The Economic Gibberish Of The Keynesian Apparatchiks

By David Stockman

If you want an illustration of the utter intellectual bankruptcy of our Keynesian policy overlords just review the attached Wall Street Journal piece on yet another downgrade by the EC of its official economic growth forecast. What’s illuminating is not that the savants of Brussels were wrong by a country-mile yet again, but that they persist in a mechanistic numbers game that resembles nothing so much as

Janet Yellen Admits the Fed is Clueless When It Comes to Correct Economic Theory and Other Stunning Admissions

By Robert Wenzel

On Thursday, Federal Reserve chair Janet Yellen delivered a speech at the  International Symposium of the Banque de France in Paris, France.

The speech is quite noteworthy since she pretty much admitted in the speech that the economic data that the Fed watches did not offer any clue that the 2008 financial crisis was developing:

FOMC Statements Have Grown in Size and Complexity

Rubén Hernández-Murillo and Hannah Shell from the St Louis Fed write:

Over the years, the Federal Reserve has developed numerous communication tools aimed at increasing transparency. One tool in particular has evolved significantly—post-meeting statements by the Federal Open Market Committee (FOMC), the body within the Federal Reserve in charge of setting monetary policy. The FOMC began releasing these statements in February 1994. Initially, the statements provided

This is How Fed Monetary Policy is Being Driven

Chart of M2 money supply, quarterly change from a year ago,



Fed money supply growth is always quite erratic. And the last 10 years have been no exception. Is it any wonder that the economy appears to be on some kind of roller coaster?

Benn Steil and Dinah Walker at the Council on Foreign Relations highlight how erratic thinking can be among Fed officials:

St. Louis Fed President James Bullard continues to burnish his reputation as the FOMC’s least predictable member, reversing course on policy for the second time in 3 months—going from dove to hawk and now back to dove again.  Having as recently as August publicly advocated a rate rise in early 2015, he is now calling for the Fed to halt its monthly taper of QE3 bond purchases, citing falling inflation expectations.

But the Fed’s own preferred measure of inflation expectations, the 5-year 5-year forward breakeven inflation rate, has barely moved since the FOMC’s September meeting—down from 2.4% to 2.3%....Bullard has always defended his policy calls as data-driven, but in this case he seems to be navigating more by gut calls as to where the data may be moving in the future.  

For a complete discussion of how these manipulations distort the economy and cause the business cycle. see:  Austrian School Business Cycle Theory by Murray Rothbard

Is Bernanke Preparing to Double the Money Supply?

On June 15, I wrote a post titled, Federal Reserve Very Concerned About Double Dip Recession.

It was a riff off a WSJ reporter Jon Hilsenrath piece. The Hilsenrath piece sounded to me like the Fed was very concerned about the economy.

Three days later I reported on the drop in the ECRI Index and wrote:

The ECRI continues to be one of my favorite indicators for tracking the economy. It tends to be much more timely and accurate than government data. This sudden drop in the index suggests imminent trouble over a broad swath of the economy.

Based on a new report from Ambrose Evans-Pritchard, my analysis does not appear to be that far off from the reality of the situation. Pritchard writes:

Fed watchers say Mr Bernanke and his close allies at the Board in Washington are worried by signs that the US recovery is running out of steam. The ECRI leading indicator published by the Economic Cycle Research Institute has collapsed to a 45-week low of -5.7 in the most precipitous slide for half a century. Such a reading typically portends contraction within three months or so.

Key members of the five-man Board are quietly mulling a fresh burst of asset purchases, if necessary by pushing the Fed's balance sheet from $2.4 trillion (£1.6 trillion) to uncharted levels of $5 trillion.

To date, Fed asset purchases have not had much impact on the economy since banks have simply kept the money on deposit with the Fed as excess reserves. However, an addition of another $2.6 trillion in assets by the Fed would most certainly see some of, if not all of the funds, enter the system. Further, as these Funds enter the system, it could very well cause banks to start to put to work the trillion they have sitting on the sidelines. The money supply (M2)would explode.

If Pritchard is anywhere near accurate on his reporting here, and keep in mind that my analysis of the situation earlier this month seemed to be heading in the direction of Pritchard's report, then we may very well be about to head into one of the most inflationary periods in American history.

The only drag on Bernanke's mad money printing plan seems to be the presidents of the Fed regional banks, but Bernanke is doing what he can to dilute their influence. Here's Pritchard again:

[Bernanke and other Fed governors] certain to face intense skepticism from regional hardliners. The dispute has echoes of the early 1930s when the Chicago Fed stymied rescue efforts... Mr Bernanke is so worried about the chemistry of the Fed's voting body – the Federal Open Market Committee (FOMC) – that he has persuaded vice-chairman Don Kohn to delay retirement until Janet Yellen has been confirmed by the Senate to take over his post. Mr Kohn has been a key architect of the Fed's emergency policies. He was due to step down this week after 40 years at the institution, depriving Mr Bernanke of a formidable ally in policy circles.

Bottom line: If such an asset purchase campaign is launched, the inflationary ramifications would be extremely severe. You would see near immediate upward spikes in the stock market and gold. Housing would follow. Then the consumer price inflation would start. Severe double-digit inflation.

How likely is Bernanke to begin such a campaign?

I have argued in the past that Bernanke does not have the "trader's touch" that Greenspan had. Greenspan's money manipulations are largely responsible for the current overall downturn and the housing crash, but on a short-term basis, Greenspan had the "touch" to add just enough money to fuel the economy and not go stark raving mad on the money printing side.

Bernanke does not appear to have this touch, he swings from near zero money printing, as is the case now and also in the summer of 2008, to extreme money printing as was the case between September 2008 and March 2009, when the money supply (M2) climbed at annual rate of near 15%. Thus, a $2.6 trillion asset purchase by the Fed under Bernanke would not surprise me. The man swings extreme, and the current negative numbers on the economy, which I am sure he understands means major problems ahead, must scare the bejesus out of him.

The Fed has not started any major asset purchases, yet. But the situation needs to be monitored closely. Any indications that Bernanke is indeed conducting massive quantitative easing operations will mean that its time to get in aggressive inflation protection mode.

As Expected, No Rate Change by the Fed

Below is the full text issued by the FOMC after their meeting:

Information received since the Federal Open Market Committee met in April suggests that the economic recovery is proceeding and that the labor market is improving gradually. Household spending is increasing but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software has risen significantly; however, investment in nonresidential structures continues to be weak and employers remain reluctant to add to payrolls. Housing starts remain at a depressed level. Financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad. Bank lending has continued to contract in recent months. Nonetheless, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be moderate for a time.

Prices of energy and other commodities have declined somewhat in recent months, and underlying inflation has trended lower. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Donald L. Kohn; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh. Voting against the policy action was Thomas M. Hoenig, who believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to a build-up of future imbalances and increase risks to longer-run macroeconomic and financial stability, while limiting the Committee’s flexibility to begin raising rates modestly.

Is the Big Inflation About to Hit?

It's a little early to tell, but Bob Murphy has emailed me a very interesting article that points to a change in strategies by banks.

The article was written by Jeff Cox at CNBC. The key points to the article are:

Surprisingly strong Treasury auctions in March had help from banks, which normally stay away from such events.

Banks snapped up $5.7 billion of the total $34 billion auctioned in 10-year notes and 30-year bonds, providing demand for auctions that many analysts thought would flop....At the same time, bank credit fell 5.1 percent in the month and loans and leases dropped 6.4 percent, according to the Federal Reserve .

The pattern suggests that banks have been starting to put their large cash balances to work, but is not an indication that bank balance sheets as a whole have started to grow," Deutsche Bank said in a research note.

The suggestion is that banks are using Treasurys as a way to get some return on their money that they might otherwise reap from making loans.

That banks would get so involved with long-dated securities came as additional surprise since they aren't usually such active participants at auctions and generally buy mostly short-dated notes. Under normal circumstances banks don't have much interest in keeping long-term rates low as that could compress the yield curve and cut into the profits they could make on lending.

Yet combined with their purchase of agency-backed debt such as mortgages and student loans, banks bought a total of $40 billion from the Treasury in March, according to analysts at Deutsche Bank.

But there's also another less-obvious reason banks could be stepping in to the Treasury market: A type of tacit quid pro quo with the Federal Reserve to keep short-term rates low by helping the government finance its debt through Treasury auctions.

Art Cashin, director of floor operations at UBS, noted after the 30-year auction suspicions among traders about who was doing the buying. In remarks to CNBC, he spoke of "all manner of conspiracy theories floating around. Is the Fed putting on a fake moustache and a raincoat and coming in as an indirect buyer?"

While there's disagreement among analysts whether the actions are part of an explicit pact between the two sides, some suspect a gentleman's agreement in which both sides benefit.

"Banks are stealing money from the public, giving consumers zero percent interest on deposits, and instead of turning over risk to the over-indebted consumers, they're loaning money to the government," says Michael Pento, chief economist at Delta Global Advisors in Parsippany, N.J. "I'm sure it's at the behest of (Fed Chairman) Ben Bernanke—we're going to keep rates low but you must facilitate the Treasury auctions going off smoothly."

The Fed funds rate is near zero, meaning that banks can borrow at almost no cost and lend out at the prevailing rate—or invest in vehicles such as Treasurys.

The 10-year yield edged over 4 percent in the days after the weak March auction for the benchmark note but has fallen precipitously since then, trading around the 3.75 percent area and helping to keep government borrowing costs down.

Now, the fact that bank loans dropped during the period would suggest on first blush that the Treasury is crowding out the private sector, i.e. banks are buying Treasury debt instead of loaning funds out to businesses.

But, there is one other intriguing piece of data.

Excess reserves fell by $41 billion in the month of March. That is almost the exact amount that banks bought in Treasury and agency-backed debt. Does this mean that the banks are starting to move some of the trillion dollars in excess reserves they are holding and starting to pump them into the system? Possibly.

One other piece of data suggests that there is a countervailing drain going on somewhere. 3 month annualized M2 growth is actually negative, so I am not ready to sound the alarm bells just yet, but I am watching things very carefully.

What needs to be monitored is how much more Treasury and agency debt banks buy, any further down trends in excess reserves, and, of course, M2 growth. If M2 growth starts to pick up with declining excess reserves and banks buying government paper, it is a signal that we are headed into a new inflation phase. It means the Fed can't keep interest rates down, without sneaky inflation via getting banks to start using excess reserves. Again it is still early, and these numbers do move around a bit, but if a trend starts to develop over the next couple of months the early warning inflation alarm bell will have to be sounded.