Martin Hutchinson
The FOMC consists of seven Fed governors, five of whom after the Obama appointments will be committed soft moniers Of the other two holdovers, Elizabeth Duke (whose term expires in January 2012) is a community banking specialist without apparent strong views on interest rate policy, while Kevin Warsh, appointed in 2006, has recently indicated support for monetary tightening and has said that at some point tightening may be harsh. The other five places are reserved for regional Fed presidents, of which William Dudley, president of the New York Fed and a fairly soft money man, is a permanent member, the other four places being filled by the other 11 regional bank presidents in rotation. Of these, Kansas City Fed president Thomas Hoenig, Philadelphia Fed president Charles Plosser and Richmond Fed president Jeffrey Lacker have all recently expressed support for near-term monetary tightening. However the three presidents will be FOMC members in different years, Hoenig this year, Plosser in 2011 and Lacker (if reappointed Richmond Fed president next year) in 2012.
You can do the arithmetic. There will always be a nexus of five members, including Bernanke and the Obama appointees, supporting soft money, with Dudley joining them much of the time and San Francisco's Janet Yellen (unless appointed a governor) reinforcing the soft money forces when on the FOMC in 2012. On the other side, there will never be more than two firm votes for tightening. Thus until the end of 2012 (assuming Obama appoints a soft money governor as Elizabeth Duke's successor), there will always be an almost impregnable majority for monetary ease. Things may change from 2013 - for one thing we may have a new president from January 20, 2013 - but until the end of December 2012, the monetary throttle will almost certainly be wedged at full open.
In writing about monetary policy over the past year, I have suggested that if Bernanke himself did not resort to monetary tightening, then either a resurgence in inflation or a crisis in the government bond market would force tightening to take place. However, with such an extreme Fed set in place, that comforting thought may be wrong. With the Bureau of Labor Statistics (BLS) doing everything it can to suppress reported inflation and the Fed doing everything it can to put the best possible face on the matter, we may before late 2012 go through progressive stages of inflation, none of which may produce monetary tightening.
In the first stage, perhaps for the rest of this year, the rate of inflation may rise only slowly, in which case its rise will be suppressed altogether by the BLS though aggressive "hedonic pricing" - seasonal adjustment and manipulation of the housing component of the index, which represents over a third of the total and represents no real-world price.
In the second stage, during 2011, moderately accelerating inflation will finally appear in the statistics, but will be explained away as a temporary phenomenon, as was the 5% plus inflation of early 2008. Later in the year, as the "temporary" explanation becomes less credible, the Fed will doubtless discover a strange interest in the recent paper by International Monetary Fund Chief Economist Olivier Blanchard, who has announced that monetary authorities should aim at 4% inflation rather than 2%, because it makes hyper-low real interest rates easier to create. Typical French socialist rubbish, to be expected from the IMF - 4% inflation over a long period halves the value of money every 17 years, and represents outright robbery of savers.
In the final stage in 2012, when even the BLS's reported inflation nears 10%, the Fed will resort to three further tactics. It will begin raising interest rates as it did in 2003-06, by ¼% at each FOMC meeting, leaving them below 2% even at the end of 2012. It will cite the still fragile economic recovery and continuing high unemployment as reasons why it cannot impose the costs of higher interest rates on the fragile U.S. economy. Finally, it will buy government bonds in large quantities, following the 1919-23 Weimar Republic's approach to monetary management, thus (probably with the tacit help of the People's Bank of China, which will be bought off by concessions in other areas) preventing the Treasury bond market from staging the collapse which would otherwise be so richly merited.
By the end of 2012, true U.S. consumer price inflation will be running at 20% or more, though it is likely that the BLS will still be reporting figures below 1% per month.
There are a number of corollaries to this. For one thing, if there is to be no significant monetary tightening before the end of 2012, then the current commodities bubble will have full rein for another three years. It is certainly possible that it will burst spontaneously, in which case we will get a financial crash similar to that of 2008, but with the major hedge funds and those banks that have foolishly lent to them as the nexus. If no crash occurs, then by the end of 2012, we will have gold at $5,000, oil at $200 and other commodities at correspondingly nose-bleed prices.
That's the bad news. The good news is that a period of inflationary finance of this length would solve the U.S. housing problem, as did the equivalent period of inflationary finance in Britain in the mid-1970s. In Britain, consumer prices roughly doubled between 1973 and 1978, so house prices that had been grossly excessive in 1973 had become once again perfectly reasonable by 1978. There was thus no great mortgage meltdown in Britain in the middle 1970s. The damage this caused only became obvious with financial deregulation a decade later; the inflation of the 1970s had effectively de-capitalized the British financial system, so that the merchant banks in particular but also the market-making "jobbers" were woefully unprepared for the piranha pool into which they were hurled by the Thatcher government's economically suicidal "leveling the playing field" in 1986.
This prolonged period of inflation would also be good for the federal budget, which is why it is unlikely to meet serious opposition in today's Washington. The deficit itself would be significantly exacerbated, as many spending items are inflation-linked, as are most income tax brackets. However the outstanding debt, including the $5 trillion of Fannie Mae and Freddie Mac obligations that the government doesn't want you to think about, would be sharply reduced in terms of either purchasing power or the U.S. Gross Domestic Product. Thus, even though the path of deficits during the Obama administration would have been horrendous, the raw increase in the federal debt-to-GDP ratio would be substantially mitigated by this inflationary phase.
The losers from this avalanche of inflationary finance, apart from any misguided conservative souls foolish enough to put their money in Treasurys, would be the People's Bank of China and the other central banks that have invested their reserves in Treasury bonds and federal agency securities. It's unclear what China would get in return for continuing to immolate its national wealth in this obviously misguided manner, but we can be fairly sure that it would get something. Needless to say, by the fourth year of ultra-loose monetary policy, in 2012, it's likely that China would be getting antsy about the losses it was sustaining, and would reduce its support for the Treasury bond market. This in turn would finally begin the process of pushing up long-term interest rates to a point at which investors got a positive real return.
There is no question that by 2012 the wheels would be falling off this financial contraption, but it's likely that Bernanke, a stubborn man, would continue in his soft money convictions for as long as he could, at least through the 2012 election. To keep the Treasury bond market under control in that last year he would resort to yet further swelling of the Fed balance sheet, buying Treasurys in as large quantities as was necessary to fund the yawning federal deficit, thereby monetizing it. Until the end of 2012, it's likely that this policy would not yet have fully exhibited its obvious downside, so it would be feasible to continue it.
In this scenario, the prospect facing the new president or the re-elected President Obama in early 2013 would be grim indeed. Inflation would be over 10% even on official figures, around 20% in reality. The federal deficit would still be around 10% of GDP, and the Treasury bond market would only be sustained at a yield of perhaps 6-7% on the long bond by massive money printing. Consequently, inflation would be in a mode of rapid acceleration. At the same time, Bernanke would still have a year to run in his second term, so there would be little prospect of an immediate clean-out at the Fed, replacing the errant governors with grownups who could clean up the mess. The financial system would either have crashed or be imminently about to while economically the United States would have been pushed into renewed recession by the high inflation and massive drain of increased energy and commodity imports. Globally, only the oil and commodity exporters would be riding high, while protectionism would be rampant as China, the European Union and other countries sought to gain assured sources of raw materials in a world where prices were exploding. Needless to say, the cleanup would take most of the next decade, and would leave the United States very much weaker at the end of it.
It is always possible to imagine an even worse monetary policy; even in the Weimar Republic they were lucky to avoid the fate of 1946 Hungary, where inflation reached 1 quintillion percent. Ben Bernanke and his new Fed cohorts are about to give Americans, hitherto spared, a painful new object lesson in the wilder forms of soft monetary policy. It is to be hoped that they remember its folly for several generations to come.
The Bears Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long '90s boom, the proportion of "sell" recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.
Martin Hutchinson is the author of "Great Conservatives" (Academica Press, 2005). Details can be found on the Web site www.greatconservatives.com
Views are as of March 8, 2010, and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security.
Gross Domestic Product (GDP) is a broad gauge of the economy that measures the retail value of goods and services produced in a country.
Federated Equity Management Company of Pennsylvania
Nessun commento:
Posta un commento