Daily Archives: September 4, 2012

Character, Policy and the Selection of Leaders

Character, Policy and the Selection of Leaders

September 4, 2012 | 0900 GMT


By George Friedman

The end of Labor Day weekend in the United States traditionally has represented the beginning of U.S. presidential campaigns, though these days the campaign appears to be perpetual. In any case, Americans will be called on to vote for president in about two months, and the question is on what basis they ought to choose.

Many observers want to see intense debate over the issues, with matters of personality pushed to the background. But personality can also be viewed as character, and in some ways character is more important than policy in choosing a country’s leadership.

Quote of the Day: 20120904

We, like Jim, would argue that the reason the Great Financial Crisis was so deep was due to the authorities continued refusal to let the business cycle take its natural course.

— Zero Hedge: Is The Fed Responsible For The Great Financial Crisis?

Flash Point: Depressing!

A video presentation by Gordon Long came to us last week. It is depressing to put t mildly. Unfortunately the picture it paints is accurate and all to common in present day America. America is in a depression. From depression-era tent cities, to 47 million Americans surviving on food stamps instated of soup kitchens, to an economy that is characterized by a “jobless” recovery, there is endless tragedy, heartbreak and despair as the American middle class is decimated. Here without further comment is The Silent Depression.

A LANDMARK: Thoughts on the death of Meles Zenawi

With this post we welcome guest contributions from Paul Merkley. Paul also writes for The Bayview Review from whom we have permission to republih material. As The Review writes:

Paul Merkley is Professor Emeritus in History from Carleton University and the author of several books and many articles about the history of Christian interest in Israel and in Zionism. His latest books are American Presidents, Religion and Israel (Praeger, 2004) and Those That Bless You, I Will Bless: Christian Zionism in Historical Perspective (Mantua Press, 2011).

Here is a new essay from Paul that does not presently appear elsewhere: A LANDMARK Thoughts on the death of Meles Zenawi. At a time when Ethiopia is well off the front page, Paul gives us an historical background preparing us for any subsequent current events that, based on its varied history, may emerge in uncertain direction at any time.

Flash Point: Welcome to Hotel California

Bernanke expressed confidence in his Jackson Hole speech,  Monetary Policy since the Onset of the Crisis, that the Fed can “exit smoothly” when it wants to:

The FOMC has spent considerable effort planning and testing our exit strategy and will act decisively to execute it at the appropriate time.

In The Dilemma of the Impatient Trader, traders wishing to acquire or divest large positions quickly pay a premium for their impatience equal to the spread between average purchase and average sell prices minus the market bid/ask spread. Any exit strategy by the Fed must include the divestiture of their large securities position. This would begin if and when the economy were heating up and needled to be slowed. It might also become necessary if inflation takes off driving interest rates up. These would not necessarily be mutually exclusive scenarios.

From a balance sheet perspective, the cause of the exit is unimportant. What happens is the Fed sells securities to primary dealers (PDs) who pay for them from their excess reserves on deposit. These reserves were created by the Fed’s initial purchases of securities from the PDs. But the PDs are patient traders and the Fed is an impatient trader. The cost to the Fed, as its assets approach zero through sales, is the premium they paid on acquisition plus the premium they pay on sales. This means the PDs have a net balance left equal to this total premium. This is the money given to the PDs for their assistance in implementing Fed policy.

To balance assets and liabilities in true accounting fashion, the Fed’s capital position goes negative and the Fed becomes insolvent. Before this happens, however, by recent arrangement with the Treasury, the Treasury will backstop (bailout) the Fed.

The monetary base is considered the base of the money supply in the economy and is known as money with zero maturity. It is roughly the sum of the reserves on deposit with the Fed plus currency in circulation. Many have argues that if the excess reserves, currently standing at  about $1.5 trillion, enter the economy, large scale inflation will result. The caveat has been that the Fed could unwind its balance sheet. But as we have argued, it can’t entirely. The trading premium incurred will remain as a liability after assets are gone. It will also remain as part of the monetary base and the Fed cannot do anything remotely orthodox to fix this. The result: built in inflation.

So welcome to Hotel California where any central bank can check in but it can’t check out.

Update 20120917

It is always gratifying to get confirmation of our thinking from people much smarter and informed than we are. Today we got this eletter from Bob Eisenbeis, Chief Monetary Economist of Cumberland Advisors: We’ll Know It When We See It! These people understand the Fed, Fed operation and policies, and debt and bond markets as well as anyone and better than most. Bob wrote:

Certainly, the materials provided imply a long period of sustained asset acquisitions and a further substantial increase in the Fed’s balance sheet. This expansion will only exacerbate the Fed’s exit problem, and to the extent that it experiences capital losses on asset sales, those losses will accrue to the taxpayer through reduced remittances to the Treasury, and increase the deficit.

The “capital losses” are what we described as “premium paid” in The Dilemma of the Impatient Trader.

Flash Point: Where Does It End?

We had just finished our latest essay The Hole in Jackson Hole, when we got this article from Bloomberg: Fed Moves Toward Open-Ended Bond Purchases to Satisfy Bernanke. In our essay we presented our arguments that LSAPs (QE) have been ineffective in stimulating the economy. The Bloomberg article, however, suggests some new LSAP will be coming soon (something we agreed with as a result of our analysis of Bernanke’s speech).

LSAPs were introduced to manipulate interest rates because the traditional tool for doing this, the  Effective Federal Funds Rate (EFFR), became ineffective when it reached the zero lower bound. Since the EFFR was designed to manipulate short-term rates and these were effectively at zero, the Fed used LSAPs to affect longer dated maturities, eventually lowering rates across the entire yield curve to the 30-year bond. All have recently touched historic lows.

As we argued, there has been no observable effect of LSAPs on the employment situation. Bloomberg speculates that the Fed will soon introduce an LSAP policy that is open ended. Its goal will not be to acquire a certain class of assets in a specified quantity in a specified period of time as previous LSAPs have done, but to set an economic target for the program rather than an asset target. Jim Rickards suggested they would do this several months ago, targeting a certain level of GDP. Bloomberg suggests they may target a certain level of unemployment – say 7%.

In an economic environment where GDP and employment are in a cyclical downturn one might assume they will return to historic norms. If however, there are structural changes in the economy, this assumption is invalid. In our essay we showed a thirty year downtrend in GDP and employment growth. We argued that this is structural since it it spans four recessions or business cycles.

Bernanke’s bet is the recovery has a cyclical basis. We argue it has a structural basis*. If Bernanke is wrong and sets a policy objective for levels that are no longer relevant due to structural changes, then he will have created an open-ended ticket to money creation at the Fed bounded by a goal that is unattainable. But what is worse, he cannot realize that the failure of his policy is based on a fundamental misreading of the economy. Rather the danger is he will misread the situation as Paul Krugman has done and feel that the problem simply requires more money to be thrown at  it.

*Update: 20120914

We find today, Ambrose Evans-Pritchard arguing in The Telegraph in his essay Era of ‘jobs-targeting’ begins as Fed launches QE3, that the employment situation is due to a structural change. He quotes Bernanke’s concern as:

a grave concern, not only because of the enormous suffering and waste of human talent it entails, but also because high levels of unemployment will wreak structural damage on our economy that could last for many years

Then he quotes Minneapolis Fed chief Narayana Kocherlakota as saying that the lack of jobs skills imply less slack than assumed – known as an upward shift in the “Beveridge Curve”. The problem is “structural”.

In The Hole in Jackson Hole, Figure 4 shows that for the current ‘recovery’, the year-over-year change in GDP is at trend. This we interpret to mean the full recovery has happened and current employment numbers are the ‘new normal’. To support this notion, we note Ambrose’s statement America’s output is now well above its previous peak in late 2007, unlike Japan and most of Europe. If output has fully recovered, there is no room for any significant expansion in employment. Indeed, the larger levels of unemployed – the actual levels, not the official levels – will prove to be a drag on economic expansion as these people will require social service support while remaining unproductive.

The implication then for a QE program that targets a level of employment is that this level will be reached only when sufficient people drop out of the labour force to reduce the numbers and not by job creation. We have  a nagging feeling, not that QE will not be effective since we believe it won’t be, but that it will actually damage the economy at an accelerating rate. We’re thinking about it.


Powered by WordPress | Designed by: photography charlottesville va | Thanks to ppc software, penny auction and larry goins