St. Louis Fed Chief Says Fed Must Inflate Money Supply More Aggressively

Considering the AMB and the narrow money figures went parabolic, with the greatest increase in Fed history, these are somewhat unusual words from a Fed official.

Best to take him at his word. He is only saying the truth about what the Fed is already doing. This sounds like a classic misdirection.

Let's guess. In order to save us he Fed should give more money to the big money center banks through Fed programs? The Fed should buy bad assets at par from unconventional parties like every large corporation with bad debts? The Fed should more aggressively debase the currency and to transfers the wealth of savers of to those who caused this crisis?

This ought to be fun to watch.


Bloomberg
Fed Should Expand Supply of Money, Bullard Says
By Scott Lanman and Anthony Massucci

Feb. 17 (Bloomberg) - Federal Reserve Bank of St. Louis President James Bullard said the U.S. faces a risk of “sustained deflation” and called on the central bank to avert a decline in prices by expanding the money supply.

The prospect of deflation is a “significant downside risk” and may increase home foreclosures, Bullard said in a speech today in New York. Adopting a target “rapid” growth rate for the monetary base, which includes money in circulation and banks’ reserve deposits with the Fed, should “head off any incipient deflationary threat,” he said.

Bullard is one of a few Fed officials to advocate a new policy tool after the Federal Open Market Committee in December cut its main interest rate almost to zero. The central bank is using money-creation authority to put assets such as home loans on its balance sheet, aiming to unfreeze credit and end the longest recession since 1982.

“By expanding the monetary base at an appropriate rate, the FOMC can signal that it intends to avoid the risk of further deflation and the possibility of a deflation trap,” Bullard said in prepared remarks to the New York Association for Business Economics.

He didn’t propose a specific figure for the target.

The FOMC said in its Jan. 28 statement that there’s “some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.”

Growth Target

The FOMC at its December meeting discussed setting a target for growth in measures of money, such as the monetary base. While a “few” policy makers favored a numerical goal for money growth, most preferred a more open-ended “close cooperation and consultation” with the Fed board on how to expand assets and liabilities, according to minutes of the session.

Bullard’s warning about deflation is stronger than comments by other central bank officials. Chicago Fed President Charles Evans said Feb. 11 that he’s “not tremendously concerned about deflation.”

Bullard told reporters after the speech he supports the adoption of an inflation target to prevent expectations for prices from falling too far. A target for inflation “would be helpful at this time,” he said.

“You have to consult with all players, including Congress,” he said. “If they don’t want to do it, then we don’t do it.”

Congressman Asks Fed to Stop Ignoring Requests for Transparency

Bloomberg
Boehner Demands Fed Identify Recipients of Loans
By Laura Litvan

Nov. 12 - House Republican leader John Boehner called for the Federal Reserve to disclose the recipients of almost $2 trillion of emergency loans from American taxpayers and the troubled assets the central bank is accepting as collateral.

Boehner, in a prepared statement, also asked the Federal Reserve to comply with a Freedom of Information Act request seeking details about the loans.

The Fed ``should comply with this Freedom of Information Act request, and in the interest of full and fair disclosure, they must begin providing lawmakers and taxpayers all information about how they are using federal tax dollars,'' Boehner said.

Fed Chairman Ben S. Bernanke and Treasury Secretary Henry Paulson said in September they would comply with congressional demands for transparency in a $700 billion bailout of the banking system. Two months later, as the Fed lends far more than that in separate rescue programs that didn't require approval by Congress, there is little disclosure about how the programs are being implemented.

Bloomberg News requested details of the Fed lending under the U.S. Freedom of Information Act and filed a federal lawsuit Nov. 7 seeking to force disclosure.

A spokesman for the Federal Reserve didn't immediately respond to requests for comment.

`Oversight, Transparency'

Boehner said he is increasingly concerned that the government's actions to add stability to financial markets is moving into areas that were not the stated intention when Congress approved $700 billion for a Treasury-administered program to bail out the financial sector that is being weighed down by the housing crisis.

``During the bipartisan negotiations between Congress and the administration, members of both parties made clear that Congress must have meaningful oversight over the use of taxpayer dollars,'' Boehner said. ``Transparency is even more important now, given that the program appears to have been implemented in some ways that were given little to no discussion as Congress was being urged to pass the rescue plan.''

Senator John Cornyn of Texas, a member of the Republican leadership, said the lack of disclosure ``should trouble taxpayers and policymakers alike.''

``There cannot be accountability in government and in our financial institutions without transparency,'' he said. ``Many of the financial problems we are facing today are the direct result of too much secrecy and too little accountability.''

Representative Scott Garrett, a New Jersey Republican who serves on both the Financial Services and Banking committees, said ``it's impossible to get to the bottom of where we are because we don't have transparency.''

Recessions and the SP 500

Paul Kasriel's latest reading of his proprietary tea leaves (a blend known as the Kasriel Recession Warning Indicator) estimates the current probability of a recession in the US economy at 65%. As the chart shows, once his KRWI reaches this critical level its a strong probability that we will see an economic recession call by the National Bureau of Economic Research (NBER). Even the period following the tech wreck of 2000 eventually read out a formal recession, although the financial engineering of the Fed and federal friends did block the traditional back to back quarters of economic contraction, as the inflation reading is subtracted from the nominal GDP number to develop real GDP. Hard as it may be to believe, the government has simply changed the rules of the game for measuring price inflation in the US, and considerably enough that what used to be a recession may no longer be called one. Changing the rules of the game is a traditional method of the privileged and elite in achieving their goals.

We give a lot of credibility to Paul Kasriel in general, as a classic macro economist who seems unaffected by the dark pollution of biased thought that corporatism has brought to an already dismal and confounding science. The Leading Economic Indicators (LEI) are already calling out recession, and as you know, the classic inversion of the Yield Curve (Ten Year Treasury Yield - Effective Fed Funds Rate) is still negative as of the Fed's official numbers last week.

So it bothers us quite a bit that the stock market, that great discounter of the future and unerringly efficient prognosticator of economic things yet unseen, is presumed to be rallying back to new all time highs, even if only on a nominal level, not accounting for inflation. We show the SP deflated by gold in this chart, and as you can see, the rebound in US stocks is a bit of a mirage. If the bad times are when the tide goes out and shows who's naked, then inflation is the hurricane storm surge that pushes the waters back in, to provide cover for those au naturel.

By the way, the perception of inflation, or inflation expectations, is not incidental, but rather is absolutely key to the kind of financial engineering that neo-Keynesian economists that infest the Fed and Treasury wish to embrace as the ripe fruits of a fiat monetary system. Don't think for one minute that what is happening with M3, CPI revisions, etc. are a mere coincidence. Its all about control of the many by the few, after all.

So what about the stock market? We decided to try and plot out Kasriel's indicator of recessions against the SP 500. Since the nominal SP is also a trend child of inflation, we wanted to get a measure of SP that tends to take out the inflationary trend, and show us the purer wiggles that stocks make in response to the anticipation of economic variations.

If in fact we are on the verge of a recession, the SP500 will likely be in the process of making a top. We might see another push higher by the broad stock indices in response to the unprecedented monetary stimulus being applied by the banks. But even with this latest phase in the financial engineering experienment currently in progress, within the next two months we should see a confirming signal from the equity markets that the economy is turning lower in real terms AND has started contracting, even if the current set of official economic measures say otherwise.

We underestimated the Fed and their banker buddies in the great reflation of 2003-2004, finally catching on to the game after some painful soul searching and genuine confusion. The July 2004 working paper from Small and Close of the Fed, which basically tried to set some boundaries in how far the Fed could go in monetizing things non-traditional was a good clue, well before the infamous speech about the Fed's printing press that gave Helicopter Ben his sobriquet.

So we will strive to not be fooled again, and keep an open mind that the fighting of the housing bubble and massive credit fraud by the banks could have a short term second order effect of inflating the stock markets, along with most other commodities, especially gold and oil. One thing we are certain is that the next twelve months may be among the most interesting we have seen, and can only wonder what we all might be saying about things at this time next year.

Recession: Straight Up, With a Twist

There is a significant debate going on in economic and financial circles about the odds for a recession in the United States in 2008. In fact we heard on Bloomberg Television a savant saying that it is unthinkable that the economy could decline to negative so quickly from its current positive growth.

Definition of a recession

The textbook definition of a recession is two consecutive quarters of negative growth in real GDP. This definition has been problematic in this decade however, because of the tinkering that our government has done with the measures of inflation. As you know, real GDP is GDP deflated by the inflation rate. The official deflator used for GDP is called the GDP chain deflator.

The National Bureau of Economic Research (NBER) recognized this and determined that there was a recession in the US in 2001 from March through November, even though the quarter to quarter real GDP annualized growth rates for the four quarters of 2001 were -0.5%, 1.2%, -1.4% and 1.6%. As you can see, we did not have two consecutive quarters of real GDP declines. How does the NBER explain this?

"Most of the recessions identified by our procedures do consist of two or more quarters of declining real GDP, but not all of them. According to current data for 2001 [as of October 2003], the present recession falls into the general pattern, with three consecutive quarters of decline. Our procedure differs from the two-quarter rule in a number of ways. First, we consider the depth as well as the duration of the decline in economic activity. Recall that our definition includes the phrase, 'a significant decline in economic activity.' Second, we use a broader array of indicators than just real GDP [including personal income, employment, industrial production and manufacturing/trade sales]. One reason for this is that the GDP data are subject to considerable revision. Third, we use monthly indicators to arrive at a monthly chronology."

The point of this diversion is to define what a recession is, although it cannot be so neatly compartmentalized to such a simple formula, especially in these times of government revision of economic data.

A quick look at the chart at John Williams' excellent site, Shadow Government Statistics will give you the idea of how the notion of Consumer Price Inflation has been distorted by the Clinton and Bush administrations. Inflation has a direct effect on real GDP, and therefore on the formal definition of recessions. Of course, it has a real impact on lots of other things including consumer and voter sentiment, and Social Security and other cost of living increases, which is a strong incentive for the government to down play inflation.


Advance Indicators of Recession

We tend to favor the US Treasury yield curve as a significantly reliable indicator of approaching recessions. Here is a description of the classic definition from Paul Kasriel of Northern Trust:

"...each of the past six recessions (shaded areas) was preceded by an inversion in the spread between the Treasury 10-year yield and the fed funds rate. But there were two other instances of inversion - 1966:Q2 through 1967:1 and 1998:Q3 through 1998:Q4 - immediately after which no recession occurred. It would appear, then, that an inverted yield curve is more of a necessary condition for a recession to occur, but not a sufficient condition. That is, if the spread goes from +25 basis points and to -25 basis points, a recession is not automatically triggered. Rather, whether an inversion results in a recession would seem to depend on the magnitude of the inversion and, to a lesser extent, the duration of it. Recession-signaling aside, the yield curve remains a reliable leading indicatorof economic activity. Although the spread going from +25 basis points to -25 basis points might not result in a recession, it does indicate that monetary policy has become more restrictive." That's the current theory, but has it? Has the growth of US money supply been restrictive?

Has Monetary Policy Been Restrictive?

The most alarming thing to us is that despite the inverted yield curve and the Fed funds tightening we just witnessed over the last few years, from historic lows to the 5+% level, monetary policy has not only NOT been restrictive, it has been what many would define as loose. When one looks at real interest rates we had been in a prolonged period of negative interest rates, and only recently had been back in the positive area. It appears that we might be slipping back down into the negative again as the Fed tries to forestall the impending recession and the collapse of the stock - housing bubbles.

It appears to us that even while the Fed feigned monetary conservatism with the right hand, with the left hand they were doing all that was in their power to encourage the reckless growth of credit and the lowering of regulatory oversight and market discipline. To use an analogy, they were preaching energy conservation while running every light on in the house, the backyard, the neighbors house, and slipping pennies into the fuse box to keep it all going. Well, here we are.

What we are seeing is true moral hazard, the unintended consequence of the financial engineering being practiced by the wizard's apprentices at the Fed helping to nuture market distortions, asset bubbles, and imbalances that have become too big to correct naturally without systemic risk. Even though one can mask one's actions with words, and use information selectively and slyly to dampen the alarms and misdirect the public awareness, the chickens will come home to roost, and in this case they are more like the nemesis of retribution for our many economic trespasses. Let us hope that it is not as bad this time as the last time the Fed tried short circuit market discipline and engineer the economy centrally. We believe that the next twenty years or so will provide a rich opportunity for study, and probably the rise another new theory, a new school of economics, that tries to account for exactly what happened and why.

We are old enough to remember that stagflation, now seemingly so familiar, was once considered an improbability, a black swan. In the 1970's stagflation was triggered by an exogenous supply shock in the disruption in the market pricing of crude oil, impacting a slowing economy in monetary inflation from the post-Nixon era and the abandonment of the vestiges of the gold standard. The tonic that time was the tough monetary love of Paul Volcker.

What will they call it when a slowing economy with monetary inflatin is hit with a currency shock, as the dollar is displaced as the reserve currency of the world? We're not sure what they will call what we are about to experience, except on the bigger scale of thing, it will be just another episode in the hubris of arrogant men who consider themselves to be above principle, above the rules.

Professor Marvel Never Guesses. He Knows!

Is it likely that a fresh look at the economic data had Ben Bernanke and Don Kohn doing a sharp about face on the balance of risks to the economy? Given the speed with which their change in policy was communicated, catching a fellow Fed head flatfooted in spouting the party line the day before, it seems more probable that something on the order of one or more major players started to spew smoke from the cracks in their mark to moonbeams calculations, and Hank made that call to the Professor.

We obviously don't know, but suspect this revelation was connected with a subprime contagion affecting the derivatives markets. If derivatives are Weapons of Mass Destruction, then the Credit Default Swaps market is the H Bomb. Credit Default Swaps, if they start unwinding, can develop a chain reaction that will take out a fair chunk of the real economy, in addition to two or three big name corporations.

Subprime had the Fed a little concerned; CDS has them staring into the abyss and shitting their pants. Aren't you glad we have men so familiar with the mistakes the Fed made in 1929 to 1932 with regard to Fed Policy? We wish they had at least audited the courses covering the Fed's mistakes form 1921 to 1929. Sure, they are the experts; we're just concerned that they may be preparing to fight the last war.

Citizen Kohn

US equity markets just had the largest two day rally in the last four years. The trigger for this rally, besides the happy coincidence of a surfeit of hot money, lots of short sellers, and end of month motivation was an interesting speech by the Federal Reserve vice-chairman Don Kohn to the Council on Foreign Relations this morning.

As you may recall, Mr. Kohn is the second most powerful member of the board, and only he and the chairman, Mr. Bernanke, are allowed to make speeches that may signal changes in Fed policy. What you may not know is that he is also the consummate Fed long term insider:

Dr. Kohn is a veteran of the Federal Reserve System. Before becoming a member of the Board, he served on its staff as Adviser to the Board for Monetary Policy (2001-02), Secretary of the Federal Open Market Committee (1987-2002), Director of the Division of Monetary Affairs (1987-2001), and Deputy Staff Director for Monetary and Financial Policy (1983-87). He also held several positions in the Board's Division of Research and Statistics: Associate Director (1981-83), Chief of Capital Markets (1978-81), and Economist (1975-78). Dr. Kohn began his career as a Financial Economist at the Federal Reserve Bank of Kansas City (1970-75).

There is a consensus among informed observers that Vice Chair Kohn signaled, contrary to the pronouncements of several lesser Fed lights in recent days, a fresh persuasion of the Fed to cut the Fed Funds rate this December 11, because of a deterioration in the capital markets and the real economy.

Is that all there is? A likely 25 basis point cut in the target Fed funds rate in December triggers one of the most powerful rallies in US equities this decade? Is a simple 25 basis point cut good for all that?

Well, we don't think as naively and simply as all that. Its the end of month, there was about a solid two days of float on short side at daily volumes, and the Fed and Treasury have been spooning out liquidity like K Street lobbyists handing out donations during election season.

Still, this is an exceptionally powerful rally. There has been no real 'good news' excepting a tsunami of excess dollars may be coming back at us from overseas, as witnessed by Abu Dhabi doing something more useful with their dollar reserves than letting them depreciate.

No. Its got to be more than that. So we did the unlikely thing among most investors and financial pundits these days, and in addition to sound bytes and commentary from the Babel-Babes of Bubblevision, we looked for a copy of the text of Mr. Kohn's speech, and actually read it.

Here to us seems to be a somewhat overlooked portion of his speech, in terms of what commentary we have seen so far. From the text of his speech:

Moral Hazard

Central banks seek to promote financial stability while avoiding the creation of moral hazard. People should bear the consequences of their decisions about lending, borrowing, and managing their portfolios, both when those decisions turn out to be wise and when they turn out to be ill advised. At the same time, however, in my view, when the decisions do go poorly, innocent bystanders should not have to bear the cost.

In general, I think those dual objectives--promoting financial stability and avoiding the creation of moral hazard--are best reconciled by central banks' focusing on the macroeconomic objectives of price stability and maximum employment. Asset prices will eventually find levels consistent with the economy producing at its potential, consumer prices remaining stable, and interest rates reflecting productivity and thrift.

Such a strategy would not forestall the correction of asset prices that are out of line with fundamentals or prevent investors from sustaining significant losses. Losses were evident early in this decade in the case of many high-tech stocks, and they are in store for houses purchased at unsustainable prices and for mortgages made on the assumption that house prices would rise indefinitely.

To be sure, lowering interest rates to keep the economy on an even keel when adverse financial market developments occur will reduce the penalty incurred by some people who exercised poor judgment. But these people are still bearing the costs of their decisions and we should not hold the economy hostage to teach a small segment of the population a lesson."

THAT was the heart of the signal, the change in policy that Mr. Kohn was embracing on behalf of the Fed. Moral hazard is not an issue when bailing out the banks of Wall Street, for the simple reason that innocent bystanders might be harmed in the process. A noble sentiment indeed. The banks, however repugnant, depraved, and venal they might become, are just too big to fail.

"But these people are still bearing the costs of their decisions..."

What costs? We won't go into a lengthy diatribe on the huge numbers of insiders who are most assuredly NOT being hurt one little bit in this wild West sideshow of a financial market, light on regulation and long on collusion. In fact we are absolutely appalled at what Wall Street has become. And we are sure that, given a little input from some of the innocent public on the chat boards we frequent, suitable punishments for that small segment of the population which harms us can easily be devised without holding the entire economy hostage.

What Mr. Kohn seems to be proposing is that, once again, as Mr. Greenspan before him so often concluded, the risk and penalties to be sustained by malinvestment and corruption are best handled by spreading them out from the few to the many, from the insiders to the public, from those who produce nothing to the broader public, which struggles to just keep going forward as best they can, in one of the great transfers of wealth in modern history.

Won't work you say? Well, of course it won't work!

The punch line, and what so few realize, is that the bankers are not trying to fix anything. The fixes were put in place after the Crash of 1929 and the Great Depression. Fixes, such as the Glass-Steagall Act. They are just trying to prolong the games as it is, which the Wall Street banking community paid good money to get, spending hundreds of millions of dollars in lobbying money to create over the period of almost twenty years.

Frontline: The Wall Street Fix - The Long Demise of Glass-Steagall

A relatively small percentage of the population can twist and corrupt the financial system, destroying the lives of hundreds of thousands of their fellow citizens, because its profitable, and because they simply do not care about the damage they do to others. The dirty little secret is that capitalism, like any other form of social structure, requires policing, regulation, laws, and enforcement to prevent the predations of sociopaths and con men, no matter what weapons they may choose to employ.

Text of Vice-chairman Kohn's Address to the Council on Foreign Relations Nov. 28, 2007