Monday, November 08, 2010

A Marcro View: Lies or Just Distortions by Distractors.

Over the weekend, Mike Shedlock {aka Mish} considered statements made by Geithner and Bernanke to be Bold-Faced Lies. Normally I find Mish to post reasonable and well thought out posts. This conclusion does not appear to be out of the normal range that people are saying, but it does point to where people are jumping to conclusions and taking words out of context. Mish accuses Bernanke of lying when Ben stated that “We are not in the business of trying to create inflation,” in the following passage.

Bernanke's Lie According to Mish:
Of course the Fed is in the business of producing inflation. It is their first and foremost goal, just as it is in Japan. Consequences, such as asset bubbles be damned.

In a simplistic manner, yes the Fed is in the business of "producing inflation" as the target is always set to a positive number of around 2% inflation rate per year. They don't in fact target 0% as even short bouts of deflation are much more disruptive to an economy than low "stable" rates of inflation. Zero rates would also not be feasible as rates tend to gyrate around a lot and zero would act as a knife edge as it would tend to drift from that rate once achieved. The measured rate of inflation is also suspect that it does not take into account that products are improving. This "rate of improvement" could be around 2% per year according to some economists. One example of this effect is the improvement in cars over the last 100 years. The amount of utility as far as comfort and safety is much improved since the cars of 1910 and also 1960.

To get a better idea of what Ben was talking about let us look for more complete set of quotes aside from the MarketWatch short incomplete quote (1). The WSJ provides the best set of quotes with writer's comments included, as I could not find any transcript.
"There is not really, in my mind, as much discontinuity as people think" in the path the Fed is currently following, the central bank chief said. "This sense out there, that quantitative easing or asset purchases, is some completely far removed, strange kind of thing and we have no idea what the hell is going to happen, and it's just an unanticipated, unpredictable policy—quite the contrary. This is just monetary policy," Mr. Bernanke said.

While he considers himself "very sympathetic" to those unnerved by what the Fed is doing now, in the current environment of tepid growth and ebbing price pressures, more aggressive policy "can be helpful" to improving conditions.

Mr, Bernanke explained "we are not in the business of trying to create inflation," and "I have rejected any notion that we are going to try to raise inflation to a super-normal level in order to have effects on the economy." But because the Fed is "equally committed to both sides of our mandate," the central bank should also avoid having prices fall below levels consistent with price stability, he said.

"If inflation is declining and continuing to decline, at a minimum we should not be satisfied," and should view current price pressure levels as "a signal more should be done."

"We see an economy which has a very high level of under utilization of resources and a relatively slow growth rate," Mr. Bernanke said. "The standard considerations suggest we should be using expansionary monetary policy, and that was the purpose of the action" taken last week, the chairman said. (2)

I bolded the original noted quote and the presumed next line which implicitly states not high levels of inflation but levels that would correspond with their two mandates of stable price levels and maximum employment given the other constraints. After the line about supra-normal levels, Wes Goodman from Bloomberg added the following sentence.
“It’s critical for us to maintain inflation at an appropriate level.” (3)

So Ben is not creating inflation for the sake of inflation but is in fact "creating inflation" for the purposes to fulfill full employment and price stability. Thus inflation is just a secondary consideration.

Mish in the above quote also mentions about asset bubbles. Nothing tells me that the normal tools that Fed has can address asset bubbles that obviously are sector driven. The Fed has a gas and brake peddle for the economy, they do not have controls on every sector. The only obvious answer is that regulations have to become more strict and more closely enforced during seemingly obvious bubbles. Given that Mish felt it was obvious that housing was in a bubble, then I would guess that he must have sold his house and shorted the housing market as much as he could have. More complete markets could have helped him short the markets, but still synthetic shorts might have worked.

Geithner's Lie According to Mish (4)
If a strong dollar was in the best interest of the country, then Geithners {sic} would not be pressuring China to weaken it. Bernanke would not be out to destroy it.

It is one thing to have a "strong dollar", it is another to allow distortions to continue even beyond what is reasonable. China by "hoarding" excess reserves, they have been in essence driving up the price of US dollars in relation to their currency. If the Chinese had already unpegged their currency from the US dollar, or at least pegged it to a basket of currencies {as they promised the world in 2005} then these set of criticisms would have more weight. As it is, on a bilateral situation, we are only rectifying their distortions.

As far as the rest of the world complaining, then they should have done more to correct the "global imbalances" sooner as the IMF has been explaining for years. But there are questions about what is considered a "strong dollar" and one that I also have wondered about. Menzie Chinn at Econbrowser provides some insights into how this term is used, although not this context specifically. (5)
What I think is interesting about this quote is that it highlights two different meanings of the idea of dollar strength. The first is the level of the dollar, adjusted for price levels. This is sometimes referred to as price competitiveness, and can be measured by the trade weighted value of the dollar after adjustment by the CPI (as in the the Fed's index) or unit labor costs (as in the IMF's series reu).

But Tom Fitzpatrick's quote refers to a second (and in my mind confusing) use of the "strong dollar" term. Here he is referring to the returns on dollar assets denominated in a common currency.

The rest of his post is even more esoteric. In more simpler terms, a strong dollar could be oriented toward a consumer society where costs of products and services are maintained at "stable prices", or it can be geared toward investor classes. Whether foreign or domestic, investors search out the highest risk adjusted investments. As long as the nominal GDP is growing faster than inflation then investors will flock to growing economies over stagnating economies. It appears that at this time they are referring to the second classification of a strong dollar.
Fed Chairman Ben S. Bernanke yesterday told college students in Jacksonville, Florida, that “the best fundamentals for the dollar will come when the economy is growing strongly.” (4)

So to come full circle, by the Fed trying to "pump money" into the system, it is in fact trying to make the US dollar strong by encouraging growth and reducing unemployment. And thus Ben is not out to destroy it but to help strengthen it. No matter how many times the inflationary hawks scream {Glenn Beck (6)}, the US has a long way before we are facing rising levels of inflation. This is not to say there is nothing to fear but a good simple explanation is by TPC at the Pragmatic Capitalism titled BEN BERNANKE EXPLAINS THAT QE IS NOT INFLATIONARY, JUST AN ASSET SWAP.

I am delighted to see Rand Paul won a senate seat also. I am sure his rants will be just as effective as Ron Paul's rants were. Most of the time, Ron's time ran out before the Fed chairman had an opportunity to respond. Not sure any response would have helped though. Keynesian vs. someone from Kenya, now that is funny.

Links:
(1) Fed chairman: Increasing inflation not a goal Bernanke say bank’s sole priority is to boost economy

(2) Bernanke Defends Fed Moves - WSJ.com

(3) Goldman Says Bernanke Engineers `Substantial Pickup'

(4) Geithner Says U.S. Won't Use Dollar to Gain Competitive Advantage in Trade

(5) Econbrowser: What's a "Strong Dollar"

(6) Glenn Beck might not know what the word "deflation" means

(7) BEN BERNANKE EXPLAINS THAT QE IS NOT INFLATIONARY, JUST AN ASSET SWAP




Misc. Links:
Jobs Report Adds to Debate Over QE2 - Real Time Economics - WSJ

Foreign exchange: Fool's gold | The Economist


The Hindu Business Line : Strong dollar keeps the US rich

Why traders don't trust word on dollar

Monetary policy: Everyone expects inflation | The Economist

Goldman and Bernanke are Wrong on Inflation

Bernanke Admits, and Defends a Spike in Inflation

Bold-Faced Lies of the Day from Geithner, Bernanke

Wages And The Slide Toward Deflation - NYTimes.com

More FREDding

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