FedUpUSA

Archive for November 25th, 2009

Tim Duy, my favorite Fedwatcher, has a very good post up which combines a general reading on the state of the consumer and then segues to the Fed’s take on matters. The section I found particularly telling:

As has already been widely noted, the minutes of the most recent FOMC meeting reiterated the Fed’s eagerness to reverse, not extend, policy:

…Overall, many participants viewed the risks to their inflation outlooks over the next few quarters as being roughly balanced. Some saw the risks as tilted to the downside in the near term, reflecting the quite elevated level of economic slack and the possibility that inflation expectations could begin to decline in response to the low level of actual inflation. But others felt that risks were tilted to the upside over a longer horizon, because of the possibility that inflation expectations could rise as a result of the public’s concerns about extraordinary monetary policy stimulus and large federal budget deficits. Moreover, these participants noted that banks might seek to reduce appreciably their excess reserves as the economy improves by purchasing securities or by easing credit standards and expanding their lending substantially. Such a development, if not offset by Federal Reserve actions, could give additional impetus to spending and, potentially, to actual and expected inflation. To keep inflation expectations anchored, all participants agreed that it was important for policy to be responsive to changes in the economic outlook and for the Federal Reserve to continue to clearly communicate its ability and intent to begin withdrawing monetary policy accommodation at the appropriate time and pace.

Read that carefully and realize this: An apparently not insignificant portion of the FOMC believes that there is a terrible risk that banks loosen their credit standards and increase lending at a time when, even if the economy posts expected gain, unemployment remains at unacceptably high levels. Silly me, I thought increased lending was the whole point of the exercise to lower interest and expand the balance sheet. That whole credit channel thing. If not to expand lending during a credit crunch, then what else are they expecting?

I am in shock that this sentence made it into the minutes. One can only conclude that a significant portion of policymakers are simply clueless. Or, more disconcerting, they have lost all faith in the ability of financial institutions to channel capital into activities with any hope of financial returns. Has the Fed now embraced the view that they manage the economy through little else then fueling and extinguishing bubbles?

Yves here. If at all possible, it’s even worse than Duy’s horrified take suggests. Inflation? In an economy with slack capacity, high unemployment, consumers duly cautious about spending, and labor utterly lacking in bargaining power even when times were better? What planet is this inflation talk from? Bond market yields rising over supply fears are not the same as inflation worries. Are there any signs of consumer hoarding in anticipation of price increases, of spending their paychecks ASAP because they fear their money will be worse in a few month’s time? No. Consumers are trying to cut debt and build up their cash buffers, the polar opposite of the behavior you’d expect if any were worried about inflation.

The Fed is shockingly seeing the US as an economic island, when pretty much all investors can seek other currencies as stores of value. And the consensus is that the dollar is a really bad bet, and a dollar bear posture is not very kind to long-dated Treasury yields. How hard is that to understand?

Japan, despite massive pump-priming, still had deflation because it was unable to get its broken bank plumbing fixed. The authorities like to pat themselves on the back and say how good our emergency responses have been, but Japan-type outcomes are real possibility. We have better demographics and a less severe debt hangover, but the Fed’s refusal to see that the banking system is still a mess is breathtaking.

These statement is an indication of intellectual bankruptcy at the Fed, that they have learned nothing from the crisis. But that isn’t surprising. CEOs usually need to be fired after they have presided over a disaster. They are incapable of seeing and remedying their errors. Why should senior bureaucrats be any different?