Notes From Underground: Did You Hear What I Hear, Senator Schumer

In his speech at the Economic Club of New York, Fed Chairman Ben Bernanke said: “Monetary policy can do little to reverse the effects that the financial crisis may have had on the economy’s productive potential. However, it has been able to provide an important offset to the headwinds that have slowed the cyclical recovery.” While Mr. Bernanke stayed quiet about Washington’s role in easing the potential fallout from the “fiscal cliff” during the election, he was very direct in letting the administration and Congress know that they are now the most important “game in town.” The Fed chairman was very clear about the potential economic drag that will result from the Congress letting previously enacted stimulus programs lapse. Bernanke voiced concerns about the impact of cuts in local and state spending and the massive job layoffs at the local government level–600,000 jobs were supposedly lost by cuts in state and local budgets. If the Federal government goes over the fiscal cliff, the unemployment impact will even be more dramatic.

The chairman was also very direct about the impact of the financial headwinds that continue to buffer the U.S. and global economic growth. Bernanke does give a “hat tip” to his friend Mario Draghi by noting the positive impact of the Outright Monetary Transaction (OMT) program. As in the U.S., the FED chairman signals that the next efforts for dealing with the European debt crisis have to come from the politicians and policy makers. Overall, the speech was  a reiteration of FED policy from the FOMC minutes and allowed Mr. Bernanke to remind his audience that the his FED will never allow a replay of the mistakes of 1937. He restated the reason for moving the extended period of low rates into 2015:

“By pushing the expected period of low rates further into the future,we are not saying that we expect the economy to remain weak until 2015; rather, we expect–as we indicated in our September statement–that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.”

The proverbial punch bowl will remain at the party well after the guests have passed out. Now, Senator Schumer, you and your Congressional cohorts are the only game in town.

***Wednesday is the 10th anniversary of Ben Bernanke’s speech, “Deflation: Making Sure “It” Doesn’t Happen Here.” This is the speech that earned Ben Bernanke the nickname, helicopter Ben. When Bernanke delivered this speech he was a FED governor and in it basically warns that the best way to deal with DEFLATION is to prevent it from happening and maintains “that deflation is generally the result of low and falling aggregate demand.” The results of a deflation from a violent financial crisis can be found in Irving Fischer’s work and notes that the end result is “fire sales” of assets and thus falling asset prices, which lead to further declines in aggregate demand as credit is frozen. Ben Bernanke maintained that the FED can prevent the onset of deflation because of  “technology, called a printing press.” He further added in the speech that “… under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”

In this look back to that November 2002 speech, we certainly see the FED playbook, but the results of the FED’s policy have not been as successful as envisioned through theoretical models. Toward the conclusion of the speech, Governor Bernanke invokes the need for fiscal policy. “Each of the policy options I have discussed so far involves the Fed’s acting on its own. In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence prices….A money-financed tax cut is essentially equivalent to Milton Friedman’s famous “helicopter drop” of money.”

He adds: “If the Treasury issued debt to purchase private assets and the FED then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets.” The re-reading of this speech should solve the problem that Mario Draghi has. It is no mystery why the gold price continues to hold in the face of low global inflation. Holders of FIAT CURRENCY fear the policies of global central banks and the need to prevent deflation. As always, the GOLD trend will change when REAL RATES OF INTEREST turn positive. As long as real yields are negative investors will remain nervous.

***The French and German 10-year yields both moved higher today following Moody’s downgrade of French debt. The German bund moved higher by 6 basis points and the French oat by 7.7 basis points. The debt of Italy and Spain though fell by similar amounts, which reflected the rebalancing away from the previously short peripheral positions. Again, the German/French spread will be a barometer but as for today it revealed little about investor intentions.

***In an effort at initiating some semblance of sanity, Mike Madsen, head of Honeywell’s defense and space business, said deep defense cuts are inevitable and “the right thing” in today’s Financial Times. While the Aerospace Industry Association is lobbying against cuts in military spending, the CEO of Honeywell has been a vocal supporter of fixing the DEBT campaign. It is a rare to have a CEO actually acknowledging that changes have to be made for the good of the country. CEO Dave Cote is to be applauded for putting the interests of fiscal sanity above the bottom line of his firm–finally someone getting ahead of the sanity curve. Let’s hope it’s contagious. All serious fiscal reform begins with the defense budget.

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8 Responses to “Notes From Underground: Did You Hear What I Hear, Senator Schumer”

  1. asherz Says:

    “All serious fiscal reform begins with the defense budget.”
    With entitlements such as Medicare, Medicade and Social Security comprising almost 70% of the federal budget, I think fiscal reform begins there.
    Targeting Defense expenditures (which certainly contain waste that could be wrung out) in this ever increasingly dangerous world is avoiding one’s eyes from the dangers to our national security that lurk outside our previously secure national boundaries.

  2. arthur Says:

    defense business: a big difference is you’re a BIG company or a small company…

    http://www.washingtonpost.com/local/virginia-politics/federal-cuts-would-take-heavy-toll-on-small-contractors/2012/11/16/90ddbd3c-2f3e-11e2-9f50-0308e1e75445_story.html

  3. Joe Says:

    * It is no mystery why the gold price continues to hold in the face of low global inflation. Holders of FIAT CURRENCY fear the policies of global central banks and the need to prevent deflation. *

    And central banks, ever increasing holders of fiat and assets backed by digital fiat, are net buyers of gold.

  4. yra Says:

    Asherz—the amount spent on Defence is insanity–the military-industrial complex is where federal largresse begins and the vietnam war was bought and secured with the war on poverty and the massive increase in entitlements that Johnson’s buy off of the liberal establishment with massive war on poverty–that is why the sacred cows of defence need to be gored so that everything else is now on the cutting board–anything else will not get real reform.So for all those defence hawks –if defence spending is not cuttable then there will be no real reform

  5. silverbug2155 Says:

    We are not the policeman of the world. The fear instilled by our lawmakers that we need constantly perputual wars is mindless.You have fallen for the lies that Pres.Eisenhower warned us about where he coined the term ” beware the military complex”. Besides there are adequate armies in the ME, Russia & China etc. to take care of themselves as they are in the blast zone. We are the most hated country because of it all.

  6. yra Says:

    Silverbug—well stated and that is where and why the budget battle has to begin

  7. Michael Greenberg Says:

    4 week t-bill rates are higher than 26 week t-bill rates. Just something to keep on your radar screen.

  8. yra Says:

    Thanks Michael–it may be a year end phenomenom but thansk for the heads up .The edz2-edh3 spread is also flat so thanks for bringing it to our attention.Thanks again as you have been here with NFU since the start–three years ago and your input has been much appreciated

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