Notes From Underground

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.

Tags: Ben Bernanke, deflation, Fed, fiscal cliff, Gold, Mario Draghi, OMT

This entry was posted on November 20, 2012 at 8:28 pm and is filed under Fed, Fiscal Cliff, United States. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.