Economy | - Part 10

Bernanke! Do Something!

It would appear that the magic elixir of a two-year pledge for freakishly low interest rates from the Federal Reserve has an effective life of only about 18 hours since, after yesterday’s remarkable 400+ point move higher for the Dow Jones Industrial Average, that gain has been reversed in trading today, markets effectively telling Ben Bernanke and the rest of the staff at the central bank, “What else you got?”

Recall that, yesterday, the Fed fired off the first of a possible three shots that could be seen prior to what some analysts predict will be another $1 trillion or so in outright money printing to buy government debt or some other asset that, if all goes well, would goose the markets for another six months or so, just like it did last year.

After the low rate promise yesterday, what’s likely to be heard next from the Fed is: a) they intend to lower the interest paid on excess reserves to compel banks to lend a little more, or b) they’re going to fiddle with the two trillion dollars in assets they’ve purchased in recent years to somehow convince somebody to do something that would somehow right the quickly sinking ship.

Neither of these steps are likely to have a more lasting impact than yesterday’s move, so, what we’re really looking at here is either the Fed can embark on QE3 and, if all goes well, boost asset prices until mid-2012, or they can sit on their hands and watch the stock market fall further while the jobless rate rises.

Based on the three dissenting votes for yesterday’s action, any subsequent moves by the Fed will be met with similar disapproval by some voting members, however, that’s not likely to stop the doves from printing up another trillion dollars or so for the greater good.

After yesterday’s baby step in that direction, Goldman Sachs said today that QE3 sometime later this year or in early-2012 is now likely and, based on how markets are moving today, it’s hard to disagree with that view, the only variable seeming to be the size and the timing.

With the Dow now closing in on bear market territory while other stock indexes have already breached that level, you’d think that it won’t take too much more of this for the Fed to act. Moreover, the only way that we’ll likely make it to the Jackson Hole group therapy session in two weeks (where a major policy initiative could be announced) without an even more severe breakdown in equity markets is if all the Fed doves start making speeches about QE3 – when, how much, and how they see this as the best of a handful of policy options.

They’re probably already working on those speeches…

Christina Romer Sums It Up

Appearing on Real Time with Bill Maher on Friday, shortly after the announcement that Standard & Poor’s had downgraded the U.S. credit rating, Christina Romer, former chair of the White House Council of Economic Advisers, reflected on our current condition.

I suppose this would just be funny rather than both funny and disturbing had Romer not uttered the line with a giggle in her belly and a twinkle in her eye. As it was, viewers were left with the impression that: a) she’s quite happy to be thousands of miles away from Washington, and b) we really are ‘Pretty Darn F**ked’.

Not Just Semantics

Kenneth Rogoff, co-author of This Time is Different: Eight Centuries of Financial Folly, makes a number of very good points in this commentary at Project Syndicate, points that, with the latest downturn for the economy, may finally sink in with policy makers.

Why is everyone still referring to the recent financial crisis as the “Great Recession”? The term, after all, is predicated on a dangerous misdiagnosis of the problems that confront the United States and other countries, leading to bad forecasts and bad policy.

The phrase “Great Recession” creates the impression that the economy is following the contours of a typical recession, only more severe – something like a really bad cold. That is why, throughout this downturn, forecasters and analysts who have tried to make analogies to past post-war US recessions have gotten it so wrong. Moreover, too many policymakers have relied on the belief that, at the end of the day, this is just a deep recession that can be subdued by a generous helping of conventional policy tools, whether fiscal policy or massive bailouts.

But the real problem is that the global economy is badly overleveraged, and there is no quick escape without a scheme to transfer wealth from creditors to debtors, either through defaults, financial repression, or inflation.

A more accurate, if less reassuring, term for the ongoing crisis is the “Second Great Contraction.” Carmen Reinhart and I proposed this moniker in our 2009 book This Time is Different, based on our diagnosis of the crisis as a typical deep financial crisis, not a typical deep recession. The first “Great Contraction” of course, was the Great Depression, as emphasized by Anna Schwarz and the late Milton Friedman. The contraction applies not only to output and employment, as in a normal recession, but to debt and credit, and the deleveraging that typically takes many years to complete.

Why argue about semantics? Well, imagine you have pneumonia, but you think it is only a bad cold. You could easily fail to take the right medicine, and you would certainly expect your life to return to normal much faster than is realistic.

Conventional recessions and deep financial crises are fundamentally different, Rogoff goes on to explain, lamenting the policy makers lamenting that stimulus programs haven’t been big enough when, in fact, the emphasis should have been placed on ridding the financial system of the bad debt that accumulated prior to the crisis.

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Have You Seen M3 Lately?

Ambrose Evans-Pritchard mentioned the remarkable resurrection of the M3 monetary aggregate in this story at the Telegraph today, hopeful that the rising number of dollars will help resurrect the U.S. economy. Since I’d not seen it in some time, it seemed like a good idea to look up nowandfutures for the latest chart.

I’m not sure this is good or bad – Ambrose seems to think quite bullish for us Americans. But, anytime you get the money supply growing at a high multiple of the growth in the population, you’re asking trouble, and that’s what we got in 2008.  I wouldn’t be surprised if this generates a little inflation trouble here in the West in the not-too-distant future.

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Debt Crisis Over, Economic Crisis Returns

I’m starting to think that the whole reason the debt ceiling debate was extended to consume most of the media’s airtime last weekend was to divert attention from the dismal report on Q2 economic growth on Friday and the horrendous effects of data revisions going back three years, the most important having to do with the economy’s current trajectory.

There’s more on this subject in Tales from the GDP Revisions at EconBrowser, a post that also includes a comprehensive set of related links. In summary, the recession was much deeper than previously believed, the recovery a bit weaker, and the most recent trend shows a fairly disturbing deterioration in that recovery.

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