John,
what if the backdrop to your confidence in a housing recovery is a massive shadow inventory of housing coupled with banks loaded with toxic debt and a reserve currency that is teetering under the powerful assault of a Fed Chairman hell bent on the destruction of the value of that currency? How do you think all of that will play out?
Bernanke's policies are terrible and prolonging the pain. They will have side effects that none on this thread believe possible. As I've said, the ignorance and hope is extreme on this thread and in the general American population. Everyone thinks Bernanke is right. What if he is wrong, as I believe? I believe the worst case scenario is a currency collapse and subsequent revaluation of the currency to much lower levels, resulting in catastrophic loss in purchasing power of the dollar. The best case scenario is Japan...a long malingering economic malaise, where growth is tepid, unemployment is high, and structural deficits gigantic in size, resulting in shrinking public expenditures on all the things we need for a vibrant economy.
Below is what the Bank of International Settlements believes. They believe that the US has taken the path to Japanization of our economy. And it's no wonder. As I've said on these threads countless times, we never dealt with the balance sheet recession, just as Japan never dealt with there's. Our banks are still loaded with shadow inventory and toxic debt and Bernanke is trapped in a quandary of his own making, responding to an ever widening problem with more and more debt, monetization of debt, and ZIRP. Exit from these extraordinary measures will not be possible in time to avert an inflation event or a monetary crisis. We should have followed the Nordic example, instead we chose Japan. How stupid is Brenanke for all his vaunted awards and degrees? And how gullible are the masses for believing he is right?
-----------------------
BIS Working Papers
No 395
The financial cycle andmacroeconomics:What have we learnt?
by Claudio Borio
Monetary and Economic Department
December 2012
scribd.com
...
What about monetary policy? The key pitfall here is that extraordinarily aggressive and prolonged monetary policy easing can buy time but may actually delay, rather than promote,adjustment. This is true for both interest policy (changes in the short-term policy rate) and central bank balance sheet policy (changes in those balance sheets aimed at influencing financial conditions beyond the short-term interest rates, such as through large-scale asset purchases and liquidity support) (Borio and Disyatat (2010)).Context matters. Monetary policy is likely to be less effective in stimulating aggregate demand in a balance sheet recession. Overly indebted economic agents do not wish to borrow in order to spend. A damaged financial system is less effective in transmitting the policy stance to the rest of the economy. All this means that, in order to have the same short-term effect on aggregate demand, policy will naturally be pushed further. But this also increases its side-effects.There are at least four possible side-effects of extraordinarily accommodative and prolonged monetary easing.
First, it can mask underlying balance sheet weakness. It is all too easy to underestimate what the ability to repay of both private and public sector borrowers would be under more normal conditions. It is easier to delay the recognition of losses (eg, ever-greening). And except when refinancing options can be exercised for free, as in the case of the US mortgage market, the policy does not reduce the (present value of the) debt burden; in fact, itincreases it.
Second, it can numb incentives to reduce excess capacity in the financial sector and even encourage betting-for-resurrection behaviour. Even if the economy is not buoyant, institutionsmay take on risks not commensurate with rewards, such as in trading activities, or in asset classes that may even inhibit growth, such as in commodities like oil. One may wonder whether JP Morgan’s highly publicised losses in the second quarter of 2012 might partlyreflect such incentives.
Third, over time, it can undermine the earnings capacity of financial intermediaries. Extraordinarily low short-term interest rates and a flat term structure, associated with commitments to keep policy rates low and with bond purchases, compress banks’ interest margins. And low long-term rates sap the strength of insurance companies and pension funds, in turn possibly weakening the balance sheets of non-financial corporations,households and the sovereign. It is no coincidence that in Japan insurance companies came under serious strains a few years after banks did (eg, Fukao (2002)).
Finally, it can atrophy markets and mask market signals, as central banks take over larger portions of financial intermediation. Interbank markets tend to shrink (Baba et al (2005), BIS(2010)), and risk premia and activity tend to become unusually compressed as policymakers risk becoming the marginal buyers. For example, it is hard to believe that the highly negative risk premia that prevailed in the government bond markets of even highly indebted sovereigns in the first half of 2012 were not to a considerable extent the result of central bank purchases. In fact, lowering those yields was a policy objective.
Over time, political economy considerations may add to the side-effects (Borio and Disyatat(2010)). The central bank’s autonomy and, eventually, credibility may come under threat.Technically, central banks have a monopoly over interest rate policy, but not over balance sheet policy. Balance sheet policies can be properly assessed only in the context of the consolidated public sector balance sheet, which is much larger. They make central banks vulnerable to losses, which can undermine their financial independence. And they make them open to the criticism of overstepping their role, such as if they are perceived to financepublic sector deficits directly (purchases of sovereign assets) or to favour one sector over another (purchases of private sector assets).
The key risk is that central banks become overburdened (Borio (2011b), BIS (2012)) and a vicious circle develops. As policy fails to produce the desired effects and if adjustment is delayed, central banks come under growing pressure to do more. A widening “expectations gap” then emerges, between what central banks are expected to deliver and what they can deliver. All this makes eventual exit harder and may ultimately threaten the central bank’s credibility. One may wonder whether some of these forces have not been at play in Japan, a country in which the central bank has not yet been able to exit.On reflection, the basic reason for the limitations of monetary policy in a financial bust is not hard to find (Caruana (2012a)). Monetary policy typically operates by encouraging borrowing,boosting asset prices and risk-taking. But initial conditions already include too much debt,too-high asset prices (property) and too much risk-taking. There is an inevitable tension between how policy works and the direction the economy needs to take.
Recent empirical evidence is consistent with the relative ineffectiveness of monetary policy in a balance sheet recession (Bech et al (2012)). The authors examine seventy-three recessions in twenty-four advanced economies since the 1960s, distinguishing the twenty-nine that coincided with financial crises from the rest. They find that, considering the recession and subsequent recovery, monetary policy has less of an impact on output when financial crises occur (Graph 10, top panels). Moreover, in normal recessions, the more accommodative monetary policy is in the downturn, the stronger the subsequent recovery,but this relationship is no longer apparent if a financial crisis erupts (Graph 10, bottom panels). In addition, the same study finds that the faster the deleveraging in such recessions,the stronger the subsequent recovery. And the link between fiscal policy and the recovery issimilar to that for monetary policy, also pointing to its relative ineffectiveness in balance sheetrecessions. |
