Opinion

The Great Debate

from Breakingviews:

Fed fundamentalists deserve fresh listen

By Rob Cox

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

A portrait of Milton Friedman hangs at the entrance to the Stauffer Auditorium at Stanford University’s Hoover Institution. It carries no identification, and doesn’t need any. All who enter here can be counted on to recognize the patron saint of contemporary free-market economics. And so it was two days last week, when the leaders of what might be dubbed monetary fundamentalism gathered under Friedman’s watchful gaze.

Stanford’s John Taylor, a former Treasury official and academic who created an eponymous and influential rule for setting interest rates, pulled together sitting and former presidents of Federal Reserve banks, along with prominent academics and former members of the European Central Bank board. They discussed a new framework for running the world’s central banks.

The cries from this boil of hawks may not have changed much over the decades, but more than five years since the financial crisis roiled the world’s financial markets and economies they deserve a fresh listen.

The views vary, but there is a common creed: The U.S. central bank has expanded its discretionary powers in monetary and credit policy in ways that threaten its existence. This isn’t mere traditionalism. It is an admission by powerful central bankers that they understand their own limitations, and they would rather see their powers circumscribed than fail abjectly, since failure could lead to the dismantlement of Fed independence.

Fed tightening will help stem inequality

The Federal Reserve Building is reflected on a car in Washington September 16, 2008. REUTERS/Jim Young

Just as quantitative easing by the U.S. Federal Reserve has inadvertently increased the country’s wealth gap, so should tapering limit its rise.

Under the central bank’s program of pumping money into the economy, purchases of financial assets have enriched the 10 percent of Americans who hold four-fifths of the country’s stocks and bonds. With the Fed’s liquidity being withdrawn, the whole effect should be more muted. And absent such underpinning for equities, corporate executives will be much more likely to invest to improve returns. This should involve more hiring and a better outlook for those outside the top decile.

Fed launches QE-lite

In a compromise, the Federal Open Market Committee (FOMC) has approved a cautious and conservative second round of quantitative easing (QE2) which may satisfy nobody but should prevent internal splits from widening.

It is designed to provide some marginal stimulus to asset markets and economic recovery without further undermining the confidence of foreign investors.

The best way to characterize the $600 billion bond-buying program implemented over eight months is “QE-lite”. The total is slightly higher than expected, but spread over a slightly longer period. The Fed has done almost exactly what it signaled over the last few weeks — no more (there was no “shock and awe”) and no less.

Two years after Lehman, risk of financial collapse is still high

GERMANY/

By Mark Williams
The opinions expressed are his own.

Events unfolding in Europe — including Greece, Portugal, Spain, Italy, and most recently Ireland — are alarming reminders that systemic risk is the most pressing of this decade.

While it’s been two years to this day since the death of Lehman Brothers almost brought down the entire financial system, global systemic risk — the chance that a single event or series of events can collapse the world financial system – remains quite high.

In response to this threat, international banking regulators just approved higher Basel III capital requirements as a step in reducing global systemic risk. Banks with more capital are being forced to make more room to absorb losses, helping to increase economic stability. Under this tougher standard, banks need to maintain a minimum tier one (core) capital ratio of 4.5 percent, more than double the previous requirement.

Forecasting and its discontents

“Prediction is very difficult, especially if it’s about the future,” is attributed to a long list of people. Even with that in mind, however, the first eight months of 2010 have been especially unkind to professional forecasters and investors as markets have lurched between extremes of pessimism and optimism.

Normally forecasters can benefit from diversification — publishing lots of forecasts ensures at least some prove correct. But heightened correlation between and within asset classes has denied forecasters and investors even that consolation.

Federal Reserve Chairman Ben Bernanke has complained about the “unusual uncertainty” clouding the outlook. And macro hedge funds have run into trouble, several prominent ones closing down and returning money to investors, as the big trends on which they thrive have disappeared amid volatility and sharp switchbacks.

Market should prepare for autumn rate “exit”

Could the first increases in  short-term U.S. interest rates come much earlier than most forecasters expect, perhaps as soon as September or November 2010?

Past experience suggests rates begin to rise about 30-35  months after the trough in the manufacturing cycle (as measured by capacity utilisation rates).

In the last four expansions, before this one, rates started rising 27 months, 48 months, 33 months and 31 months after  capacity utilization had hit its low point.

Locking up bank reserves is wrong policy focus

– John Kemp is a Reuters columnist. The views expressed are his own. —

Plotting an exit strategy and shrinking the Federal Reserve’s balance sheet has become a hot topic as policymakers try to underscore their commitment to price stability and markets ponder the risk of inflation.

But micro-managing the reserve base is a curiously inadequate way to respond to medium-term concerns about inflation. Interest rates (the cost of credit) and supervision (leverage) are broader, more appropriate tools.

There’s no way to hedge politics

Ben Bernanke in peril and the Volcker crackdown on proprietary trading by banks show two truths of the current dispensation: there is no effective hedge against politics and the reflation trade rests on fragile foundations.

Neither of these realities is particularly good for financial markets and neither is going away any time soon.

Both, too, are utterly related not just to each other, but to the Senate election in Massachusetts which installed a Republican into what had been a Kennedy seat, in the process terrifying Democrats who fear they will be sunk by association with a set of policies perceived to be favoring Wall Street.

Fed’s wondrous printing press profits

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– James Saft is a Reuters columnist. The opinions expressed are is own. –

Now finally we see what it takes to be a profitable bank with no capital worries and secure funding: own a printing press.

Sadly, since it is the Federal Reserve showing record $46 billion profits last year we have to conclude that, though it is a fool-proof plan, it’s not really scalable.

Fed stuck doing the heavy lifting

-James Saft is a Reuters columnist. The opinions expressed are his own-
With employment weak and consumer credit weaker, look for extended official measures to support the U.S. economy.

Recent data show that despite emerging glimmers in manufacturing, de-stocking having reached its limit, and some strong showings globally, the U.S. recovery is far from self-sustaining.

With Congress serving as an effective roadblock to a comprehensively expanding fiscal stimulus, the heavy lifting, if any is to be done, may fall on monetary policy and “off balance sheet” forms of stimulus.

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