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Treason?

So the Fed has gone ahead and done Operation Twist even though the Republican congressional leaders took the unprecedented step of politicizing the Fed and trying to dictate policy. Some might say, the Fed did it because the congressmen interfered. If you go to the post with the BNN clip from earlier today, you can hear Cardiff Garcia speculating about just this possibility.

If you believed the Republican leaders, you would say this is reckless monetary policy aimed specifically at supporting President Obama, a Democrat. You saw the last post I wrote, with the court scene from “A Few Good Men” tacked on. Boehner, Cantor, McConnell and Kyl would have you believe that Ben Bernanke is the misguided and dangerous Jack Nicholson character and they are the Tom Cruise character, trying to get him to admit to his crimes.

Is Bernanke ‘almost treasonous’ then, as Rick Perry has said he is?

Here’s my take.

Bernanke is a Republican. Let’s get that out of the way. Ben Bernanke is a Republican holdover into the Obama administration first appointed by George W. Bush, much like former FDIC chair Sheila Bair and former Defense Secretary Robert Gates. Look it up. These three are exemplary public servants in that they have tried to serve their country as best they could regardless of the party in power. You might not agree with their policies, but acting like any one of the three is favoring a Democratic President for partisan reasons is preposterous. I would say it is even reckless – just like calling Bernanke ‘almost treasonous’ is.

But what about the new Fed policy, Operation Twist? Isn’t it so reckless as to be ‘almost treasonous’. The short answer is no; Operation Twist is a big yawn.

The Republicans do have one thing right. I think they are onto something when they say:

we have seen no evidence that further monetary stimulus will create jobs or provide a sustainable path towards economic recovery.

It’s not that monetary stimulus is completely ineffective. It’s that you must really jam it on and you would have to target price instead of quantity to get any measurable effect and even then the transmission channel is going to be weak.

The Fed said:

This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative.

Put simply, the Fed wants to lower rates. Lower rates have two distinct transmission channels (outside of simple animal spirits and private preferences aka the Bernanke put). First, low rates lower net interest margins for banks and returns for savers. Simultaneously, they should increase the demand for credit by lowering the price i.e. the rate of interest. If the effect of the latter outweighs the effect of the former then this policy is good in generating more credit demand and therefore more economic activity and jobs.

There are some incipient signs that the credit impulse is better than it has been and that credit is growing again. But it is certainly not that good. However, with the Fed Funds rate at effectively zero percent, the price of credit (i.e. the interest rate) is not driving the marginal consumer of credit. It is the lack of jobs and unanticipated asset price volatility juxtaposed to an overhang of large levels of household sector debt. Consumers, therefore, can neither count on income or wealth gains to deal with their accumulated indebtedness and have cut back as a result. Until this indebtedness is worked down, credit growth will be stalled.

Bottom line: Operation Twist can only move rates a few basis points. And since the Fed is targeting quantity not price AGAIN, it’s not even clear that rates will decline. Rates are already so low that these basis points won’t make ANY difference. I see this as a non-event, a big fat yawn. It’s not treason at all. It won’t even be effective.

P.S. – When the congressional leaders say “Ultimately, the American economy is driven by the confidence of consumers and investors and the innovations of its workers,” they show they know zero about economics. This isn’t about the confidence fairy. That’s the same ridiculous stuff Obama talks about. It’s about debt and jobs. If both Republicans and the President are spouting this confidence fairy palaver, then I say “God bless America,” because we’re going to need that blessing without leaders that understand basic economics.

Source: Full Text: Republicans’ Letter to Bernanke Questioning More Fed Action – WSJ

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.

15 Comments

  1. SH says:

    Hi Ed:

    I like the fact that you pointed out that these are Republican holdovers, but Robert Gates clicked a little nerve in that logic. It brings up that ol’ “Change we can believe in” comment.

    I know you’re on to this as you have been from the beginning with your comments on kleptocracies and now you’re advocating quick and real fixes as opposed to kicking the can, but as a libertarian minded individual, isn’t maybe the system busted? Isn’t the distrust more than political. Even when a bill passes we all know we did not actually have any input.

    Suddenly, as an aside, I’m thinking a flip in Congress and a flip in the presidency is a better option than a congress and president aligned. I’ll take another four years of indecision over two or four years of a blank check any day, but the distrust runs deep in these parts.

    Thanks again.

    • Yeah, I was thinking that about the holdovers. I was on the verge of ignoring this whole QE story just as I did the ‘jobs’ bill, another non-event. But since everyone is talking about it, I thought I’d give it a go.

  2. Matt Stiles says:

    Thank you for also pointing out the “confidence palaver.”

    I see it in politics all the time. “It’s not what we’re doing that is wrong, we’ve just communicated our intentions improperly to foster sufficient confidence.” The upshot, naturally, is that policies do not need to change – merely those charged with implementing them need to be changed. A convenient way to dismiss policy failure that is blatantly obvious.

    • Thanks for that, Matt. I should also point out that when I use the term ‘effective’ I mean yielding the desired result. But QE is bad policy. I am not in favor of a central planner manipulating rates and distorting the price signal that a market-determined rate would send. If it worked, then maybe I could yake a less ideological view. But since it doesn’t that is my default.

      • SH says:

        Hey Ed or Matt:

        I can’t resist, but have you studied Mancur? I think the Tea Party is the definition of a small group assuming a larger share of power than would otherwise be possible only because they are more organized. The theory states that it the smaller party has more to gain on a marginal basis than the larger party has to gain a marginal basis. No one talks about it.

        By the way Ed, you talked about NHS in a few articles too. You beat Mauldin to the punch.

        http://www.investorsinsight.com/blogs/john_mauldins_outside_the_box/archive/2011/09/20/res-politica-versus-res-economica.aspx

        I only see Jensen’s equality in those graphs, but otherwise it makes sense.

      • David Lazarus says:

        It also ignores the fact that low interest rates create other problems. Savers and investors looking for better returns chasing risk for those returns. That is the seed for the next bubble. I would prefer they actually allowed credit write downs to actually happen rather than extend and pretend like Japan.

        As for the confidence fairy it is also being mentioned throughout Europe. The UK coalition invoke the confidence fairy for why they are not even considering alternative policies even though the UK economy has stalled, just as it was predicted it would by non neoclassical economists last year. They fear that even mentioning alternatives will kill the confidence fairy that has clearly left the UK economy last year.

  3. DavosSherman says:

    Read page 29 where Bernanke says OT is a failure [in his own effing report]:

    http://www.federalreserve.gov/pubs/feds/2004/200448/200448pap.pdf

  4. David Lazarus says:

    As for the treason comment I think that Rick Perry is guilty of that charge for effectively harming the US economy. I do not approve of QE as it distracts politicians from actually doing something but if Congress will not act then the Fed does have to. To do nothing should be treasonous.

  5. Diogenes says:

    You write: “Operation Twist can only move rates a few basis points. And since the Fed is targeting quantity not price AGAIN, it’s not even clear that rates will decline. Rates are already so low that these basis points won’t make ANY difference.”

    While I agree with your last point (there are probably as many costs as there are benefits for each incremental drop in long term rates at this point and the resulting wealth transfer is likely to be counter-productive to savings and rational capital investment), I am not sure why you are so confident that rates won’t decline as a result of this most recent fed action.

    I grant you I say this with the benefit of 18 hours of hindsight (the 30 year has traded up about 7 full points since the Fed announcement, a rather material move in price that corresponds to an almost 35 basis point drop in yield), but I personally expect the long bond to touch close to 2 percent before we reach anything that could be called a bottom (or, depending on your perspective, a top).

    While this may not be the Fed’s intent, it seems highly likely that the Fed’s recent move will– rather than encourage new lending and further capital investment– help to push the economy into the long awaited double dip of a recession. I expect that that further economic contraction could easily produce another 75 basis point reduction in the yield on the long bond owing to the pressures of broadening asset deflation.

    • Diogenes, I agree with you that there are costs as I indicated in the post regarding savers and net interest margins.

      “First, low rates lower net interest margins for banks and returns for savers. Simultaneously, they should increase the demand for credit by lowering the price i.e. the rate of interest. If the effect of the latter outweighs the effect of the former then this policy is good in generating more credit demand and therefore more economic activity and jobs.”

      The lost interest income is a direct transfer of net financial assets from us to the government sector, meaning that lower rates translate into a lower private sector net financial asset increase. And this makes a recession MORE likely unless you get credit growth (where I am sceptical). So we see eye to eye.

      I would also say that, in any event, it would be hard to disaggregate the direct interest rate effects of Fed policy from other factors here since I believe the drop in longer rates is mostly about a poor economy (and expected /disinflation/deflation and risk off/liquidity trading). The Fed can SAY they cause the drop, but we all know that a poor economy mandates this drop based on the expected path of future policy rates and inflation.

  6. Zimmer says:

    I agree with everything except the implication that creating more credit would be a good thing. While I agree that ZIRP, QE and OT have and will be pretty ineffective at creating more credit, if they had been effective, that would have been a terrible outcome.

    The thing that most concerns me about Bernanke’s policies is not that they are ineffective, it is that the goals are wrong. The goal should be facilitating the deleveraging, not preventing or reversing it.

    How long can Bernanke et al continue with the idea that the reason their policies haven’t been successful is that they haven’t yet done enough? And, what might they do if they ever reach the conclusion that they can’t create more credit?

    • You caught that too. I did say in the comments that “I should also point out that when I use the term ‘effective’ I mean yielding the desired result. But QE is bad policy.”

      And I agree with you that levering up again by having more credit isn’t the goal. It should be about increasing incomes and reducing credit exposure, which gives people the ability to take on credit later, but when their own balance sheets are healthy.

  7. hutrade says:

    YES! couldn’t agree more. Cheers!