Monday, March 26, 2012

Bernanke is being way too cautious

Fed Chairman Bernanke's remarks today were designed to justify the continuation of ultra-accommodative monetary policy. To be sure, the economy is suffering from a huge "output gap," but nevertheless, there are plenty of signs that things are improving on the margin.

The economy is definitely creating new jobs, and it's even possible that jobs are growing at an accelerating pace, as suggested by the household survey of private sector employment in the chart above. The economy is likely still well below where it should be, but if current trends continue there will be a full jobs recovery within a year or so. We don't need cheap money to make that happen, we just need to let the natural forces of recovery and growth do their thing. The profit motive is a powerful source of growth, and left to their own devices entrepreneurs and workers will expend lots of effort to figure out how to work harder and more efficiently.

One of the big reasons the last recession was so deep and protracted was that the market's fear of a global financial collapse and depression reached extremely high levels. It's taken three years to slowly and gradually erase these fears, and both the equity market and the economy have responded rationally to the reduction of perceived risk by growing.

Equities have also tracked the behavior of unemployment claims. Claims are a good proxy for the degree to which the economy has to make painful adjustments. The economy had to shift massive amounts of resources away from the residential construction and banking industries into other areas. With claims now close to returning to "normal" levels, it's not unreasonable to think that most of this painful adjustment process has been completed. Going forward the economy is going to do more of what comes naturally—grow—rather than slash and burn. Fear has returned to more normal levels, and most of the painful adjustments to new economic realities have been completed, so it is not surprising that equities have recovered much of the ground that they lost .

What's still lacking, however, is confidence in the future. As this chart shows, Treasury yields are extremely low, and have only responded weakly so far to signs of improvement in the economy. When I see 10-yr Treasury yields at or near 2% I can't help but think that the market holds out almost no hope of any meaningful economic growth in the years to come. I think Bernanke's repeated expressions of concern, and the Fed's continued willingness to pull out all the monetary stops in order to goose the economy, are contributing to the market's pessimistic outlook.

Investors are still shell-shocked from the events of a few years ago, so they have little problem believing that if it weren't for ultra-accommodative monetary policy and massive fiscal deficits, the economy would sure enough slip back into a recession. Investors think the economy is on life-support, whereas to me it looks like the economy is recovering in spite of all the ministrations of Washington.


Anonymous said...

It's a bit early, but it looks like y-o-y growth in withholding tax receipts might be starting a breakout to the upside. If it continues, it means either March's or April's jobs report could be a blockbuster ... or at least both will be semi-blockbusters. Will keep everyone updated.

Benjamin Cole said...

For a moment, based on his headline, I hoped Scott Grannis had joined the Market Monetarists, a conservative group calling for a more-aggressive Fed----a Fed more aggressive about growth, that is.

Market Monetarists believe in balanced federal budgets but (in a recession) a more bullish Fed. As such, both political parties hate us.

Are interest rates low? Hard to say. Inflation is dead. Inflation as measured might be overstated.

Additionally, in the world of economics, there is no such thing as shortages or gluts, with one exeption.

The price mechanism resolves such issues---except with capital supplies. Interest rates cannot go into negative rates.

Hence, we have gluts of capital, and no way to resolve that through negative interest rates. Interest rates should be at negative two percent or something like that.

Some banks are eating at capital around the edges with fees etc. but basically we have global gluts of capital, getting worse every year.

That's why central banks the world over need to engage in QE and stimulative policies.

I wonder what people mean when they say the Fed has rates artificially low or high. What is the "right" rate? What is the right rate in a deflationary environment? What is the right rate if the globe is generating more capital than can be deployed? What makes any rate artificially high or low? I would like to see lower rates.

The Japanification of Europe and the USA is underway. Only the central banks can prevent deflationary perma-recessions, through aggressive QE.

People who have spent lifetimes concerned with inflation will have to adjust. The concern now is with growth.

Times change. If polcymamkers do not change, they will meet catastrophe.

Benjamin Cole said...

Dow jumps on dovish Bernanke
CNNMoney - ‎9 minutes ago‎

By Ben Rooney @CNNMoneyMarkets March 26, 2012: 4:12 PM ET NEW YORK (CNNMoney) -- US stocks rallied Monday after Fed chairman Ben Bernanke's comments on the job market gave investors reason to believe interest rates will stay low.


Can we have some boom times before we start fretting about inflation?

Let it rip, Bernanke, let it rip to the moon.

Jake said...

I believe this is an example of the importance of causation vs. correlation. Curious how convinced you are that the following is not the cause; the Fed keeping rates low via monetary easing which is causing assets to inflate and the economy to rebound?

Everything that has happened the last 4 years has allowed me to re-evaluate my "priors" as real life examples played out around us. You've repeatedly stated that you are a supply sider and montetarist. Has anything that happened (i.e. especially the lack of inflation) caused any self-reflection and re-evaluation of these views?

Scott Grannis said...

Jake: on the contrary, everything I see is consistent with my supply-side and monetary beliefs.

The economy is weak because fiscal policy is not only crowding out the private sector with massive transfer payments, it is depressing expected after-tax returns and depressing investment by raising expected future tax burdens. Tax policy is far from optimal, with a very steep marginal tax rate curve and huge distortions stemming from our extremely complex tax code.

Monetary policy can facilitate growth by stabilizing and strengthening the value of a currency, but it can't create growth by running the printing presses. Monetary policy that is too easy only weakens the economy, since it reduces confidence and promotes speculative activities rather than healthy investment. Investment-led growth requires confidence in long-term economic and financial stability, and current monetary policy is inconsistent with that condition. That explains our huge output gap.

The economy would be much stronger today if a) government spending were lower, b) tax rates were lower and flatter, c) tax deductions and subsidies were fewer (thus broadening the tax base), and d) monetary policy were tighter and the dollar stronger.

McKibbinUSA said...

I regret that whatever Dr Bernanke does at this point in monetary policy is irrelevant to the future. The major firms in the US have already restructured away from US consumers and given up on raising dollars as investment capital. The reality is that Dr Bernanke is simply doing what he thinks he must to save the Federal Reserve and US dollar from marginalization or extinction. Anyone still holding bonds can expect those holdings to be wiped out in the coming years. Cash is fleeing from bonds into stocks and real estate as safe havens.

We need to all accept that the dollar is doomed, and that the future of enterprise in the US will likely focus on revenue streams that are equity vice cash driven. Dollars are dead and only fools will bet on the future viability of the dollar in the global marketplace.

Best to exit dollars and dollar-denominated debt instruments (credits) and move instead into equities in haste. Also consider converting dollars into world-class skills and education for yourself and your children (become a doctorally-trained physician, biochemist, geologist, or electrical engineer as examples). Again, the dollar is ruined, and nothing the Federal Reserve does can reverse that reality.

The end of the dollar is actually a money-making opportunity for those who fully accept that reality and act accordingly right now (today, this hour, this minute, right now). The time is coming when dollars become a "funny moneey" that will not be accepted in exchange for for equities, and that day is right around the corner. I know of a deal now where the entire amount required by the seller must be in gold bullion. We should all take notice.

Accredited investors (those with skills and holdings) are moving away from dollars with abandon -- everyone else should take cover...

PS: Keep a close eye on municipal bonds...

brodero said...

I believe Mr Bernanke has done a remarkable job with situation given to him. One day he deserves the Medal
of Freedom. Confirmation of this is the hatred he gets from the far right and the far left.

Benjamin Cole said...


How has Japan's strong currency worked out for that nation?

William said...

Scott - Sounds like the Conservative Party's coalition in Great Britain has implementing the kind of policies which you favor. Thus far, the results are not looking so good with higher unemployment, decreased GDP, decreased tax receipts and larger government deficit than was predicted.

The Keynesian are in uproar saying that they were correct in predicting the policies would fail.

What is your take on the developments in Great Britain?

Scott Grannis said...

Re Japan's currency: The yen has been the strongest of all global currencies in the modern era, and it has been in a strengthening trend against the dollar since early 1971, when it traded at 358 yen to the dollar. It is now 81 to the dollar, which equates to an appreciation of 342%, or 3.7% per year on average. Since 1971, Japanese inflation has totaled 192%, while U.S. inflation has totaled 375%. The yen has appreciated far more (62% more) than the differential between U.S. and Japanese inflation, and that is a measure of its strength. The yen has moved from being a deeply undervalued currency to a strongly overvalued currency by my calculations.

Currency extremes are bad, in my view. Being too weak is bad, and being too strong (like the yen is now) is bad. The very strong yen is symptomatic of monetary policy that is tight, and Japan's decades-long flirtation with deflation confirms that policy has been tight if not too tight. This explanation why Japanese real per capita growth has averaged only 0.8% per year over the past 20 years according to the World Bank.

The dollar, on the other hand, is very weak, just about as weak as it has ever been, both nominally and in inflation-adjusted terms against a large basket of currencies. That is bad, because it means monetary policy is too easy, and that implies higher inflation likely in the future; it also implies a low degree of confidence in the future of the U.S. economy. Periods of extreme dollar weakness, such as we have today, have tended to be weak-growth periods, not surprisingly.

A "strong and stable" dollar, as Treasury Sec. Robert Rubin liked to say, is what we really need. Stronger than it is today, and more stable.

A stronger and more stable dollar would most likely give us a lower and more stable price of gold, by the way.

Scott Grannis said...

William: I think you are forgetting the UK's disastrous decision to sharply increase marginal income tax rates in recent years. That is the wrong kind of austerity. Much better to eliminate deductions, broaden the base, and flatten tax rates. The UK has not done this at all, and that likely explains the poor performance of the economy, not to mention that spending is still a huge fraction of GDP.

William said...

Thank you very much for responding, Scott. I truly appreciate your insights - as with your enlightened response to my Bill Gross quote last week.

Thank you for this very informative, Blog.

PS: Looks like stock market participants are finally catching on to what you have been forecasting! A Melt Up, perhaps??

Benjamin Cole said...


Thanks for your insightful reply. I still disagree---I think the US needs to get aggressive on growth, not fighting inflation---but I respect your thoughtful insights.

And check out the Market Monetarists. You might find a lot to like there.

Steve K said...

Nice day in the stock market. Talking heads say market responded to Bernanke's accomodative rhetoric.

When does Bernanke's accomodative rhetoric become a negative for investors confidence?

Are we starting to see the "Obama shorts" getting squeezed? Maybe a nice bull run forthcoming?

Benjamin Cole said...

BTW, re Japan: Friedman, John Taylor, Alan Meltzer, Bernanke and Frederic Mishkin all advised Japan, in various years, to go hot and heavy into QE---monetizing the debt.

John Taylor, the very picture of a GOP solon-conservative, actually raved about a then-Bank of Japan QE program, in a paper he wrote in 2006.

Okay, so we know very conservative types have no problem (Friedman was particularly emphatic) with monetizing the debt, in principle.

The question becomes whether monetizing the debt is right for the USA, not whether it is Satanic ritual or inherently a wrong policy (well, except maybe to Ron Paul).

I suspect if Friedman called for QE in the USA (I think he would have) then the right-wing would drop its suspicions about QE. And if Romney wins.

See here, Friedman unabashedly calls on Japan to print more money and keep printing it until it got come growth and inflation. Using QE:

Ed R said...

What are the 'natural forces of recovery'?

And why haven't we seen them yet??

Hans said...

"One of the big reasons the last recession was so deep and protracted was that the market's fear of a global financial collapse and depression reached extremely high levels. It's taken three years to slowly and gradually erase these fears,"

There is an element of truth to this statement, however, let's call what it really was a government-recession; thanks in part to the ongoing failed energy policy and the housing debacle...Oh yes, the level of incompetence of this administration, also delayed the natural course of recovery..

It was a govcession, from the federal government and the rest of the government complex..

"economy is likely still well below where it should be, but if current trends continue there will be a full jobs recovery within a year or so."

I am rather befuddle and shocked at this statement!!

There are a least five million Americans still unemployed and perhaps as many who are part time or have left the labor market...

Economist, Dr John Locke, stated that its takes around 160k new jobs per month just to maintain the status quo.

How will we have full employment with 24 months, unless there is massive hiring...

Scott Grannis said...

Hans: when I say I expect a "full jobs recovery" what I mean to say is that the number of jobs will return to their pre-recession level.

Ed R said...

" . . . . a "full jobs recovery" what I mean to say is that the number of jobs will return to their pre-recession level."

While the population grows 0.8% to 1.0% per year.

Hans said...

"Are interest rates low? Hard to say"

Ben Jamin, how could you make such a statement...? How low before you would affirm low rates, zero?

If you and your economic attest conservative values, why are you endorsing QE's?

If you are conservative, why would you use the byproduct of the Central Bank, to control and manipulate the economy...?

Hans said...

Thank you for your explanation, Mr Grannis..That could indeed happen, especially if CommieCare is ruled unconstitutional...

I continued to be amazed at the lexicon used by your profession and the inability of the layperson to comprehend them...

Barrier to entry, anyone?