Although we got the bear market bounce mooted here yesterday, and how in Europe, there was a worrying collapse of conviction going into the close of the American session:
As Delusional Economics shows this morning, the rally is going to be constantly strangled by European wrangling. That the S&P500 fell some 2% from its rampaging highs on just one utterance does not bode well.
It seems lack of conviction was the theme of the evening. Two Federal Reserve Governors offered speeches criticising “Operation Twist”. From Bloomberg:
Federal Reserve Bank of Atlanta President Dennis Lockhart said the Fed program announced last week to buy more long-term securities will probably give no more than a slight boost to the U.S. economy. “The transmission mechanism for monetary policy remains somewhat impaired, and for this reason I am not expecting large gains from the Fed’s most recent action,” Lockhart said today in a speech in Jacksonville, Florida. “It’s realistic to expect modest positive impact from this program.” The Federal Open Market Committee voted Sept. 21 to extend the average maturities of the Treasuries in the central bank’s portfolio by purchasing $400 billion of long-term debt while selling an equal amount of shorter-term securities. The so- called Operation Twist is an attempt to push down mortgage and other loan rates to spur growth. Stocks fell for two days last week as investors weren’t persuaded the “maturity extension program,” similar to an action in 1961, would lift growth. Chairman Ben S. Bernanke and his policy-making colleagues also cited “significant downside risks” to the outlook. Dallas Fed President Richard Fisher said today the program to push down longer-term interest rates risks proving ineffective and may hurt job creation. It was “a strategic decision where I did not feel the benefits outweighed what I perceived to be the costs,” Fisher said in a speech in Dallas.
Well, sheesh, you’d think they’d at least give it a chance to work. As I’ve written before, I believe at the zero bound for interest rates, where price signals cease to matter, the only signal that remains is the conviction of policy-makers to either inflate the system or not. This kind of public conflict makes me think that the RBA’s black ban on public comment is a damn good thing.
But the conflict apparent amongst Federal Reserve governors is also obvious in the Chairman of the FOMC, Ben Bernanke. Fed observor, Tim Duy, writes an excellent piece today on how Bernanke has turned away from his own research in Operation Twist:
I recently had reason to re-read then Federal Reserve Governor Ben Bernanke’s 2003 speech on Japanese monetary policy, and realized again that he eliminated virtually every objection to doing more. Concerned about a temporary inflation increase beyond the target rate? Not an problem, according to Bernanke:
…first, the benefits to the real economy of a more rapid restoration of the pre-deflation price level and second, the fact that the publicly announced price-level targets would help the Bank of Japan manage public expectations and to draw the distinction between a one-time price-level correction and the BOJ’s longer-run inflation objective. If this distinction can be made, the effect of the reflation program on inflation expectations and long-term nominal interest rates should be smaller than if all reflation is interpreted as a permanent increase in inflation.
Fearing the possible capital loss on the Fed’s balance sheet should interest rates need to rise quickly? Bernanke offers a solution:
In short, one could make an economic case that the balance sheet of the central bank should be of marginal relevance at best to the determination of monetary policy. Rather than engage in what would probably be a heated and unproductive debate over the issue, however, I would propose instead that the Japanese government just fix the problem…the Ministry of Finance would convert the fixed interest rates of the Japanese government bonds held by the Bank of Japan into floating interest rates. This “bond conversion”–actually, a fixed-floating interest rate swap–would protect the capital position of the Bank of Japan from increases in long-term interest rates…
Is the debt an impediment to additional fiscal policy? We can fix that, too:
My thesis here is that cooperation between the monetary and fiscal authorities in Japan could help solve the problems that each policymaker faces on its own. Consider for example a tax cut for households and businesses that is explicitly coupled with incremental BOJ purchases of government debt–so that the tax cut is in effect financed by money creation. Moreover, assume that the Bank of Japan has made a commitment, by announcing a price-level target, to reflate the economy, so that much or all of the increase in the money stock is viewed as permanent.
The supposed impediments to additional policy, according to Bernanke himself, are illusionary. Simply ghost stories to scare the public into thinking there are no more policy options. So why the delay? It all comes back to deflation:
In that spirit, my remarks today will be focused on opportunities for monetary policy innovation in Japan, including specifically the possibility of more-active monetary-fiscal cooperation to end deflation.
In Bernanke’s view, only obvious evidence of deflation jusifies the use of aggressive policy.
That view seems also to be shared by Andrew Sentence, formerly of the Bank of England, who writes in the FT:
The policy agenda for the western economies now should not be about demand expansion, but structural adjustment: ensuring labour markets are flexible; the business climate is not encumbered by excessive regulation; tax rates are as low as they can be; and tax structures are efficient and reward enterprise and innovation.
The third ingredient needed is for central banks to stop pretending they can remedy all the deficiencies of the economic system by providing unending amounts of stimulus whenever growth appears weak in the short-term. Historical experience suggests that continual injection of demand stimulus to counter weak growth leads to persistent inflation and financial instability.
In short, deflate your way to competitiveness. I completely agree with the assessment here of the failings of monetary policy over the last few decades. But, the remedy strikes me as politically naive. How is the US supposed to deflate it’s way to prosperity when there’s a Chinese currency peg preventing the relative pricing adjustments in the currency? Moreover, there’s no way Americans are going to work cheaply enough to compete with the Chinese for the next twenty years. If this is the alternative then more QE looks a much better option. But, as we know, it isn’t coming for the time being.
The bear market rally is on very thin ice.
