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Legerdemain and Misdirection – The Debate over the Fed’s Mandate

0 1904 Market Intelligence

Alex Carrick

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Alex Carrick is Chief Economist for Reed Construction Data. He specializes in economic forecasting and statistical services.

Economists

Classic political spin tries to perform magic by means of misdirection. A measure of this is currently underway with regard to the debate over the mandate of the U.S. Federal Reserve. Twenty-three persons of prominence have signed a letter to Chairman, Ben Bernanke warning against the Fed’s plan to purchase $600 billion in U.S. Treasury bills. It is contended this will lead to a surge in inflation and a devaluation of the U.S. dollar, while not really helping the economy much. While this is a legitimate concern, there is a political agenda being advanced.

Classic political spin tries to perform magic by means of misdirection. A measure of this is currently underway with regard to the debate over the mandate of the U.S. Federal Reserve. Twenty-three persons of prominence have signed a letter to Chairman, Ben Bernanke warning against the Fed’s plan to purchase $600 billion in U.S. Treasury bills. It is contended this will lead to a surge in inflation and a devaluation of the U.S. dollar, while not really helping the economy much. While this is a legitimate concern, there is a political agenda being advanced. In many nations, the responsibility for inflation lies in the hands of the central banking authority. Overall economic growth, including job creation, is carried out through fiscal policy. There is an implied goal for inflation of about +2.0%. In the U.S., the size of the combined fiscal and foreign debt has somewhat tied Washington’s hands on the fiscal side with respect to stimulatory tax cuts. Furthermore, the suffering of Americans has precluded too deep spending cuts. As a result, the fed has donned the mantle of both inflation monitor and job creator. With respect to the former, the immediate concern is deflation, since the core CPI rate of only +0.6% is the lowest in 52 years. One way to counter deflation is to expand the money supply. It doesn’t hurt that such a course of action will also help with the second goal of greater employment. This is where the dispute with some Republicans comes in. More conservative members of the caucus, Tea Party loyalists and conservative media pundits are pushing an agenda of tax cuts and reduced government spending. They are trying to elbow the Fed out of the way. In my reading of the business media on the subject of the Fed’s $600 billion injection into the money supply, the best quote I’ve come across is by the well-respected Governor of the Bank of Israel, Stanley Fischer. To paraphrase, he’d rather see a stronger U.S. economy and a weaker greenback than a weaker U.S. economy and a stronger greenback. Further on this subject, will the U.S. dollar really drop in value as a result of the Fed’s moves, given the sovereign debt problems in Europe? If so, probably not by much. Last spring, Greece needed to be bailed out by EU and IMF money. Now Ireland has required financial intervention. This was against the will of the Irish Parliament. But once international investors lose confidence in a government, it becomes impossible to raise money at reasonable rates to keep functioning. The premium on bond rates is the reason that deficits need to be kept under control. When government debt has been downgraded, aggressive action is needed to stop a continual spiraling descent. In Ireland, recent huge public sector commitments to bail out the nation’s two largest banks pushed the government’s debt problems over the brink. Being bailed out by the EU essentially means being bailed out by Germany, since that nation is by far the region’s largest and most stable economy. In fact, with the exception of Ireland, the countries that are having the sovereign debt problems lie mainly around the southern perimeter of the Euro zone. For this reason, they are being referred to as nations on the “periphery.” The speculation about sovereign debt problems in the EU region won’t stop with Ireland. That’s not how the speculative beast feeds. Once one vulnerable nation succumbs, attention inevitably swings to the next most likely target. By consensus, that nation appears to be Portugal. According to Bloomberg News, a term has been coined for traders who engage in the kind of pack mentality that brings a nation’s finances down. They are known as vigilantes. This is a term adopted, under different circumstances, by Edward Yardeni of Yardeni Investments, New York. Portugal’s problems are several. It has not shown the same commitment to reducing its debt problems as some other at-risk nations. Only recently has the government in power come to an agreement with the opposition to cut wages and raise the VAT. It may be too little too late. It’s not just a matter of cutting spending. Economies also have to grow in order to raise enough tax revenue to contribute towards deficit reduction on the fiscal side. Portugal is not expected to record positive growth in 2011. The OECD is calling for GDP change of -0.2% next year. If the U.S. were not the world’s largest economy (i.e., the supreme example of too big to fail), there seems little doubt that international rating agencies would be looking at its problems with sharper pencils. The legitimacy of credit rating agencies is a whole other subject area, given the role they played in exacerbating the sub-prime mortgage mess. Their too willing acceptance of securitized debt as Triple A removes a certain degree of confidence in their judgment. For at least the foreseeable future, the U.S. dollar remains the world’s currency of last resort. No other coinage offers anything like the same degree of liquidity. The world is awash in U.S. dollar-denominated notes and bills. That guarantees the greenback’s place at the top of the heap. But the Yuan and the Euro do offer an alternative over the longer term. China must first become more transparent in its economic policy moves and more open to capital inflows and outflows. It must also clean up its statistics. It is no longer acceptable that decisions made by the second largest economy in the world are based on data that is questionable at best and may be subject to manipulation at worst. For the Euro zone, the weaker members must be propped up or ejected. Why should the average person (i.e., Canadian) care about any of this? Because it is crucial in determining inflation and interest rates. It also plays out in the value of the Canadian dollar. Alex Carrick

Find Canadian construction-related economic articles in Canadian Construction Market News and in the Economic Outlook section of Daily Commercial News. Mr. Carrick also has a lifestyle blog that can be reached by clicking here.

by Alex Carrick

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