The Federal Reserve, in announcing the results of this week’s meeting of the Open Market Committee, surprised the market by revealing it will begin purchasing US Treasury notes and bonds with the principal income it receives from its vast holdings of Fannie Mae and Freddie Mac mortgage securities. This practice – wherein the Fed buys up US government securities and injects cash into the public market as payment for these securities – is a form of monetizing the debt. The last time the Fed did this on a big scale was back in the 1960s when it attempted to mop up the excess Treasury securities that were flooding the market as a result of Lyndon Johnson’s efforts to finance the Vietnam War. That Fed program was viewed at the time as a failure, since the cash the Fed put back into the economy in exchange for the securities was a big reason – perhaps the major reason – why price inflation accelerated from the late 1960s until a decade later, when Paul Volcker managed to squelch inflation once and for all with forbiddingly high interest rates.
The market was expecting some sort of monetary stimulus, but not this. The expectation was that the Fed would renew its “quantitative easing” program involving Fannie Mae and Freddie Mac securities – a program designed to push down long term mortgage rates. That program was successful inasmuch as mortgage rates are at record lows, but it left the Fed with well over a trillion dollars of these securities on its balance sheet. Fed officials have lately been pondering publicly how to get rid of these securities, and apparently have concluded they can’t under present market conditions without forcing mortgage rates back up again, which would only hurt the housing market. Instead, these officials have concluded that the Fed has no choice but to hold on to these securities until they mature, which is well over 10 years from now for the portfolio.
The Fed receives billions of dollars of principal and interest payments every year on this portfolio, and what to do with this cash has always been open for discussion until now. But using principal proceeds from these securities to monetize the government debt is fraught with risk. For one, should the housing market start to weaken again and foreclosures rise from current levels, the Fed will be sitting on billions of dollars of credit losses on its portfolio. This could eat up most if not all of the profit it would otherwise earn on this portfolio. Second, older investors have memories of the nasty inflationary consequences the last time the Fed monetized the debt, and the market has become very skittish about the risk of inflation, and maybe even hyperinflation ala Weimar Germany, that could result from the enormous fiscal and monetary stimulus put into the economy since 2007.
In terms of these risks, the best thing the Fed has going for it at the moment is that the pricing problem facing the current economy is not inflation, but deflation. A growing number of economists, and even some Fed governors, are worrying outright about deflation, but at least in a deflationary environment the Fed is given a lot more leeway to monetize the debt and build up its balance sheet as a consequence. The Fed press release today did not mention deflation per se, but the FOMC no longer described the economy as “progressing”, as it did in June. Instead, the Fed sees an economy with substantial slack, a stagnant housing market, repressed earnings power for workers, and very low inflation.
The bond market was happy to buy Treasuries on this news, concentrating in the 2 to 10 year maturities, in anticipation of higher prices (and thus lower yields) once the Fed begins actively purchasing. So far, in other words, the bond market sees no risk of inflation, much less hyperinflation, and is content to see yields continue to head to record low levels. Such excessively low yields on government bonds have only been seen in deflationary economies like Japan has experienced for nearly two decades. This is in essence what the bond market is forecasting for the US economy.
The stock market, which has been on a tear since early July, took this news in stride, but time and past experience is weighing heavily on this stock rally. When bond yields fall to record lows, this has never boded well for equities. In a deflationary economy, stock prices are one of the main victims, and the US stock markets have so far shown no significant adjustment downwards to reflect deflation. Stocks may have some serious “catching up” to do.
At the least, we can say we are no longer in that environment in the spring when Fed governors were talking seriously about how they were going to remove all their monetary stimulus now that the economy has recovered. Instead, we are witnessing yet another round of monetary stimulus, a recognition by the Fed that their previous efforts have failed to ignite a sustainable recovery.
was a spring mistake. Monitizing right now is such a minimal response. Low interest rates does not resolve structural issues.
The question to be asked: is THIS the new normal?
Population growth is slowing, fossil energy is peaking, productivity is displacing labor.
If these factors are part of the new normal, then
The generation of GDP per unit of energy (indeed per unit of commodity input) has to rise substantially
Renewable energy needs to be developed and brought on line at fossil energy cost; and at a pace much faster than it is (scaling would achieve both)
Transport costs have to be brought much lower than they are, either efficiency, shifting modes of transport, non fossil energy inputs, localization, or all of the above. Transport is like a leaky bucket in the face of peak fossil energy.
Fixed costs for business for labor has got to go down because in this new normal environment of high and accelerating productivity, the work week has to be 30 hours (a four day week) to maintain acceptable employment levels as a percentage of working age adults.
This means health care cost, in particular, needs to be nationalized and federalized.
This also means that the entire educational system has got to provide a much more comprehensive and advanced level of universal education. A college level education needs to be integrated into our concept of ‘Public Education’ Blue collar labor has been permanently displaced by machines and computers. We are entering an economy where all our food and all our goods can be manufactured by less than 5% of workers (compared to 80% in 1945)
It’s not being recognized that something fundamental has changed. It is part demographic, part resource constraint and part technology. But taken together it is creating a perfect storm. The emerging seriousness will likely require the US to redeploy its military resources to solving these domestic issues (gee, what a concept).
This
= spending the military budget at home, and not necessarily on the military.
and this:
is only true if and only if the there is a reasonably priced supply of energy. If not we are back to muscle power on the farms. Computers? they’ll be for the rich.
And finally, it would take an R president to pull this off. A very strong and visionary R president
Well said. If the energy piece is not solved all bets are off.
I will wonder no more. I don’t even think they believe in this move, it is just a stop gap to get past the 1st Tue in Nov. Shorting stocks after that date could be a lucrative investment.
Then before 2012 I expect they’ll dump the rest of TARP or whatever else they have left in the ammo heap. Then we have an election and promptly go broke.
I agree completely.
By the time the coal and oil industries are pushed back to where Washington has to consider renewables on a basis other than as a figleaf to liberals, I think we’ll be too far behind the eight-ball.
Electric cars are great, but where are you going to get the electricity? From coal? Whoops!
Right now, fossil fuels get 10 times the subsidies of renewables from Uncle Sam (~$500B to ~$50B). That balance needs to shift in a hurry.
So I think the philosophy of the elites buying time and putting in safeguards that protect the assets of the wealthiest 1% are going to become the policy. This will be done while giving lip service to renewables and talking about “job creation” while continuing to define unemployement in such narrow terms as to make the public think it’s always 9% when it is really around 20% or higher. You know, like if you are unemployed for over 99 weeks, we kick you out of the system and you don’t count anymore. Or you went from being a technology team manager (~$70K/yr) to a McDonald’s shift manager (~35K/yr) meaning, you are employed so you don’t count. And other neat tricks to mask the true numbers.
This week, we saw thousands die in Russia due to heatwaves and fires that the Russians say have NEVER been equaled in their history, over a million displaced with hundreds (maybe thousands) dead in Pakistan flooding, flooding also in the midwest, and huge mudslides killing hundreds with thousands more missing in China. Oh yeah, and a 100-square mile patch of glacial ice slipping off the Greenland ice sheet. What’s coming next week?
So I post this grim weekly summary up on my Facebook (which my friends are supposedly musicians and intelligent folks) and what do I see? Many even of this group don’t think scientists agree that warming is happening. Aaaarrrgh!!! The disinformation lobby is kicking our ass, even at this late stage!
At this point, most Americans do not understand the need to get off fossil fuels, and if they do, they are thinking of oil, when the true monster is coal.
So, maybe ‘all bets are off’ is too extreme a position, given that there is still time, NOT to avoid serious consequences of climate change, but to still mitigate the worst case scenarios.
I still have faith that America will wake up before we allow the worst case scenarios (a.k.a the “business as usual” projections you see in the computer models), but my prediction is that it will get quite a bit worse before it gets better.
America’s failure to lead on this vital issue is going to throw back the entire planet’s response time to the global issues (poverty, starvation, ignorance, refugee and population migration problems, ethnic strife, etc) that climate change exacerbates.
The reason is that all these problems are linked. Climate disasters don’t create all the other issues, but it brings them to a new peak of volatility. Climate change can push a broken national economy over the edge. It can, through climate refugee problems, cause ethnic tensions to explode into civil wars, it can force fights over precious resources to move beyond being merely political battles to actual skirmishes between groups of people desperate for water, food, and other basics.
Or, as Bob Marley said “A hungry man is an angry man.”
I don’t know at what point Americans will come out of their self-induced consumer-stupor and rise up again. But we aren’t there yet, as and far as I can tell, we are still several critical election cycles away.
Wasted time that we will pay for by a steady degradation of our lifestyles. We are already seeing, for the first time in America’s history, new generations coming on whose prospects are not brighter, but darker, than the generations of their parents. Our grandchildren will live on a much less biodiverse planet than we do, and fight a much harder economic battle to be comfortable and happy in life.
How low does it have to go? We’ll find out, probably within the next 10-15 years.
what the problems we face are. And while we may argue over the solutions, agreeing on the problems as a country would be a really good place to start.
“SÃ che dal fatto il dir non sia diverso.”
-Dante
It is manifest in the way corporations are hoarding all the cash they can get, and deriving their profits not from increased sales, but from exploiting their workers. Many have cut back on hours for salaried employees, forced everyone else to work 10 hours a day, reduced medical benefits, eliminated contributions to 401k plans, restricted bonuses to executives, and all the while finding new ways to outsource work to Asia so they can eliminate more jobs. Those companies which do have job openings offer them at menial wages and then become surprised when no one can afford to take the job.
Americans are getting squeezed as never before and third world lifestyles are here to stay.
on this issue, check out Mike Whitney’s article at CounterPunch
http://www.counterpunch.org/whitney08042010.html
and especially his link to a report by Nomura’s chief economist, Richard C. Koo comparing the current US situation to Japan’s.
http://www.house.gov/apps/list/hearing/financialsvcs_dem/richardc.koo.pdf
We all pay into Social Security but what happens to that money? Is the use of Social Security payments a form of debt monetization?
Debt monetization occurs only when a nation’s central bank buys up its own federal debt. Politicians may think this is an elegant solution to a debt financing problem, particularly if they are having trouble selling the debt to the private sector. It is the private sector – the open marketplace of domestic and international bond buyers – which ultimately determines whether a nation’s debt is a “good buy”. If bond buyers go on strike, they are saying there is too much debt out there, and the strike alone would force interest rates on the open market up in order to ultimately get the paper sold. If the central bank steps in a buys the paper that cannot be sold to the public, it looks at first as if it can keep interest rates down. This is a distortion. Ultimately the central bank given its monetary role pumps money into the economy for every bond it buys, and this money has to go someplace, which in the end means it contributes to domestic inflation. This is exactly what happened to the US in the 70s. Interest rates started to shoot up ironically because the Fed raised them super-high to kill off inflation.
Social Security taxes go into a trust fund consisting of Treasuries. This is not monetization of the debt because the Social Security Administration is not the Fed. It cannot issue money out of thin air to buy the bonds. It must use cash it receives from the Social Security taxes, and it can only buy as much bonds as this cash allows.
Assuming the nation doesn’t go bankrupt and default on its bonds, this trust fund will have enough money to make its promised payments to retirees until the 2030s. Through a sleight of hand, however, Congress for decades has added in this trust fund to its accounting of the federal deficit, which has given Congress leeway to expand spending beyond what pure income taxes would allow. This has jeopardized the ability of the US to meet its debt obligations down the road – not seriously yet (the US still has a AAA rating), but obviously things are dicier than before.
I thought you might be interested in some research I conducted on Social Security back in 2005 based on my alarm over Bush’s infamous “personal accounts.” Sean Paul was good enough to post it for me shortly before I joined the Agonist. While some of the report is obviously outdated, parts are still valid, and I’m always concerned that, given our institutional amnesa, “personal accounts” may yet resurface.
Link is below:
http://agonist.org/annex/socsec.htm