it seems to me that the fed has used every bullet in the rate reduction drive to stimulate economic growth, so onto plan B.
but you know....the bottom line here is there is still a tremendous amount of debt overhang and even if the fed is successful in monetizing private debt there is no guarantee that the horse when lead to the trough, will drink.
they have been saying for months that the consumer has kept the economy afloat and the expectation was that corporate spending should have picked up by now, and that just hasn't happened.
they know very well that if the consumer AND corporate spending continues to remain stagnant, it's only a matter of time that this economy is dead in it's tracks.
(i happen to think we are there, but the numbers aren't going to bear that out for several months)
pimco.com
Bluntly put, I thought7 that Bernanke's Rule (of non-engagement of bubbles by the monetary authority) in tandem with Taylor's Rule of holding the real Fed funds rate above "neutral" if inflation was above "price stability" was a powerful one-two prescription for precisely what has unfolded in the American economy over the last two years: a bursting equity market and business investment bubble that would nail aggregate demand not just via a retrenchment in investment, but via a systemic (Minsky!) urge/necessity to delever balance sheets suffering from a bubble of excess debt.
There would come a time, I've argued repeatedly and not always pleasantly in this space, when the Fed would have to quit pretending that all it really could do was peg the Fed funds rate, and admit that it indeed had the power of the printing press itself to save capitalism from its boom/bust, deflationary self. To wit, there would come a time when the Fed would have to quit feigning impotence, and announce that it did indeed have the necessary powers to prevent/abort a Minsky Meltdown, including "unconventional" means, most importantly, the power to put a price floor under private sector credit obligations.
I've urged8 the Fed to do that implicitly by "ordering" the banking system to quit withdrawing from contingent lines of credit for private business, either directly or indirectly, via the credit default swap market. The Fed responded with one hand clapping. Until last week, when Mr. Bernanke saw my ante and upped me; big time! Rather than focus on the "micro" details of aborting a debt-deflationary spiral, as I've done, he openly declared that there was a "macro" way: monetizing, directly and indirectly, private sector debt!
And, indeed, Mr. Bernanke's very declaration of the Fed's power to do so, and willingness to do so, if necessary, actually makes the potential need to do so fall precipitously. The famous (or infamous) Greenspan Put9, heretofore "applied" to common stocks and household real estate, has now been supplemented by the Bernanke Put for private sector debt. And the more that private sector risk takers believe in the Bernanke Put, the less likely it is that it will ever "go into the money," requiring the Fed to actually monetize anything.
Bravo, Ben! As Keynes intoned long ago, smart men change their minds when they get new information, and I applaud you for changing your mind about the efficacy of "targeting" asset prices, if necessary to prevent/abort a debt deflationary spiral. (Truth be told, I'm quite sure that Governor Bernanke has always believed this, notwithstanding his strident advocacy of the view that the Fed should eschew "targeting" asset prices). Here's what he said, first at the most general level:
"…the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation."
And after echoing Mr. Greenspan's declaration that the Fed has the power to reduce/peg long-term government rates, Gentle Ben issued the Bernanke Put:
"If lowering yields on longer-dated Treasury securities proved insufficient to restart spending, however, the Fed might next consider attempting to influence directly the yields on privately issued securities. Unlike some central banks, and barring changes to current law, the Fed is relatively restricted in its ability to buy private securities directly. However, the Fed does have broad powers to lend to the private sector indirectly via banks, through the discount window. Therefore a second policy option, complementary to operating in the markets for Treasury and agency debt, would be for the Fed to offer fixed-term loans to banks at low or zero interest, with a wide range of private assets (including, among others, corporate bonds, commercial paper, bank loans, and mortgages) deemed eligible as collateral. For example, the Fed might make 90-day or 180-day zero-interest loans to banks, taking corporate commercial paper of the same maturity as collateral. Pursued aggressively, such a program could significantly reduce liquidity and term premiums on the assets used as collateral. Reductions in these premiums would lower the cost of capital both to banks and the nonbank private sector, over and above the beneficial effect already conferred by lower interest rates on government securities."
Governor Bernanke stressed that the Fed should never, ever allow the economy to get into a debt-deflationary spiral requiring such "unconventional" uses of the Fed's powers to reverse it. Preempting deflation was a far preferred course to reversing it, he evangelically preached. Amen, and amen, I shout. But it was hugely important that Mr. Bernanke put the facts squarely on the table: If America "accidentally" goes into the Japanese deflationary soup, it will not stay in the Japanese deflationary soup, as the Fed policy makers are not too blind to find the printing press. And use it!
Bottom Line
I am not qualified to opine on the course of regime change in Iraq. I am, however, qualified to opine on regime change in Federal Reserve policy, and I'm ecstatic to report, my friends, that we just witnessed one! The Fed's secular war against inflation, which Paul Volcker inaugurated on October 6, 1979, is over. Alan Greenspan declared victory on November 13, and Ben Bernanke laid out the terms of the armistice on November 21. In the years ahead, democracy and capitalism will be necking in the mezzanine where the Fed keeps the printing press.
Inflation in America can go no lower without morphing into deflation, a hellish place where capitalism would be consumed by its own debt-deflationary fire, as in Japan. The Fed is not too blind to see, and will do whatever it takes, using the full scope of its printing press powers, to reflate the American economy back from the deflationary cusp.
My principled populist soul rejoices. And but for the matter of the course of genuine uncertainty about looming regime change in Iraq, my cravenly capitalist instincts would be to advocate a wholesale swap of U.S. Treasuries into U.S. corporate bonds: The Fed has put its reflationary PUT beneath corporations' wings!
But I don't know, and can't know, the course of President Bush's plans for Iraq. Thus, let me conclude more circumspectly, with the closing three sentences of my June Fed Focus, written after PIMCO's Secular Economic Forum 2002:
"Secular shifts by definition occur in the context of cyclical exigencies, shaping the prices for secularly-oriented portfolio shifts. That said, sometimes it is important to buy and sell at the right prices, and sometimes it is important to buy and sell. So, dear reader, if you are still lifting your glass in celebration of the ascendancy of capitalism in our mixed economy, don't just stand there: do something!" |
