I monitor statements by senior officials of the Federal Reserve System. There are supposedly "hawks" among the regional Federal Reserve banks — privately owned banks. These "hawks" oppose the "doves." The "doves" are always ready to inflate. The "hawks" are always ready to remind the "doves" that inflation may be a problem one of these days, but not yet. Then the "hawks" vote with the "doves" to expand the monetary base.
If you have not seen a chart of the adjusted monetary base lately, you owe it to yourself. Take a look.
If this chart did not send a chill down your spine, you must work for the Federal Reserve.
In recent weeks, the FED's party line has become clear. The officials all parrot it. They do not explain it, but they parrot it. Let me summarize.
1. "THERE IS NO THREAT OF INFLATION AT THIS TIME."
When they say "inflation," they mean price inflation. The rate of price inflation is measured by various statistical indicators. I have long used the Median Consumer Price Index, which is published by the Federal Reserve Bank of Cleveland. It went up less than the CPI when the CPI moved up. It has not fallen, unlike the most recent CPI. So far in 2009, the Median CPI has moved up, January—April, at 0.2% per month. This is not price deflation, but it is comparatively low by Federal Reserve standards, i.e., too high.
It is safe to say that price inflation is not yet a threat. It is not a threat because the commercial banks are not lending. They are not lending, because bankers all over the world are scared of this economy. They are keeping funds above the legal minimum at their respective central banks. This means that policy-makers at the FED have had little room to maneuver. The federal funds rate is just barely above zero.
Reporters or Congressmen who hear party line #1 should ask this series of questions of Chairman Bernanke:
When the recovery arrives, and commercial banks start lending, what will happen to the M1 money multiplier?
Will it rise?
If it rises, will this increase the money supply?
Is price inflation always a monetary phenomenon, as Milton Friedman argued?
2. "THE FEDERAL RESERVE WILL REVERSE POLICY IN A RECOVERY."
The officials are a bit vague about how this will be accomplished. It can be accomplished in two ways: (1) the sale of assets on the FED's balance sheet, thereby shrinking the monetary base; (2) raising reserve requirements for commercial banks, thereby blocking any expansion of commercial bank lending.
This argument that the FED will do this rests on the following premises:
The recovery will be self-sustaining, once it arrives.
The rise in T-bond rates, due to the rising Federal deficit, will not reverse the recovery.
The rise in all American corporate bond rates will not reverse the recovery.
The rise in mortgage rates will not reverse the recovery.
The FED's addition of supplies of bonds and toxic bank assets through FED sales will not raise rates.
The banks that swapped assets worth pennies on the dollar for Treasury assets at face value will give back the T-bills in exchange for those assets.
Reporters or Congressmen who hear party line #2 should ask this series of questions of Chairman Bernanke:
What will be the effect on interest rates, long term and short term, when the FED sells these assets?
What will be the effect on the recovery of rising interest rates?
Which assets will be impossible to sell at face value?
How will the Federal Reserve record capital losses on its books?
Will the FED swap back the banks' toxic assets for the T-bills it loaned the big banks?
Will those banks be allowed to carry those assets at face value?
Why hasn't the FED already swapped back these toxic assets for the FED's T-bills?
3. "THE ECONOMY WILL RECOVER IN THE SECOND HALF OF 2009."
This statement rests on the assumption that falling housing prices will have no significant macroeconomic effects on the public's spending and saving decisions. It also assumes that there can be a sustained recovery with unemployment rising faster than it has since the Great Depression.
The argument rests in the following assumptions:
Keynesian economists were correct when they blamed the recession — and all previous recessions — on a reduction in public consumption and an increase in thrift.
Keynesian Federal Reserve economists are correct when they argue that rising thrift and decreasing consumption as a result of falling house prices and rising unemployment will not reverse the recovery.
Reporters or Congressmen who hear party line #3 should ask this series of questions of Chairman Bernanke:
Why is the public's rising thrift in response to a continuing fall in net worth not a threat to the recovery? (Please do not use Austrian School analysis to frame your answer.)
If it is true, as almost all economists argued after 2001 — except the Austrians — that the housing boom led the economic recovery, why do you expect recovery, given the fact that housing prices continue to fall, and construction is minimal?
What about commercial real estate in the second half of 2009? How will rising vacancy rates and bankruptcies not affect commercial bank balance sheets negatively?
4. "THE ECONOMIC RECOVERY WILL BE SLOW."
This rests on the following assumptions:
The unemployment rate will go higher.
Real estate prices will go lower.
Consumers will be hesitant to spend.
Producers will be hesitant to borrow.
Employers will be hesitant to hire.
Commercial bankers will be hesitant to lend.
It's hard to argue against any of these arguments. I cannot see any flaw here, except for this: It's illogical to argue for economic growth, given these circumstances.
Reporters or Congressmen who hear party line #4 should ask this series of questions of Chairman Bernanke:
What rate of growth should we expect in the second half of 2009?
What rate of growth should we expect in 2010?
When will unemployment peak?
At what rate?
How much further will housing prices fall nationally?
When will they turn upward nationally?
What evidence do you have for any growth at all?
5. "THE WORST OF THE BANKING CRISIS IS BEHIND US."
This statement rests on the following assumptions:
The banks' borrowers have solved the problem of credit default swaps and other high-leveraged contracts.
J. P. Morgan has solved the problem of its capitalized net worth, given the fact that it has more derivatives on its books than any other U.S. bank.
The banks are solvent, despite the fact that their assets are in default and illiquid, though not marked to market. The FDIC will not have to tap its remaining $13 billion, down from $50 billion in early 2008.
The FDIC will not draw on the $500 billion line of credit that Congress has issued to it.
Reporters or Congressmen who hear party line #5 should ask this series of questions of Chairman Bernanke:
What is your estimate of the percentage of total bank capital likely to fall to zero over the next two years?
What is the effect on interest rates of the sale of FDIC assets, including the sale of Treasury debt necessary for Congress to lend money to the FDIC?
How much bank capital is at risk due to the continuing house foreclosures?
How soon will these foreclosures return to 2007 rates?
THE FED'S POLICY OPTIONS
These were described years ago by coin dealer Franklin Sanders: (1) inflation, (2) blarney.
To this, Bernanke has added the exchange at face value of marketable Treasury debt for non-marketable toxic assets owned by the largest banks.
So, here are the FED's policy options: (1) more inflation, (2) more blarney, (3) more accounting fraud.
The FED may say that monetary deflation is an option: reducing its balance sheet by sales of unnamed assets. If this really is an option, why wait for the recovery? Why not now?
Why not in 2007—2008?
Why not since 1914?
The FED's officials not only blow smoke, they inhale before blowing. I hate to tell you where the FED is blowing this smoke, but Nancy Pelosi and Barney Frank are the prime targets. CNBC is second in line.
The FED has as few policy options as all other central banks. All of them have inflated. All have driven down short-term bank lending rates to close to zero. All have overseen domestic recessions. All are finding that the recovery has not arrived, despite short-term rates at close to zero.
If banks will not lend money they can get from the central bank at 0%, there is a major problem. What will be the basis of recovery? Which will be the #1 sector that drives up the world economy? It was housing in 2001—2006. It won't be in 2009.
What now? More T-bond purchases to hold down T-bond rates? But this inflates the monetary base. This policy is not supposed to continue. When will it stop?
The Federal Reserve has a party line. There is no systematic effort at any level of the national government to elicit from the FED a description of exactly how its scenario is documented. There is no attempt to inquire about the specifics of the means of the predicted monetary deflation of the recovery period.
In short, nothing has changed with respect to Federal Reserve transparency.
Smoke gets in our eyes.
June 19, 2009
Copyright © 2009 Gary North