Ben Bernanke Speaks to Congress and the world listens and analyses

Yesterday was a day where we learned the results of central bankers from two of the world’s central banks. The Chairman of the Federal Reserve gave a speech to Congress whilst the latest minutes from the Bank of England’s Monetary Policy Committee were released. Before I get to these there were two other issues which were significant. Portugal auctioned some twelve month Treasury Bills and had to pay a much higher yield of 2.45% against the 1.036% she paid back in March 17th. This updates what I wrote on her yesterday. Whilst still way below the level that Greece would have to pay it is a significant and therefore disturbing rise in only 4 months. As Portugal is in an austerity drive an increase in expenditure of just under 14 million Euros this year does matter and of course it implies higher costs on future borrowing.

We also saw something happen which I did not expect to see at this stage of the market recovery. In London a company listed called Ocado which  appears never to have made a profit in its lifetime and according to many analysts had a value way below the suggested 200-275 pence price range. Then on the day before listing the price dropped to 180 pence and approval of this was rushed through. In all the shenanigans I am left with the view that this resembled a listing at the top of a bull market but my point is we are not in such a market. If you look at this company one is left with a disturbing question, if it is way overvalued as it appears to be how were the shares sold?

The US Economy: Ben Bernanke Speaks

This speech acquired extra significance in the run-up to it because the last few weeks have seen signs of a slowdown in the US economy. The minutes of the last Federal Reserve meeting on June 22/23 had hinted that the Fed is becoming a little concerned. As it has expanded its balance sheet to around 2 trillion US dollars to encourage a recovery you can see why.

As Mr. Bernanke spoke we saw the US stock market fall with the Dow Jones industrial average going from up on the day to down 150 points quite quickly and it closed 109 down. Here are the sections which caused this.

Most participants viewed uncertainty about the outlook for growth and unemployment as greater than normal, and the majority saw the risks to growth as weighted to the downside

Of course, even as the Federal Reserve continues prudent planning for the ultimate withdrawal of extraordinary monetary policy accommodation, we also recognize that the economic outlook remains unusually uncertain. We will continue to carefully assess ongoing financial and economic developments, and we remain prepared to take further policy actions as needed to foster a return to full utilization of our nation’s productive potential in a context of price stability.

I think that US equity markets heard the words “uncertain” and “downside” and panicked. Two contrasting themes clashed here as the one supporting a panic is that central bankers often talk in coded language, Mr. Bernanke’s predecessor Alan Greenspan was very prone to this. On this basis then there may be concern as a central banker will always try to avoid forecasting a downturn in case the forecast itself contributes to it. So for a central banker such issues are rightly difficult. However the other theme is that markets should be well aware of the uncertainties that the US economy faces and recent economic figures should have had them worried about the downside anyway.

For the more thoughtful of mind the lower paragraph illustrates a dilemma about which I have written often. Central banks around the world planned 2010  to be the year where there would be a “withdrawal of extraordinary monetary policy accommodation” and yet find themselves “prepared to take further policy actions”. Another theme I have is our authorities definition of the word temporary as some of these measures are starting to look more and more permanent aren’t they? To my mind the question that is genuinely concerning is how and when will we finally free ourselves of these measure and what are the implications? I am of the view that if US equity markets asked this question we would have fallen by much more than 109 points.

US Unemployment

Mr. Bernanke’s speech was revealing in his and the Federal Reserve’s view on US unemployment and the news was not good for America’s job queues. The phrase “attendant uncertainty about job prospects” was followed by.

After two years of job losses, private payrolls expanded at an average of about 100,000 per month during the first half of this year, a pace insufficient to reduce the unemployment rate materially. In all likelihood, a significant amount of time will be required to restore the nearly 8-1/2 million jobs that were lost over 2008 and 2009.

Those unfortunate enough to be in America’s job queues might reasonably be wondering how “long a significant amount of time” is and I would suspect their definition of it is not the same as Mr.Bernanke’s. Interestingly Mr.Bernanke goes on to discuss the issue of long-term unemployment and the effects of it which in some respects is the best part of his speech. It is good to see this issue addressed in an honest fashion.

Moreover, nearly half of the unemployed have been out of work for longer than six months. Long-term unemployment not only imposes exceptional near-term hardships on workers and their families, it also erodes skills and may have long-lasting effects on workers’ employment and earnings prospects.

One of the reasons I approve of this section of his speech is that it addresses a fundamental problem. Many to my mind have assumed that the world hit a crash made some extraordinary moves to deal with it and then will move on. In a way the current fears about a “double-dip” reflect this as again something is expected to happen quickly. However I have been concerned for some time that the build up of issues such as lack of reform of the banking sector and debt problems both private and public act as a dragging anchor and economies grind slowly forward over the next few years. A type of what was called stagflation in the 1970s ( I will deal with US inflation in a moment). Now if you imagine the effect of this on the long-term unemployed I hope my point (and my fears) become clear.

US Inflation

Here Mr.Bernanke is very relaxed for a man who has pumped the best part of 2 trillion dollars into the US monetary system.

Inflation has remained low. The price index for personal consumption expenditures appears to have risen at an annual rate of less than 1 percent in the first half of the year.

Here he and I disagree and I invite readers to look at my article of the 2nd July which argues that inflation in America is higher than that shown in official figures. There are bigger fans than me of the European harmonised measure but even it exposes issues with the American Consumer Prices Index.

US Treasury Bond Market

These responded with a further drop in yields. the ten-year yield closed at 2.89% and the thirty-year closed at 3.9%. If you wish to borrow for two years then you would be happy to borrow at the 0.56% the US Treasury can. This rate has dropped by 0.4% over the past year. In a way you could look at what investors think of the US economy over the next few years from this one fact. Consider it for a moment, if the market has reduced the rate of return they are willing to accept over the next 2 years from a measly 0.96% to 0.56%  this is hardly a hopeful sign.

Personally my concerns over inflation mean that I think such investments are unwise. There is of course a more disturbing view that investors are willing to accept an expected loss in real terms over the next two years to be in US dollars and to have their money guaranteed by the US Treasury. That is quite an apocalyptic scenario….

On a more technical point I spotted this in the speech concerning US Treasuries.

In addition, the average maturity of the Treasury portfolio nearly doubled, from three and one-half years to almost seven years. 

Those with a memory which reaches back to my article of yesterday may already be thinking of the problem with this. For those who did not read it let me point out again that the United States has been on a trend where it funds itself on an ever shorter basis. The average maturity of US government debt has been shortening. However of the longer-term debt we find that the US has been buying it off herself. This is not an inspiring combination to say the least. If you look at the yields above you can see how funding in the short-term can seem attractive.

However this is bad debt management. If the US economy prospers no doubt those responsible will congratulate themselves on how clever they have been. Should it hit trouble however and find problems in selling her debt then this will be exposed as a very unwise strategy and could even lead to a calamity. Before I move on I would just like to point out that the US has a lot of debt to sell over the next few years…..

Conclusions

1. The Federal Reserve is caught in a real dilemma. At a time when it planned to reduce and take away its extraordinary measures it finds itself having to consider new ones. I pointed out yesterday that if QE mark 1 fails then it is wise to at least question whether QE mark 2 ( i.e more of the same) is likely to succeed. Many economists seem to have an almost messianic faith in this as opposed to looking at the evidence.

2. US debt management has adopted a very risky strategy. Yes it reduces her fiscal deficit right now but at the expense of future risk.

3. Another theme is that “kicking the can down the road” is colliding with the fact that essentially short-term measures are ending or at least being planned to end. The long-term unemployed,for example, might seriously wonder what plans there are which will help them regain work in the medium and long-term.

4. After all the measures by economic authorities and all the vast sums spent we arrive in a position where the future is “uncertain”.

UK Monetary Policy Committee Minutes 

Here we saw some similar themes to that of Mr.Bernanke and the Federal Reserve. They too are concerned about a slowdown in economic growth in the UK and worldwide. Having an explicit inflation problem they appear to feel the need to keep repeating the phrase “falling inflation”. Perhaps they feel that repeating this technically true statement according to the official figures will mask the reality that it is way over target and sooth some of the pain of having to include this section.

Near-term inflation prospects had also worsened. Although CPI inflation had fallen again in June, it was likely to be higher during the remainder of 2010 than envisaged in the May Inflation central projection. And the increase in the standard rate of VAT to 20% announced in the Report Budget was likely to add to inflation, particularly in 2011. Because of that, it was increasingly likely that inflation would remain above target for some time. This followed a period of several years in which inflation had been above target for much of the time.

Apart from the spin of “fallen again” if you consider that this is written by the MPC it is quite an indictment of their tenure. Those like me who think that their policies have contributed to the inflation problems of the UK will be concerned to see that they considered doing more of them. However the intellectual tangle the MPC appears to have got itself into is best illustrated by this.

“The Committee considered arguments in favour of a modest easing in the stance of monetary policy…………..But there were also arguments in favour of a modest tightening in the stance of monetary policy”.

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8 thoughts on “Ben Bernanke Speaks to Congress and the world listens and analyses

    • I shudder with horror at the quote
      “Yet Mr Dale offers another explanation as to why inflation is staying so stubbornly high – businesses having to protect their cashflow. He says that he has learned from getting out and meeting firms that the thing that drives companies out of business is cashflow”

      There is a popular phrase involving Sherlock that comes to mind. Where do these people come from who are amazed at a universal truth for SMEs? Where did they acquire such lack of knowledge about the real world? How do they get to the positions they are in?

    • Hi Sean

      Thanks for the link, I had heard about it on the radio but had then in truth forgotten it. There is something of a PR spinning operation going on at the MPC isn’t there?When you look at what the MPC has actually done then this is breathtaking.
      “”We know the evils of inflation. It adds to uncertainty, it destroys value of hard-earned cash and reduces the efficiency of the economy. We have to be incredibly vigilant.”
      I notice that Spencer seems unclear about the meaning of the word little and that later the journalist appears unclear about the meaning of the word savage….

      The CV is interesting too. At least there is one organisation in the UK that still gives jobs for life.

  1. “…my article of the 2nd July which argues that inflation in America is higher than that shown in official figures.” Of course it is, but surely the same is true with the UK numbers? Most of the statistical techniques used for manipulation are similar if not the same, and the intent is to deceive.

    Surely what is at the base of all of this is that economists and politicians know what they should be doing according to classical economics to correct the problems, but they shy away from doing that and do the opposite, and manipulate the numbers to deceive the people:

    1) to protect the banks, since if they did the correct thing there would be many more mortgage foreclosures and many banks would have solvency problems again;

    2) Because they mistakenly believe that what they are doing will protect employment permanently;

    3) Because they want to protect the reckless from losing the houses they paid much too much for, and took on mortgages which they could not afford with an adequate margin of safety.

    As a result we risk severe real inflation and economic collapse.

    They then get to the point where they actually delude themselves, and believe that they are doing the right thing. In my opinion Max Keiser has it summed up more than most commentators.

  2. Good blog, started reading it in the last few days.
    I understand the concept of inflation as a tax/theft, and the role of the ‘banksters’ and fiat money. I also recognise the BoE strategy of very low base rates to help rebuild the banks balance sheets.
    However I find some difficulty in totally understanding the perceived requirement to raise base rates to counter ‘inflation’ measured on any index when that ‘inflation’ is caused by events which may mathematically increase an annual index but in themselves reduce the amount of ‘money’ in the general economy, ie imported fuel priced in dollars, raising the rate of VAT. Surely these events are net deflationary, to raise rates which in itself raises the index again is self-defeating. If the economy was growing faster than efficiency gains and there was pressure on wages etc from these events then it would be different, but surely we are far from that situation.
    Unless I am missing something, I presume the MPC recognise all this, and so I am in agreement with the author that this is all spin by the MPC in order to ‘convince’ someone ( I am not sure who) that they ‘ on the inflation case’. If this is indeed what is happening then we can question the need for such spin, but surely not the need to ignore pure maths when formulating the correct economic response.

    • Hi JW, I understand your viewpoint, but the first thing is that real (classical) inflation can only be caused by an increase in the money supply when the real wealth in an economy remains the same, or by a reduction in that real wealth when the money supply remains the same. As Keynes explained clearly true inflation can generally only be caused by governments, and it results from a situation (almost having become the norm these days) where a government spends more than it receives from all revenues and borrowings, and decides to make up the remaining deficit by increasing the existing money supply to balance its account.

      There are a number of different ways to control inflation, and in the past various of these means were used (such as the gold standard). Latterly the approach of a one hammer toolkit became (for no entirely logical reasons) the vogue for fiat currencies; that was to use only interest rates to control inflation. Prior to the supposed concept of an independent central bank, the government fiscal controller (in the UK the Chancellor) set base rate and other fiduciary parameters, but clearly did so with an intense political bias. The concept of the MPC was to supposedly have an “independent” committee which would set base rate (on a similar basis to the Bundesbank), so that this would not be subject to political bias or whim. However, when Brown set up the MPC he included devices within the defining document which allowed the UK Chancellor to take back control of base rate at any time he chose clandestinely. Judging by the factual evidence this option has been exercised somewhat frequently and continuously since then, making a mockery of the concept of independence. The specific remit of the MPC is extremely simple and very limited, if you read it on the BoE web-site. It limits their authority and responsibility to solely setting the BoE base rate, so as to control inflation, and to ensure that it remains at 2% per annum. However, Brown also arranged that he as Chancellor only could select each member to sit on the MPC. He then selected them very carefully and cunningly, so that every one was of the semi-neo-Keyensian school, thus of effective left-wing Socialist persuasion. There was no balance of the selected members, and for example there was not a single one selected of the Austrian school (which is the oldest economic faculty, with a monetarist understanding). It would therefore be reasonable to expect that in these circumstances any decisions made by such an MPC would have a political and economic school bias!

      So the present economic vogue is to control inflation by only adjusting interest rates and neglecting the other means which could also be used. The remit of the MPC is only to do that – to adjust the base rate. They have been given no other responsibility nor authority. So when they discuss in their meetings issues, such as QE, fiduciary parameters and control, the dangers of further recession or depression relative to base rate etc., they are acting illegally and outside their remit and authority. They have been granted no authority at all to discuss let alone to take any action on these issues, which are fiscal and fiduciary.

      So when you make the observation “…However I find some difficulty in totally understanding the perceived requirement to raise base rates to counter ‘inflation’ measured on any index when that ‘inflation’ is caused by events which may mathematically increase an annual index but in themselves reduce the amount of ‘money’ in the general economy, ie imported fuel priced in dollars, raising the rate of VAT.”, that is where we must start from. The reason that base rate must be adjusted to control inflation is that this is the sole control parameter which has been chosen in the system for controlling inflation, and it is the supposedly “independent” MPC which has been given the authority to do that (unless overriden by the incumbent UK Chancellor, who can ultimately override and still make the decision of what base rate should be). I think part of the problem is that you are confusing “retail price inflation” with real inflation. That is part of what the trickery is all about. “Retail price inflation” is affected by exchange rate, changes in taxes and a number of other parameters. Real (classical) inflation is not; it is only a function of the amount of money in circulation, with a number of ancillary variables (such as the velocity of circulation) impinging and interacting to a minor degree.

      There have always been and will always be cycles of supply and demand, and cycles of availability which will influence prices in the marketplace. These are natural phenomena and will exist regardless of any changes in the money supply or the velocity of circulation. They therefore have nothing to do with real inflation, and cannot be controlled, except by assisting production of shortages in supply. Changes in currency exchange rate are not inflationary in the classical sense, but do affect the prices of imported items, and they do affect “retail price inflation”. (Clearly the base rate also affects the currency exchange rate.) The issue of liquidity is not actually about the money supply if this remains constant. It is more about debt (including overseas debt) and the velocity of circulation. It is quite difficult to quantify current “retail price inflation”, and due to the desire of politicians to deceive it is made more difficult by the gambits which they encourage statisticians to use to misrepresent the truth, so as to conceal their debauchment.

      There are never in reality any “…events which may mathematically increase an annual index (of real inflation) but in themselves reduce the amount of ‘money’ in the general economy..” The amount of money in an economy is the quantity of money or money supply, but there have also become a number of ways (M1, M2, M3 etc.) to measure this supposed money supply, again selected to confuse the real issues and deceive the unwary. The truth is that with a given amount of wealth in an economy, if real inflation increases then this indicates that the money supply has increased relative to the real wealth in that economy. There is no other possibility, and that is what semi-neo-Keynesians do not like, because they do not accept ALL of the written arguments of Keynes, but only those which fit their Socialist dreams!

      I hope that my brief attempt to expound these issues helps you now to understand the perceived requirement to adjust base rate to control inflation. This is not the only way to attempt this, but it is the vogue presently chosen way. What we currently have in the UK is a complete refusal by the MPC to take any necessary action, as specified in their remit, despite it being the stated requirement, and this is being neglected for political objectives, for the reasons I suggested in my previous post here today.

  3. Regarding the low rates currently seen in government bond markets, the Barclays Capital 2010 equity gilt study came to the conclusion that the baby boom is largely responsible (as it was for the equity bull markets of the 80s and 90s) – i.e. an excess of capital chasing the same sort of investment at the same time. I guess we are now near the tail end of the baby boomer retirement peak, so that demand should soon dry up… I started trying to check who the major holders of US treasuries of different maturities are, and was surprised to learn that around 50% are Federal reserve and Intragovernmental holdings, of which a large part are held by the Social Security Trust Fund (money lent to the government by workers on the understanding it will be paid back to look after them in their old age). This source of demand for government debt (particularly longer maturities?) should start to fall as the workforce contracts. Barclays Capital’s conclusion was that equities, although not obviously attractive at current prices, should out-perform bonds over the next decade.

    I think you’re right to be worried about inflation in the medium term though because, in this ‘dollar standard’ world, the Fed will continue their soft default by printing money for as long as their foreign creditors choose inflation over currency appreciation and lost exports. It’s basically a game of Chicken, so let’s hope somebody blinks before too long.

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