Thursday, September 22, 2011

the Fed, the ECB, and you

After yesterday's Fed announcement the stock market dropped sharply. Bond yields fell too and the dollar rose against the euro. All three responses indicate the expectation of an economic downturn which will result from a shortage of dollar liquidity. The Fed has so far failed to meet the increased demand for dollars which arises from the danger of widespread bank failures in Europe resulting from defaults on sovereign debts. I commented on this situation in this post a couple of weeks ago.

Please remember that a drop in bond yields now is a very bad thing for it shows that investors expect the economy to remain depressed for a long time to come. The goal of the Fed and of the European Central Bank (ECB) should be to satisfy the demand for dollar liquidity by permanently expanding their balances sheets via the purchase of long maturity assets. More importantly, the central banks must convince the markets that they intend to continue this policy until the growth of nominal GDP has at least reached its trend line of 5% annual growth.

So far both the Fed and the ECB have failed to do this largely for political reasons. Moreover, commercial bankers have great influence over both institutions and bankers are of a "liquidationist" bent almost to a man - they prefer depression to any risk whatsoever of inflation.

Sadly, I think the world economic crisis (and it is indeed a crisis) is playing as a "Greek" tragedy in slow motion. The players have doomed themselves to destruction because they are unwilling to break away from old patterns of thought.

Until the Fed and the ECB can convince markets that they are prepared to accommodate the increasing demand for dollar liquidity world wide stocks will remain in a bear market and the dollar will rally against the euro as well as against other currencies.

22 comments:

BullandBearWise said...

Nice wrap-up of Street-like thinking. The problem is the populace does not want any more debt creation. They will win this battle. Power to the people!

Carl Futia said...

Bull:

Yes, and they will lose the war.

Edwin said...

simply brilliant! Hat off to ypu Dr. Futia.

FH said...

The Fed created this problem. They can't fix it. The problem should have been addressed long ago, but wasn't.

bull-bear said...

Carl - what policies might the Fed implement in order "to meet the increased demand for dollars"?

bull-bear said...

"The Fed has so far failed to meet the increased demand for dollars..."

What fed policies would address meeting the increased demand for USD?

Harry said...

Carl

How would you suggest the Fed create dollar liquidity?

Thanks

Carl Futia said...

"The goal of the Fed and of the European Central Bank (ECB) should be to satisfy the demand for dollar liquidity by permanently expanding their balances sheets via the purchase of long maturity assets."

BullandBearWise said...

In other words, eat your young.

Tim- said...

carl, these people bashing the fed and other central banks don't understand what it is to expand a balance sheet. they think by they are simply printing money. THEY ARE NOT!!!!

only the treasury could actually monetize the currency

George Rahal said...

Thank you for sharing your interpretive insights, Carl.

Carl Futia said...

My dear Bull:

The Fed does NOT create debt for future generations to repay. Only the US Treasury dept. can do that.

BullandBearWise said...

A central bank that's buying most of that nation's newly issued sovereign debt is not a properly functioning central bank. Again, back to the eating its younng analogy.

David said...

We've lived in decades of flowing virtual USD (debt), we've got to learn leaving without for a while...

That's long and painfull.

David said...

I think the FED action was worst, because it caused an overpricing of commodity, like oil copper, which slown down the recovery.

For a nice recovery we need cheap comodities... Expensive commodities was just a way for speculators to make money.

Michael said...

For those that have failed to realize this, "Operation Twist" does NOT EXPAND the FED's balance sheet. It is a "steralized" operation.

Given that the Fed acknowledged "significant downside risk to the economy" in their comments yesterday... but yet chose NOT TO EXPAND their balance sheet, the market turned up their nose and headed South.

It's as simple as that.

PS. I've never been a Fed Basher.

Spudthorpe said...

Carl, just curious, how come you have drastically lowered your original target for ES (compared to a few months ago) but you still have the same bullish target for Apple? Do you expect Apple to defy the market decline and continue to rise? Thanks.

Graph1159 said...

Hi Carl,
If more dollar liquidity is the solution to restoring economic growth, why did QEII fail to revive the U.S. economy? What seems to have happened is that after QEII began, commodity prices spiked, which is largely blamed for the major slowdown in GDP growth this year.

Adi said...

Unfortunately, power to the people means power to the mediocre, these days.

There are two kinds of mediocre people: the ones that know they are like that and go and sit silently in the corner, and the ones that are knowledgeable and thus think they are "wise" (any allusion to bull-bear-wise from above is unintended but, still, valid). This last kind is the most dangerous.

Today, this "wise" mediocrity is the source of our political leaders and their support also. They are running to meet the goals of this moody cohort every two years. What a circus!

And, also, what a byzantine tragedy! While we are busy watching the circus, we are forgetting the gate to our fortress open.

Win said...

One of the most important things the Fed does, by monetizing the debt, is win the currency war for the U.S. Prior to the this leg up in the dollar, manufacturing was actually returning to the United States. After many years, it was simply cheaper to build cars and trucks here, than to build them in China and ship them here. What the Fed bashers don't realize is that they (and the politicians spouting their populist anger) may have stopped this nascent recovery in manufacturing in its tracks.

dcatlowpj said...

Carl, there is an interesting lack of correlation between liquidity, EU specifically, and liquidity/borrowing needs here in the USA. We are in economic contraction; no one is hiring (evidence); demand is flat to depressed; Unemployment figures are flat to declining (repeat); Companies are shutting plants (personally I know of at least 10 plant closures in the last 60 days alone); Companies such as HP are struggling (evidence, management shake-ups); and in effect, the demand for CREDIT (Loan demand, dollar-denominated) is down dramatically. The Fed manipulations, seemingly aimed at providing cheap interest rates (aimed at borrowing?) is a lie. Could you comment on the liquidity you mention and credit demand. I think that these are very correct points for discussion and I am once again a fan of yours. This was your best post in over a year.

MaverickUK said...

Hi Carl
In my article entitled "Stupid Politicians" dated 15th August 2011, which is published on my blog http://www.theSarayiahpost.com, I comment that there is absolutely no solution to this crisis. I've been saying this for a while, but finally the markets have caught up with reality.

The solution, in my opinion, was to never print money to solve a problem that was created by debt in the first place and to let the banks fail. All the governments did was focus on the short term and transfer the debt at the micro level to the macro (ie sovereign) level and now those sovereigns are collapsing in what will be a domino effect of unprecedented disaster. WW3 but on an economic scale most likely leading to a depression lasting for decades.

If history repeats itself we will most likely have a strong equity market rally until mid/ end of October before complete collapse in equity, commodity and bond markets etc across the world.

The direct link to this article is:

Stupid Politicans

Isaac Sarayiah