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Bernanke running out of bliss space
By Julian Delasantellis
Thanks to the recent actions of the United States Federal Reserve Board,
including Tuesday's twin 75 basis point cuts to the Federal Funds Target Rate
and Discount Rate, the ancient, philosophical question as to how a soul can
achieve unparalleled paroxysms of unadulterated bliss has finally been
answered.
Take a hammer. Hit yourself over the head, hard, several times. (To paraphrase
those warnings on US TV car advertisements that show Grandma driving the new
car to church accompanied by the information that you're watching a
"Professional Driver on Closed Course; Do Not Try at Home" - I'm a
"Professional Pundit; Don't Try This at Home.") When finally you stop and put
the hammer
down, waves of bliss that you've never felt so exquisite will wash over you.
Much like the children of the 1960s discovered with their particular paths to
ecstasy, you probably can't achieve your state of bliss in this fashion all
that many times. Fed head Ben Bernanke probably can't, either. For him, the
hash pipe essentially comes around to his lips every six weeks or so, with
every Federal Reserve Board meeting. Two more hits, then Bernanke, and with him
the rest of the world, will have to find a new way to stay eight miles high.
Not even three months into it, and it's already been a busy time for Bernanke
and his happy band of monetary minstrels. It is generally agreed that the US
economy essentially rolled right off a cliff in mid-December 2007, and by
mid-January it was becoming obvious to all. On January 4, it was announced that
the US unemployment rate had risen to 5%. On January 21, as the SocGen trading
scandal began to make it look like it was going to eat the world's equity
markets alive, the Fed moved into action - 75 basis points, 0.75% came off both
the Federal Funds Target Rate and the Discount Rate, along with 50 more points
of cuts at the Fed's next regularly scheduled meeting the following week. (see
Bernanke hits the joy button, Asia Times Online, February 1, 2008).
The rate cuts, of course, were designed to counteract the spreading negative
effects of the subprime mortgage crisis. ( Over at Justin Fox's "Curious
Capitalist" blog at the Time.com website, they're taking nominations as to a
new moniker that would better describe these current unhappy events, since just
continually calling it the "subprime crisis" fails to illustrate the real
problem - what happened to the subprime mortgage paper when it got eaten by
Wall Street's gaping maw, then expelled out the Street's backside and then sold
to the investment world as fresh candy. The best contenders are "The Great
Deleveraging", "Dollerdamerung", "The Waterboarding of Wall Street" and, my
personal favorite, simply "Splat". )
The natural time lag of monetary policy means that we really won't know whether
these moves are succeeding in pulling the economy out of its recession until
next year, but, as the markets moved through February, we did see that the Fed
rate-cut policy, which had started the previous August and in less than six
short months had already taken 225 points off the Federal Funds Target Rate,
was already having a significant negative effect.
If inflation is classically defined as too much money chasing too few goods,
the market began to fear that the Federal Reserve was willy-nilly creating so
much new cash that soon all the country's consumers would be like the
proverbial gerbil on a wheel, furiously chasing after the necessities of life,
as inflation seemingly put the little bits of food and fuel further away from
the reach of consumers' little paws on the little spinning wheel.
Just from early February to mid-March, crude oil futures prices rose over 28%,
to US$111 a barrel. Wheat futures rose 35%, corn 15%. Like two-toned platform
shoes and shiny avocado green polyester leisure suits, it seemed like another
yawning terror from the late 1970s, simultaneous inflation and unemployment,
popularly called stagflation, was once again being released from its cage, this
time by Bernanke, to stalk the quiet countryside.
Of course, all the surging commodity prices had, at their core, a common
causation - the flight away from confidence and desire to hold wealth in the
form of US dollars. The euro versus the US dollar broke above 1.50 for the
first time after the January cuts, reaching 1.59 on March 17. With the nation's
monetary authorities seemingly hell-bent on printing lots more of the currency
why wouldn't someone choose something other than US dollars as their store or
wealth - it may be messier or noisier to store your fortunes in pork bellies or
live chickens, but at least Bernanke isn't making more of them.
Also, as the early days of March arrived, it began to be seen that all the new
monetary infusions the Fed was applying to the markets didn't seem to be doing
all that much good. The funds weren't getting to the places where they were
really needed - the wounded balance sheets of the financial institutions stuck
with the subprime mortgage paper.
By mid-February, the spreading damage essentially shut down the auction rate
securities market (see
Wealth destruction gathers pace, Asia Times Online, February 20, 2008),
and everybody knew that, whatever you wanted to call it, the crisis was still
gathering force.
To a certain extent, it began to be seen that the Fed's traditional palliative
for economic uncertainty, simply lowering interest rates to the system as a
whole, was as if to deal with a house on fire at the bottom of the hill, the
house at the top of the hill was doused in the hope that the water would roll
down to where it was most needed. Super billionaire investor Warren Buffett
once termed financial derivative instruments, such as leveraged subprime
mortgage paper, financial weapons of mass destruction; some way, then, had to
be found to stop them from continually blowing up inside the vaults and balance
sheets of the Western world's core financial institutions.
In my review of the first year of the subprime crisis, (And
the band played on, Asia Times Online, March 6, 2008) I pointed out how
a consensus was developing that looked for a solution outside of simply
lowering rates. Various proposals are floating around the public policy
wonk world that call for a far greater role by the US government in saving the
subprime/structured finance world. Most of these call for some branch of the
government to, in effect, take the subprimes out of the hands of the private
sector, by buying these mortgage securities from the banks. Since it would take
these rapidly declining in value securities off their hands, in exchange for
cold, hard, rock-solid (as long as you're not comparing its value to that of
the surging euro) American cash, the banks would love this. Bank of America
advanced a plan to do just this in late February. In the past
few weeks, it seemed as if the Federal Reserve was finally getting the message.
On March 11, the Fed announced a new policy initiative, the Term Securities
Lending Facility, in which the Fed would accept, instead of its traditional
preference of US Treasury Securities, lower-quality collateral, including
subprime mortgage debt, for 28-day repurchase loans. Thus, the Federal Reserve
was, in actuality, taking the subprime paper off the banks' hands in exchange
for real cash - if only for a four-week (but potentially renewable) term.
Over the weekend, Bear Stearns faced its comeuppance. The new Fed flexibility
was also in effect here as well, as it was announced that the Fed's discount
borrowing window would now be available to a broader range of financial
institutions other than just the small pool of preferred trading desks called
primary dealers. Also, to encourage the financial community to use these new
borrowing facilities, the Fed in under 48 hours from its next scheduled
meeting, lowered the rate it charges to borrow directly from it, the Discount
Rate, from 3.50% to 3.25%.
But there was still another Fed meeting scheduled for Tuesday. Even though
there was the new developing consensus that interest rate cuts alone weren't
going to do the trick here, and that, indeed, the hard cuts of mid- and
late-January had in actuality produced a negative effect, through enhancing
inflationary expectations, the markets had learned that, like an owner with a
dog on a leash, all they had to do was bark out an order and the Fed would
comply.
The markets ordered the Fed to roll over with 100 point cuts of the Federal
Funds Target and Discount Rates. The market was surprised when the Bernanke Fed
just growled, did not comply. Citing the risk of inflation, the Fed board voted
8-2 to cut rates 75 points. From the board's post meeting statement: Inflation
has been elevated, and some indicators of inflation expectations have risen.
The committee expects inflation to moderate in coming quarters, reflecting a
projected leveling-out of energy and other commodity prices and an easing of
pressures on resource utilization. Still, uncertainty about the inflation
outlook has increased. It will be necessary to continue to monitor inflation
developments carefully. On of the two dissenting voices, who
presumably voted for an even less aggressive cut of 50 points, president of the
Dallas Federal Reserve Richard Fisher recently compared monetary policy to good
liquor - you thought I liked my metaphors. He compared monetary policy to "a
good single malt whiskey or perhaps truly great tequila. It takes time before
you feel its full effect."
The dollar rallied about 1% on the news, and the US stock market, already up
200 points on good profit reports from Goldman Sachs and Lehman Brothers,
tacked on another 200 points for a 420-point Dow up day. One market observer
said, probably correctly, that another 200 points or so could have been added
had the cut only been twin 50-pointers. Someone was finally showing concern for
inflation and sound money, if only by giving the possible 100 point cut a 25
point haircut.
Of course, it was easier for the Fed to show independence, and concern for
inflation, with the markets up about 500 points from Monday morning's Bear
Stearns panic lows.
But it still was a 75 point cut, to a 2.25% Federal Funds Target Rate. Most
observers feel that the Fed can't realistically lower the rate past 1%; at this
rate, assuming inflationary expectations in the commodity and foreign exchange
markets allow them to keep cutting this fast, which is a big if, they'll hit
that level at the June 25 meeting, after the next scheduled meeting on April
29-30.
What happens then? Will the Fed's big gamble on new monetary techniques be seen
to have been working by then? If it's not, and there's no more real room to
cut, what next can de done for the world economy?
By then, will the ideological opposition to the Fed going all out and buying
out the subprime paper from the banks be dissipated? One right-wing pundit said
that would be like raising the flag of the old Soviet Union over every housing
development in America. But by early summer, with a presidential election then
just four months away, that might be seen as preferable to seeing the flags of
Hillary Clinton or Barack Obama fluttering in the breeze over those said same
cul-de-sacs.
Julian Delasantellis is a management consultant, private investor and
educator in international business in the US state of Washington. He can be
reached at juliandelasantellis@yahoo.com.
(Copyright 2008 Asia Times Online Ltd. All rights reserved. Please contact us
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