As everyone knows, Chairman of the Federal Reserve Ben Bernanke can by re-appointed by the President to a 4 year term in January. As expected, the Fed-haters are making something out of nothing.
This week Bernanke went in front of a television audience and answered questions asked by the average joe off of the street. Bernanke announced at the beginning of his term that he would try to make the Fed more transparent and help the American people understand exactly what is going on in the economy.
Libertarians have perverted Bernanke's intentions... in the stupidest way possible. If your going to make a long rant about how bad Ben is, at least make it a logical argument. Look at what this blog has to say (http://blogs.reuters.com/james-pethokoukis/2009/07/27/candidate-bernanke-hits-the-campaign-trail/).
"If Ben Bernanke were running TV ads, taking polls and holding town hall-style meetings, it wouldn’t be any clearer that he’s conducting an explicit reelection campaign for another four-year term as Federal Reserve chairman come next January."
So this guy thinks Bernanke is trying to campaign to be re-appointed to the Fed. The last Chairman of the Federal Reserve remained Chairman for the most amount of time he could (14 years). Would it not therefore follow logic to say that Bernanke, a smart fellow, would take a play out of Greenspan's playbook and do the same things Greenspan did to be re-appointed.
But, and the anti-Fed author admits this in his article, Greenspan stayed as far away from the public as possible. So, by explaining things to the public, Bernanke is doing the opposite of what the last 14 year Chairman did to be re-appointed.
This is ridiculous. Clearly, if Bernanke's only goal is to be re-appointed, he would do what the last Chairman did to get re-appointed did. He isn't, so clearly there is another motive for why Bernanke is doing what he said. Anti-Fed idiots will say anything to get attention and to create suspiscion about the Fed.
Friday, July 31, 2009
This Weeks Auctions
Today marks the end of a record auctions week. The government auctioned over $205 Billion dollars of T-Bonds to private investors and foreign governments. By selling T-Bonds to the public the government is doing two things. First, it raises the supply of T-Bonds in circulation. Theoretically this would raise the interest rates. Second, by accepting cash from investors it reduces the amount of cash investors will have to invest with in the future. Combining the double whammy of rising interest rates and reduced cash for investment gives us a good picture of why governments don't like going into debt: they don't like stifling investment.
However, this weeks auctions, under the supervision of the Fed and the Treasury, yielded lower interest rates! This means that investors don't expect inflation to be an immenent problem. It also means that investors still have confidence in the US to pay back the bonds. This is a clear indicator that the Fed is doing a good job because inflation expectations are low while money is being printed to stimulate the economy.
Adversly, though, it means that there will be $205 Billion less for investors to invest with in the future. From an investor's standpoint, it also means that they believe that an investment will yield less than the meager 2-4% the bonds pay them in interest each year.
This weeks auctions show us that the Federal Reserve is doing a good job with what it has to work with. In a perfect world Congress would not be spending like they are currently doing and this would make the Fed's job of handling inflation expectations much simpler. The Bernanke Files is going on record and suggesting that Congress should begin reducing spending soon, and arguing that the Fed has been and will continue doing a good job keeping inflation low while stimulating the economy.
However, this weeks auctions, under the supervision of the Fed and the Treasury, yielded lower interest rates! This means that investors don't expect inflation to be an immenent problem. It also means that investors still have confidence in the US to pay back the bonds. This is a clear indicator that the Fed is doing a good job because inflation expectations are low while money is being printed to stimulate the economy.
Adversly, though, it means that there will be $205 Billion less for investors to invest with in the future. From an investor's standpoint, it also means that they believe that an investment will yield less than the meager 2-4% the bonds pay them in interest each year.
This weeks auctions show us that the Federal Reserve is doing a good job with what it has to work with. In a perfect world Congress would not be spending like they are currently doing and this would make the Fed's job of handling inflation expectations much simpler. The Bernanke Files is going on record and suggesting that Congress should begin reducing spending soon, and arguing that the Fed has been and will continue doing a good job keeping inflation low while stimulating the economy.
Thursday, July 30, 2009
Reminder
Tomorrow, Friday the 30th of July, is the final day of the governments bond auctions. This week saw a record sale of treasuries auctioned to investors. Usually this steep increase in the supply of bonds would raise the interest rates. This would be bad because it stifles investment and borrowing. Also, higher interest rates signal the threat of impending inflation.
The Bernanke Files will do a full survey of this weeks auctions after the markets close tomorrow so that readers get a better understanding of what is happening in the credit markets right now.
The Bernanke Files will do a full survey of this weeks auctions after the markets close tomorrow so that readers get a better understanding of what is happening in the credit markets right now.
Monday, July 27, 2009
The Great Preventer
Last week in the NY Times two top-notch economists debated Bernankes re-nomination chances. Nouriel Roubini, an economist from NYU who has gained fame for publishing a 12 step list the recession would go through before it became severe, argues that Bernanke was The Great Preventer. By taking creative steps, in Roubini's opinion, the Fed and Bernanke prevented Great Depression 2.0. The Bernanke Files agrees and would also like to point out that Bernanke can be assumed to have just as creative maneuvers to prevent inflation.
Anna Schwartz, a retired Professor from Chicago (boo, hiss, remember: Chicago schools of economic thought are synonymous with Libertarian, Fed-hating ideology), argues that Bernanke and the Fed failed to foresee the recession, failed to warn investors and failed to communicate their anti-recession plans to the public. But, uh, hello, are any of these things in the Fed's job description? Absolutely not. As is turns out, Schwartz was Milton Friedman's partner and has a general bias against the government, the Fed, and convertible money (money not backed by the gold-standard). Sorry, Schwartz, but you have to have a better argument than that the Fed didn't look into the crystal ball and prevent the future from happening.
Anna Schwartz, a retired Professor from Chicago (boo, hiss, remember: Chicago schools of economic thought are synonymous with Libertarian, Fed-hating ideology), argues that Bernanke and the Fed failed to foresee the recession, failed to warn investors and failed to communicate their anti-recession plans to the public. But, uh, hello, are any of these things in the Fed's job description? Absolutely not. As is turns out, Schwartz was Milton Friedman's partner and has a general bias against the government, the Fed, and convertible money (money not backed by the gold-standard). Sorry, Schwartz, but you have to have a better argument than that the Fed didn't look into the crystal ball and prevent the future from happening.
Saturday, July 25, 2009
China Calls For an International Currency
The current global economic regime utilizes the US dollar as its 'reserve currency.' Reserve currency simply refers to the currency that foreign central banks purchase with their extra revenue. Lately, the Chinese and Russian governments have called for a new currency to be used for reserve currencies. They argue that when central banks diversify into reserve currencies, they should purchase SDR's (special drawing rites) instead of US dollars. Theoretically, countries would try to quit using the US Dollar for excess reserves if they thought the United States was going to go bankrupt.
An SDR is simply a bond (an IOU) that is issued to governments that give more money to the IMF (International Monetary Fund) than they have to. For example, the United States has over $2 Billion of SDR's. The SDR is weighted by the US dollar, the Japanese Yen, the Euro and sterling silver.
Most economists believe that China and Russia's push for a different reserve currency is all talk and no bite. Economists point out that if China and Russia actually believe that the United States is going to go bankrupt they could simply quit buying US bonds with their reserves and instead purchase the Japanese Yen, Euro, silver, and less amounts of the US dollar. By doing so, China and Russia would achieve the exact same diversification as purchasing an SDR.
Instead, economists believe that the call for a new reserve currency is political posturing. Next year the IMF is meeting to determine the NEW weight of SDR. If the Russian and Chinese governments can get their currencies into the SDR there will be many advantages for their countries. It is believed that these governments are trying to question the US dollar just enough so that IMF countries will see a need to diversify the SDR with Russian and Chinese currency.
An SDR is simply a bond (an IOU) that is issued to governments that give more money to the IMF (International Monetary Fund) than they have to. For example, the United States has over $2 Billion of SDR's. The SDR is weighted by the US dollar, the Japanese Yen, the Euro and sterling silver.
Most economists believe that China and Russia's push for a different reserve currency is all talk and no bite. Economists point out that if China and Russia actually believe that the United States is going to go bankrupt they could simply quit buying US bonds with their reserves and instead purchase the Japanese Yen, Euro, silver, and less amounts of the US dollar. By doing so, China and Russia would achieve the exact same diversification as purchasing an SDR.
Instead, economists believe that the call for a new reserve currency is political posturing. Next year the IMF is meeting to determine the NEW weight of SDR. If the Russian and Chinese governments can get their currencies into the SDR there will be many advantages for their countries. It is believed that these governments are trying to question the US dollar just enough so that IMF countries will see a need to diversify the SDR with Russian and Chinese currency.
BRIC Nations
Brazil
Russian
India
China
Emerging market investors have emphasized the growth of these four countries so much that they have given them a special name: BRIC.
Hypothetically, these countries are on the brink of becoming fully developed countries and have large populations. Therefore, they are ripe for investment. When the US invests in other countries company's it is called FDI (Foriegn Direct Investment). Policy makers in BRIC countries compete for FDI by streamlining the investment process, giving tax-breaks to investors and middle men, and making infrastructure (ports, shipping, roads, airlines and regulation) more efficient to make FDI more appealing.
Each of the BRIC countries has unique advantages and disadvantages for FDI. Brazil has several advantages. First, it has some of the largest oil and natural gas reserves in the world. Brazil is also rich in coffee, soybeans and other natural resources. It has been de-regulating its financial sector since the 1970s and has a healthy stock market (the Bovespa). Brazil also has a large population that is focused on industrializing.
Brazil has several disadvantages as well. With a large population comes many challenges. The education system is poorly funded and does not specialize in a specific area. The government is involved in a lot of corruption. Inflation worries seem to haunt the Brazilian central bank and it is difficult for entrepeneurs to open a business. Overall, however, Brazil is poised for strong growth as it continues to focus on trade relations with China and the United States and continues to deregulate its economy.
Russia's primary strengths are its education system, natural resources and industrialized regions of the country. Impeding its potential for growth are bad relations with surrounding countries, unstable currency, inflation fears, and corruption in the government. Brazil has great potential for growth, but also is very risky due to the risk of default from the government that constantly drives investors away.
See future posts for Indian and Chinese strengths.
Russian
India
China
Emerging market investors have emphasized the growth of these four countries so much that they have given them a special name: BRIC.
Hypothetically, these countries are on the brink of becoming fully developed countries and have large populations. Therefore, they are ripe for investment. When the US invests in other countries company's it is called FDI (Foriegn Direct Investment). Policy makers in BRIC countries compete for FDI by streamlining the investment process, giving tax-breaks to investors and middle men, and making infrastructure (ports, shipping, roads, airlines and regulation) more efficient to make FDI more appealing.
Each of the BRIC countries has unique advantages and disadvantages for FDI. Brazil has several advantages. First, it has some of the largest oil and natural gas reserves in the world. Brazil is also rich in coffee, soybeans and other natural resources. It has been de-regulating its financial sector since the 1970s and has a healthy stock market (the Bovespa). Brazil also has a large population that is focused on industrializing.
Brazil has several disadvantages as well. With a large population comes many challenges. The education system is poorly funded and does not specialize in a specific area. The government is involved in a lot of corruption. Inflation worries seem to haunt the Brazilian central bank and it is difficult for entrepeneurs to open a business. Overall, however, Brazil is poised for strong growth as it continues to focus on trade relations with China and the United States and continues to deregulate its economy.
Russia's primary strengths are its education system, natural resources and industrialized regions of the country. Impeding its potential for growth are bad relations with surrounding countries, unstable currency, inflation fears, and corruption in the government. Brazil has great potential for growth, but also is very risky due to the risk of default from the government that constantly drives investors away.
See future posts for Indian and Chinese strengths.
Wednesday, July 22, 2009
A New Bernanke Arch-Nemesis
Ron Paul, the psycho-libertarian, has been added to the Bernanke Arch-Nemesis list today. His ignorant questioning of the Chairman begs the following question: How did this guy get through Eco 101.
Answer: He probably didn't: Professor Bernanke had to inform Paul that inflation is the rise in the price of goods. Paul, for some reason unbeknown to me, thought that inflation was a rise in the Fed's balance sheet. After an awkward moment when everyone thought Bernanke was going to break out laughing, Bernanke informed Paul that he was wrong- even though I did sense a humorous tone in the answer.
Answer: He probably didn't: Professor Bernanke had to inform Paul that inflation is the rise in the price of goods. Paul, for some reason unbeknown to me, thought that inflation was a rise in the Fed's balance sheet. After an awkward moment when everyone thought Bernanke was going to break out laughing, Bernanke informed Paul that he was wrong- even though I did sense a humorous tone in the answer.
Tuesday, July 21, 2009
Bernanke Calms Inflation Expectations
Today, July 21, Bernanke reported to Congress. This hearing was expected to be a challenge for Bernanke because he had to balance the markets expectations. On the one hand, some investors believe we have printed so much money that inflation is imminent. On the other hand, some believe the economy is still too fragile to quit stimulating the economy. Bernanke had to keep inflation expectations low while making sure others believed the Fed would continue growing the economy.
So, how did he do? The Bernanke Files gives him an A.
Why? Let's look at the numbers:
Remember, if bond interest rates go lower, INFLATION EXPECTATIONS ALSO GO LOWER. Here is the graph of what the rates did today:
Bond .....Change in Rate
5-Year ...... -.032
10-Year ...... -.030
20-Year ..... -.013
30-Year ..... -.026
As this data shows, interest rates clearly went lower today. Bernanke subdued any rational inflation expectations.
So, how did he do? The Bernanke Files gives him an A.
Why? Let's look at the numbers:
Remember, if bond interest rates go lower, INFLATION EXPECTATIONS ALSO GO LOWER. Here is the graph of what the rates did today:
Bond .....Change in Rate
5-Year ...... -.032
10-Year ...... -.030
20-Year ..... -.013
30-Year ..... -.026
As this data shows, interest rates clearly went lower today. Bernanke subdued any rational inflation expectations.
Thursday, July 16, 2009
The Truth Comes Out
The truth continues to seep out... great Americans like Henry Paulson are being persecuted by a bunch of cowards whose IQ's are inversely related to their egos (and their egos are famously high).
Today, July 16, Congressmen and Congresswomen railed Paulson for the action he took to fight the largest recessionary forces since 1933. Defending himself against accusations from Bank of America CEO Ken Lewis, Paulson made many enlightening statements. Initially, Paulson threw the Committee a curve ball when he admitted to telling Lewis that the Federal Reserve had the authority to relieve Lewis of his position if he enacted MAC. MAC (Materially Adverse Change) is a clause that says that once a company agrees to purchase a company, it can only back out of the deal under certain circumstances.
One could tell this was a curve ball because each Senator asked the same question: "Did you threaten to fire Lewis if he enacted MAC?" But this question needed to be asked only once because Paulson admitted to... what exactly? Well he informed Lewis that the Fed had the authority to remove him... a law that Congressmen approved! Clearly they did not expect Paulson to be so honest and so innocent at the same time. Of course the Secretary of the Treasury can inform someone of the law- that's his job. Clearly this blame game needs to end and Bernanke and Paulson need to be cleared of wrongdoing. As Ken Lewis himself said, "They were forceful, but I don't believe they acted illegally."
Some may think that even if Paulson only informed Lewis of the law, he should not have done even that. But think about it. Lewis, a terrible CEO in my opinion, SIGNED A CONTRACT to purchase Merrill Lynch. The conditions stated in the MAC clause, which is a standard clause that many mergers utilize, did not include worsening market conditions. This is because it takes a long time for mergers to go through (six months or so), and it would be stupid if a side could back out once they realized they made a bad investment. Additionally, it was several days from the time the contract was signed to the time Lewis questioned the deal, and the those several days could have been spent finding a new partner for Merrill Lynch.
Anyways, the Senators continued to embarrass themselves. One Senator from Ohio berated Paulson for how bad things were in her state. Paulson said that he realized things were bad, but said they would have been worse had TARP not passed. To this she answered, "If that's your answer, its not good enough." To this Paulson could easily have responded: "Well that's fine, but where was your plan? Where were you when I was planning and making the hard decisions? Show me one sentence from a plan that you put forward to save your state." He could have gotten up and walked out of the hearing in disgust, if you ask The Bernanke Files. Lets analyze this for a second. First, if she is mad that TARP didn't work, wouldn't it make sense that she had a plan that was better? In reality, she didn't have a plan and still doesn't have a plan. None of the Congressmen do. They will continue to attack the smart officials that get the job done... that is until another shock hits the system and they go running back into their little holes, hoping intelligent people like Paulson, Bernanke, Geithner, Hoenig, Kohn, Plosser, Fischer, and (dare I say it) Bush Jr can jump in and save them once again.
Today, July 16, Congressmen and Congresswomen railed Paulson for the action he took to fight the largest recessionary forces since 1933. Defending himself against accusations from Bank of America CEO Ken Lewis, Paulson made many enlightening statements. Initially, Paulson threw the Committee a curve ball when he admitted to telling Lewis that the Federal Reserve had the authority to relieve Lewis of his position if he enacted MAC. MAC (Materially Adverse Change) is a clause that says that once a company agrees to purchase a company, it can only back out of the deal under certain circumstances.
One could tell this was a curve ball because each Senator asked the same question: "Did you threaten to fire Lewis if he enacted MAC?" But this question needed to be asked only once because Paulson admitted to... what exactly? Well he informed Lewis that the Fed had the authority to remove him... a law that Congressmen approved! Clearly they did not expect Paulson to be so honest and so innocent at the same time. Of course the Secretary of the Treasury can inform someone of the law- that's his job. Clearly this blame game needs to end and Bernanke and Paulson need to be cleared of wrongdoing. As Ken Lewis himself said, "They were forceful, but I don't believe they acted illegally."
Some may think that even if Paulson only informed Lewis of the law, he should not have done even that. But think about it. Lewis, a terrible CEO in my opinion, SIGNED A CONTRACT to purchase Merrill Lynch. The conditions stated in the MAC clause, which is a standard clause that many mergers utilize, did not include worsening market conditions. This is because it takes a long time for mergers to go through (six months or so), and it would be stupid if a side could back out once they realized they made a bad investment. Additionally, it was several days from the time the contract was signed to the time Lewis questioned the deal, and the those several days could have been spent finding a new partner for Merrill Lynch.
Anyways, the Senators continued to embarrass themselves. One Senator from Ohio berated Paulson for how bad things were in her state. Paulson said that he realized things were bad, but said they would have been worse had TARP not passed. To this she answered, "If that's your answer, its not good enough." To this Paulson could easily have responded: "Well that's fine, but where was your plan? Where were you when I was planning and making the hard decisions? Show me one sentence from a plan that you put forward to save your state." He could have gotten up and walked out of the hearing in disgust, if you ask The Bernanke Files. Lets analyze this for a second. First, if she is mad that TARP didn't work, wouldn't it make sense that she had a plan that was better? In reality, she didn't have a plan and still doesn't have a plan. None of the Congressmen do. They will continue to attack the smart officials that get the job done... that is until another shock hits the system and they go running back into their little holes, hoping intelligent people like Paulson, Bernanke, Geithner, Hoenig, Kohn, Plosser, Fischer, and (dare I say it) Bush Jr can jump in and save them once again.
Tuesday, July 14, 2009
TARP Effectiveness: A Challenge
One job that economists enjoy is predicting what effects certain policies will have. This could be the effects of a policy from the government, or a policy enacted by a small business owner. Either way it is very important to look at the effects from as many sides as possible.
For example, when Congress passed the TARP legislation they basically agreed to purchase enough shares of certain banks available stock so that the investors THAT HELD BONDS WOULD BE BAILED OUT... the stockholders were not bailed out.
Let me explain. Large companies need to invest. 30% of the money they use to invest comes from selling bonds, not from profit or from the stock market. Bonds are popular purchases because they accrue a constant interest rate over several years and because they are much less risky than stocks. The reason stocks are more risky is because they "protect the bonds." In other words, if a company is headed towards bankruptcy, every penny of every stock becomes worth $0.00 before any bonds can be defaulted upon. Therefore, bonds are safer than stocks. In return for this protection stocks, obviously, have more potential for profit.
To clarify, use this analogy: pretend you are an archer in a medieval army. You, as an archer, wouldn't stand in the middle of the battlefield. You stand behind the frontline (the swordsman and shield-bearers and cavalry, etc.) The infantry, in other words, protects you from attacks. The archers are like the bonds of businesses, and the infantry is the stock market. The archers (bonds) are more important than infantry (stocks) and are therefore heavily protected.
TARP, in essence, did NOT bailout any shareholders (unless you consider stocks going from $100 to $2 a bailout). They injected just enough cash into the stock market to make sure the BONDHOLDERS were not touched. For that to happen, remember, they simply have to keep stock from going to $0.00.
So here is the challenge for Fellow Bernanke Fans: What future effects does TARP have on banking stocks (stockholders), bonds (bondholders), and bank CEO's and executives.
Here is an example from an MIT professor named Simon Johnson (www.baselinescenario.com). Johnson argues that CEO's of the future will not have an incentive to take excessive risks independently (like many pundits now argue), but they will have incentive to take excessive risks that all of the other CEO's are taking. This is because they realize that while they're bank may not be systemically important by itself, if all of the banks mess up than the government will bail them out so the economy does not go into a recession.
While I generally agree with Johnson, we know this is somewhat oversimplified. He is 100% correct if CEO's retire every couple of years, thus being able to sell their stocks at a high price. However, if the laws are changed so CEO's can only sell a certain amount of shares each year after retiring (and presumably close to none before retiring) than they will have an incentive to grow their company over the long term.
Anyways, if you can think of any effects that TARP may have on bonds, stocks and CEOs let us at The Bernanke Files know!
For example, when Congress passed the TARP legislation they basically agreed to purchase enough shares of certain banks available stock so that the investors THAT HELD BONDS WOULD BE BAILED OUT... the stockholders were not bailed out.
Let me explain. Large companies need to invest. 30% of the money they use to invest comes from selling bonds, not from profit or from the stock market. Bonds are popular purchases because they accrue a constant interest rate over several years and because they are much less risky than stocks. The reason stocks are more risky is because they "protect the bonds." In other words, if a company is headed towards bankruptcy, every penny of every stock becomes worth $0.00 before any bonds can be defaulted upon. Therefore, bonds are safer than stocks. In return for this protection stocks, obviously, have more potential for profit.
To clarify, use this analogy: pretend you are an archer in a medieval army. You, as an archer, wouldn't stand in the middle of the battlefield. You stand behind the frontline (the swordsman and shield-bearers and cavalry, etc.) The infantry, in other words, protects you from attacks. The archers are like the bonds of businesses, and the infantry is the stock market. The archers (bonds) are more important than infantry (stocks) and are therefore heavily protected.
TARP, in essence, did NOT bailout any shareholders (unless you consider stocks going from $100 to $2 a bailout). They injected just enough cash into the stock market to make sure the BONDHOLDERS were not touched. For that to happen, remember, they simply have to keep stock from going to $0.00.
So here is the challenge for Fellow Bernanke Fans: What future effects does TARP have on banking stocks (stockholders), bonds (bondholders), and bank CEO's and executives.
Here is an example from an MIT professor named Simon Johnson (www.baselinescenario.com). Johnson argues that CEO's of the future will not have an incentive to take excessive risks independently (like many pundits now argue), but they will have incentive to take excessive risks that all of the other CEO's are taking. This is because they realize that while they're bank may not be systemically important by itself, if all of the banks mess up than the government will bail them out so the economy does not go into a recession.
While I generally agree with Johnson, we know this is somewhat oversimplified. He is 100% correct if CEO's retire every couple of years, thus being able to sell their stocks at a high price. However, if the laws are changed so CEO's can only sell a certain amount of shares each year after retiring (and presumably close to none before retiring) than they will have an incentive to grow their company over the long term.
Anyways, if you can think of any effects that TARP may have on bonds, stocks and CEOs let us at The Bernanke Files know!
Friday, July 10, 2009
Bond Yield Basics
This week (7-03-09) there were several US Government Bond auctions. These are important to watch because the results from the auctions can give us a good idea of important economic indicators such as inflation, US deficits, and the US government's credit worthiness.
Here is how we examine the results of bond auctions. Bonds are denominated in two ways: the price and the yield. If the price goes up then the yield goes down, and vice versa. The easiest way to examine a bond is by the price. If you see that the price goes up (or the yield goes down) than you know that either the demand for the bond went up or the supply went down. This follows the same supply and demand idea as any other product you may purchase. So lets say the price does go up and the yield goes down. What implications could this have? First, it tells us that more people want bonds. These "customers" of the US believe a) that the US government will be able to pay them back and b) that inflation will not increase too much above the yield that they recieve the bond.
Here is how we examine the results of bond auctions. Bonds are denominated in two ways: the price and the yield. If the price goes up then the yield goes down, and vice versa. The easiest way to examine a bond is by the price. If you see that the price goes up (or the yield goes down) than you know that either the demand for the bond went up or the supply went down. This follows the same supply and demand idea as any other product you may purchase. So lets say the price does go up and the yield goes down. What implications could this have? First, it tells us that more people want bonds. These "customers" of the US believe a) that the US government will be able to pay them back and b) that inflation will not increase too much above the yield that they recieve the bond.
Tuesday, July 7, 2009
The Bernanke Files and Inflation
The Federal Reserve is constantly trying to successfully maintain acceptable levels of inflation and unemployment. Unfortunately this a balancing act because an excess of one is often the result of attempting to achieve the other. This is a difficult, thankless job for which the Federal Reserve receives much criticism. If unemployment levels go too high the Federal Reserve is blamed, if inflation goes too high the Federal Reserve is blamed.
However, we at The Bernanke Files have unbiasedly examined the plight of the Fed and the job that they have done in their unending balancing act. We conclude that, in general, the Federal Reserve has maintained realistic levels of both unemployment and inflation. More importantly, though, we have also found overwhelming evidence that shows that the Federal Reserve has learned from its mistakes! In the 1970s, after the Federal Reserve maintained policies that would lead to inflation, the Federal Reserve realized their mistake and reversed their position. This occurred on October 9, 1979, five months after Carter replaced Arthur Burns with Paul Volker as Chairman of the Federal Reserve. Inflation subsided, but unemployment skyrocketed. This occurred because of Volker's belief in the Monetarist Experiment which limited the printing of money. Investors didn't like this policy and reacted by not investing, thus driving unemployment to over 10%. By 1982, though, Reagan and Volker and Reagan realized the Monetarist Experiment emphasized inflation too much and ignored unemployment altogether, so they once again reversed their position by printing money until the cows came home. By the late 1980s inflation and unemployment have evened out.
The point of this little story is that while the balancing act the Fed must attempt on a continual basis is difficult, they are the right person for the job. The Bernanke Files looks at how efficiently the Federal Reserve has responded to this crisis and concludes the excessive inflation is nothing to worry about! Chairman Bernanke implemented never before seen policies to offset a potential Great Depression II, and it would be naive of us to say that he doesn't have as good of a playbook to offset inflation when the threat occurs (and we believe it will once the economy begins to recover).
However, we at The Bernanke Files have unbiasedly examined the plight of the Fed and the job that they have done in their unending balancing act. We conclude that, in general, the Federal Reserve has maintained realistic levels of both unemployment and inflation. More importantly, though, we have also found overwhelming evidence that shows that the Federal Reserve has learned from its mistakes! In the 1970s, after the Federal Reserve maintained policies that would lead to inflation, the Federal Reserve realized their mistake and reversed their position. This occurred on October 9, 1979, five months after Carter replaced Arthur Burns with Paul Volker as Chairman of the Federal Reserve. Inflation subsided, but unemployment skyrocketed. This occurred because of Volker's belief in the Monetarist Experiment which limited the printing of money. Investors didn't like this policy and reacted by not investing, thus driving unemployment to over 10%. By 1982, though, Reagan and Volker and Reagan realized the Monetarist Experiment emphasized inflation too much and ignored unemployment altogether, so they once again reversed their position by printing money until the cows came home. By the late 1980s inflation and unemployment have evened out.
The point of this little story is that while the balancing act the Fed must attempt on a continual basis is difficult, they are the right person for the job. The Bernanke Files looks at how efficiently the Federal Reserve has responded to this crisis and concludes the excessive inflation is nothing to worry about! Chairman Bernanke implemented never before seen policies to offset a potential Great Depression II, and it would be naive of us to say that he doesn't have as good of a playbook to offset inflation when the threat occurs (and we believe it will once the economy begins to recover).
Saturday, July 4, 2009
An important indicator
Since this recession began with a freezing of the credit markets, indicators that measure the health of the credit markets are extremely important. In October 2008, Alan Greenspan made a speech arguing that the credit markets would not return to normal until the LIBOR-OIS spread returned to "normalcy." This post will attempt to explain what the LIBOR-OIS spread is and its importance/background to the current recession.
Essentially what the LIBOR-OIS spread does is measure the difference between the interest rates that banks can borrow from each other for and what they can borrow from the Federal Reserve for. LIBOR stands for the London InterBank Offering Rate. Each day, economists in London call about 50 banks spread throughout the world and ask them how much they charged (what the interest rate was) other banks to borrow from them. This "interbank" market is very important because banks can borrow from other banks to maintain healthy Reserve requirements. With out the interbank market, banks would be like you and me and the average business would be without banks: always in danger of being unable to invest or even to pay bills.
The OIS stands for the Overnight Index Swap and measures the interest rate that large banks are charged to get a loan from the government. It is just another tool to ensure the health and well being of financial institutions.
Whatever the difference is between the LIBOR and the OIS measures the willingness banks are to lend to other banks. If Bank A thinks Bank B is going out of business tomorrow they will not lend them money or they will charge them very high interest rates. So if LIBOR sky rockets, something in the economy is screwing with bankers confidence and this is never a good thing.
The average LIBOR-OIS spread (spread being the difference between the two) was .1% for the 18 months leading up to the recession. For example, the LIBOR was at 2.9% and the OIS was at 2.8%. A huge exogenous shock occurred on September 8, 2008: Lehman Brothers was allowed to file for bankruptcy. This sent the LIBOR to 6%, while the OIS remained constant (at about 3%). That means that the LIBOR-OIS spread went up to 3.00%- ten times the average spread!!!
At this point, the failure of Lehman Brothers, everything went awry. Within a few hours, AIG was on the brink of bankruptcy, WAMU went bankrupt, Wachovia went bankrupt. The stock market plummeted and people finally started paying attention to how bad the mortage backed security market really was.
It was also at this point that Bernanke started enacting drastic measures to increase lending. Using the LIBOR-OIS spread as a gauge, he implemented a plan that would increase the Fed's balance sheet (and thus the money supply) to increase the financial systems ability to lend money to other institutions.
Essentially what the LIBOR-OIS spread does is measure the difference between the interest rates that banks can borrow from each other for and what they can borrow from the Federal Reserve for. LIBOR stands for the London InterBank Offering Rate. Each day, economists in London call about 50 banks spread throughout the world and ask them how much they charged (what the interest rate was) other banks to borrow from them. This "interbank" market is very important because banks can borrow from other banks to maintain healthy Reserve requirements. With out the interbank market, banks would be like you and me and the average business would be without banks: always in danger of being unable to invest or even to pay bills.
The OIS stands for the Overnight Index Swap and measures the interest rate that large banks are charged to get a loan from the government. It is just another tool to ensure the health and well being of financial institutions.
Whatever the difference is between the LIBOR and the OIS measures the willingness banks are to lend to other banks. If Bank A thinks Bank B is going out of business tomorrow they will not lend them money or they will charge them very high interest rates. So if LIBOR sky rockets, something in the economy is screwing with bankers confidence and this is never a good thing.
The average LIBOR-OIS spread (spread being the difference between the two) was .1% for the 18 months leading up to the recession. For example, the LIBOR was at 2.9% and the OIS was at 2.8%. A huge exogenous shock occurred on September 8, 2008: Lehman Brothers was allowed to file for bankruptcy. This sent the LIBOR to 6%, while the OIS remained constant (at about 3%). That means that the LIBOR-OIS spread went up to 3.00%- ten times the average spread!!!
At this point, the failure of Lehman Brothers, everything went awry. Within a few hours, AIG was on the brink of bankruptcy, WAMU went bankrupt, Wachovia went bankrupt. The stock market plummeted and people finally started paying attention to how bad the mortage backed security market really was.
It was also at this point that Bernanke started enacting drastic measures to increase lending. Using the LIBOR-OIS spread as a gauge, he implemented a plan that would increase the Fed's balance sheet (and thus the money supply) to increase the financial systems ability to lend money to other institutions.
Creating Money
There are several ways the Federal Reserve can print money. The federal government cannot print money, though they are often accused of doing so. This blog will discuss the implications of how money is printed.
In 2008, the federal government (and by this I mean the President's office and Congress) ran a $1 trillion deficit. This means they spent $1 Trillion that they didn't have. This doesn't mean that they printed $1 trillion. To pay for the deficit the government goes to the Treasury and asks them to print $1 trillion in bonds. The government then has to sell the bonds in exchange for cash to pay for the $1 trillion deficit. Remember, though, that cash used to pay for bonds is already in existence. The government is taking money from one group of people and giving it to another group of people. The monetary base does not grow.
The Federal Reserve can print money and this done in several different ways. What most people think of when they hear that the Federal Reserve is printing money is actually called "monetizing the debt." This occurs when the Federal Reserve prints cash and pays for the bonds the government printed to fund their deficit.
The Federal Reserve can also print money in other ways as well. They can utilize OMO's (Open Market Operations) to print money. This occurs when the Federal Reserve buys bonds from private dealers (banks, hedge funds, etc.). A multiplier effect occurs when OMO's are utilized. Another way the Federal Reserve can create money is by lowering the Reserve Requirement. When the average person deposits money into a bank, the bank profits from the deposit by loaning the money to other people. However, to ensure safety for depositors, banks can only loan a certain amount of the deposit, usually about 80%. The remaining 20% is the reserve requirement and is fairly innefficient because it just sits in the bank constricting supply of loans thus raising the price of loans.
To put these in perspective of the current recession, I have accumulated some of the stats for what has occurred to the money supply over the last several months. Only about $35 Billion have been monetized. Currently, the Fed will escalate these purchases until they reach $350 Billion. The Reserve requirement has been unchanged since the beginning of the recession. The most interesting money creation that has occurred over that last year has been the OMO's that have occurred. The Fed's balance sheet has expanded from $800 Billion to over $2 Trillion dollars. Initially, the Fed offset all purchases of private bonds (they purchased bonds from private companies like Lehman Brothers) by selling an equivalent amount of short term government bonds. Once they realized that the credit markets had siezed up, they began expanding the balance sheet (which expands the money supply) by purchasing bonds from private banks. This added money and therefore liquidity to banks, allowing them to loan more money to borrowers in an attempt to stimulate the economy. Inflation is almost sure to follow if the economy recovers before the Fed has time to unwind the purchases from the OMO's.
In 2008, the federal government (and by this I mean the President's office and Congress) ran a $1 trillion deficit. This means they spent $1 Trillion that they didn't have. This doesn't mean that they printed $1 trillion. To pay for the deficit the government goes to the Treasury and asks them to print $1 trillion in bonds. The government then has to sell the bonds in exchange for cash to pay for the $1 trillion deficit. Remember, though, that cash used to pay for bonds is already in existence. The government is taking money from one group of people and giving it to another group of people. The monetary base does not grow.
The Federal Reserve can print money and this done in several different ways. What most people think of when they hear that the Federal Reserve is printing money is actually called "monetizing the debt." This occurs when the Federal Reserve prints cash and pays for the bonds the government printed to fund their deficit.
The Federal Reserve can also print money in other ways as well. They can utilize OMO's (Open Market Operations) to print money. This occurs when the Federal Reserve buys bonds from private dealers (banks, hedge funds, etc.). A multiplier effect occurs when OMO's are utilized. Another way the Federal Reserve can create money is by lowering the Reserve Requirement. When the average person deposits money into a bank, the bank profits from the deposit by loaning the money to other people. However, to ensure safety for depositors, banks can only loan a certain amount of the deposit, usually about 80%. The remaining 20% is the reserve requirement and is fairly innefficient because it just sits in the bank constricting supply of loans thus raising the price of loans.
To put these in perspective of the current recession, I have accumulated some of the stats for what has occurred to the money supply over the last several months. Only about $35 Billion have been monetized. Currently, the Fed will escalate these purchases until they reach $350 Billion. The Reserve requirement has been unchanged since the beginning of the recession. The most interesting money creation that has occurred over that last year has been the OMO's that have occurred. The Fed's balance sheet has expanded from $800 Billion to over $2 Trillion dollars. Initially, the Fed offset all purchases of private bonds (they purchased bonds from private companies like Lehman Brothers) by selling an equivalent amount of short term government bonds. Once they realized that the credit markets had siezed up, they began expanding the balance sheet (which expands the money supply) by purchasing bonds from private banks. This added money and therefore liquidity to banks, allowing them to loan more money to borrowers in an attempt to stimulate the economy. Inflation is almost sure to follow if the economy recovers before the Fed has time to unwind the purchases from the OMO's.
Friday, July 3, 2009
The Grilling of the Fed Chair
James Hamilton, a renowned economist and econometrician, recently defended Chairman Bernanke from the angry, condescending attacks waged against Bernanke by several Congressmen. Being a close follower of Hamilton's blog, which can be found at www.econbrowser.com, I paid close attention the responses made by other Hamilton followers. I was immediately struck by the number of responses that were created. An average Hamilton post recieves 10 replies. This post had hundreds of replies!! I closely examined as many of them as I could and found that the vast majority were Bernanke-haters!!!
One can draw many important conclusions from comparing the amount of anti-Bernanke replies to the average amount of regular post replies. First, it shows us that people in general recieve more satisfaction from unfairly criticizing things they don't understand than they do from contemplating difficult economic theories and replying with a well-thought out response. I believe this is called Monday morning quarterbacking in the sports world. It also gives us good insight to those who are criticizing Bernanke, and might even suggest that their ethos is lacking. I say this because if you can't even come up with an intelligent response to issues that have been clearly presented and explained, why would you think that you could come up with a plan to battle the worst economic downturn in 70 years?
This leads me to the main point of this blog: Bernanke was the man with a plan. Others (inlcuding Congressman) were not. These other people became insecure and did what the average person does- belittles those with a plan to make themselves feel bigger. The repliers and Congressmen have this in common. They have no idea what they are doing, they subconciously realize this and therefore compensate for their shortcomings by tearing others down to their level.
One can draw many important conclusions from comparing the amount of anti-Bernanke replies to the average amount of regular post replies. First, it shows us that people in general recieve more satisfaction from unfairly criticizing things they don't understand than they do from contemplating difficult economic theories and replying with a well-thought out response. I believe this is called Monday morning quarterbacking in the sports world. It also gives us good insight to those who are criticizing Bernanke, and might even suggest that their ethos is lacking. I say this because if you can't even come up with an intelligent response to issues that have been clearly presented and explained, why would you think that you could come up with a plan to battle the worst economic downturn in 70 years?
This leads me to the main point of this blog: Bernanke was the man with a plan. Others (inlcuding Congressman) were not. These other people became insecure and did what the average person does- belittles those with a plan to make themselves feel bigger. The repliers and Congressmen have this in common. They have no idea what they are doing, they subconciously realize this and therefore compensate for their shortcomings by tearing others down to their level.
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