In These New Times

A new paradigm for a post-imperial world

Ideological and hostile- Commentary and weekly watch by Doug Noland

Posted by seumasach on November 23, 2010

“I find it embarrassing – to blame our trade partners and creditors for our predicament. Worse yet, it is frightening that there is obviously no plan of attack for dealing with the structural issues of the US. The Geithner/Bernanke “global rebalancing” gimmick is to have China and the “developing” economies inflate domestic demand and stimulate imports. In the meantime, we stay the course with massive deficits, monetization and near-zero interest rates. This approach has no chance of rectifying the country’s deep structural impairment nor resolving global imbalances. It does, however, increase the odds of a crisis of confidence in the US debt markets and currency.”

Doug Noland

Asia Times

23rd November, 2010

Click on above link for full bulletin

With eurozone tensions on the rise, Wednesday’s headline from the Financial Times read “Anger at Germany boils over”. “Bernanke Fires Back, Takes Aim at China,” was how the Wall Street Journal titled its analysis of the Federal Reserve chairman’s speech on Friday morning in Frankfurt. Paul Krugman also takes direct aim at Germany and China – and throws in the Republicans – with his “Axis of Depression” piece in Friday’s New York Times. In a troubled backdrop beckoning for level-headed analysis and cooperation, the mood has turned decidedly ideological and hostile.

Bernanke has compiled speeches and academic papers that will be scrutinized for generations to come. He added one more to his list on Friday. Global policymakers – already deeply skeptical – will not be impressed. Officials from the “developing” economies are sure to be displeased. The Chinese must be incensed – and it is difficult for me to discern how this will work to the advantage of the United States. It is the big debtor and importer. In no way does US policymaking qualify as the “moral high ground”. Indeed, most would argue it has been permanently disqualified. The latest round of Fed quantitative easing – QE2 – was one step too far – it crossed the line.

The Bernanke Fed has boxed itself into a corner. QE2 has been poorly received at home and abroad. Yet with this policy having succeeded in inflating global markets, there will be no turning back from the monetary experiment. Bernanke came out swinging on Friday – or at least finger pointing. Appreciating that QE3, 4, and 5 … are now anything but sure things, he calls for help from additional fiscal stimulus. In the following breath, he pays lip service to the need to resolve long-term fiscal challenges. We’re at the point where it all lacks credibility. Bernanke has always been an inflationist – and these stripes are increasingly apparent for all to observe. Having been unsuccessful in “marketing” his latest installment of Treasury debt monetization, it is apparently now time to identify culprits.

From Bernanke’s speech, “Rebalancing the Global Economy”:

As currently constituted, the international monetary system has a structural flaw: It lacks a mechanism, market based or otherwise, to induce needed adjustments by surplus countries, which can result in persistent imbalances. This problem is not new … In particular, for large, systemically important countries with persistent current account surpluses, the pursuit of export-led growth cannot ultimately succeed if the implications of that strategy for global growth and stability are not taken into account. Thus, it would be desirable for the global community, over time, to devise an international monetary system that more consistently aligns the interests of individual countries with the interests of the global economy as a whole.

After US Treasury Secretary Timothy Geithner’s “global rebalancing” proposals smacked up against a cement wall at the autumn Group of 20 gathering in South Korea, chairman Bernanke must know his global rebalancing speech will be flatly rejected in terms of providing a legitimate policymaking proposal. It was instead a rehash of flawed doctrine – and a stinging slap in the face. The US economy has been running current account deficits since the 1980s. The Fed has been accommodating financial excesses since then. We’ve had insufficient household and national savings since the ’80s. Monetary policy has nurtured imbalances for decades. So, we’re going to castigate the Chinese?

I find it embarrassing – to blame our trade partners and creditors for our predicament. Worse yet, it is frightening that there is obviously no plan of attack for dealing with the structural issues of the US. The Geithner/Bernanke “global rebalancing” gimmick is to have China and the “developing” economies inflate domestic demand and stimulate imports. In the meantime, we stay the course with massive deficits, monetization and near-zero interest rates. This approach has no chance of rectifying the country’s deep structural impairment nor resolving global imbalances. It does, however, increase the odds of a crisis of confidence in the US debt markets and currency.

“In Defense of Ben Bernanke” (Wall Street Journal, November 15, 2010), Alan Blinder states that QE2 is “not a radical departure from conventional monetary policy”. Only an individual that has been an integral part of the revolution of monetary management at the Federal Reserve would make such a statement.

Beginning back with early ’90s banking system impairment, the Alan Greenspan Federal Reserve nurtured Wall Street financial engineering and the rapid expansion of non-bank marketable debt. The government sponsored enterprises (such as mortgage guarantors Fannie Mae and Freddie Mac), securitization markets and derivatives were viewed as instrumental for fostering the needed credit expansion in the face of severe banking and fiscal headwinds. The Fed unleashed a lion.

No longer was monetary policy focused on creating and extracting banking system reserves in an effort to influence bank lending (and through bank credit, growth and inflation). The old rules for governing a largely contained financial system no longer applied. A New Era was born.

The Fed now could manipulate short-term borrowing costs and immediately stimulate flows into the securities markets, speculator risk-taking and leveraging, asset inflation, mortgagerefinancing and equity extraction, home price gains, additional household net worth, spending … It became The Age of the Maestro, The Masters of the Universe, the enterprising investment banker and opportunistic mortgage originator. Traditional measures of economic health – the current account, savings rates, sound investment, productive capacity, stable money and credit, balanced financial flows – were discarded. What mattered now were the markets, market perceptions and how the Fed could be counted on to orchestrate and sustain a boom.

I’ve argued for years now that the Fed had adopted a radical approach to monetary management – and it was disturbingly apparent that the US central bank had become enamored with history’s most powerful monetary policy mechanism. And with dynamic marketable debt increasingly supplanting the boring old bank loans as the main driver of system credit expansion (especially as the ’90s progressed), the Federal Reserve had to take an increasingly aggressive and activist approach to ensuring ample marketplace liquidity and unwavering market confidence.

The ’94 bursting of the bond/mortgage-backed securities bubble, the Southeast Asia Financial crisis, Long-Term CapitalManagement, the tech bust … The Fed nurtured a historic credit bubble and the larger the bubble inflated the greater role monetary policy had to play to ward against a devastating crisis of confidence. Policy was conspicuously radicalized in the aftermath of the 2008 collapse of the mortgage/Wall Street finance bubble.

But the chickens are bound to come home to roost – especially after the past two years of unprecedented global expansion of government debt, marketable debt securities that now absolutely dominate the world. The specter of market illiquidity reemerged with this spring’s Greek contagion crisis, and it was sufficiently scary. The European Central Bank intervened to support struggling debt issuers and a vulnerable banking system. The Fed, fearing a more systemic crisis, played its QE2 trump card. The markets perceived this move as an unending commitment from the Fed to provide a liquidity backstop. Risk markets have inflated across the globe.

It is my view that a world financial apparatus dominated by marketable debt instruments is inherently unstable. Implement a monetary policy regime to manage marketplace liquidity and asset prices at your own peril. Be prepared for market dependency and ever-increasing liquidity injection requirements. Such a regime will reward the savviest speculators and ensure acute systemic vulnerability. To be sure, recent notions of perpetual quantitative easing inflated global markets indiscriminately. The “liquidity trade” threw caution to the wind. Liquidity overabundance also pushed inflationary forces in China and throughout Asia into the danger zone.

These days, Fed policy to manipulate US securities markets has extraordinary spillover effects. In my vernacular, inflationary biases have shifted from US mortgage finance and American housing to China, Asia, the “developing” economies and commodities. The Fed will now have an increasingly challenging task of ensuring sufficient liquidity to sustain inflated US securities markets. Meanwhile, the “periphery” will have an increasingly frustrating job of trying to manage unwieldy financial flows into their markets and attendant overheated economies.

The basic premise of the “Bretton Woods II” thesis has been that it is in the interest of both parties for the US to run current account deficits and for Asian economies to send us manufactured goods while their central banks recycle the resulting dollar flows back into US securities. And for as much distaste as I’ve had for “BWII” analysis, there has been the semblance of truth to the thesis of mutual benefits.

I’ve argued that the arrangement where we exchange new debt instruments for imported goods, services, energy and commodities was dysfunctional and unsustainable. Today, with our massive expansion of non-productive – hence inherently vulnerable – debt and Asia’s heightened susceptibility to inflation and unwieldy financial flows, this arrangement has turned problematic. It is also fundamental to global marketplace liquidity.

Our policymakers are acting to the detriment of our creditors. They speak in a tone that does not inspire confidence and may likely antagonize. The Chinese, in particular, can be counted on to act in what they perceive as their own best interest. They today confront serious inflation, “hot money” and overheating issues. As such, what has appeared as favorable prospects for continued global liquidity overabundance now look a lot less certain. Global yields were on the rise again this week, with heightened attention to structural debt issues. US municipalbonds were hammered. My premise has been that the markets will inevitably discipline Washington. This may occur after it works its way up the food chain

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