Posts Tagged ‘quantitative easing’

Does “Helicopter Ben’s” Napalm Drop Smell Like Victory?

Thursday, August 22nd, 2013

Those who’ve seen Francis Ford Coppola’s “Apocalypse Now” will recall Robert Duvall’s air-cavalry colonel (and surfing enthusiast) by his declaration of love for “the smell of napalm in the morning….smelled like…victory.” Since then, few people have been similarly associated with the power of things dropped from the sky (metaphoric or not) so much as Fed Chairman Bernanke, whose famous remark referencing Milton Freidman’s concept of countering deflation via a “helicopter drop” of money earned him the nickname “Helicopter Ben.” That moniker has only been reinforced by the money creation and Fed balance sheet expansions of the central bank’s Quantitative Easing programs.

However, back on May 22, when Bernanke didn’t rule out some so-called “tapering” (he didn’t actually use that term) of the Fed’s asset purchases as early as this coming September, the fixed-income market has behaved as if he’d called in an airstrike. Indeed, the sell-off seemed to motivate some of Bernanke’s colleagues on the FOMC (as well as the big man himself) to at least project the appearance of walking back the incendiary comments, emphasizing that the decision process on tapering would be data driven and even implying that weak numbers might move the central bank to increase purchases. Case in point: the equivocation evinced in the July Fed minutes released yesterday.

This uncertainty is understandable in the face of less than robust indications of economic expansion, e.g., second-quarter GDP growth of 1.7%. Moreover, inflation continues to be subdued, begging the question of why Bernanke & Co. would choose to discuss reining in bond buying now.

Perhaps one hint is to be found in the yield spread between Treasuries and the inflation-indexed variety known as TIPs. An indicator of market expectations of future inflation, the ten-year TIP spread has widened from near zero in late November 2009 to around 2.15% as of this writing. While in excess of the 2% rate the FOMC has generally acknowledged to be their current target (though some have indicated a willingness to consider a range about this figure), the problem is that as the taper rhetoric has increased, the TIP spread has been contracting. As can be seen from the accompanying graph (with Fed assets expressed as a fraction of their 1/2/2008 value), even as Fed asset growth accelerated in 2013, the central bank has struggled to increase inflation expectations, with the TIP spread maxing out at 2.59 this past February before beginning its fall to current levels. To be sure, by many measures actual inflation has increased since its post-crisis lows, but with the Core Personal Consumption Expenditure price index (the Fed’s preferred measure of inflation) still running at only 1.22%, neither current inflation nor expectations give the Fed vast breathing room.



Meanwhile, recent job creation figures have been only modestly solicitous, with a stubbornly low participation rate even as employers confront incentives to move full-time workers to part-time status under health care reform. The prospect of coming quarters is also haunted by the specters of fiscal drags from the delayed effects of sequestration and increased taxes.

Of course, regardless of the economic statistics, the Chairman could be forgiven for wanting to put in train at least a reduction in the rate of Fed asset purchases so as to indicate the will to deal with the central bank’s massive and growing balance sheet before leaving office, let alone prior to a more meaningful increase in inflation or fall in the value of the dollar. After all, the Fed’s assets now stand at over 20% of the national debt, and the central bank current bond purchase rate has it pretty much buying up the entire Federal deficit this year, raising fears of monetization (see “Uncle Ben’s Reverted Price”). Yet with unemployment still high, corporate profits decelerating and even the hint of tapering having caused mortgage rates to spike, there is a serious potential for taper-induced economic deceleration. Given that inflation is at best just nudging up into its perceived target range, if any Fed taper is followed by a fall in growth it may be difficult for Bernanke or his successor to justify meaningfully dialing back quantitative easing. Even as far from the ocean as Jackson Hole, FOMC members gathered without their leader must feel the alternatives are a bit like the choice Duvall’s colonel gave his men: engage in a firefight or attempt to surf under an artillery barrage.

Currency War Is The Continuation Of Stimulative Policy – And Politics – By Other Means

Wednesday, February 20th, 2013

One does not generally think of G20 communiques as hilarious, but Carl von Clausewitz might have been amused by the one put out over the weekend (Prussian military theorists are known for their sense of humor) and perhaps honored its comic genius with the above corollary to his famous maxim*. The document essentially re-classified recent competitive currency devaluation, without even calling out the tactic by name, as one of a variety of “policies implemented for domestic purposes,” on the part of G20 members seeking to “minimize” “negative spillovers” on other countries.

Got that? So when the Fed prints money to fund QE “infinity and beyond” and the dollar slides against the euro it’s just a “spillover,” as is apparently the effect of Japanese Prime Minister Shinzo Abe’s call for a weaker yen (precipitating a 20% dive) since he’s just trying to stimulate his “domestic” economy. Indeed, as market commentators seized on the G20 statement as a ratification of Japan’s devaluation policy, the point of the group’s statement became clear; one might paraphrase it as “hey, big advanced economies, we’re cool with you devaluing – just call it quantitative easing or monetary stimulus and try not to be too obvious in stating how low you want your currency to go.”

The problem, of course, is that for any nation that trades with the world, there really is no such thing as a purely “domestic” economic policy. For example, when a nation’s central bank creates currency to buy financial assets in quantitative easing, all that money printing can drive down the value of the currency versus that of the country’s trading partners, giving the QE the added stimulative kick of improving balances of trade and payments. The US may well be enjoying this effect, while Japan, facing monstrous energy-driven trade deficits in the wake of its post-Fukushima near-total nuclear shutdown, desperately wants to increase exports. Indeed, the newly-elected LDP government has entertained purchasing foreign bonds to flood the world with cheapening yen, though Abe downplayed the need for going this far following both the yen’s plunge and the G20 summit, perhaps fearing the optics at the moment.

The fall guys in a currency war tend to be the countries that don’t devalue, a point not lost on ECB president Mario Draghi, who only a few months ago stated his intention to “fully sterilize” Outright Monetary Transactions – his own quantitative easing – and prevent a decline in the euro, presumably by using foreign currency reserves to mop up the excess euros used to buy Eurozone bonds. That was a nod to inflation hawks like Bundesbank president Jens Weidmann, who fear currency debasement may lead to higher prices, but it was also before the G20 devaluation love-fest. Right after the summit, Draghi made clear that while he was not targeting a specific exchange rate (of course not – after all, he read the communique) he was cognizant of the “deflationary” effects of too strong a euro. Translation: “Hey folks – I’ve got a printing press, too!”

Of course, in a policy free-for-all like the one the G20 just had, there has to be something in it for everyone, including emergent economic powerhouses like the BRICs. Thus the comment about the need to “minimize” “spillovers,” including measures to prevent all that newly-created, developed-world “hot money” bidding up and crashing developing nations’ domestic markets as it roars in and out of their economies. In other words, the new kids on the block get a green light for currency controls.

Beggar thy neighbor devaluations, protectionist currency controls…this kind of thing can get very out of hand, with bad consequences, economic and otherwise. As the G20 expands the scope of this game, its members had better learn to play nice. After all, past competitions of this kind have preceded events which prove the veracity of von Clausewitz’s observation.

*“War is the continuation of politik by other means.” Then as now, the shadings of the translation of politik (policy or politics, depending on the translator) are both intriguing and ominous.

Uncle Ben’s Reverted Price

Thursday, April 19th, 2012

The price of financing the U.S. debt is the interest paid to America’s creditors, but to whom does America pay that interest? Who owns the biggest slice of the U.S. debt? If you’re thinking China or Japan, those trade deficit bogeymen of the East, you’d be wrong and by quite some distance: those relative pikers are in a close battle for second, with the PRC slightly edging out Nippon but each holding about a trillion dollars worth, good for 7% apiece. The reigning champ out-distances both by 70%, holding $1.7 trillion dollars or nearly 12% of America’s $14.28 trillion national debt. Fortunately for Uncle Sam, however, that top lender is like no other, for this is a creditor from whom all interest paid on the debt it holds is “reverted” straight back to the borrower, which is to say the U.S. Treasury. I refer, of course, to the Federal Reserve.

With the Fed funds rate hovering near zero, the Fed resorted to massive Treasury purchases in an effort to drive down interest rates and stimulate the economy, a policy which has made the central bank Washington’s largest creditor. Because all Fed profits are rebated back to the Treasury, the interest on the 12% of U.S. debt held by the Fed is being returned directly to the Federal government’s coffers and, by extension, to American taxpayers, since every dollar of interest the Treasury receives back from the Fed is a dollar it does not have to collect from taxpayers in order to finance the debt. Given that 20% of tax revenue goes to servicing this debt, that’s quite a break we’re receiving from Bernanke & Company.

Yet it gets better. Like disk jockeys programming an oldies station, the FOMC’s members recently brought back a blast from the past, the 1961 monetary policy sensation known as “Operation Twist.” In the September 2011 remix of this interest rate two-step, the Fed announced it would sell $400 billion of Treasuries with maturities of no more than three years, using the proceeds to purchase an equal amount of 6- to 30-year T-bonds. Given how low short rates already are, the idea is to lower rates at the long end of the yield curve by pushing out the maturity of the central bank’s holdings and taking longer-dated T-bonds out of the market. The theoretical argument is that lowering the long rates should stimulate the economy, while the counter-balancing short-maturity sales hold the size of the Fed’s balance sheet constant. A side effect of this kind of maneuver is that, as it skews the Fed’s holdings toward higher-yielding long Treasuries, the fraction of total interest on U.S. debt rebated to the Treasury by the Fed will increase even though the value of the Fed’s Treasury holdings are held constant. As an added bonus, those lower long-term rates mean reduced long term costs of further borrowing by the Treasury as it finances that ever-increasing U.S. debt.

All this may sound suspiciously like the free lunch your economics professors told you was but a culinary myth. But the tab’s arrival may be delayed while markets extract a higher price for the fiscal over-consumption of other nations. The Fed’s epic Treasury purchases are funded by money the central bank creates and injects into the markets, which, ceteris paribus, might be expected to depress the value of the dollar and increase inflation. However, ceteris hasn’t been particularly paribus lately; ongoing Euro-antics continue to place a safe haven premium on both the currency and debt of the United States (see “Send Treasury Your Retired, Your Not-So-Poor, Your Befuddled Classes Yearning To Invest Risk-Free…”) while, in the wake of the financial crisis, sluggish global growth has restrained increases in both labor and commodity costs. This trend has been reinforced of late by recent slowdowns in China and India, engineered by those countries’ central banks in the hopes of restraining their own domestic price pressures.

Nevertheless, the nascent recovery in the U.S. has been attended by a run-up in the price of oil and, recently, rising unit labor costs, causing the TIP spread between regular and and inflation-protected Treasury bonds to widen, albeit modestly. If, as some recent data from Beijing indicate, China’s landing proves to be more of a brief layover, and should concern over a full-blown Euro implosion continue its recent ebbing, then the U.S. may learn a truth diners at complimentary buffets generally discover: sooner or later, gorging on a seemingly free lunch is paid for with inflation, be it in your waistline or your currency. But for a Fed faced with the alternative of stalled growth, increased inflation risk may be, as the old saying goes, just the price of rice, converted or not.

The “Crowding-In” Effect, Or, If Washington Wants To Help Small Businesses, Maybe It Should Borrow On Their Behalf

Wednesday, September 22nd, 2010

As I write this the US Treasury market seems to be providing a way for the government to put some money where its mouth is and do something meaningful for small business.

First, we’ll need some background. Throughout the debate on extending tax cuts to individuals making over $200K, many prior to this writing have pointed out that to not do so amounts to a tax hike on small businesses, with such firms accounting for around 60% of recent job creation in the United States (the increase would kick in at $250K for couples, about the combined salaries of two professors in a major metropolitan area, who would I’m sure be surprised and excited to learn they are now considered among the mega-rich). Indeed, by some estimates, to not extend the cuts would in fact raise the tax on half of all small enterprise income in the country Some argue, a bit disingenuously, that only 3% of small business would be affected, but that’s only because most small firms make little or no money at all; the tax increase would hit hardest that minority of entrepreneurs who in this anemic economy are doing well enough to have some hope of hiring.

And while there is a case to be made that tax cuts for lower earners more efficiently translate into short-term stimulative spending, it’s the saved and invested tax cut dollars of higher earners that tend to fuel longer-term growth in business and hence job creation.

Those in favor of this tax increase point to the ballooning national debt, arguing the country can ill afford tax relief for the entrepreneurial. Using some numbers to put this claim into context might be helpful. Not raising taxes on the so-called higher earners would cost an average of $70 billion per year over 10 years, or $700 billion. That’s about 23% of the $3 billion 10 year cost of extending the cut to the rest of the country (as proposed by the Administration), and well under the $814 billion cost of the stimulus package whose efficacy has been, shall we say, underwhelming.

Given how small the cost of tax relief on those most likely to invest would be when compared to the giant debt rung up over the past two years and the massive borrowing currently proposed, there is little logic in raising taxes on people managing some level of entrepreneurial success in this difficult environment. The truth of this is made especially clear upon consideration of one of the few silver linings to be found in the dark clouds of our economy, that being the government’s remarkably low cost of borrowing.

While risk aversion has abated since the depths of the crisis, many market participants continue to seek the safety of US Treasuries, thanks to a witches’ brew of fear including that of European sovereign and US municipal defaults, real estate overhangs, malfeasance real and imagined and yes, expanded regulation and higher taxes. Pervasive dread has pushed vast capital out of risk markets and into US government debt. You can think of this as the causal obverse of the famous “crowding out” effect, in which increasing government indebtedness pushes other would-be borrowers and those seeking equity investment out of the market. In the present case, the withdrawal of fearful capital from other forms of finance has created a vacuum into which ever vaster quantities of Treasury debt are sucked in, allowing the debt of the nation to be financed at rates at which most small businesses can only dream of borrowing. The past and potential purchases of Treasuries by the Federal Reserve under the banner of stimulative “quantitative easing” has (so far) served to further lower the yields on Treasuries. As of this writing, yields on 10 and 30 year Treasuries are about 2.5% and 3.75%, respectively, and this at a time when the implied inflation rate based on inflation-protected “TIPS” bonds is between 1.75% and 2.25%, making the expected real return on Treasuries slim indeed.

Thus the Treasury could fund tax relief for small businesses by effectively borrowing on their behalf at long-term fixed rates unattainable by them on their own, allowing the income of those enterprises to be reinvested. At these low fixed rates, with luck and limited further economic mischief in both the public and private sectors, there’s a reasonable chance the return on that capital will substantially exceed the cost of financing, facilitating the service of the added debt through the taxation of profits.

Some will complain this prescription further elevates a borrowing trend which is long-term unsustainable. I agree, but the increase is slight compared to the overall growth in the debt, which will in the end have to be addressed by other measures, including (dare I speak its name?) spending cuts, even in entitlements. Others will note the increase in Treasury issuance and the Fed’s purchases of same raise the specter of debt monetization, potentially driving up rates, weakening the dollar, and increasing inflation. Again that is true, but, the fact remains right now the world is willing to let the US lock in its financing at rates that seem to ignore this possibility.

Finally, there are those who will say I propose using the public credit to gamble on American entrepreneurship. Perhaps so, but given that we just bet over eight hundred billion dollars on, amongst other things, Amtrak and a combination of Chrysler and Fiat, I’d say my proposed wager is hardly the most speculative the nation has been presented with. Its time to give small business a chance.