Fed sets historically low interest rate

From the Wall Street Journal:

WASHINGTON -- U.S. Federal Reserve officials on Tuesday slashed official interest rates to an historic low range to combat a deepening recession and signaled they will keep rates "exceptionally low" for some time amid rapidly waning price pressures.

Officials also signaled a new phase for policy in which lending programs financed by the Fed's ballooning balance sheet, a process known as quantitative easing, replace the federal funds rate as the Fed's primary policy tool.

The Federal Open Market Committee voted unanimously to reduce the target fed funds rate for interbank lending from 1% to a range of zero to 0.25%, the lowest since the Fed started publishing the funds target in 1990. The market-determined effective fed funds rate already has already hit record lows in recent weeks. (Read the Fed's statement.)

Economists had expected a smaller cut of just 0.5 percentage point, and hadn't envisioned the Fed setting a range.

"The Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time," the Fed said, adding it will "employ all available tools' to promote growth and maintain price stability.

The Fed has used a variety of operating targets through the decades, including the discount rate and monetary aggregates.

The Fed also lowered the discount rate paid by commercial and investment banks for Fed loans by 0.75 percentage point to 0.5%.

In a statement, the FOMC said its focus "will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level."

Ben Bernanke tipped the shift toward quantitative easing -- in which cash is essentially created and used to finance lending facilities -- earlier this month. He said that while the Fed's ability to use interest rates to support the economy "is obviously limited" with rates so low, the "second arrow in the Federal Reserve's quiver -- the provision of liquidity -- remains effective."

This is getting into what Paul Krugman has described as "The Return of Depression Economics." From a review of his book by that name, here is what Krugman means by Depression Economics.

Krugman does not think the world is about to descend into a 1930's-style depression. In fact, he argues that such a fate can be avoided if we instead remember the economic theories born of the Depression, most notably the work of Lord Keynes. Depression economics, Krugman says, ''is the study of situations where there is a free lunch, if we can only figure out how to get our hands on it, because there are unemployed resources that could be put to work.'' He thinks that in some places, most notably Japan, it is time for government to actively seek inflation.

...Krugman argues that now, as in the 1930's, there is too much emphasis on economic orthodoxy and on somehow restoring the confidence of investors. To be sure, confidence is of immense importance at certain times, and a major reason that country after country suffered currency collapses was that investors took flight. But countries facing crises now are not going to be any more successful than Herbert Hoover was at winning confidence by slashing public works spending while their economies stagnate.

What appalls Krugman now is not the problems the world faces but the reluctance to learn from them. ''Those who worried about balanced budgets back when uncontrollable deficits were the problem suddenly insist that raising taxes and cutting spending will actually prevent a recession, because it will improve confidence,'' he says. ''Those who wanted stable prices back when inflation was the risk now claim that 'managed inflation' will somehow backfire.''

The reality to Krugman is that there are few, if any, economic policies that are always right for all countries. What you should do depends on where you are and on an ability to think clearly about how you got there. There are times when capital controls can work, and when they would be disastrous. There are times when fixed exchange rates can work wonders, and times when they can blow up. That is not the easy answer, but it is the right one.

Krugman's book has been updated and reissued this month. The updates include

~ The failure of regulation to keep pace with an increasingly out-of-control financial system
~ Steps that must be taken to contain the crisis (a rarity in the spate of books coming forth in response to the failing economy)

The economic rules that the Republican Party has been spouting since Reagan was elected will NOT be helpful now that they have caused the greatest Recession since the Great Depression.

Bernanke confirms severity of economic recession

I've been saying for over a year now that the economic difficulties America is having are getting deeper and that there is no current indicator that the bottom is anywhere near. I'll say it again. America is in recession now, it will last all of 2009, and there is no telling how much longer.

Now Fed Chairman Ben Bernanke is saying much the same thing. The occasion for his remarks was the report that the 542,000 new claims filed for unemployment insurance last week was the highest number since the summer of 1992. As would be expected from either the Fed Chief or the Treasury Secretary, Ben Bernanke's statement is hedged in positive terms so that nothing he warns of is likely to cause the stock market to drop. The financial powers always have to speak in financial happy talk, even when giving bad news for fear they will make the financial market reactions to a bad economy worse then they already are. Since the Dow Jones Index has already dropped 50% from its high, those involved in the market sure don't want it to get worse if they can help it.

The Fed is expected to lower the key rate from 1% by a quarter percent in order to try to combat deflation. Of course, once they get to zero, there is nothing further the Fed can do to prevent deflation. After that they would have to pay people to take their money.

The fiscal stimulus that the Republican Congress members are now blocking are the only possible way of slowing the economic difficulties.

Game of Economic chicken: Fed hanging tough, Bankers not bailing out Lehman Brothers on their own.

Palin who? There's real ECONOMIC news happening today.

Lehman Brothers is essentially bankrupt. The other bankers together with the Fed's Ben Bernanke andthe Treasury's Henry Paulson are trying to save the banking industry and the economy. The weekend is not going well.

Summarized from Nouriel Roubini: Lehman brothers financial bank is essentially bankrupt. They have operated on a business model like regulated banks in which they borrow short term money and relend it long term in investments that cannot easily be sold on short notice. Unlike regulated banks, they have no government insurance for the short term money they borrow.

Bear Stearns was in a similar situation last Spring. When no one would buy the essentially bankrupt BS, the Federal Reserve swapped solid government securities for BS's nearly valueless securities which made BS a financially going concern that J.P. Morgan was glad to buy. Of course, the taxpayers will take the losses on the junk assets that BS traded in.

After the Federal Government took flack over paying out taxpayer money to save multibillionaires who invested badly, the Fed has not wanted to repeat the deal. Yet recently it simply took over Fannie Mae and Freddie Mac, essentially doing much the same thing. So the Fed and the Treasury have been hanging tough demanding that Lehman Brothers find their own buyers with no government subsidy.

The problem is, Lehman Brothers is bankrupt if they properly report all their bad investments at true value (Mark to Market.) No sensible buyer is going to buy LB at even a price of zero, since it will require so much more investment to save. The potential buyers are waiting for the Federal Reserve to sweeten the pot and take off the garbage investments before they buy LB.

The Fed and the Treasury Department are hanging tough, unwilling to spend more taxpayer money to bail out the ultra wealthy. Krugman reports today "Uh oh, black smoke

They still haven’t chosen a Pope found a way to rescue Lehman."


Nouriel Roubini writes:

If Lehman does not find a buyer over the weekend and the counterparties of Lehman withdraw their credit lines on Monday (as they all will in the absence of a deal) you will have not only a collapse of Lehman but also the beginning of a run on the other independent broker dealers (Merrill Lynch first but also in sequence Goldman Sachs and Morgan Stanley and possibly even those broker dealers that are part of a larger commercial bank, I.e. JP Morgan and Citigroup). Then this run would lead to a massive systemic meltdown of the financial system. That is the reason why the Fed has convened in emergency meetings the heads of all major Wall Street firms on Friday and again today to convince them not to pull the plug on Lehman and maintain their exposure to this distressed broker dealer.[Snip]

The Fed may delude itself in thinking – as its stress models suggest – that the systemic risk of a collapse of Lehman are less serious than those of Bear Stearns: after all Lehman is less involved into CDSs [Credit Default Swaps] than Bear was and now both Lehman and the other major broker dealers have access to the discount window with the PDCF [Primary Dealer Credit Facility of the Federal Reserve]. A collapse of Lehman instead will have as much of a systemic effect as the collapse of Bear for many reasons: Lehman is larger than Bear was; Lehman is a major player in a variety of key financial markets; all the other major Wall Street institutions are interconnected with Lehman in dozens of different types of counterparty activities; the PDCF support of the Fed is neither unlimited nor unconditional, i.e. investors cannot assume that Lehman or any other broker dealer can borrow unlimited amounts with no conditions from the discount window. Thus, a collapse of Lehman would trigger a panic and a potential run on all sort of other broker dealers and also on other distressed financial institutions like banks (WaMu) and insurance companies (AIG) and smaller member of the shadow financial system (distressed and highly leveraged hedge funds, etc.). [Snip]

What we are facing now if the beginning of the unraveling and collapse of the entire shadow financial system, a system of institutions (broker dealers, hedge funds, private equity funds, SIVs, conduits, etc.) that look like banks (as they borrow short, are highly leveraged and lend and invest long and in illiquid ways) and thus are highly vulnerable to bank like runs; but unlike banks they are not properly regulated and supervised, they don’t have access to deposit insurance and don’t have access to the lender of last resort support of the central bank (with now only a small group of them having access to the limited and conditional and thus fragile support of the Fed). So no wonder that this shadow banking system is now collapsing. The entire conduits/SIV system has already collapsed with the roll-off of their ABCP financing; next is the collapse of the broker dealers (Bear, Lehman and soon enough the other ones) that rely mostly on unstable overnight repos and other very short term funding for their financing; next will be hundreds of poorly managed hedge funds that will face a tsunami of redemptions; and finally runs on money market funds that are not supported by a large financial institutions or other smaller member of the shadow banking system as well as highly leveraged and distressed private equity funds cannot be ruled out either.

This is indeed the most severe financial crisis since the Great Depression and occurring at a time when the US is falling in a now severe consumer led recession. The vicious interaction between a systemic financial and banking crisis and a severe economic contraction will get much worse before there is any bottom to it. We are only in the third inning of a nine innings economic and financial crisis. And the only light at the end of the tunnel is the one of the incoming train wreck.

The question for today and tonight is who is going to blink? And if no one blinks, how bad are the results, because there are no good possibilities.

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Addendum 5:01 pm CDT
Bank of America, the most likely purchaser of Lehman Brothers has been reported to have pulled out of the talks and begun talks to merge with Merrill Lynch instead. Barclay's Bank PLC, Britain's third largest bank and another bank considered very likely to buy Lehman Brother's assets has similarly left the talks. A spokesman for Barclay's stated "Lehman was attractive but did not meet what he described as Barclay's stringent requirements."

Treasury Secretary Paulson is reported to be adamant that no government money was going to be used to bail out Lehman Brothers.

The prospect of a Lehman Brothers bankruptcy filing grows larger. "[But] there was also an emergency trading session being held at the International Swaps and Derviatives Association to 'reduce risk associated with a potential Lehman Brothers Holdings Inc. bankruptcy.' The ISDA, which arranges trades for derivatives, said it was allowing customers to make trades and unwind positions linked to Lehman _ but that those trades would be voided if no filing occurs before midnight."

That's what Greenspan meant when he said "'Oh, by far,' Greenspan said, when asked if the situation was the worst he had seen in his career. 'There's no question that this is in the process of outstripping anything I've seen and it still is not resolved and still has a way to go and, indeed, it will continue to be a corrosive force until the price of homes in the United States stabilizes. That will induce a series of events around the globe which will stabilize the system.'"

The financial world we wake up to Monday morning will be very different from the one we thought we went to sleep with Friday night, and it's going to be economic Terra Incognito.

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Addendum p:40 pm CDT

From Paul Krugman's blog

September 14, 2008, 9:21 pm
When is not a bailout a bailout

So the word seems to be that Lehman will be liquidated — hey, no more taxpayer takeover of risk, no more moral hazard; but to cushion the markets against the shock, the Fed will start accepting lower-quality assets, such as equities, as collateral for its credit lines — hence, more taxpayer takeover of risk, and more moral hazard. Oh, kay.

By the way, I’m not sure this was the wrong thing to do. But it drives home the essential craziness of the situation.

Here comes the inflation I have been predicting

Ian Welsh reports that Barclay's anticipates a sharp increase in inflation.

"We're in a nasty environment," said Tim Bond, the bank's chief equity strategist. "There is an inflation shock underway. This is going to be very negative for financial assets. We are going into tortoise mood and are retreating into our shell. Investors will do well if they can preserve their wealth."...

...Traders said the Fed seemed to be rowing back from rate rises. The effect was to propel oil to $138 a barrel, confirming its role as a sort of "anti-dollar" and as a market reproach to Washington's easy-money policies.

The Fed's stimulus is being transmitted to the 45-odd countries linked to the dollar around world. The result is surging commodity prices. Global inflation has jumped from 3.2pc to 5pc over the last year.

Here's my "I told you so."

Last Fall I reported that the economy was going to be rocky in 2008. I said "I still suspect that the Federal Reserve Board under Bernanke is going to try to delay the recession, which will lead to greater inflation." I was right.

The Fed was going to have two choices. They could lower interest rates to pump up the economy, at the cost of stimulating inflation, or they could increase the interest rates to prevent inflation at the cost of letting the economy go into the tank.

They have chosen to lower interest rates for a short term pump of the economy, probably because this is an election year and one of the surest ways to replace the party holding the Presidency is to have the economy go into the tank during the election year. Greenspan ensured that the interest rate was high in 2000 when he wanted the Democratic President replaces by a Republican. Immediately after the election, he started lowering the interest rates to make Bush look good until by 2004. (See my earlier post Economics and politics of the Fed fund rate.)

Greenspan's Republican-appointed replacement, Ben Bernanke, appears to be playing the same game this year.

Here's the thing, though. The effect of pumping up the economy by lowering the interest rate is relatively fast. It's short term. But the effect of the lower interest rate to increase inflation works more slowly. It's long term. So Bernanke is making abet that he can keep the economy pumped up until after the election (meaning October) before his mismanagement puts it into the tank. From Barclay's:

Barclays Capital said in its closely-watched Global Outlook that US headline inflation would hit 5.5pc by August and the Fed will have to raise interest rates six times by the end of next year to prevent a wage-spiral. If it hesitates, the bond markets will take matters into their own hands. "This is the first test for central banks in 30 years and they have fluffed it. They have zero credibility, and the Fed is negative if that's possible. It has lost all credibility," said Mr Bond.

What "the bond markets will take matters into their own hands" means is that interest rates will do what they did in the late 1970's. They will go sky high even without the fed causing it. More from Barclay's:

Traders said the Fed seemed to be rowing back from rate rises. The effect was to propel oil to $138 a barrel, confirming its role as a sort of "anti-dollar" and as a market reproach to Washington's easy-money policies.

The Fed's stimulus is being transmitted to the 45-odd countries linked to the dollar around world. The result is surging commodity prices. Global inflation has jumped from 3.2pc to 5pc over the last year.

Mr Bond said the emerging world is now on the cusp of a serious crisis. "Inflation is out of control in Asia. Vietnam has already blown up. The policy response is to shoot the messenger, like the developed central banks in the late 1960s and 1970s," he said.

"They will have to slam on the brakes. There is going to be a deep global recession over the next three years as policy-makers try to get inflation back in the box."

This means that the price of oil will continue to rise, one of many causes of American inflation, while the inflation will spread to the countries tied to the dollar around the world.

Bernanke's attempt to elect McCain and continue the Republican Party in the White House is going to severely damage both America and the world economy - even more than the current President and his party have already done.

The only question is whether Bernanke's bet that he can pump up the economy until the election will work. He is going to have to raise interest rates, and it looks like it will be before the election. That's lose-lose for the republicans, but the entire Republican economic small government - no regulation policy since 1980 has led to this.

But it's also lose - lose for both America and for the world economy. We have already lost. The only remaining question is how badly and how soon it will be so obvious that even those who don't want to believe is are forced to believe.

Don't believe me? Here's more from Barclay's:

David Woo, the bank's currency chief, said the Fed's policy of benign neglect towards the dollar had been stymied by oil, which is now eating deep into the country's standard of living. "The world has changed all of a sudden. The market is going to push the Fed into a tightening stance," he said.

# Gazprom chief expects 'radical' change in oil price
# More comment and analysis from The Telegraph

The bank said the full damage from the global banking crisis would take another year to unfold.

I haven't gotten this on my own. One of the key writers I have been reading is Ian Welsh. Here is his explanation of what is happening to oil prices.

I have been warning about inflation for some time, and predicting stagflation (high inflation, high unemployment). I have also noted that the problems were not going to be confined to the US and that the idea that other economies were "decoupling" was absurd.

Note also the mention of oil as an "anti-dollar". This is something Stirling, Oldman and myself were discussing as far back as 2004. Simply put, oil is the "unit of ultimate scarcity" in modern economies because it's very hard to substitute away from it. Sure, you can try, with foolishness like corn ethanol, but we're seeing where that leads. Oil makes the modern suburban economy possible. It is deeply embedded in how we make food, so much so that decades ago the late author Robert A. Heinlein came to the conclusion that the limits on food growth were based on oil, and that food wouldn't become a problem till oil became scarce. He's looking rather prescient today. The suburban economy of the US, likewise, simply requires oil to run. Suburbs and exurbs require automobiles and automobiles require oil.

At one time the dollar was backed by gold. What a lot of people failed to realize is that now the dollar has been backed by oil. Countries throughout the world wanted dollars, because dollars bought oil. As the dollar has been inflated by massive money printing, the price of oil has soared. This isn't the only cause of the increase in oil prices, but it is a significant reason. There is no reason for producers of a scarce, essential resource, to accept inflation unless you, well, have them over a barrel. For a long time the US did have them over a barrel—dollars, which were also the key currency for buying securities and various high tech devices, were more rare than oil was. Then Greenspan put the pedal to the metal. It is not a coincidence that oil prices begin to rise after Greenspan started providing huge liquidity hits in the late nineties.

What does it mean that "Greenspan put the pedal to the metal?" Look at the low interest rates again, designed to reelect Bush. Economics and politics of the Fed fund rate.

When you pay $5.00 plus per gallon for gas, consider it your contribution to the Bush reelection fund. As your food bill rises, that too is your contribution to the Bush reelection fund. As your rent goes up and you are unable to get a loan to buy a home, that is your contribution to the maintenance in power of the Republican Party conservatives. As your pay fails to keep up with the increased costs you face, that, too, is the direct result of the Bush Tax Cuts and their low interest rates designed to reelect Bush - and designed by Ben Bernanke to elect John McCain this year.

The American economy is no longer a free market if it ever was. This is today much the same battle as was fought from 1800 until the Civil War about creating a Bank of the United States that would give control of the economy to unregulated bankers. It is now a tool used by Republicans and their controlling bankers and big business CEO's to maintain and increase their political power. Their power and wealth matters. The way the rest of us live or don't live doesn't. If you are one of them, I pray for less power to you. For the rest of us, it's time to make that prayer come true.

Remember that this November, and be damned sure you vote. If you want to vote for the Democrat, make sure in advance of voting day that you are registered and have the required documentation to vote. Voters Registration are being denied as I write, and no notice is being provided to the registrant. You won't know until you try to vote and are turned away. Individuals are being required to present a picture ID issued by the government to vote, and in Arizona, you have to present proof of citizenship. These are Republican requirements that affect primarily Democratic voters.

So check now to be sure you are registered and have the required picture ID and proof of citizenship in order to vote. I'm an election judge, and if you don't have the legally required documentation I will turn you away. Your provisional vote will not be counted. Election day is too late.

When you do vote, if the Republicans let you, remember that the Republicans have put the economy into the tank so that whey will maintain power. They are incompetent at running the government, but they are very very good at stealing elections and corruptly stealing money from the government.

For some of my earlier posts on the economy click "economics" on the list of labels below.

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By the way, I have been focused above on the problems of the contradiction of keeping the economy running at a reasonable level vs. letting inflation run rampant. Ian Welsh's article makes really significant point on the threat of simultaneous inflation and deflation. The two economic events can occur simultaneously. Here's what he has to say about that possibility:

Finally there's this bit on the threat of deflation, which I think is worthy of commentary:

A small chorus of City bankers dissent from the view that inflation is the chief danger in the US and other rich OECD countries. The teams at Société Générale, Dresdner Kleinwort, and Banque AIG all warn that deflation may loom as housing markets crumble under record levels of household debt.

Bernard Connolly, global strategist at Banque AIG, said inflation targeting by central banks had become a "totemism that threatens to crush the world economy".

He said it would be madness to throw millions out of work by deflating part of the economy to offset a rise in imported fuel and food prices. Real wages are being squeezed by oil, come what may. It may be healthier for society to let it happen gently.

The threat of deflation has been looming for some time due to the housing crisis and how housing is tied to the money stock. It isn't actually a contradiction to be concerned with both inflation and deflation. What I've been expecting for a long time was first stagflation and then deflation (with an outside chance at hyperinflation, if the response by central banks is blown badly). Moreover, both can occur simultaneously, in a very nasty squeeze. There's no real contradiction in having food and fuel prices rise while prices for other items crash.

However notice the words "real wages are being squeezed by oil, come what may." Those words should send a chill of fear down your spine. Both because of their undeniable truth, and because of what they imply, which is that the world's elites intend for the peons to pay for this by having their real wages slashed in half. In fact, while it's inevitable there be some decline in real wages (I would guesstimate about 20%), there's a lot that could be done to mitigate such declines and to spread the pain around. But spreading the pain around means the rich would take an even bigger hit than they're going to take, and that's not acceptable. What will happen instead is that Bernanke and other central bankers will continue to provide huge sums of money in an attempt to bail the rich out of their losses and to avoid real, serious restructuring and regulation of the financial industry, despite the fact that the finance sector has a huge portion of the responsibility for this crisis, as it has for multiple bubbles over the last 30 years.

In the end though, what Barclays is saying is more interesting because Barclays is saying it than because it's great analysis. It isn't. It would have been good analysis a year ago. it would have been great analysis 3 years ago. There are bloggers who did most of this analysis 3 or even 4 years ago. Still, where the conventional wisdom is is important, because the conventional wisdom tells you what actions are now considered possible. And the debate right now doesn't include heavy re-regulation, or taking over banks, or even allowing banks to fail and go into government receivership. It doesn't include huge incentives for conservation of oil. It doesn't include the possibility of currency controls. What it comes down to is a simple debate between brute monetary policy approaches - easy money, or expensive money. High interest rates, or lower interest rates. Squeeze inflation out and suffer the consequences or don't squeeze it out and let inflation destroy real wages, wiping out all the gains of the post-war period.

Welcome to the world created by the rich when they think they can be rich while ordinary people become more poor. Welcome to the world that gets created when people think that they can have prosperity now and put the bill off till tomorrow.

As everything I have written earlier has pointed out, the wealthy and the bankers expect the rest of us to pick up the tab for their failures an losses while they get richer from taking risks that succeed.

Why not? With the conservative Republicans in power implementing the Reagan Revolution, the wealthy and the bankers are in the position to get rich from the upside risk and hand off the losses from the downturns to the rest of us. That's a great position for any financial person to be in.

But I'm sure that none of you mind making the Bush family, Dick Cheney, and the already wealthy bankers of J.P. Morgan, Citibank, and Bank of America more wealthy as the rest of us suck up the costs. Because that's the conservative way.

Economics and politics of the Fed fund rate

The most recent changes in the Federal Funds rate by the Federal Reserve demonstrate clearly that Alan Greenspan screwed up with his long series of rate increases that started in February 2005. The timing of that start is significant because it is only to months after Bush was reelected in part on the basis of no recession in 12004. It is clear that historically every time there is a recession during a Presidential election year, the Party of the incumbent President is removed and replaced by the candidate of the other party.

Greenspan, fully aware of the effects of the economy on Presidential elections, increased the federal funds rate in 2000 (making a Bush election over Gore more likely) and then lowered the Fed funds rate in 2004 so that Bush would be reelected. The evidence is in the timing of fed fund rate changes.

Note the years in blue which are election years, and the years in yellow which are the year after. In 2000 Greenspan was making the economy more difficult in order to defeat the Democrat. In 2004 he was making it better to elect the Republican.

In 2005 Greenspan knew that the low interest rates had created the housing bubble, so he was trying to stop the bubble. The continued into 2006. Greenspan was still trying to correct the problems he had created in 2001 through 2004. In early 2007 CountryWide, the nations' largest mortgage lender, announced in early Spring that the collapse of the housing bubble was causing economic problems. The result was the credit crunch that became obvious to everyone by Summer 2007, but which they thought could be isolated in just the mortgage markets. We now know that was living in a fool's paradise.

Intended federal funds rate 1997 to present

Year	Date	Rate
2008	March 18	2.25
	January 30	3.00
	January 22	3.50
2007	December 11	4.25
	October 31	4.50
	September 18	4.75
2006	June 29	5.25
	May 10	5.00
	March 28	4.75
	January 31	4.50
2005	December 13	4.25
	November 1	4.00
	September 20	3.75
	August 9	3.50
	June 30	3.25
	May 3	3.00
	March 22	2.75
	February 2	2.50
2004	December 14	2.25
	November 10	2.00
	September 21	1.75
	August 10	1.50
	June 30	1.25
2003	June 25	1.00
2002	November 6	1.25
2001	December 11	1.75
	November 6	2.00
	October 2	2.50
	September 17	3.00
	August 21	3.50
	June 27	3.75
	May 15	4.00
	April 18	4.50
	March 20	5.00
	January 31	5.50
	January 3	6.00
2000	May 16	6.50
	March 21	6.00
	February 2	5.75
1999	November 16	5.50
	August 24	5.25
	June 30	5.00
1998	November 17	4.75
	October 15	5.00
	September 29	5.25
1997	March 25	5.50

(Source Federal Reserve.)

Alan Greenspan comes clean

And Kevin Drum reports his statement.

Alan Greenspan today:

The current financial crisis in the US is likely to be judged in retrospect as the most wrenching since the end of the second world war. It will end eventually when home prices stabilise and with them the value of equity in homes supporting troubled mortgage securities.

This means, presumably, that he thinks we may be about to enter a recession worse than the one in 1981 — and that it's not going to end until house prices stop falling, which probably won't be until 2010 or so. This is bad, right?

Yeah, this is bad.

The Bush administration and the Fed are in the process of bailing out the bankers who assisted the Bush administration in creating this mess. And what do the people who suffer foreclosures Get?

Let's see. They are being foreclosed because Greenspan lowered interest rates, the conservatives deregulated banks, all while Greenspan refused to regulate loose (even non-existent) mortgage underwriting standards - all in the service of pumping more cash into the economy so that Bush would be reelected in 2004 while he paid for the unnecessary war in Iraq and the ridiculous tax cuts for the wealthy. So while the people who were used to pay for all the conservative Republican extravagances get screwed.

Par for the conservative Republican course, isn't it? Like American CEO's - screw everyone else and walk off with the money.

Dollar Still dropping (Feb 2008)

Just over a year ago I wrote that if you want to know how America is doing economically, watch the value of the dollar. Well, as of yesterday the dollar has reached a new post WW-II low against foreign currencies.

The Euro was established in 1999 and at at that time the value of one dollar for one Euro was established. Ss of yesterday it cost $1.4981 in Dollars to buy one Euro. Here is the Bloomberg Report:

Feb. 26 (Bloomberg) -- The dollar sank to a record low against the Euro as U.S. home prices and consumer confidence tumbled, bolstering bets the Federal Reserve will keep reducing interest rates.

The U.S. currency declined to the weakest level since the Euro began trading in 1999, and slumped against all 16 of its most-active counterparts. It reached its lowest level of the day after Fed Vice Chairman Donald Kohn said turmoil in credit markets and the possibility of slower economic growth pose a ``greater threat'' than inflation.

Kohn's comment ``confirmed the Fed will keep cutting interest rates,'' said Adam Boyton, a senior currency strategist in New York at Deutsche Bank AG, the world's biggest currency trader. ``That brought more downward pressure on the dollar.''

The dollar weakened to $1.4981 per euro at 4:32 p.m. in New York, from $1.4830 yesterday, falling past the previous historic low of $1.4967 set Nov. 23. The U.S. currency dropped to 107.24 yen from 108.07, and has lost 4 percent this year.

Boyton forecasts a dollar drop to $1.55 per euro in the next three months. He's more bearish than the consensus. The dollar will rebound to $1.48 per euro by the end of March and to $1.40 by year-end, according to the median forecast in a Bloomberg News survey of 41 analysts.

The U.S. currency has lost about a quarter of its value in the past five years, according to the Fed's U.S. Trade Weighted Major Currency Dollar index, which comprises seven currencies of U.S. trading partners. The weaker dollar has made U.S. goods cheaper abroad, boosting exports to a record and shrinking the nation's trade deficit last year for the first time since 2001. [Snip]

`Bleak Assessment'

The U.S. currency extended declines after Kohn, speaking in North Carolina, said ``the adverse dynamics of the financial markets and the economy have presented the greater threat'' to the U.S. economy than inflation.

``Kohn painted a very bleak assessment of the U.S. economy,'' said Brian Dolan, research director at Forex.com, a unit of online currency trading firm Gain Capital in Bedminster, New Jersey, which has about $250 million funds under management. ``What he indicated is that the Fed will keep providing lower interest rates regardless of inflation. It's outright dollar- negative.''

The rest of the world is watching as the U.S. economy becomes less and less economically competitive against Europe and Asia. The Federal Reserve is now promising to lower interest rates to spur the economy in spite of the threat that such lowering of interest rates will cause an increase in inflation.

The lowered interest rates are all the Fed can do, but they are a short term fix, while the inflation that will result is a longer term threat. At some point, lenders will start anticipating the inflation and increase the interest they charge for loans. That's already happening in the long term mortgage markets. In spite of the recent actions by the Fed to lower interest rates, mortgage rates have not gone down.

In spite of all the happy-talk about how strong the U.S. economy is, there is little evidence to support that talk. That's what the drop in the value of the dollar is telling us.

For some of my previous economic reports, go here.

Dollar value uncertain - inflation and recession or healthy economy coming?

The dollar has slipped to the lowest rate against the Euro ever (1.4481 dollars will buy one Euro today), and the recent interest rate cuts by the fed (required to keep the economy out of recession) will cause the dollar to drop even further.

How does the dropping dollar effect people?

BBC News provides a few examples of that this means for international businesses currently writing new contracts:

• Brazilian supermodel Gisele Bündchen is requiring that all her new contracts be written so that she is paid in Euros rather than dollars.
  
• Billionaire investor Warren Buffett is buying investments that pay in currencies other than dollars.
  
• Jim Rogers, a former investor partner of George Soros, recommends that anyone buying currency now buy the Chinese renminbi, the Japanese yen or the Swiss franc rather than the dollar
  

So savvy business people do not know what the dollar is going to do. Their solution is to sell dollars and buy other currencies.

Supply and demand says that if everyone prefers to sell one currency and buy others the currency being sold will drop in value while the others will go up in value. That action will reinforce what is already happening. The dollar is already in uncharted waters, so there is no telling how much more it will drop.

How does the dropping dollar effect the economy?

This drop in the dollar value will ultimately make American exports less expensive to foreign buyers and cheaper than similar products from competitors, so exports are likely to increase. However, it's not like there are warehouses full of American-made widgets sitting around ready-made and looking for foreign buyers. The export products will have to be produced, and that takes a while. Expect employment to increase because of any increase in exports, but not immediately. [*]

What will happen immediately is that imports will go up in price, with oil being the first and most noticeable increase. That means pressure for inflation. Money lenders will increase interest rates to protect the value of their loans from the anticipated inflation. This is exactly the opposite of what the fed has been doing - which is lowering interest rates to avoid a recession.

Keep in mind the time lag between the time interest rates and the dollar value change and the time exports can be ramped up and help the American economy. This time lag is going to be important.

The Fed's bind

So the fed is in a bind. A looming recession demands lower interest rates. But it also lowers the value of the dollar against other currencies, contributing to inflationary pressures. Inflation will cause interest rates to go up (whether the fed acts or not because lenders increase interest rates to protect themselves from loss of value of their loaned money caused by inflation. That interest rate increase will increase pressures leading to recession.

What does this mean?

Here's where that time lag between financial changes and changes in the rate of production of real goods and services will be important. If exports create enough new employment fast enough, then the fed might be able to head off inflation through an interest rate boost. That depends on whether the economy itself is getting more active rather than heading towards recession. Remember, interest rate changes and changes in the value of the dollar happen rapidly. An improvement in the economy is a lot slower. The fed's goal is to keep the economy out of recession while avoiding inflation that would cause the lenders to jack up interest rates.

I think the fed is going to have to stick with lowering interest rates to avoid recession and hope that the economy will rebound rapidly enough so that lenders don't demand an interest rate increase to protect their loans from inflation. There appears to be at best a very narrow range of options that allow the fed to thread the needle between causing recession by raising interest rates and permitting inflation by lowering them. But that's just my guess.

It may not be possible to maintain that balance. It will only be possible if the lag time between financial changes and the actual production of goods and services for export is very short.

This is, as I said, my guess. If anyone knows which way this is going to work out and has money to invest, they are going to make a lot of money. I don't know what is going to happen, and apparently Warren Buffet doesn't either -- so I don't feel too bad about not knowing. But the fed chief, Ben Bernanke, is facing a great deal of uncertainty which I am sure he wishes would resolve itself quickly.

---

[*] While total employment can be expected to increase as exports increase, there are a lot of people who have quit looking for work and are not counted in the unemployment statistics. If employment increases, many of them can be expected to reenter the workforce and start job hunting, so the unemployment rate may not drop.

If the unemployment rate does not drop, that's good. The statistic - the unemployment rate - was designed to predict inflationary pressures. The lower the unemployment rate goes, the more likely we are to get inflation in the economy caused by labor wage rate increases as employers raise wages in an effort to attract more of the scarce workers.

Likely effect of disastrous employment figures

Bonddad referred me over to Mish's analysis of the really, really bad employment report. His analysis is:

Two days ago in Mass Layoffs Soar I proposed "One of these months there is going to be a massive "unexpected" downward jobs revision. More than likely that will be used as an excuse by the Fed to cut (or further cut) rates. It won't help."

So Soon?

The August BLS Employment Situation Report shows that "One of these months" has already arrived.

Nonfarm payroll employment was essentially unchanged (-4,000) in August, and the unemployment rate remained at 4.6 percent, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. Over the last 3 months, total payroll employment changes have averaged 44,000 per month and private sector employment changes have averaged 72,000 per month (as revised). In August, employment in manufacturing, construction, and local government education declined, while job growth continued in health care and food services.

Participation Rate Sinks to 65.8%

How does the BLS hold the unemployment rate low with such pathetic numbers? The answer is of course the participation rate.

"In August, the civilian labor force edged down to 152.9 million, and the labor force participation rate decreased to 65.8 percent. The declines were largely due to a drop in labor force participation among teenagers; their participation rate fell to 39.7 percent."

Well participation rates can't go negative so this source of nonsense will eventually have to stop.

Mish is saying that the employment figures were only as positive as they were because the Bureau of Labor Statistics (BLS) is fudging the figures like mad. Or, as he states it, there is a great deal of BLS "moonbat activity" designed to make the already bad looking numbers from showing the true dimensions of the disaster that has occurred. If economic numbers in tables don't cause your eyes to glaze over I strongly suggest that you go read his report in full.

From the macroeconomic point of view, these numbers point to the coming problem in the economy.

Gross Domestic Product (GDP) = Consumption (C) + Investment (I) + Government Expenditures (G). [GDP=C+I+G)]

But since Bush took office, "I" and "G" have not become significantly larger. Think about it - for the tax cuts to have kept the economy working, "I" would have had to increase. it didn't. What has kept the economy from going into recession has been the continued consumer ("C") spending.

But real wages have not increased since the Clinton administration. Consumption spending ("C") has been the main cause of any increase in GDP since Bush entered office, and that has been manipulated to prevent recessions from causing Bush to be defeated for reelection in 2004.

As I wrote earlier, Federal Reserve Chairman Alan Greenspan wanted Bush reelected and the Republicans to remain in power. He did it by lowering interest rates and by failing to regulate the quality of mortgage loans that banks were issuing.

The resulting housing bubble kept both employment its resulting consumption spending artificially high. But the economy needed to go into recession early in Bush's first term, so the efforts to artificially pump up the economy required more and more effort as time went on. Or to say it another way, the housing bubble was created to artificially pump up the economy for political purposes, but the longer the bubble was permitted to last, the more damage it did to the economy.

Greenspan started slowly rising the interest rate in February 2005 to try to slowly correct the damage he had done, but it didn't work.

A housing bubble takes a long time to demonstrate its damage. I'm sure that the mortgage companies could see it in 2006, but it did not become publicly known until the largest mortgage company in the nation (Countrywide) announced that it was having problems in early 2007. The damage of the bubble has been slowly surfacing since then, The credit crisis from this Summer are just the latest effects. Countrywide has announced that it expects a 25% drop in mortgage lending next year, and is now laying off 20% of its workforce (a number that has not yet made it into the BLS statistics.)

There are more economic problems to come. The only thing no one knows is how severe they will get. Recession? More likely now than not.

One thing about this, though, is that the President usually gets credit or blame for the status of the economy because he was in office when it happened, no matter what he did. In this case, however, George Bush and the Republicans are directly responsible, and demonstrably so.

The Bush administration has been faulted for politicizing a lot of things that should not be politicized so that they can keep Republicans in power. Attorney General Alberto Gonzales has just resigned over the scandal of politicizing federal Justice. Michale Brown was fired as head of FEMA because FEMA had been made a dumping ground for unqualified political activists and the disaster in New Orleans proved it. Here we can see how the same process of politicizing everything the government touches has also effected how the economy is managed by the Federal Reserve.

There is nothing in America (or Iraq) that the Republicans and the Bush administration have touched that is not the worse for it. Our next recession (among many other disasters) has been worsened by our Republican party.

Remember that when you go to vote next. That vote is the only protection we, the average American people, have from the Republicans.

Fed puts politics over economics; credit bubble results

The current international credit crisis is a creation of the central banks, and primarily Alan Greenspan. Greenspan gave the sellers of high-risk high-return an essential guarantee that if they borrowed money to leverage the profits from the risky investments, he would bail them out by lowering interest rates if the market went against them.

Here is Bill Fleckenstein at MSNBC Money on the subject:

"The global credit bubble is bursting. This bubble is primarily leverage financing for owning risky assets. The people who were responsible for what happened played with other people's money, marketed arcane financial products with false promises of fat profits, but stuffed their own pockets with big bonuses. Neither these masters of the universe nor their greedy but naive investors deserve to be bailed out. They deserve what is coming to them.

"The central banks should focus on price stability, not financial market stability, and should provide liquidity only to contain the multiplier effect of the bubble bursting on the economy. Nor should central banks stimulate to avoid recession at any cost. Business cycles are not bad. Excesses must be followed with cleansing. . . .

"Markets have been taking more risk than they should because they believe that central banks will come to their aid during times of crisis, like now. The penchant of Alan Greenspan, former U.S. Federal Reserve chairman, to flood the market with liquidity during financial instability is the genesis of this 'central bank put.' As long as this expectation remains, financial bubbles will occur again and again. Now is the time to act. Let the crooks go bankrupt. Central banks should bury the Greenspan 'put' for good."

Why would Greenspan do this?

Simple. Electing the Republican George Bush was more important to him than was rationally managing the money supply for the American economy.

Wait to see if the Fed bails out the speculators. That will tell us of Ben Bernake is continuing Greenspan's practice of protecting the speculators.

Nourial Roubini makes the point that there is a difference between being illiquid and being insolvent. A debtor in illiquid if they could pay back their debts over time if their creditors would give them time by restructuring the debt. A debtor is insolvent if they cannot repay their debts over time even if they were given the time by their creditors.

An illiquid organization is in a temporary cash crunch but is an otherwise economic viable organization. Chrysler was in such a situation several decades ago. They could not pay their debt at the time, but with a bailout they were able to completely pay off their debts without costing those who bailed them out anything. Enron was not an economically viable organization. it was insolvent. It could not be bailed out. With that in mind, consider:

Insolvent and bankrupt households, mortgage lenders, home builders, leveraged hedge funds and asset managers, and non-financial corporations. This is not just a liquidity crisis like in the 1998 LTCM episode. This is rather a liquidity crisis that signals a more fundamental debt, credit and insolvency crisis among many economic agents in the US and global economy. Liquidity runs can be resolved by the liquidity injections by a lender of last resort: in the cases of the liquidity crises of Mexico, Korea, Turkey, Brazil that international lender of last resort was the IMF; but in the insolvency crises of Russia, Argentina, and Ecudaor the provision of the liquidity by the lender of last resort – the IMF – only postponed the inevitable default and made the eventual crisis deeper and uglier. And provision of liquidity during an insolvency crisis causes moral hazard as it creates expectations of investors’ bailout.
[Emphasis mine - Editor WTF-o]

I would not at this time predict an insolvency crisis, but it should be very clear that Alan Greenspan was papering over problems in the economy in order to reelect George Bush in 2004. By doing so he made the current problems deeper and uglier. The only question is how severe the underlying economic problems - other than merely illiquidity - really are. The central bankers really don't want the level of the problems to be seen. If it all comes out at once right now there is a chance that the credit markets would simply shut down for a period of time. So they want to try to talk nice while they are secretly cleaning up the mess in the background.

Let's all hope that Ben Bernanke practices economics as a central banker rather than politics as a Republican like Greenspan did. Oh, and let's hope that there is a reasonable chance remaining after Greenspan's economic mismanagement for the repairs to work.

See my prior posts

• More mortgage loan problems
  August 12, 2007
• Credit crunch spreads outside U.S.subprime markets to the rest of the world.
  August 10, 2007