Will they...or won't they?
Turmoil might be addressed without fed funds rate cut: Fed's Plosser
By Greg Robb, MarketWatch
Last Update: 3:25 PM ET Sep 8, 2007
WASHINGTON (MarketWatch) -- The Federal Reserve might not have to resort to a cut in its target federal funds rate to address the financial market turmoil and credit crunch, said Philadelphia Federal Reserve Bank president Charles Plosser on Saturday.
"I believe disruptions in financial markets can be addressed using the tools available to the Fed without necessarily having to make a shift in the overall direction of monetary policy," Plosser said in a speech prepared for delivery to the Pennsylvania Association of Community Bankers meeting in Hawaii. A copy of his remarks was released here.
Plosser said the Fed can continue to provide liquidity in the face of financial shock. On Aug. 17, the Fed cut its discount rate and has taken a series of technical moves to provide the market with cash. The Fed has also undertaken a series of injections of funds in to the market.
Many Fed watchers believe the Fed district bank presidents are more reluctant to cut the federal funds rate than the members of the Fed board of governors.
In the past few days, some bank presidents have stressed that the Fed must avoid the "moral hazard" problem by bailing out investors who took excessive risk.
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Some excerpts from Coxe's call this week:
Now, there is nearly a unanimous opinion out there that the only way this can be resolved is for the Fed to finally capitulate and to lower the Fed funds rate, starting with fifty basis points and keeping on with that. What that is, as one writer commented on it today, I saw in the press, that’s a tax on savers. Well this country is obviously not built on savers, it’s built on borrowers. And so this is the equivalent of what’s happened in banana republics in the past, where what they do is inflate the currency so that the people who’d saved get wiped out and the people who had debts, get redeemed. But to do this as a national policy would of course be a disgrace.
I've been admiring Ben Bernanke's creativity and his resistance on this. Similarly with the ECB and the Bank of England where they have similar problems but not on quite the same scale. They're holding it because they're looking at rising inflation - rising energy inflation, rising food inflation. We've talked about that before.
Maybe the Fed will be forced into it but that will not solve the problem. All that will do is punish savers and it will tend to take the pressure off those very organizations and billionaires that created the problem in the first place.
In other words, the old concept of too big to fail - which is what they used to bail out the Continental Illinois - is now going to be done for those billionaires who ten years ago were paying off their student loans. And this is what Jim Grant called socialism for the rich.
So if the way that it's going to be solved is one where it's not going to solve the problem of somebody whose mortgage is more than 100% of the value of his home but what it's going to do is provide liquidity for those who’ve got paper where they don't know the value of it and they might be able to actually sell it to some other greater fool if there's still a supply out there. This is going to be a sordid outcome.
Well, there's always a winner out of all of this. And today the DX, that's the US Dollar index, broke 80 and gold broke out on the front month future which is the December contract decisively yesterday through 700 and spot gold is 696.
So gold finally has been doing what we said it should do but boy it took longer than we thought. And so therefore looking at my screen what stocks are green, they're gold producers. And that means that those of you who have kept the faith in this are finally getting rewarded.
Meanwhile everything else is in red. And this is going to be a problem globally because obviously you can't finance the stock market or the economy on the basis of the profitability of gold mines. But that's why you owned them in the first place, was a hedge against the financial system going bad. And the problems of the financial system no matter what the Fed does are going to continue.
There's no quick fixes available and those people who say "Ah, well, if the Fed does this," - I mean I've read more stuff to the effect that if they cut 50 basis points now and twice more this year that by year end things will be okay. That's balderdash! No, when it's a balance sheet problem and not an income problem, then you don't solve the problem simply by bailing out those who lent when they shouldn't have. And even their bailouts will have to be more and more of them. There will be remorselessly more demand as they discover that these assets that they were valuing at par are worth less.
The Dutch bank which had invested not wisely but too well in triple AAA US mortgage product when they finally had to liquidate it, got 68 cents on the dollar. How's that for a return on a triple AAA investment? That's the only market based evidence we've got as to what these hundreds and hundreds and hundreds of billions of dollars of these Jurassic Park Avenue products that are showing on balance sheets as being 100, what they're actually worth. So we've got a lot to go through.
Against that is the fact that beyond the world of Jurassic Park Avenue, the world is in good shape. Just as we've had capital being pumped in from the Third World this time to buy this lousy product we've got the economies of Third World countries still growing. And so we can get through this, but the saviour this time will not be the Fed and it will not be European central banks. What it will be is the growth of the new middle class in the Third World particularly in China and India.
So, this is not going to be a global recession or depression. Even if it is a US recession here. Because the dynamics of growth in countries where they're not only growing their economies fast but have high savings rates. This is a magic combination for success. Whereas the US has a slow growth economy and a negative savings rate. And what it's got is balance sheet problems on a majestic scale.
We reiterate then that this is not a reason for getting out of emerging markets, because the fundamentals for emerging markets for the first time ever have less endogenous risk in them than we have in the US economy. Therefore there's going to be all sorts of portfolio adjustments that you're going to need to make going forward. And you got to get the notion as to what the risky assets are and change it around. The idea that the riskiest assets out there are triple AAA debt and that the less risky assets are good commodity producing stocks or even emerging markets derivatives. That's a huge change. It's going to take a while before that sinks in.
Haven't changed our views then, that the outlook for commodities is good going forward because the supply and demand imbalance remains and the amount of investment that's going to be required to get the supplies that are needed is gigantic.
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