James Saft

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

Jamie Dimon is just doing his job, which is why it is more important than ever that Ben Bernanke do a better job at his.

Dimon, JP Morgan Chase & Co Chairman and CEO, staged an unusual confrontation with the Federal Reserve Chairman at a conference in Atlanta on Tuesday, drawing a line between tighter banking regulation, heavier capital requirements and slow growth and joblessness.

“Has anyone bothered to study the cumulative effect of all these things?” Dimon asked.

“And do you have a fear, like I do, that when we look back and look at them all that they will be a reason it took so long that our banks, our credit, our businesses and most importantly, job creation, started going again?”

Well Jamie, I have other fears that outweigh yours; that you, your bank and others like it will use your positional advantage to extract wealth from the economy which exceeds, on a risk-adjusted basis, the value you add. What’s more, you will do so by arbitraging a government guarantee that will allow you to make profits all the while building risks that, when they explode, will become taxpayer liabilities.

The very nature of his question, with its overtones of holding the economy hostage, are evidence of the unsavory and unacceptable relationship between finance and the rest of the economy.

Dimon was reacting not just to the patchwork of new regulation enacted since the crisis, but to recent proposals for higher capital weightings. Fed Governor Daniel Tarullo last week said the Fed was considering capital requirements that could end up being more than double those envisioned under the international Basel III plan. Also on the table is some form of extra capital weightings that would penalize banks based on their size. This, meant to encourage too-big-to-fail banks to slim down, is a dagger aimed directly at Dimon and J.P. Morgan’s unfair advantage.

It would impair his profits, and, as Dimon argues, would hit the economy.

He’s exactly right, of course: higher capital requirements and better supervision will crimp economic growth, perhaps imposing a lower ceiling on the booms we have grown to love and fear. After all, the freely available credit of 2006 created many jobs, from originating no-doc mortgages to fitting marble bathroom fixtures.

There are two problems with this type of growth; it is a wasteful misallocation of resources, and also the growth is ephemeral. Financial crises are hugely damaging, and as we are seeing, the recovery is long and painful. That is an illness which more bank intermediation will not cure.

It’s Bernanke’s job to recognize that he is not charged with creating growth at any price, but at fostering sustainable growth. That means tough banking regulation, aggressively enforced.

HOW MUCH FINANCE IS TOO MUCH?

Even beyond the issue of too-big-to-fail there are real questions over how large a financial system is actually beneficial to an economy. Because the U.S. subsidizes finance, through deposit insurance, mortgage support and in many other ways, this is an appropriate area for government control.

A recent paper by economists Jean-Louis Arcand, Enrico Berkes and Ugo Panizza explores the relationship between the effects of financial development and economic growth.

While there is little doubt that finance is important in an economy, the authors found that after a certain point the effects of more financial intermediation are actually negative for growth. The high-water mark is when credit to the private sector is 110 percent of GDP; after that our banks are, in effect, a tax, privately levied but publicly paid.

All of the major economies are above that 110 percent threshold. The U.S. is among the most debt-ridden, with credit to the private sector at more than 200 percent of GDP in 2009, according to World Bank data.

On that basis, higher capital requirements and tighter regulations are an unalloyed good. Growth may be lower at times, but there will be less of the ruinous ups and downs. Importantly too, the fruits of growth will be more fairly shared out, between industry and government, among industries and among individuals.

“They’re concerned about their return on equity, and I’m concerned about the safety of the banking system and the American depositor and taxpayer,” Thomas Hoenig, the president of the Federal Reserve Bank of Kansas City, told American Banker.

“All the safety net has done is allowed them to leverage up to their advantage on the backs of the American taxpayer. I have a hard time as a person, who is more concerned about the safety of the system and the taxpayer, to worry about their position.”

This is exactly the approach Bernanke should take.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

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

HUNTSVILLE — Wednesday was a weird day, caught somewhere between being a victory for the paranoid and a genuine step forward for openness and transparency.

And no, I am not talking about the sad spectacle of President Obama trotting out his birth certificate to assuage his deluded doubters. I am instead speaking of the Federal Reserve, which for the first time in its long history has taken the step of actually taking questions from the press after announcing its monetary policy decision.

Unlike the birth nonsense, there are two not mutually exclusive ways you can interpret the Fed’s decision to put itself at the mercy of the hacks. First, it is a real step forward for transparency, a step along the way towards renouncing the cant of the era of Greenspan, who seemed to regard himself as part economist, part Delphic Oracle and part Wizard of Oz.  Second, it marks a waning of the power of the Fed, which has been diminished by its poor track record and by steps it took which opened it up to attack.

It is perhaps this second point which is more important; the Fed is under attack, under suspicion and trying very hard to husband its credibility. This is a tough combination of factors, and a state of play that could make it more difficult for the Fed to effectively fight inflation.

The most important weapon of any central bank is its credibility, which amounts to the faith that people have that it will follow its mandates. That’s not simply faith that a bank will do what it says, but belief that it can do what it says. For the Fed, which has a dual mandate to foster employment and keep a lid on inflation, this is sometimes nearly impossible. It may also not be something that is aided by transparency. Fiat money is a system of faith, and as many religions have found, faith and transparency don’t always mix.

“It used to be the mystique of central banking was all about not letting anybody know what you are doing,” Bernanke said during a notably uncomfortable performance in the press conference.

Quite right, it was not until the 1990s that the Fed actually began to announce its rate decisions. Before that they simply signaled them through market operations.

THE AGE OF DISBELIEF

The past decade has not been kind to the reputation of central banks, not least the Fed’s. Whereas once there was naive faith that economists, who played a cultural role not dissimilar to scientists during the early part of the Nuclear Age, knew what was best and would bring prosperity, now there is widespread doubt and distrust.

Wages have not grown, wealth has become more and more concentrated in a small sliver of the population and Americans have quite surprisingly not all grown rich by buying each other’s houses.

The central tenet of this belief system –  the idea that enlightened management had brought on a Great Moderation of low-volatility growth — is now discarded.  Many people distrust the Fed for having intervened too much, while others deride it for having done too little.

Will a press conference help to change this? Perhaps, but much of the problem is inherent in the situation and in the Fed’s dual mandate.

“So why not do more?” Bernanke said in response to a question about why he was not more aggressively fighting unemployment.

“The trade-offs are getting less attractive at this point. Inflation has gotten higher, inflation expectations are a bit higher, it is not clear we can get substantial improvements in payrolls without some additional inflation risks. In my view, if we’re going to have success in creating a long-run, sustainable recovery, we’re going to have to keep inflation under control.”

At one point Bernanke said that the longer unemployment persists the less it can be aided by monetary policy, saying instead it requires retraining, in a moment handing off some of his mandate to the Department of Education.

To be sure, to the extent that a press conference makes the views of the Fed more clearly known, it can help it in carrying out its intentions with a minimum of volatility and disorder. On this important measure, the conference was a reasonable success.

The larger issue is what happens when or if longer-term inflation expectations become unmoored and the Fed has to tighten meaningfully. When that day arrives I am not sure that a reasoned understanding of the competing pressures exerted on the Fed will actually increase the chances that they will be taken at their word.

I can’t help but think that would have been easier for former chairman Volcker in the bad old days of opacity than it will prove for Bernanke.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

Will bond investors keep faith with U.S. government debt amid signs of growing global inflation?

In the end, as with all banks, even central banks, it boils down to trust.

Asked on Wednesday at an appearance before the U.S. House of Representatives Budget Committee if the Fed’s $600 billion programme of quantitative easing amounted to monetization — that Peter to Paul transfer when a government prints money to pay for a shortfall — Ben Bernanke said an interesting thing:

“Monetization involves a permanent increase in money supply though money creation. (QE) is a temporary measure that will be reversed. Money will be normalized and there will be no permanent increase in outstanding balance sheet or inflation.”

So, because he intends to undo it later, he’s not doing it now.

This is both demonstrably false and deeply, at least for now, true.

False because, of course, money is being created to fund the purchase of debt issued by the Treasury. True because Bernanke can avoid the disaster often associated with monetization so long as he retains the faith of the world’s investors that he not only intends to unwind QE but will be able to do so at the right time in the future.

Monetization is an inflammatory term because so often in the past the practice of funding a revenue shortfall by buying debt with newly printed money has worked out poorly, resulting in an inflationary spiral that beggars creditors and kills the real economy.

You can bet your last Confederate dollar that all the previous central bankers who bought their own bonds with their own printed money promised that they too would withdraw before it was too late. And some of them actually did withdraw the extra money, including some of Bernanke’s predecessors at the Fed during and for a time after World War II.

Daniel Thornton, a vice president at the St Louis Fed,  suggests a slightly broader but still self-referential definition of monetization, in essence saying that it can only be judged not by action but by comparing a central bank’s performance against its targets. <http://research.stlouisfed.org/publications/es/10/ES1014.pdf> That is well and good, but really leaves investors with nothing to rely upon but faith.

NO SIGN OF PANIC
So far, at least, the signs are that the world’s bond buyers believe Bernanke; so-called 5yr5yr forwards, a measure of inflationary expectations in five years’ time, show an uptick of about a percentage point since QE2 came on to the agenda last August, but only up to a pretty tame 2.8 percent or so. It is likely that some of that move represents rising risk of runaway inflation, but it also reflects rising confidence in growth.

Despite medium- and long-term concerns about the budget and the economy, Bernanke is in a reasonably strong position; he represents the world’s largest economy and its principle reserve currency.

That said, the loss of confidence, if it came, would be swift and devastating, more all of a sudden than little by little.

While Bernanke’s recent comments give little indication that a rethink of QE is coming soon, his colleagues are now sounding a lot less enthusiastic.

“Barring some unexpected shock to the economy or financial system, I think we are pushing the envelope with the current round of Treasury purchases,” Dallas Fed President Richard Fisher, a noted hawk, said in a speech on Tuesday.

“I would be very wary of expanding our balance sheet further; indeed, given current economic and financial conditions, it is hard for me to envision a scenario where I would not use my voting position this year to formally dissent should the FOMC recommend another tranche of monetary accommodation.”

Fisher goes on to blame Congress for creating the debt, but the message and fear are clear: monetization should be rolled back.

In speeches the same day, Jeffrey Lacker of the Richmond Fed recommended that the Fed consider adjusting QE in light of improving data while the Atlanta Fed’s Dennis Lockhart said he thought no more bond buying would be needed after the expiry of the current $600 billion plan at the end of June.

Those are still minority views, and will be until Bernanke changes his tone. Given the very mixed signals coming out of the U.S. jobs market, don’t expect that to happen any time in the next month. Remember too what happened last year, when the Fed stepped back from QE1 only to see the economy weaken undesirably as the year wore on. Markets only revived once Bernanke all but promised another round of bond buying at the end of August.

For now, the controls are still in Bernanke’s hands, but keep watching the bond market.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. email: jamessaft@jamessaft.com)

Call it what you like — war, tragedy or farce — but the disagreement over global currency exchange rates shows no sign of coming to a peaceful negotiated agreement.

Asked last week if loose Federal Reserve monetary policy was to blame for inflation in emerging markets, Ben Bernanke stoutly denied that it was anything to do with him, maintaining in central banker-speak that he’d been tucked up in bed at home at the time.

“I think it’s entirely unfair to attribute excess demand pressures in emerging markets to U.S. monetary policy, because emerging markets have all the tools they need to address excess demand in those countries,” the Fed chief told reporters assembled at the National Press Club in Washington.

“It’s really up to emerging markets to find appropriate tools to balance their own growth.”

Now on the face of it, that statement is a nonsense: regardless of emerging markets, like say, China, having tools at their disposal to put out the fire of domestic inflation, it is still possible, even likely, that Fed policy is partly responsible for widespread commodity price pressures.

Bernanke is right that rising living standards in emerging markets play an important role in price pressures and right too to point out that emerging markets have unused tools at their disposal.

“They can, for example, use monetary policy of their own. They can adjust their exchange rates, which is something that they’ve been reluctant to do in some cases,” Mr Bernanke said.

Bernanke argued that inflation in the U.S. did not yet appear to be a threat while high rates of unemployment were. Unsaid in this is that China’s policy of artificially keeping the yuan cheap has played a role in high rates of U.S. unemployment.

The U.S. stepped up its rhetoric against Chinese policy in a report from the Treasury Department last week, stopping short of labeling China a currency manipulator but calling the yuan “substantially undervalued” and complaining that “progress thus far is insufficient and that more rapid progress is needed.”

China for its part seems utterly unlikely to do very much to substantially address the issue of a weak yuan, based both on its track record and recent body language.

The truth is that this is a dangerous and destructive way to manage competing global interests, dangerous both in terms of the threats of inflation and hunger and destructive in the ways that Chinese policy has helped to distort the global economy over the past decade, albeit with a massive helping hand from overly loose U.S. policy.

A WIDENING CONFLICT
No one should expect the rest of the world to sit by as the dueling Chinese and American policies spray stray bullets into the crowd.

French Finance Minister Christine Lagarde on Sunday was forthright, blaming a, for her, highly inconvenient strength in the euro on the U.S and the Chinese.

“We must reform the international monetary system so that the euro is not caught in the middle, hit by the expense of trade-offs between two currencies that are deliberately weak,” Ms. Lagarde said in an interview on French television.

And while the word “China” did not pass his lips, U.S. Treasury Secretary Geithner’s meaning was clear on Monday on a visit to Brazil:

“Brazil is seeing a surge in capital inflows. This is happening for two reasons. First, investors around the world see Brazil growing at a faster pace and offering higher rates of return relative to other major economies. But these flows have been magnified by the policies of other emerging economies that are trying to sustain undervalued currencies, with tightly controlled exchange rate regimes.”

That is both true and not true; Chinese policy is terrible for Brazilian industry, threatening to turn the country into a larder for natural resources while suppressing other exports, but a lot of the money which is flooding the country and pressuring its currency upward is part of a huge carry trade that is directly attributable to U.S. monetary policy.

In this way perhaps the real risk of the currency skirmishes is that all countries are so focused on getting their share of global growth that they fail to take individual steps to control inflation, and thus allow it to grow rapidly in a way that proves difficult to control.

It does not have to work out that way; an inflation shock that does not become self-reinforcing will kill asset returns but whittle down debts in a very useful way.

The truth though is many countries are all trying to control the same knife at the same time and that is a tough way to whittle.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. Email: jamessaft@jamessaft.com)

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

Apparently not satisfied with being unable to fulfill its dual target of price stability and maximum employment the Federal Reserve has set itself a third mandate: higher asset prices.

Speaking on CNBC at a Federal Deposit Insurance Corporation-sponsored forum on small business lending last week, Fed Chairman Ben Bernanke was asked how, in essence, his $600 billion quantitative easing programme could be called a success when interest rates and commodity prices had actually risen in response.

“We see the economy strengthening, its gotten better over the last three or four months, a 3-4 percent growth number for 2011 seems reasonable,” he said.

“Our policies have contributed to a stronger stock market, just as they did in March of 2009, when we did the last iteration (of quantitative easing). The S&P 500 is up about 20 percent plus and the Russell 2000 is up 30 pct plus.”

So, there you have it; the man who controls the printing presses congratulating himself for driving stock prices higher.

First off, this is a very low hurdle of success. It is a bit like playing battleships in the bathtub and calling yourself a great admiral for pulling the enemies’ ships under the water.

We know he can do it — as he says he has done it in the past. The question is: should he?

The theory is that higher asset prices, particularly rising asset prices, will help to restore confidence and will entice greater investment and consumption.

Consumers, feeling a bit richer, will spend a bit more, and businesses will respond by committing to investment in new capacity to meet new demand.

Money parked on the sidelines will go from feeling smart to feeling stupid and will move into riskier assets like stocks or high yield bonds.

On this analysis, Bernanke and his supporters on the Federal Reserve are exactly right, some of the money that is summoned from the ether by rising stock prices will be spent and that once notional cash will have a real impact.

But really, how well did this work out the last couple of times it was tried, first in the 1990s and then again in the last decade? Not well.

Many Americans committed to spending programs that their earning power really wouldn’t support and huge and insupportable debts were created in the process. The dotcom and housing bubbles were produced and duly burst, and each successive bubble dealt deeper damage to the financial system and global economy.

KEEPING IT SIMPLE

While we have known for months that the Fed was targeting asset prices with QE, it really is shocking to hear it enunciated so clearly.

As money manager John Mauldin mused in a letter to clients, would the Fed be setting targets for shares? Were there other assets it would like to target?

The Federal Reserve is deeply compromised by doing this; it is two thirds of the way down a slippery slope and the mud is starting to fall from above.

The policy may not work and may have considerable unintended consequences, as hinted at by Philadelphia Fed President Charles Plosser in a speech on Monday.

“The notion persists that activist monetary policy can help stabilize the macroeconomy against a wide array of shocks, such as a sharp rise in the price of oil or a sharp drop in the price of housing. In my view, monetary policy’s ability to neutralize the real economic consequences of such shocks is actually quite limited …

Attempts to stabilize the economy will, more likely than not, end up providing stimulus when none is needed, or vice versa. It also risks distorting price signals and thus resource allocations, adding to instability. So asking monetary policy to do what it cannot do with aggressive attempts at stabilization can actually increase economic instability rather than reduce it,” Plosser said.

Perhaps even more disturbing is the idea that the Fed’s bathtub play with stocks and shares opens it up to outside pressure which could fundamentally undermine both its reputation and independence.

As was the case with its decision to direct capital to specific sectors of the economy, bubbling asset prices will be viewed by people like new Congressional Monetary Policy subcommittee Chair Ron Paul as an infringement of Congress’ traditional control of the purse strings.

When it comes to purchasing securities the line between fiscal and monetary policy becomes all but meaningless, and so the Fed’s action is a counterweight to inaction by Congress and the Executive branch.

More stimulus may well be what the economy needs, but if true it needs it from the fiscal side rather than by encouraging more share holders to spend more money they haven’t really got.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

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

China’s Christmas day interest rate hike may prove to be bad for global growth but good, at least for a time, for risky assets.

From that perspective, the Chinese policy change could end up being a much-needed helping hand to Federal Reserve chief Ben Bernanke, who has engineered a policy partly aimed to boost economic growth through the false miracle of asset price inflation.

The Chinese rate hike, taking the benchmark interest rate up by a quarter of a percentage point, signals an increased willingness by Chinese authorities to do what they must to dampen the party domestically. The move increased the one-year lending rate to 5.81 percent and one-year deposit rate to 2.75 percent.

It is aimed at cooling inflation, which is running at 5.1 percent annually on the consumer level, not to mention making itself felt through a booming property market and gold-rush-like appreciation in things like herbal remedies and rare delicacies.

Of course, higher interest rates, while they may cool speculation domestically, will only make China more attractive to international capital, which is already slavering at the prospect of an eventual appreciation of the yuan.

This is well understood within the People’s Bank of China: “Many domestic academics are worried that interest rate rises may accelerate global speculative inflows into China,” Sheng Songcheng, the head of statistics at the PBOC, wrote in a piece published on the bank’s website, warning that these flows were exacerbating inflation.

That implies that China may be steeling itself to more effectively block international capital flows.

But these flows, so-called hot money, don’t just exist because people think China is going to be a good investment over the next few years.

Those flows are, at least in part, a function of the extremely easy monetary policy in the United States and Europe, policy that is aimed at forcing money from the sidelines into risk asset markets. For a time, the easy implication of that easy policy appeared to be a grand carry trade, in which  investors partook of the generous liquidity and terms available in Frankfurt and New York and plonked it down in emerging markets, notably China.

MONEY NEEDS A HOME

China appears to be becoming less hospitable to that money, but it will not cease to exist. It will find a way into other markets, perhaps other emerging markets or places like Australia that are a play on emerging markets. It will also drive the developed markets of Europe and the United States.

This is not because growth prospects have improved in the West — given that Chinese growth may be capped by the rate rise, they haven’t — it is because it is cheap money that is seeking some sort of a home.

Federal Reserve officials have been relatively upfront that the second round of quantitative easing was aimed in part at fomenting a rally in asset prices and with it an increase in consumption and demand. Thanks to the latest PBOC hike, they may find that more of that wealth effect is concentrated in the United States.

This is not to say that a U.S. monetary policy aimed at boosting consumption by inflating asset markets is a good thing; it worked out badly the last 10 years and very likely will work out badly this time as well.

For the time being at least, that will not be in the front of investors’ minds. They will see that markets are going up, and if they are fund managers whose performance is tied to a benchmark, that will compel them to take on risk. This in turn will make a lot of economists inclined to see the glass as half full and the talk will be of how the recovery is becoming something worthy of the name.

One crucial hurdle will be the behavior of companies, which have been sitting on billions in cash and have been reluctant to add jobs even if they have been forced to add hours. Will they see a sustainable increase in demand and put money back to work? Or will it be simply another round of speculative frenzy, profitable for some but disruptive for the economy as a whole?

Ultimately China will likely have to raise rates repeatedly and take other strong steps to brook bank-fueled speculation, none of which will do anything good for global demand.

Even so, unless the market gets a shock, most likely from a troubled euro zone, it is fair to expect risky assets to continue to rally, seemingly without reference to the underlying fundamentals.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)