Week in Review

The collective market view is that we are experiencing a moderate slowing: in China, due to Bk of China braking; in Japan, as expected, due to the tragedy; in the UK, sideways but with the threat of a lift over its head; in the EU, the reality of the periphery disassembling, only Germany and France packing the load; and finally, in the US, with manufacturing slowing, with signs of employment doing the same and with the reality of gasoline and Fed policy (lower $) smacking the consumer where it hurts.

We are not in a sweet spot at the moment; we cannot detect just where there may be a major flaw in consensus, just where resides the next opportunity for our clients. We’ve got a long weekend ahead, so plenty of time for thought.


Robert Craven

Farmers, Commodity Prices and The Fed

We were in the San Joaquin Valley this weekend wanting to hear first hand from the farmers; we ran into an old timer who has witnessed higher prices for his crops and who told us, "I’m not used to making money!" Suddenly, the cotton, cereal and nut farmers have seen prices go through the roof; so have the cattle guys.

We told one cattleman friend that he ought to replace that picture of Charlie Goodnight in his den, with one of Ben Bernanke.

Excesses at the Fed have enabled exporters and commodity producers at the expense of the rest of us. The central bank and the administration now follow the god of mercantilism. China was the last to tread that route; now even she has had enough, taking mercy on her own consumer.


Robert Craven

Today’s FOMC "Minutes"

The Fed’s come a long way since a few of us beat them up in the Halls of Congress.

Now we know policy at the end of each meeting; we don’t have to guess before it is leaked to the WSJ.

After each meeting we wait three weeks for these "minutes," down from six as of Jan/05. What we won’t learn today is who dissented from the official view, and why, which is why these are "minutes" and not minutes.


Robert Craven

A Layman’s Guide - The Week Ahead

(Bear with us folks, we’re a tad wordy with this installment, joining the rest of the media. My son tells me - keep it brief Dad. OK, OK, just this once!)

Background: The financial media delivers mostly filler and fluff; it’s good business for them apparently but serves no other purpose, leaving a void. This provides opportunity for a service like ours.

Most of us are not wired to screens all day long; most of us have other jobs but still don’t enjoy being ambushed by economic events. This includes small business owners who wonder just when to hire or fire, just when, if ever, that parking lot will fill; it includes active investors, those with a job but who manage their own funds. Our exercise at this firm is providing to these individuals by distilling the impact of economic events just ahead. Past years, through other vehicles, we’ve done a good job at that.


The Week Ahead

Every week we face a stream of US economic releases; they’re all featured in the media but they’re not all important. Some carry market-moving horsepower, some do not. That role changes with time, some shedding power, others acquiring it. It’s better to have a leg up, better to anticipate reaction, than react.

This week’s releases are focused on Manufacturing and Housing. We know manufacturing led the recovery; and we know with a weaker dollar and booming exports this sector continues to show vigor. Of the three releases dedicated to manufacturing we do not anticipate a surprise; they will cooperate. The two dedicated to housing will show some improvement, but this sector is in such sad shape, the markets will not be impressed.

With the world as tightly wound as it is, we also must monitor key offshore releases when we feel they will have an impact on our markets. The EU April CPI to be released May/16 is key. A print much through consensus will spark the view for an ECB lift, and sooner rather than later as especially Germany and France are booming. This will worry the US equity markets. The UK April CPI is to be released Tuesday, May/17. The UK will have a real problem with a print through expectations as the Bk of England will be more likely to lift, but this in the face of a struggling real sector (not the case with Germany or France). Won’t be pretty. With both these banks inclined to lift official rates, the Fed will be cornered, blamed even further with reckless policy at home.

Finally - the US debt ceiling. Most, including the Fed and Treasury are in hysterics and predict an end of the world if we don’t raise the ceiling. This is nonsense. Geithner prediction of a "double-dip recession" is simply dishonest. He knows better. Some clear thinkers, including the famed money manager Stanley Druckenmiller, hope for the benefit of all that we leave the ceiling well enough alone. From the WSJ report on an interview with Druckenmiller, "...he's willing to accept a temporary delay in the interest payments he's owed on his U.S. Treasury bonds—if the result is a Washington deal to restrain runaway entitlement costs." And this is the way institutional markets will view such an event, past the first 10 minutes of panic.

Robert Craven

Briefing For The Business Planner

Encouraged by the results of Nov/2 and Congressional follow through, employers came alive. Encouraged by the same event, including extended tax relief, consumers came alive. This brings us to Q1.

Momentum has now slowed. This is due to 1) permanent elimination of job positions by employers frightened to death by Obama’s statist agenda (Obamacare and other unpredictable costs) 2) billowing commodity costs related to a) Fed policy and b) Middle Eastern upheaval and 3) wage gains which have lagged #2.

Those businesses dependent on discretionary spending were encouraged late Q4 concerning economic reality ahead; those same businesses are now less buoyant, feeling let down.

Next Six months:

Fed policy is not a boon but a bust to the average consumer. Liquidity is not the problem; it is not needed. QE II has thus 1) inflated equity prices and 2) inflated commodity prices. Stock holders have done well. That’s not enough. The rest have been hurt.

Spending cuts ahead? Fine. The more the better. Don’t believe the nonsense that severe cuts will provide a stall. This will instead provide a spark. There is zero evidence that government spending ever provided anything but a wash (except to unions) and plenty that it threw a wrench in the works.

To the extent Fed and Congressional interference subsides we can grow increasingly constructive; the recovery will kick into 4^th gear.

Just crude prices will remain the piano overhead. That is, the odds are very high for further violence in the Middle East as the adjustment (Arab Spring) continues.


Robert Craven

The Week in Review

Key releases this week were on net, a disappointment, one reason the 10 yr Treasury yield fell from a 3.37% Monday to a 3.30%, Friday.

Of course there are always many factors impacting Treasury prices, including both fiscal and Fed policy, and the occasional flight to quality from folks panicked about one event or another. But the major influence, ongoing, is just plain old real sector developments. Nothing fancy here whatsoever.

For example, Oct/7/2010 the 10 yr was at 2.40%. Nearly everyone looked for dismal economic performance ahead - lousy key releases that is. End of October we advised our clients to look for just the opposite. Sure enough, Dec/8 the10yr printed 3.33%, being a witness to "surprising" vigor. Then the market crowd really got behind the growth mantra, the 10 yr printing 3.53%, Mar/7. About this time we reversed course, warning our clients that there was a piano directly overhead. Yet exuberance continued into early April, the 10 yr printing 3.60% on Apr/8. The trout were still keyed in to the fly long departed. But finally, folks began to catch on. Last print - 3.30%. A interesting little journey.



The equity market went the other way this week, celebrating, but then it’s had a life of its own for some time now.

Key economic data presented nothing to cheer about. Q1 GDP came in under expectations, and key - as we had predicted they would be, those expectations had been shaved substantially from a month earlier. Next, Jobless Claims were up 25M vs market expectations for a decline. Nothing to cheer about there. Both Personal and Disposable Income grew moderately in March. OK, not bad. But Real Consumer Spending was up only 0.2%, not a stick in the eye maybe, but no spark either, suggesting that spending slowed at the end of Q1.

If there’s one primary player which has thrown the ‘ol engine a curve ball, it is oil. We got downright personal with folks several weeks ago and stated that it’s foolish to be constructive (lower prices) on crude. If you are, don’t let your friends know it. Why commit social suicide?


Robert Craven

Bad News For Fed Watchers

Bernanke’s press conference tomorrow is bad news for the Fed watching industry! None of them like us very much anyway since we started the whole thing rolling back in late ‘93; now the rest are actually going to have to find something productive to do.

Background: Pre - 1994 the Fed never announced a policy change; a legion of Fed watchers had to read it in the tea leaves. They’d watch reserves for example to determine any change. Eventually, Greenspan would leak the decision to one of two WSJ reporters, an illegal act which would see any of the rest of us taking our meals through a slot.

After change was announced in 1994, we got all sorts of hate mail. There were 500 tea leaf readers on Wall Street without anything to do.

Tomorrow’s briefing is good news however for many in Congress who have been demanding more transparency. The reverse side is that it could provide insurance against political meddling, no doubt a prime motivation for the briefing in the first place.

Another reason for the historic change may be wild commentary by other policy makers, often at odds with formal policy. Bernanke does not like this stuff. It was rampant in the old days, one point of contention in our testimony. Jerry Jordon for example, the then president of the Cleveland Fed was a loose cannon. Gov Wayne Angell was close behind. Both were dangerous because the market crowd didn’t know any better but to take them seriously.

Bernanke’s comments will of course be measured; he knows markets could swing wildly on the wrong word. He will defend QE II, tell us it will end in June, and, he will outline just how this generosity can be successfully reversed, "if necessary." There are different ways this can be done. One is to sell the cattle herd back. That is, take the money out of the system that way. The Fed may also boost the interest it pays on bank reserves, so called excess reserves held at the Fed. The idea is that this would discourage the banks from venturing elsewhere. They could also stick with the Fed Funds, the rate banks charge each other of O/N loans, and nudge that upwards.

Just how they do it, if they do it, will impact interest rates somewhere along the yield curve (90 days - 30 yrs). We’ll try to provide a heads up on that.


Robert Craven

Potential For Worry - The Week Ahead

We’ve got a full week of economic indicators and the first ever post-meeting press conference given by a Fed president.

Indicators are important if they carry market-moving muscle. We’d rather our clients be armed up front, than not.

We have several housing related numbers this week (beginning with today’s March New Home Sales) but none of these carry much muscle.

March Durable Orders (new orders for hard goods) on Wednesday however carries plenty of muscle, and the greater potential to worry the market than to cheer it. This key number was off 0.9% in February when it was expected to be up 1.2%. A component of this release is so-called Non-Defense Capital Goods Shipments, something which is really a proxy for capital spending so it’s important. That February component was better by 1.1%. Thus, the February release was mixed but another decline in the headline number for March combined with a decline in the Shipments component will greatly worry the markets, indicating a stall.

Thursday’s Q1 GDP advance report is also key. Q4 was up 3.1%. Estimates for Q1 have been significantly reduced due to higher energy prices. Consensus is now + 2%. But even a number through expectations won’t cheer much because the market crowd is becoming a believer in our piano just overhead. Also key on Thursday is the Jobless Claims report. Recall that this number disappointed last week (higher than expected). An improvement is expected (390 vs 403). Both of these releases then carry more muscle to worry the market than to cheer it.

Wednesday we will have Bernanke’s testimony. The FOMC meets for two days this week (Tues, Wed). The policy statement will be released early (12:30 pm ET) then Bernanke’s press conference at 2:15. World markets will hang on every word. We’ll have a special issue prepping our clients for this event.


Robert Craven

The Federal Reserve, The Debutante Ball and The 15 Parrots

Alan Greenspan thrived through complexity. That is, he snowed his opponents.

Ben Bernanke is instead intellectually honest; he’s not trying to hide the decision making process as did his predecessor. Thus, we will have an explanation of policy intent Apr/27 following the 2-day FOMC meeting. This is a debutante ball, a coming out, something which we and two other individuals, like good parents, funded Oct/19/1993 in the halls of Congress.

So we want to prepare our clients up front for this event. Relevant background material serves as a good start.

In our Sep/5/10 sketch - Caught Flat Footed - we predicted the Fed may launch another stimulative program. That was announced Nov/3 and called QE II.

We have offered several past issues explaining the workings of the Federal Reserve for those who have a job or are otherwise occupied, but do have at least a passing interest. We have also explained the mechanics of QE II and, how it can be reversed. It’s pretty simple stuff. Want to flood the markets with money? Buy that herd of cattle at the asking price, credit the rancher’s bank’s account at the Fed. The source of the money? Thin air naturally. Want to reverse QE II? Sell a herd of cattle at the market price, debit the rancher’s bank’s account at the Fed and you’re done.

We anticipated QE II, yes, but saw it as unnecessary and still do. See our sketch of Dec/5/10- Too Big For Its Britches for the reasons why. We did not agree, understanding that QE II serves not other purpose but to 1) fuel commodity price inflation abroad and 2) bolster the equity prices of otherwise less deserving US firms. The US economy was not in need of more liquidity for goodness sake. The ground is saturated. It all runs off.

But now there is rancor in the ranks. Some policy makers are taking our side. There is always disagreement among policy makers naturally but in the old days it was hidden - all were supposed to tow the party - Greenspan’s - line. For example, Greenspan hosted a conference call before the hearing we attended, coaching all the governors and district bank presidents how to answer our inquires (as they had them in advance). They did just that, sounding like 15 parrots. (Ref., HR28, Hearing before the Committee On Banking, Finance and Urban Affairs, Serial # 103 - 78, US GPO, 1994)

No more. We have democracy at the Fed, freedom of expression.

We’ll see how Bernnake handles this bunch, Apr/27.


Robert Craven

The CPI, Fashion in Central Banking and the Fast Draw

We all recall Abe’s story - just because you call a calf’s tail a leg doesn’t make it so. And so it goes with today’s inflation report. The Federal Reserve is excused because one of them, Art Burns, snowed the BLS and Congress, Alan Greenspan style, to ex out any dangerous stuff.

Today’s CPI headline was as expected, up 0.5% yet because core was up only 0.1% the Federal Reserve by calling the tail a leg can sit tight for a bit.



In the old days folks we just plain had more fun. Politics played more of a role in worldwide central banking - no politician in his right mind wants their central bank to stomp on growth - and a lot of the central bankers went along, Burns style. That’s no longer in fashion.

It’s the fashion nowadays among central bankers to be tough hombres. We know some of them personally. It’s good for their career. Like Wyatt and Morgan Earp, they practice their fast draw at every opportunity.

Bernanke has just forced those at the ECB and Bank of China to clear leather.

Bernanke’s Federal Reserve through the policy of supplying liquidity in great excess, liquidity we in the US never needed, liquidity which like rain on saturated ground flows elsewhere, is the key culprit in triggering commodity inflation offshore (see our post of Feb/16 for background).

Now it’s understood that certain excesses are no longer appropriate. Thus, the ECB and Bank of China have already lifted their key interest rates because it’s in fashion to do so. After today’s news - higher core numbers for the EU and China, these guys will move again in the near term.

These developments cannot help our recovery, one which others have now come to understand is already being hampered by events in the Middle East.

Robert Craven

Reformation at the Fed - An Escape From the Dark Ages - A Special

Islam is the only religion not to have experienced a reformation. Many of us have suffered as a result. The Fed was the only major central bank not to have experienced a complete reformation. We all suffered as a result.

Chairman Bernanke’s recent decision to hold four press conferences following FOMC meetings signals that a central bank still clinging by a finger to the dark ages has finally relinquished that hold.

The story of reformation begins Oct/19/1993 with three of us before the House Banking Committee. We had been called as witnesses to explain the damage done to markets and taxpayers through the Greenspan Fed’s lack of transparency and lack of accountability. My presentation addressed three concerns - communication of policy change, Fed leaks, and reckless inter-meeting commentary from bank presidents and governors (something which Andrew Brimmer, former Fed gov, called an “open-mouthed practice which must be stopped.”)

Greenspan’s practice was never to announce a policy change; it had to be guessed by watching Fed numbers. This provided work for “Fed watchers” but served no other purpose aside from sparking great confusion. Sometimes Greenspan himself would leak the change to one of two WSJ reporters (an act which would have the rest of us taking our meals through a slot). We scolded one of these for cooperating. “I’ve got to feed my kids,” he responded.

Convoluted policy communication, outright leaks and careless media stunts from Fed members often resulted in violence in US markets, sometimes much higher yields on Treasury debt than would be otherwise. We taxpayers picked up the tab.

All the Fed presidents and governors were there that October day. They had our concerns up front so a few days earlier Greenspan held a practice session on a conference call as to how to best beat the rap. Indeed, each of the fifteen parroted the other, all in unison that we were wrong. Instead, they were wrong.

It did not hurt that I had Milton Friedman’s endorsement along the way. Then after the hearing we circulated a petition among street economists and academics. That received wide press coverage. This, coupled with Congressional pressure, effected the desired result. In early 1994 the Fed decided to announce policy change same day; that formalized Feb/95. The markets took this in stride, exactly as we predicted. The leaks also stopped. So did the reckless commentary.

And ground zero, the heart of darkness at the Greenspan Fed? Simply an economist’s horror at being found out, at not wanting to be cornered.

As a private economist Greenspan’s record as a forecaster was awful, “the worst” as Worth mag put it. He was a mortal; he simply did not want the rest of us to find out (a malady effecting many other policy makers). This is why at the hearing he denied there were any tapes available of past deliberations. This proved to be false.

And that is why he felt he had to be slippery when policy was changed. More than once colleagues reported Greenspan as “depressed” because markets reacted to policy change differently than he had predicted. But if the process of discovery was protracted, a cushion was provided along with an escape from accountability.

We have always praised Bernanke for his intellectual honesty. His recent change in procedure is proof we were right.


Robert Craven

Central Planners at the Fed

It never works. A planned economy that is. As most of the world has given it up - China and India the largest and most recent examples - first Obama, and now Bernanke have embraced it.

With 2012 in mind Obama pretends he’s learned his lesson. Bernanke makes no such overtures.

The Fed’s mandate was price stability; full employment is now included. An individual or individuals may see to the first, the later is far out of scope for any would-be social architect.

When the Fed sticks close to home - supplying or extracting short term funds, letting the rest of the term structure see to its own, it does pretty well. When the Fed tries to manipulate longer term interest rates - rates then no longer driven by the old fashioned myriad of mkt pressures, but by planners at the FOMC - we are in for some trouble (See our Feb/9 sketch).

Sure they’ve got all the statistics at their disposal, sure they’re all experts, these Fed types, sure they’ve got the power to pull almost any trigger. But that’s no different from any planners of the past - all of whom have failed. Heck, even modern day Communists and socialists have begun to repudiate this approach. Communist China, a phony, knows best. As they replaced planning with more reliance on markets their growth rate spiked.

Thomas Sowell reminds us that, “Elites may have more brilliance, but those who make decisions for society as a whole cannot possibly have as much experience as the millions of people whose decisions they preempt. The education and intellects of the elites may lead them to have more sweeping presumptions, but that just makes them more dangerous to the freedom, as well as to the well-being, of the people as a whole.”


Robert Craven

Inflation (of another sort) at the Fed

Bernanke was taken to task yesterday by Rep Paul Ryan, a well know critic. Ryan is more than a critic; he is a would-be executioner. Some at the Fed think Ryan’s elevator doesn’t go all the way to the top. Yes it does and he’s providing a real service to all of us.

Since CSPAN came along most legislators fear a confrontation with Fed policy makers. When challenged at a hearing for example Greenspan would launch a circuitous counter attack, saying nothing really but drawing on endless words and numbers which snowed his opponents, and, right in front of their constituents. Thus, most just let it go.

Ryan won’t do that. Whether we agree of not with his view, Ryan’s providing fresh air.

Bernanke’s intellectual honesty distinguished him from his predecessor. We hope it still does. Yet he is in fact a tad “cocky” as Ryan noted. What’s behind that exactly?

Being human, policy makers are often drawn in by the aura of their surroundings, by the complexity of their wares, by the fawning of the masses, their egos soon inflating to before unknown proportions. After a while they admit they’re still mortals, but just barely. Or so they pretend.

Fed presidents remain more grounded in this regard; governors less so. Presidents work their way up, actual business people; gov’s are appointed. Some like Greenspan are simply and purely politically promiscuous. For example, Worth mag noted that Greenspan when in private practice was the “worst forecaster ever.” No problem.

All of the FOMC however, every one of them carry with them a haunting, a perceived vulnerability, their own heart of darkness. That would be the very fact that they know they don’t know a whole lot more than the rest of us; they’re not seers and they’re not prophets. Policy making is a crap shoot; they know it, they’ll just never admit it. For the rest of us to know that they know it, would, or so they believe obliterate their credibility. That is why for example they had and will always fight to the death, efforts to video tape their deliberations.

They’ve got a tough job. They make it a lot tougher by pretending they’re something they’re not.


Robert Craven

Thouhts on the Fed chair before the House.

Chairman Bernanke defended his expansionary policy today. Our view is that it’s misguided.

But whatever it is, it is a stealth operation. Bernanke points to Core CPI (not the broader #) as cover for QE2, noting that Core CPI is now as low as it's been in many years. Well naturally Ben. It’s “EX” everything that’s on its way to the moon - food & energy. This is convenient for the Fed, just as it was when Art Burns decided to take food & energy out so he could fuel Nixon’s reelection. It stuck. His rationale? The Fed has no control over wheat or oil prices; these are mostly driven by weather and other acts of God.

Now of course the spike in world commodity prices is driven, not just by natural phenomena but by the Fed’s dollar-creation machine. It hits first the 40-odd countries who peg or closely peg to the $. As we noted in an earlier sketch, they either import inflation (print their local currency to buy $’s to keep the $ expensive) or they allow their currency to strengthen and tank their exports. Either way, it comes back to hit us, or a portion of it does.

Too bad for offshore folk but not to worry here in the US says Bernanke because he can exit gracefully when things become overheated. Maybe so but we don’t see how. Recall that under QE1 & 2 the Fed buys longer-term treasuries and mortgage paper through so-called recognized dealers. It pays for these bonds by crediting the banks’ account at the Fed. (If the bank wants paper $, the Mint takes care of that, and delivers the things in trucks.)

So how will Bernanke reverse? He will sell securities to this group, reversing the process by taking the money out of circulation. If he sells short-term T-bills, short term rates will move higher. If he sells longer-dated stock, longer term rates will come under pressure. They don’t own as many t-bills so we guess they’ll hammer the longer end - 2 - 10 yrs perhaps that impact all of us.

He figures he can fine tune the act but over the years we have never known the Fed to have much of a handle on anything but their traditional targets - O/N money and reserves. They are far out of their league when they try to figure the direction of longer rates.

Every prospective home buyer, corporate planner, trading operation and saver has a stake in just how they pull this off, if at all.

Robert Craven

Thalidomide and the Fed

Until their plan to buy everything-under-the-sun the Fed provided (or extracted) liquidity mainly through an O/N market by the way of so-called “repos” or “reverse repos,” these with so-called registered dealers. The Fed fine-tuned with “Fed Funds” as the speedometer. FF’s is the rate prime banks charge each other for O/N money on which to make their required reserves good with their regulator. Some are flush, some aren’t. The hungrier banks are to make loans the more pressure on FF’s. If the Fed wants to slow things then they won’t meet the demand in that mkt; short term rates will spike, and in theory, economic activity will slow. If the Fed wants to be accommodative they supply more money to that market; banks take it as reserves and (Econ 101) the multiplier effect takes over.

Key here folks is that nothing was forced on the market, on the general interest rate environment; takers could come to or stay away from the trough, given demand or lack of in the economy. Longer-term rates ( 2 - 30 yrs) which impact all of us, were left to find their own level.

This worked fine until Q4 ‘08. Policy makers were desperate. Nothing in the medical cabinet would impact this new pathogen. Thus massive Fed intervention - no longer just short term operations, but buying long treasuries and mortgage paper, QE 1 (12/08 - 3/10) - was meant to 1) prevent a world meltdown and then 2) fire a recovery with lower rates. The meltdown was prevented. No one knew the side effects of this kind of medicine however.

Now there is no crisis but they’re at it again. We all know that Bernanke decided on the second major dose - QE 2, Nov ‘10 and plans to continue that medication to Q3 ‘11. Bernanke is now out of his league; if there is a Oath of Hippocrates for central bankers he hasn’t taken it.

Instead of a central banker he has become a government planner. QE2 is fraught with danger. His intervention is a useless as Obama’s attempt at gov’t planning, that which delayed the recovery. Bernanke is providing money which is not needed or wanted, except by the gov’t, banana republic style (The fed owns more Treasuries now than the Bank of China.) The US economy in not in need of liquidity.

The Fed’s program is meant to 1) feed the gov’t and to 2) feed the home market, a repeat mistake. It only penalizes the prudent - savers who would otherwise put their savings to more productive uses. This provides a distortion as these lower rates are purely artificial, driven by money created out of thin air. The Fed’s buying spree could create the very bubbles which brought us here in the first place. At the very least it is creating malformations on the US economic body.


Robert Craven

Too Big For Its Britches?

The Federal Reserve system was created under Wilson in 1913. Originally tasked with protecting the value of the currency its mandate was expanded in the 70's when the Federal Reserve Act was amended to promote the goals of, “maximum employment, stable prices, and moderate long-term interest rates,” (Section 2A).

“Stable prices,” means protecting the value of the $. The Fed is armed to do this by expanding or contracting the supply of $’s available - too many and they are worth less, too few and they are worth too much.

“Moderate long-term interest rates,” are not something the Fed controls very well, if at all. “Maximum employment,” are the two words however that can get the Fed in a lot of trouble.

At the moment critics claim that through the pursuit of this “maximum employment” mandate the Fed has been reduced to an extension of the administration, that is, Bernanke more the politician than the central banker.

We’ve all heard of QE2. This means that the Fed is buying practically everything under the sun in an attempt to quick start a recovery. The idea is to get medium-to-longer term rates lower, the dollar just a tad weaker in order to spur exports, all of this with employment in mind. This is not equivalent to addressing a crisis, to preventing a melt down. (Without the Fed’s emergency action Q4 ‘08, we’d all be paupers.) No, it is a completely discretionary, non rule-based activity and a mistake, one which first will have little to no impact on the pace of recovery and two, is corrosive to Fed independence, a necessary item, the heart of monetary control.

It is this trend at the Fed toward discretionary actions that is alarming to so many and who see this, correctly we believe, as just an attempt to bail out BO’s failed fiscal policy.

A group of 23 economists, money managers and former government officials issued an open letter to Bernanke on Nov. 15 saying the central bank’s planned bond purchases “risk currency debasement and inflation” and won’t boost employment.

Another critic is Fed governor Kevin Warsh, who noted recently that, "The Federal Reserve is not a repair shop for broken fiscal, trade, or regulatory policies.”

Apparently, Bernanke is not listening. We need only recall Hayek’s “Fatal Conceit” to know that a few individuals, no matter how gifted cannot replace in their judgement the complexities of a free functioning market. This applies to the FOMC as well as to Obama’s wanna-be planners.

We have followed the Fed closely for 20 years; never has it come so close to shedding its independence. Let us hope the new Congress re-writes the Fed’s mandate to confine its activities only to those of price stability.

Robert Craven

Dem Governors - Expecting Something From Nothing

By now we’ve all heard Democratic governors sound off, every one critical of Obama’s stimulus effort. “I’m disappointed in Washington,” said Ill gov Pat Quinn. “They don’t understand how you fight a recession. The federal government has to run a deficit in recessionary times because we’ve got to get out of the ditch.”

It is Quinn who does not understand how to "get out of the ditch."

“I think the bottom line is they’re not seeing the jobs that should have come from it,” says West Virginia gov Joe Manchin. “They oversold the job creation part of it,” says Colorado gov Bill Ritter.

Sorry Manchin and Ritter but there are no jobs to come of it, not on a net basis anyway and that is true no matter how much $ BO throws down the drain.

Review: Where in the world does the “stimulus” money come from? A slush fund of some sort, held in reserve all these years for just such an emergency? No, it comes from 1) taxes or 2) borrowing or 3) inflation. Higher taxes mean less spending, business, all of us.. US gov’t borrowing means crowding out the private sector, the employer. Inflation (accommodative Fed) means pain for all.

It’s that simple. There is not one drop of evidence that FDR’s or any other gov’t spending programs created jobs on a net basis and plenty that they have not. We have cited many of these in past blogs. BO’s programs are at best a wash.

But at least the Democrats are consistent. Their signature failure is to always and everywhere take what appears to be the easy way out, or pretend to. Their followers take the bait. Now it’s come back to haunt them.

Robert Craven

We Are Left With The Fed

The new administration’s rescue plan(s) will impact over the longer term, if at all. There will be no near term impact, zero, notwithstanding the mix. We are left with the Fed.

Few of us specialize in central banking. Yet central banks - Fed if American, Bk of Eng if Brit, ECB if European - hold the key to the West’s economic well being. Fed policy now impacts all of us Americans directly, sometimes immediately. Thus, hadn’t we better get a grip? Who are these guys and what are they up to?

We are told that the Fed’s target is near zero. What in the world does this mean? From soph year, Eco & Bkg 101 recall that banks are required to hold a certain % of reserves against loans. Day to day some are flush, some are short. Those that are flush lend o/n to those that are short. The rate they charge is called the Fed Funds rate. This is also the Fed’s target. Here is why. Reserves and currency are base money - the heart of the system. The Fed figures that by manipulating, fine tuning the amount of reserves available it can fan or retard the economic flames. Very true, usually. The FF’s rate simply indicates tension. The Fed can increase or decrease the supply of "non-borrowed" reserves through so-called "open-market operations". No big deal here. It means that the NY desk injects reserves by buying U S securities, usually on a temporary basis, or repo, agreeing to reverse the transaction in a few days. It does the reverse to shrink reserves. In the orchestration it is far more complex; fine, we don’t care as long as we have the thrust of it.

So now, with the FF’s target at near zero banks can fetch all the reserves they want (with which to make loans) at practically nothing. But they’re not. Why? It’s not just that they’re risk adverse - wimps really, but that is for another sketch. It’s that many of their assets are near garbage and even they don’t know what they’re worth, yet. They’d rather see to that first, as soon as they can get a grip, poor things.

Back to the Fed. So orthodox policy is not working. What is next is what Bernanke calls "quantitative easing" or the Bk of Eng "the nuclear option". It’s not nuclear or new, just rarely used. No one at the Fed has much experience with it; yet the Fed as it turns out can buy anything they want, outright (not temporary, not a repo) - a herd of long horn steers / the NY Giants. All the Fed needs is emergency powers and those exist under Article 13 (3) of the code. Where does the Fed get the $? Out of thin air. For a non-special forces approach, assume the U S gov’t cuts taxes, financed by bond issuance. The Fed can buy this US debt outright. The Fed’s balance sheet expands, the $ goes to US citizens.

But the Fed is now working out of its comfort zone, more of a Delta Force approach. Bernanke says he can "expand the menu of assets he buys". Sure enough, the Fed is already fast at it. Have a credit card? Haven’t received a notice that your limit has been reduced? Likely because the Fed is already buying securities collateralized by credit card receivables. Have a mortgage? Terms are easier? Same answer. You’re a corporation with a good credit but can’t sell your commercial paper (short-term IOU’s) anymore? Call the Fed. For three months they have been buying this stuff.

Back to Eco 101. Isn’t this inflationary? Guess not. All observers see are signs of deflation. There is no fear on the part of central bank officials at the moment. They’ll reverse policy at the appropriate time. Maybe.

Robert Craven

Monday Morning End to Wall St Socialism?

Last week found the Treasury literally on its knees begging the UK bank Barclays to rescue Lehman. Reports this am are that the Treasury, Fed and other regulators (working overtime at our expense) have given up on finding a buyer for an intact Lehman and now look to sell off parts of the firm, winding down the balance. Well find out soon enough, probably tomorrow.

Here we go again. What is this all about? What does this mean to US taxpayers? Is the preservation of these investment banks in the public’s interest?

One may consider the simplicity of the Chrysler bailout or the complexity of Wall St deals; they reflect the same change of order - government-sponsored socialism directed at frail or failing private industry. "We’re too big to fail," regulators are told by victims of poor judgement or other nuisances. Those who have losses want help; naturally a disaster of unimaginable consequences will be the result if they don’t get it. And most of the time - in the case of Wall St, because of the complicity, the near incestuous, clubby connection between the Federal Reserve, Treasury and the street’s major firms, and the pressure from major offshore investors such as China or the Saudis - they get it.

This time Treasury Secretary Paulson has resolutely stuck to his position that no taxpayer money goes to the Lehman bailout. Not really. Some of it already has. Still, this statement delivers hope. And if there is to be a change in government largess toward Wall St types it is because the growing public outrage is deafening. One may argue with the Treasury’s role but the Fed’s involvement, a mission-creep far from its original mandate of price stability, the role of Wall St deal maker at risk, is to some observers like retired St Louis Fed president Bill Poole, nothing if not appalling.

In March the Fed - in our view without any authority to do so - stepped in to manage the sale of a distressed Bear Stearns. The Fed extended a loan of $29bln to JPMorgan as an enticement for them to buy Bear. As collateral Morgan offered troubled mortgage-backed securities that were marked-to-market at $30bln but no one really knows what they are worth (at this writing there is no market for these securities). That is the problem for the taxpayer. The Fed will lose something, maybe eventually a lot. The Fed is a government bank and usually earns a surplus which is remitted to the Treasury. The losses will come out of that surplus, a taxpayer loss.

Next was the Fannie/Freddie bailout. This one was not so much the moral stretch due to the quasi governmental nature of both yet it will still cost us a fortune.

Finally, we will hear from other Wall St firms in the near term, perhaps next week as they too cry for help.

Why is it that we as taxpayers are asked to socialize the losses of fat cats whose third home was bought on the back of our recent mortgage, the same clowns who are now in a panic? Part is as noted above - the incestuous relationship between Wall St and its regulators, especially the Fed; it is done by reflex, aiding your pals. The factor driving the panic is the recent boom in what one keen observer called financial instruments of mass destruction - derivative securities. These are such things as "default swaps" and other arcane exercises that banks, hedge funds and other use to bet for or against certain market moves. The value of these instruments is in the trillions of dollars; most of this activity is unregulated. The fear is due to the size and complexity of it all. One party’s inability to honor its commitment could topple the rest. Or so we are told.

This fear is not as real as it is manufactured, and by guess who? Wall St types. A boatload of observers outside the club maintain otherwise - painful yes but a cataclysm? No way. One of the most credible of these being professor Alan Meltzer, a veteran economist at Carnegie Mellon. "I’ve heard this so many times," says Meltzer. "I don’t believe it." Janet Tavakoli, a Chicago-based consultant on derivative securities scoffs at the idea. Let’s find out she says, "It’s a good time to have a test case."

How then did we get into this mess? Greenspan’s mis-management of the Fed provides the beginning (see our Sep/2 sketch). The US government’s lack of understanding and lack of regulation of the derivatives market provides the ending. So things got tough for the financial masters of the universe. They now look to us for sustenance. As taxpayers we can no longer enable this behavior. Firms that may fail after doing stupid things should fail. There will certainly be more pain for the speculator, including the homeowner, but, the adjustment will be accelerated and then we can recover with a clean slate and a healthier economy. Finally, the government’s role is not to dole out our money to failing firms but to come to better understand the "maneuverings" of Wall St types and affect reasonable regulations aimed to prevent the mess in the first place. Where is Henry Gonzalez when we most need him?

Robert Craven

Fed Policy - An Update

In the last sketch (July/7) we highlighted the Fed’s apparent lack of concern for a weak US currency and the consequences, using the price of oil as an example.

Since then there has been a change in Fed rhetoric designed to indicate a growing willingness to support the $. First, Bernanke assured lawmakers that inflation is a concern for the central bank. Then Gary Stern, the long-time president of the Minneapolis Fed and a voting member of the FOMC said that, "We’re pretty well positioned for the downside risks we might encounter from here. I worry a bit more about the prospects for inflation. Headline inflation is clearly too high."

These two statements were enough to birth a change in view among Fed watchers and currency, bond and commodity traders. We had advised in the last post that either a rate lift or jawboning to that effect was necessary to firm the $. That was the result, the $ improving against most other currencies, especially the Euro. That is also one key reason that crude prices have dropped considerably, past few days.

Robert Craven