up and inflate it again.
will see, i know the stock market and economy is heading back down again because the fed doesn’t get it.
TPC, holy crap, look at all the comments brother. Congrats again on a great blog and your fans shall spread the word to all finance freaks in the world!! Have a good night.
good debate, everyone. hope for the best for our economy (and globally too.) everyone has their own opinion and we should respect that. just think the fed has meddle in too much.
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