I´d like… a matter of free choice

I´d like to discuss for Spain the best monetary policy , as done by Beckworth in http://macromarketmusings.blogspot.com/2011/02/more-questions-for-bernanke-when-he.html & Co. for US.

So, what is better for US and its monetary policy? a price (or NGDP) rate of increase, or a level target?

Well in Spain (or Portugal or Ireland), we can´t choice. That kind of discussion is delicatessen for ours. ECB doesn´t ask to Spaniard (or Irish people) if they prefer this or that NGDP increase.

In the graph, the different measure of GDP an AD in US. Beckworth, Sumner, Cowen, etc, don´t agree on what would be the best or worst attitude of Bernanke face to the crisis. The “only” problem for US is the net import (green line), which rise when the Fed rise the money supply. But that is an international clash with China, that doesn´t afford its exchange rate to move.

We, members of euro, we have not these problems. W haven´t any exchange rate problem . The only problem is to follow the dictate of ECB.

It is a matter for freedom? yes it is. Have we choice  membership of euro? not really. It is logical that this decision was once and  forever? I have serious doubts.

FRED Graph

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It´s the politic, stupid!

Today we learn by Wolfgang Münchau in the FT:   http://www.ft.com/cms/s/0/6100d1f0-42a8-11e0-8b34-00144feabdc0.html#ixzz1FF9X5HNA

very interesting things about the stress of Germans with the membership of euro:

“It is time to stop pretending that we are about to see a “grand bargain” for the eurozone in March. Last week, the political developments in Germany shifted dramatically in the wrong direction. The Bundesbank, the parliament, the small business community and influential academics have all come out openly against an extension of the various support mechanisms. German society as a whole is in open revolt against the eurozone.

The single most important event was the decision by the three coalition parties in the Bundestag to reject, categorically, bond purchases by the European stability mechanism. The ESM will be the permanent anti-crisis institution from 2013. The Bundesbank came to a similar conclusion in its monthly report. On Thursday, 189 German economists wrote a letter to a newspaper denouncing the ESM, calling for immediate bankruptcy proceedings of insolvent eurozone states. It is no longer just the constitutional court that puts a break on the process.”

So, more and more angry German with their participation in the cost of maintain the Euro´s show; a show that become every day increasingly expensive.

Münchau criticize all the package to save the euro in the name of sovereignty. It is too late to worry about this neglected aspect of the affair, when the euro was launched, ten years ago.

But the sovereignty has much to do with economic result. A counter example is Poland, an EU country that decided rightly not to enter in the euro. Its astonishing result to save Poland of the crisis are compelling: see why in

http://thefaintofheart.wordpress.com/2011/02/27/poland-didn%C2%B4t-miss-many-beats/#comment-447

Poland has not contracted in 2009, thanks to its monetary sovereignty. Probably it has been the country better managed during it, as the

Marcus´graph shows:

Münchau is a fan of the Euro, so he is not suspected of anti-system position. In spite of what, he is sceptical on the ay Germany and France has decided to follow without the rest of members.

Here, his latter words:

“The EU’s crisis resolution strategy is to draw attention away from the underlying causes of the crisis: that you cannot have nationally controlled and undercapitalised banking systems in a monetary union with structural current account imbalances. The difficult job is to translate this technical statement into a language understood by politicians and their constituents, and to do so without lying. This is not a fiscal crisis. It is not a crisis of the south. It is a crisis of the private sector and of undercapitalised banks. It is as much a German crisis as it is a Spanish crisis. This acknowledgement must be the starting point of any effective resolution system. A veto in March is thus a necessary first step in crisis resolution.”

The euro has become a monster that need continuous ad hoc resolution for it doesn´t crumble. This resolutions are destroying the solemn (and successive) Treaties on which the Euro was funded. Don´t worry: there is no easier think in Europe than change  Treaty.

China & US: who is the beast and the beautifull?

I read in http://canucksanonymous.blogspot.com/2011/01/it-takes-two-to-tango.html?showComment=1298833266660#c2446813117650544444 (very good blog) a Debate about if China or the US  is the bad guy in the problems of Global Imbalances.

US would like an effective monetary policy to rise its NGDP.  If China doesn´t like the upward pressure on its own Internal Demand, It has to do never, except to see as its Remimbi appreciate. an revaluation of Chinese money will eventually balance the huge trade  imbalances between both countries.

But China, since 1998, doesn´t like very much to lose competitiveness by this way: It prefer to maintain an artificial exchange peg with the $, buying all the $ in excess that is needed to it.

That is a measure of little profit for the Chinese people, because the import  are more expensive, and so the prices level in China.

But China is not a democracy, where chinese could vote for their preferences.  They are not asked if the prefer more or less consumption today, in exchange of less or more consumption in the future, or buy better products around the World .  That is a question decided by the power. And the power has decided to save more and more dollars (up to a level of 50% of NGDP).

For me, if I must to choice a guilty, the data are straightforward: China continue to accumulate trillions of dollars for impeding an appreciation of its money.  So much as $ 2,8 trillion – with an increase of 16% in 2010 – are hoarded and lended throughout the world, financing countries that are net importers  from China. Note, By the way, that the yields on this money lend to the world is not profited by chinese people.

Leakage

from http://mjperry.blogspot.com/2011/02/us-manufacturing-more-output-fewer.html, I took this graphic:


It is productivity per worker of American manufactures. Impressive, is not it? More and more productive, those guys. But attention, the reverse of that is that, thanks to that productivity, the employment created per unit of GDP is declining. And the U.S. problem, since the recession of 1991, it is harder and harder to regain the jobs lost in the fall.
Here comes the analysis of Rajan (http://press.princeton.edu/titles/9111.html): much of the expansionary demand policy leaks into imports. As inflation remained low, the Fed made a  expansionary policy between 2003 and 2006. This policy succeeded in recovering some of the jobs lost in the recession of 2001, but also stimulated many imports from countries like China, refusing to lose their currency competitiveness. In the chart below, I paint the nominal GDP (red line) and aggregate demand (blue line), which differ in the external account. Also I put imports (green line), showing the draining   factor of import from these countries. As shown, at the highest  of increased in domestic demand (blue line), a good share of GDP is “leaked by ” imports. Recession (gray area) was a brutal contraction of demand, and imports fall sharply. But recovery policy (not just monetary: the great increase in public spending also)  is making imports once again  are growing faster than GDP. It’s about time that the external deficit is placed back in the high 2005 levels.

This shows that the U.S. does not have autonomy to carry out domestic policies needed. And that is so because countries  export-or-die, are not going to fold to lose the huge American market, the largest in the world. They are Non-liberal country, and therefore internally they can arrange dysfunctions of this policy. At the moment they are happy with Bernanke and their expansions.

No need to resort to complex problems such as Beveridge curve: imports are the leakage of employment. Leakage that, following Rajan, originated the glut of funds searching a yield, and that was in the root of tha Great Crisis…

Expectations

The economy is an affair of expectation. The recent movement in financial indicators yield partial information about how markets see the next future. The center of concern is naturally the oil prices, that has risen a lot, as we can see in the first graph, Up to 112 $/b. In the opinion of many observers, that has launched the inflation expectation. But if we  watch the evolution of the inflation expectations in the TIP market (1o years bonds protected of inflation compared with normal bonds) in next graph, we see that expectations have not risen since the revolt in Libia launched the oil price.

Texas brend oil price (last 112 $/b)

Taking account for the stock markets fall, it seems that the main preoccupation in the markets is a reversal effect in the solid world recovery that was going up.

In others words, the markets don´t buy the idea that central banks are to accommodate the  prices upward pressure.

The Fed in the interrecessions period

In the chart below, I discuss the behavior of some variables in the period between the last two U.S. recessions. I intend to see if they fit well to the explanation of R. Rajan and Beckford.

I selected a few variables for greater clarity, but I think that is enough.
The shaded areas are the two recessions that limit the period. The solid blue line is the (% anual of) final sales in domestic markets. It is an approach to GDP (in dashed blue line): it is a measure of domestic demand, which includes imports and excludes exports and inventories. If I understand correctly, is the preferred measure for David Beckford to measure how successful has been monetary policy. We refer to as final nominal domestic demand.
The continuous black line is the interest rate the Fed official.
Finally, the broken line is the mortgage rate.
What I seek is:
Did have something to do  the drop in interest rates by the Fed with the housing bubble and subsequent Great Recession?
In the first recession in 2001, domestic sales fall much, and the Fed lowered its interest rates to 1.75%. When the recession was over, domestic sales recovered to almost a 4% annual increase
But in late 2002, the final demand falters and begins to fall, and Greenspan drops further Fed Funds, until mid-2003, the famous “too low for too long” 1%.
Note that during this period and after, final demand continues to accelerate up to a very high yearly growth, exceeding 6%, and reaches up to 7.5% between 2005 and 2006 (note the differnce with NGDP: that difference are imports). In 2005, the Fed begins to raise rates, although domestic demand has continued to rise too much. Here, “too much” means something very specific: imports were being ballooning,  and the external deficit reached more than 5% of GDP. (I rememberGreenspan saying then that it was not disturbing, since the revolution of finance allowes more foreign debt.)
But here come the nuances  of Raghuram Rajan: there are countries that are exporters ( their philosophy is “exports or dies”), and have decided to adjust its exchange rate(devaluation), what  was necessary not to lose their markets. This translate to an sterilization of Fed policy, since monetary expansion was exported to these countries, which accumulate large amount of reserves to maintain their competitiveness.
Thanks to this policy, the Fed was creating jobs in the rest of the world: inflation of demand in the U.S. was leaked to import.
The Fed, which would increase employment, does not realize that employment was been “exported”  to those countries.
The next point is equally important: increasing the U.S. money supply was recycled back as reserves in search of profitability. And here begins the history of mortgage securities created by domestic banks eager to mediate between these flows of funds coming from all corners of the globe. Note that mortgage rates doesn´t  respond in 2005, when the Fed begins to raise the interest rate , due on one hand to the large supply of funds coming from abroad and that the Fed had inadvertently helped creat; on the other hand, because of the anesthetic effect of the promise by the Fed that interest rate will continue to be low for much time…
So to the question if the low interest rate during so much time has contributed to the ballooning of leverage and the crisis, the answer is yes. Yes for the final demand was “too high too much times”, and yes also for the flows od fund from the rest of the world led by  the loosening of monetary policy.





There is not a problem of guilt (or only one guilty): The Fed followed its dual mandate. If were not for the mercantilist policy of Asian countries, the Fed probably had not created such an accumulation of reserves in those countries. The first responsibility is undoubtedly China’smercantilism and others.
On the financial front, there were, as Bernanke says, regulatoryand supervisory failures that were the source of the high leverage andthe final crisis; in part, responsability of Fed.
Summing up,  the Fed created an excessive  growth in domestic demand, whose effectiveness  in employment was diverted to imports from countries with exchange controls. All that  created a surplus of funds that had to be placed. Funds in pursuit of profitability created propitious circumstances for financial creativity to be acelerated to create new products of dubious value, which resulted in high leverage of banking.

where is going QE2?

Debate continues on effectiveness of the  Bernanke´s QE2.

Here, http://macromarketmusings.blogspot.com/2011/02/is-us-treasury-department-undermining.html there is a very educational article by David Beckworth on the theoretical intentions of the operation. A fairly sophisticated operation, whereby the Fed buys long-term Treasury bonds,  “forcing” the agents to change their asset portfolios towards less liquid and more profitable assets. If the Fed buys bonds at 5-10 years, it is increasing the price of these bonds, and reducing, therefore, long term yields.

Let’s put ourselves in the mind of a normal agent, which has a portfolio full of cash, treasury bills, and commercial paper. The reason for this overload  in liquid assets is the crisis, which has increased demand for liquidity. The Fed starts buying in the market 10-year bond (against money, or  treasury bills), thereby increasing liquid assets in the system. The owner of the portfolio will seek to counterbalance  its overload portfolio, buying long term debt, that  will rise in price. While the Fed will continue to buy long-term bonds and issuing money or bills, the appetite for riskier assets and more profitability increases. That will help the investment through  interest rates (which will fall) and through consumption, given the increase in liquidity.

One problem is that (as we can see in Beckworth),  the Treasury is “boycotting ” the operation of the FED,  issuing and offering long-term bond amounts greater than what the Fed for its part is taking, so it is not happening the desired effect: actually the rates are rising, not falling.
An other problem is that the operation seems too subtle if it is not a net emission of money, or what Friedman called High Powered Money, when he analyzed the case of Japan and wrote one of his best articles. Friedman said that the Bank of Japan should go to  the secondary market  and buy bondholders many bonds as were necessary to increase liquidity and inflation until this  reached a normal level 2-3%. (See the article by Friedman in  http://www.hoover.org/publications/hoover-digest/article/6549.)
Once inflation and  growth rate increased, the bank could gradually subtract the excess liquidity.
This is what leads me to say that Bernanke is a timid, because as it can see in the graph
until now there has no been increased in  printing of money: increasing the monetary base has gone completely to  stagnate in banks reserve. A simple change of accounting records for the Fed to banks that does not convert into increased liquidity, as seen clearly. (The red line are part of the monetary base that goes to reserves, it is clear that increases at the same rate as the base.)
A graph in the post of Beckworth very illustrative about the increase in demand for liquidity: 

A graph showing the shift towards the liquidity of companies and households that justifies any operation of the Fed to counter it. The graph reaches the III quarter and we´l wait to see if  Qe2 has become  effective.

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