A rate pirate on the high debt sea
By Max Fraad Wolff
There are many opinions on how best to captain a gigantic national economy
across roiled seas. No one can presume to know the best course with certainty.
All must contend with an unknowable future string of consequences from action
and inaction. History is hard to know with clarity and context is ever
changing. Every US Federal Reserve chairman is owed some deference as he charts
a course to please diverse constituencies, dodge rocks, and sail through
storms.
Now that we gotten that out of the way, what is Federal Reserve head Ben
Bernanke thinking? We have heard much of his
disciplined and prudent approach. We have been treated to talk of his careful
and technically advanced reliance on cold calculation. Oops, that seems to have
lasted through about one month of market turmoil.
On Tuesday, the Federal Open Market Committee (FOMC) cut its target rate for
interbank loans - the Federal Funds rate - by 50 basis points or 0.5 percentage
point. During the same meeting, a 50-basis-point cut was made in the discount
rate - the rate at which the Fed lends to banks. This brought the Fed Funds target
rate to 4.75% and the discount rate to 5.25%.
The Fed felt the pressing need to cut its target Fed Funds rate by 9.5% and its
discount rate by 8.7%. Markets, speculators and Congress have been calling for
such a dramatic response to buoy markets and financial conditions. Oh yeah,
they also blabbered something about helping families like the 260,000 that saw
their homes enter foreclosure in August. It is too late for them, but they make
better poster children than the likely beneficiaries.
By way of benchmarking these
rates, some historical perspective is in order. In
the 50-year period from 1957-2006, the average
effective Federal Funds rate was 5.88%. We were
below the long-run average before Tuesday's cut
and are now well below it. The average for the
past 20 years was 4.9%. We are now below that
average as well. Over the period from 1957-2002,
the average discount rate was 5.59%. We have moved
below this average as well. The 20-year
discount-rate average was 5.64%.
Thus it would be fair to say
we were below the averages prior to Tuesday's cuts and are now further below
the averages. How might one understand that? The United States is a debt economy
and requires more accommodative and easy money then ever before. Turmoil in
credit markets is very dangerous, and the US can no longer have a stable
economy with historically "normal" interest rates. Give us cheap, easy money or
the economy walks the plank!
A million years ago, on August 7, Fed economists saw inflation risks and a
generally strong economy. I must admit, I found that shocking and wondered what
they were smoking. They must have too, because a mere 10 days later, they acted
in complete contradiction to that position.
On August 17, the Fed slammed those betting on markets to fall by suddenly
slashing the cost, conditions and collateral for bank borrowing. They cut the
discount rate and began accepting more types of collateral for longer periods.
Banks did take advantage of this. They hit the Fed credit buffet like Las Vegas
tourists. These well-fed bankers are yet to extend any extra opportunity to
legions of distressed debtors. Foreclosures continued to break records and went
on to a 115% increase over August 2006.
Not to worry, monetary policy is really made for middle- and lower-income
Americans. The bankers may be at the buffet, but the great unwashed get to play
in the bankruptcy casino downstairs. Who wants a free meal when there are
opportunities to play foreclosure roulette?
The
August 7 FOMC statement issues sounds of confidence and offers an all-clear:
Economic
growth was moderate during the first half of the year. Financial markets have
been volatile in recent weeks, credit conditions have become tighter for some
households and businesses, and the housing correction is ongoing. Nevertheless,
the economy seems likely to continue to expand at a moderate pace over coming
quarters, supported by solid growth in employment and incomes and a robust
global economy.
In Fed-speak this is tantamount to an "all is
well, remain calm". Thus Tuesday's actions and pronouncement are strange and
contradictory:
Economic growth
was moderate during the first half of the year,
but the tightening of credit conditions has the
potential to intensify the housing correction
and to restrain economic growth more generally.
The latest action is intended to help forestall some of the adverse effects on
the broader economy that might otherwise arise from the disruptions in
financial markets and to promote moderate growth over time. Readings on core
inflation have improved modestly this year. However, the committee judges that
some inflation risks remain, and it will continue to monitor inflation
developments carefully.
There is so much to say here. The first
half of the year ended before either meeting. US economic growth in the second
quarter has been revised upward since the August meeting, so it is better than
we thought on August 7. It appears that the Fed is acting to prevent a downward
economic trend. That sounds great until you realize that this has already come
to pass. Whom are they kidding?
Not the quarter-million US households that formally entered the
losing-their-house good times in August. Backward-looking data that measure
August made inflation look moderate. Preliminary access to those data was
available during the August meeting and throughout last month.
New data for September are available now - after all, it is September now.
These data suggest rising prices led by surging oil, wheat, gold and
foreign-currency prices. Not to worry, the Fed will monitor that while pumping
money into banks and slashing rates to prevent the economic downturn that has
already arrived!
In early August it was clear that foreclosures were spiking, markets were
boiling over and panic was rife. Bernanke decided that it was time to sound the
all-clear with a cautionary note on inflation risks. After all, oil was a
whopping and scary US$70 a barrel back then. Now it has settled down to $82, and
so the worry has lifted?
Food costs - especially wheat - have surged in the month since the Fed worried
about inflation. I guess that is why we are now worried about financial-market
conditions. Across the one month and one week between the meetings, the
broadest US stock-market index, S&P500, went from 1,476.71 to Monday's
close of 1,476.65. This must have been the radical deterioration that caused
the about-face!
Bernanke is ideally focused on inflation-fighting, price stability and economic
growth. It would seem he is concerned about bank demands for liquidity and
equity-market indices. I am not saying there is anything wrong with that. I am
saying the talk, the action and the statements are not anywhere near to being
on the same page.
Action and pronouncement swing between mutually exclusive broad outlooks. Fast
and furious actions are targeting asset prices and ignoring reported economic
data, except when obsessed with increasingly outdated numbers. There must be a
real drawdown in the rum supply aboard the Pirate Ship Bernanke.
The truth is that Tuesday's reassurance and logic are as frightening as the
logic and all-clear sounded on August 7. Buckling under Wall Street pressure
and slashing rates help stock prices. The way and timing in which the discount
rate was cut - twice now - attack market shorts and artificially push up stock
prices.
Thus it will be seen as genius by those you hear on TV, radio, and many
newspapers. I am concerned that the Fed acted late, is confused about where we
are in the calendar year, pays no mind to its recent statements, and is acting
to head off future economic trouble that everyone else knows is already here.
Max Fraad Wolff is a doctoral candidate in economics at the University of
Massachusetts, Amherst, and editor of the website GlobalMacroScope.
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