Mark Thoma has an interesting article on the dilemma facing the Fed: does it respond to rising inflation or the anemic economic recovery? On the one hand, the Fed is concerned about maintaining its inflation fighting credibility and its independence from Congress. Thus, it wants to be seen as vigilant on the inflation front. On the other hand, it does not want to undermine the economic recovery, as sluggish as it is. What will it do? For a number of reasons, Thoma believes the Fed will err on the side of fighting inflation. This is unfortunate because any honest, fact-based assessment of the economy will show that long-term inflation expectations are well anchored, money demand remains elevated, and there remains much economic slack.
Guess what: rising energy prices are taking a toll on consumers.
The results of the Irish stress tests are going to be released this afternoon at 430PM Irish time. I will be talking about the implications for investors in European markets on CNBC’s Power Lunch show.
I think one has to be cautious about the sovereign debt of any of the periphery countries at this point. I also think haircuts on Irish bank debt are coming as well as a Portuguese bailout. But there are a lot of unsolved issues concerning Spanish banks and as well as the German, British and French holders of Irish bank debt. Here’s the background to what I will say on the show.
One factor that should perhaps get more emphasis is the role of the financial sector. Central banks have repeatedly cut or held down interest rates over the past 25 years in an attempt to boost bank profits and prop up asset prices. With this subsidy in place, is it surprising that earnings in finance have outpaced wages for other technologically skilled jobs?
Attempts to remove that subsidy are met by threats from international banks to move elsewhere. This is a little reminiscent of the protection rackets run by the gangsters in Mario Puzo’s “The Godfather”. It is as if the finance sector is saying: “Nice economy you got there. Shame if anything should happen to it.”
The huge compression of the investment horizon towards an extreme short term bias continues to be a major barrier to real recovery. A methodology to develop a direct capital flow between investors and the real economy is now desperately needed. Reflexivity, or simply put, the fact that markets have de facto no self adjusting mechanisms, should now be a most powerful wake up call to build the foundation of new economic and financial approaches; to explore new frontiers to save a declining West.
I am delighted to be back in China this week for a high-level seminar in Nanjing on the international monetary system. Every time I come to this part of the world, I am impressed by the dynamism of the economies and the optimism of the people. The future is here.
Last week The New York Times reported that the drug cartels, after shaking the political and economic structures of Colombia and Mexico to their foundations, are moving into Central America. Just one more sign, as if we needed it, that the United States is losing its endless war on drugs.
The Truth About the Economy that Nobody in Washington or on Wall Street Will Admit: We’re Heading Back Toward a Double Dip
On March 29, the government announced a new decree in the Official Gazette, increasing the financial-operation tax (IOF) on overseas loans—corporate loans and debt sold abroad by banks and companies. The tax was raised to 6% from 5.38% on international bond sales and extended to transactions with a maturity of up to 360 days from the previous 90-day limit. Brazil’s central bank said the increase was aimed at curbing foreign currency loans with a maturity longer than three months; which have grown around 39% since the end of 2008. In addition, the local newspaper Folha de S.Paulo, asserted that since January 2011, the inflows of U.S. dollars into the country had reached almost US$35 billion, reflecting an increase of 42% with respect to 2010’s total inflows.
My central complaint with Federal Reserve Chairman Ben Bernanke is his penchant for what is often described as running the Fed like a university economics department. Internally, I do not see this as a challenge, and for the Fed’s culture may be an effective management style. Externally, I see this a potential communications disaster always in the making. The recent uptick in inflation heightens my unease at this approach, and I think Ryan Avent hits the nail squarely on the head:
…An increase in inflation is only worrying to the extent that it undermines the Fed’s efforts to satisfy those mandates, and the above clearly doesn’t count. Yet the simple fact of increasing inflation sends writers running to speculate on and, in many cases, demand central bank action.
And central bankers often play along. You have a number of regional Fed presidents warning that they may be ready to end the latest round of asset purchases ahead of schedule. I don’t know whether there’s any communications strategy within the Fed—whether Ben Bernanke is tacitly approving of these comments or upset by them—but it’s fairly certain that the comments themselves represent a tightening of monetary to the extent that they shape actual market expectations (and there does seem to have been some impact).
That’s no way to make policy. It’s a poor means of communication and a poor decision to tighten. And these poor choices are encouraged by writing that misrepresents the extent of current inflation and its consistency with Fed mandates.