Notes From Underground: Draghi, Yellen and Fischer … Oh My

As we reflect on the various speeches delivered over the last week there appears to be more questions than answers to the issues that weigh on the markets. Mr. Draghi was the one central banker that had the courage to ponder the issue: What if central banks have misjudged the strength of consumers and the effort to bring DEMAND forward to energize the economies of the developed markets may be flawed? Again, drawing upon the Draghi speech to the IMF on May 14:

“Secondly, there are always distributional consequences to monetary policy decisions. When monetary policy acts to stave off disinflation by lowering interest rates, this has inevitably a distributional effect by reducing the interest income of savers and lowering the debt burden of borrowers. But such interest rate cuts are necessary to raise aggregate demand by encouraging firms and households to bring forward spending decisions–that is, they discourage excessive savings and incentivize investment by lowering the cost of finance.”

This is an honest assessment of why the ECB is in a full-blown war on SAVERS in an effort to generate economic growth in an immediate fashion. Financial repression in the form of destroying the return on savings is meant to incentivize consumers to either take on more financial risk or spend all of their earnings, which OUGHT to promote growth and lift the animal spirits of entrepreneurs to invest in capital expansion. But Draghi has the courage to admit, “For pensioners and those saving ahead of retirement,low interest rates may not be an inducement to bring consumption forward. They may on the contrary become an inducement to save more, to compensate for a slower rate of accumulation of pension assets.” If we substitute Germany for pensioners, it raises the issue of the potential severity of Draghi’s problems. In economic terms, this is the problem of “intertemporal misallocation” constantly bringing forth demand in order to slay the business cycle.

It is the prospect of  INTERTEMPORAL MISALLOCATION that may be responsible for the decline in productivity for business seems to be adverse to invest in new capital because of fears for future demand. It is easier to hire more labor because it is easier to fire workers if the economy slows than it is to work off excess capital.
  In Janet Yellen’s speech May 22 at the Providence Chamber of Commerce, the FED Chair raised the issue of low productivity. She doesn’t definitively say why she believes productivity is low–an on the one hand and then the other hand–but states: “Firms slashed their capital expenditures during the recession, and as I noted earlier, the increases in investment during the recovery have been modest. In particular, investment in research and development has been relatively weak. Moreover, a lack of financing may have impaired the ability of people to start new businesses and implement new ideas and technologies.”
The problem with Yellen is that she hasn’t the heart to accept the idea of an economy in intertemporal misallocation. Ms. Yellen opined that stock market valuations are stretched but how can equity prices be overvalued if there is a lack of financing in the system. Between the FED‘s zero interest rate policy and the power of shadow banking to generate financing, it is highly doubtful that capital investment is suffering because of a lack of money available. It would be wise for Chair Yellen to comprehend the advice of Schumpeter’s Pushing On A String theory: A central bank can stop businesses borrowing by raising rates but it cannot generate investment activity if entrepreneurs cannot generate adequate returns. Chair Yellen needs the strength of HEART to admit the possibility of intertemporal misallocation as a reason for the low growth in productivity.
Vice-Chairman Stanley Fischer delivered a speech in Tel Aviv yesterday, “The Federal Reserve and the Global Economy.” Fischer seems to be on a mission to prepare the global financial system for an inevitable rise in U.S. interest rates.
“The actual raising of policy rates could trigger further bouts of volatility, but my best estimate is that the normalization of our policy should prove manageable for the EMEs (emerging marketing economies). We have done everything we can, within the limits of forecast uncertainty, to prepare market participants for what lies ahead.”
It certainly seems that the FED wants to limit the fallout and deflate the global response to a raise in U.S. rates. The May 2013 taper tantrum has stirred the Fed to preemptive strikes against excess market volatility. This appears to be monetary policy in the times of excess fear and overvaluation.
My problem with Fischer is not his efforts of preemption but his claiming that the FED seems to have a third mandate: “responsibility to the global economy.” The FED has to be concerned about the global reactions to policy actions because of possible negative consequences for financial stability. He continued: “Thus, as part of our efforts to achieve our Congressionally mandated objective of maximum sustainable employment and price stability, the Federal Reserve will also seek to minimize adverse spillovers and maximize the beneficial effect of the U.S. economy on the global economy.” Mr. Fischer needs to reset his brain for the FED is under intense scrutiny and Congress will not be wanting to hear that the Vice Chairman is raising the issue on that international stage that the Fed will be extremely conscious of global concerns in its efforts to set monetary policy. The dual mandate is tough enough to defend in Janet Yellen’s appearances before Congress.
***Bank  of Canada held rates steady and there were no surprises in the BOC statement. It is apparent that the Canadians are waiting to see if U.S. GDP accelerates before becoming more optimistic about the Canadian economy. All in all a very neutral outlook and appears to be “data dependent.”
***Posting a response to a comment from reader MarkT on last night’s blog post as he raised some very thoughtful issues on the IMF role in the Greek Debt Drama. In thinking this through, I don’t believe the German and French banks took that large of a haircut, for much of the loses were loaded onto sovereign wealth funds, pensions and the ECB‘s books. The banks took very little write downs and have been disposing of their Greek paper through the ECB‘s asset purchasing schemes during the last three years. The IMF was a deep pocket composed of OPM (other people’s money), which irritated the Chinese and other emerging markets and highlighted the dual standards applied to Europe and the emerging world.
Also, as one of the previous blogs highlighted at the bottom of yesterday’s NOTES acknowledges, the typical IMF  advice could not be followed for Greece because Greece did not have the power to devalue its currency, the euro. The IMF conditions for the bailout thus put the entire burden on the austerity side of the equation. SYRIZA is correct in calling for a greater sharing in the burdens foisted upon the Greek polity and economy. This, I think, is an important point for any type of realistic settlement and the IMF should not be allowed to escape from further responsibility.

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16 Responses to “Notes From Underground: Draghi, Yellen and Fischer … Oh My”

  1. ShockedToFindGambling Says:

    Yra- Great post.

    Lowering interest rates is, at best, a zero sum game. Every penny saved by borrowers is lost income to investors/savers.

    If you slash rates, and people/companies do not borrow, it is a net negative for the economy…….the savers/investors have lost income, but borrowers are not benefitting.

    Based on the $Triliions in excess reserves at the FED, this is the situation we find ourselves in.

    To me this is just common sense, but I have never heard anyone say it.

  2. Rony Schlapfer Says:

    Yra you said it so well…. and you are so right! Bravo

  3. costaselgreco Says:

    Hi Yra, great post. I beg to differ on the Fed’s mandate. As the world’s reserve currency, surely the Fed has to have a third mandate? If Congress is concerned only about Fed policy effects on the US, that’s fine, but it cannot then also be the global reserve currency. Being the reserve currency must carry responsibility beyond what is good only for the US. Needless to say, that responsibility extends to the requirement that its decisions are not geopolitically adverse to countries that compete against it only on an economic basis. Would you be willing to compete against a football team with more players than in your team, and where the referee wears the same outfit as your opponent? Personally, I would rather seek to find teams willing to compete on an equal footing in a rival championship.

    • yra Says:

      costas–I agree with your premise about the Fed’s third mandate because it is the global reserve currency but then it gives the FED cover to never being wrong–never.Well we didn’t raise because we deemed global economic growth too weak–the FED will never be wrong and will always have an excuse as to why it did what it did when it did—-I am certainly not naive as to the workings of the world but I struggle to accept this notion of Fed infallibility —see the dollar in terms of gold since 1971—and I didn’t include it last night but in Fischer’s speech from Tel Aviv he said this that didn’t sit well:”I would also argue strongly that U.S. monetary policies were not beggar thy neighbor policies in that,on balance,they generally did not drain demand from other economies.Federal Reserve staff analysis finds that an easing of monetary policy in the U.S. benefits foreign economies from both stronger U.S. activity and improved global financial conditions.” think about this comment and the latitude it gives the FED

  4. Chicken Says:

    Isn’t growth essentially responsible for climate change?

  5. Joe Says:

    I am thinking along the same lines as costaselgreco. Since the day the $US became the world’s reserve currency, I believe there has been an unwritten, unacknowledged 3rd mandate, one that the Greenspan Fed seemingly ignored in it’s last terms. It is now evident Congress and everyone else in positions of power never imagined there would be consequences of ignoring that reality. It’s laughable when any Fed chair or member hides behind the quaint notion that the “dollar” is entirely the Treasury’s responsibility, as if the monetary authorities are bystanders when it comes to dollar value. Price stability with an acknowledgement of the dollar’s role in world finance should be the only mandate to the Fed. If policy makers are no longer concerned about the dollars status, they should then ignore it and like anything else that’s ignored, it’ll eventually go away.

    • yra Says:

      Joe–see the reply to Costas

      • Joe Says:

        Yra, Thanks! It also makes me remember Bernanke appearing before congress and affirming the dual mandate and reminding congress that the “dollar” is the responsibility of the Treasury. Cordial deference in a game of tag where every one with a title gets a turn at being it.

  6. Chicken Says:

    I thought John Connally already clarified this subject?. I think he was right for an arms-length list of reasons essentially serving special interest groups primarily.

    The highest bidder always wins, too many people trust government isn’t substantially conflicted. Pretty sure our founding fathers are rolling over in their graves with this shameless free-for-all transfer of wealth.

  7. Blacklisted Says:

    The Fed and Fischer have become an embarrassment, just as the Obama Administration. Like FASB accounting standards, the metrics used for “price stability” and “employment” are a total joke to be massaged as needed to avoid accountability. How in God’s name will the Federal Reserve “seek to minimize adverse spillovers and maximize the beneficial effect of the U.S. economy on the global economy”? These bozo’s have never incorporated global capital flows into their “analysis”, and it will be proven again when capital starts avalanching into the dollar by the sovereign debt earthquakes that will start hitting at the end of the year. Outside of maybe Volcker and Burns, CB’s will not even acknowledge the business cycle, much less admit that it CANNOT be manipulated. Why can’t they go back to their original mandate and buy corporates instead of treasuries when stimulus is needed?

    Even if pricing metrics were accurate, which they are not, a 2% inflation target is not “price stability”, as the erosion of purchasing power over the decades has proven. If the unemployment is below their mandate, but the bulk of the new jobs are less than full time and/or at lower wages, would the economy and tax receipts be improved? What if stock prices continue to rise and employment and CPI remain weak? Will the Fed still not raise rates or will they be more concerned about their reputation over blowing another asset bubble? My money is on their self-interested ignorance, which means they will be responsible for blowing themselves up, along with the other nations, corporations, pensions, insurance companies, and others that hold too much “risk-free” govt paper.

  8. kevinwaspi Says:

    Excellent points, ones that prompt a myriad of thoughts:
    1) To date, Fischer has been a very disappointing addition to “the team”. I may be guilty of having placed too much expectation in his no-nonsense historical record, but thoughts of a third mandate bring my blood to a boil. I shudder at the thought of seeing a weekly H.4.1 statistical release at some point in the near future that shows the Fed holding x million shares of Shake Shak, y million shares of LinkedIn , and z million shares of any other stock that trades at some unimaginable multiple of sales, all in the effort to “minimize adverse spillovers and maximize the beneficial effect of the U.S. economy on the global economy.”
    2) Monetary policy was never intended to be a stimulus for demand. Fiscal policy (including all important regulatory regimes) have much to do with aggregate demand that this and many developed economies have forgotten. Now 7th on the list of the Ease of Doing Business Index (see ) the U.S. follows Singapore, New Zealand, Hong Kong, Denmark, Korea, and Norway. Call that what it is, lost opportunity.
    3) “Intertemporal misallocation” (constantly bringing forth demand in order to slay the business cycle) has brought us to the Richard Koo “balance sheet recession”
    (see )
    Thank you, Sir Alan Greenspan. We baby boomers have borrowed our way to prosperity to the point where demand for the fiscal year 2030 has already been experienced. Outside of consumption of housing, health care and higher education (all the places were inflation has been problematic for the past 20 years), we’ve basically demanded our lifetime consumption in the time frame of two thirds of our life expectancy. The final third is now a “maintenance period”, and as Koo pointed out, ” in the absence of people borrowing and spending money, the economy continuously loses demand equal to the sum of savings and net debt repayments.” Cutting rates to zero does nothing to remove the burden of repaying principal. Watch out for the next shoe to drop, that of 1+ trillion and rising student loan debt, not a promising future for our “Millennials.”
    4) Capital expenditures, demand for labor, and productivity, are directly related to incentives provided to the agents in our economy. Business has been incented to reduce costs to bolster profits. Labor and capital expenditures have suffered, and now at the end of the cost wringing cycle, productivity has been exhausted, and is in decline. Our corporate tax system is one that rewards cost minimization and in the process, pushes those costs of production onto society and social programs through lower labor participation rates and safety net transfer payments. It is time to tear up the corporate tax code, and write a new one that rewards the business sector for shouldering costs of producing goods and services. I am an advocate of a system that has a reverse graduated corporate tax rate based on “domestic content” of the goods and services produced. Domestic content less than 50% has profits taxes at the current 35% rate, content between 50 and 60% pays at a 30% rate, between 60 and 70% pays 25%, 70 to 80% pays 20%, 80-90% pays at 15%, and above 90 pays a flat 10% corporate tax rate.

    Sorry for the lecture, but good posts bring out my claws.

    • Joe Says:

      kevinwaspi – Don’t apologize for the lecture. I thoroughly enjoyed it and agreed with the points you made. It is the opposite of, say, the handball competition between choices of austerity and non-austerity we hear in the financial media and press conferences. Like Europe, I believe U.S. problems are structural and come from the institutions that make the rules most of us have to live by.

  9. costaselgreco Says:

    Thanks for the feedback Yra, if having multiple mandates allows the Fed to claim victory for their actions each and every time, what is the solution? And in the first place, should we not consider that they might already have too much power and control over markets and the economy, both domestic and international?

  10. yra Says:

    Costas–see Bernanke’s blog from today to make your case

  11. Jeffrey Carter (@pointsnfigures) Says:

    Ironically, what we’re seeing is inflation in later stage valuations of startup companies-and relatively ease of funding seed stage companies compared to prior times. Seeing private companies stay private longer. The change in risk/reward has pumped up the value of all assets, as real estate values are at highs as well.

    Yet GDP is anemic, the amount of people dropping out of the labor force at all time highs. The neo-keynesians scream it’s the new normal and we need to keep easy money with corresponding increases in government spending…..

    It doesn’t end well but who has the capital to fight the fed other than the fed?

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