Posts Tagged ‘Paul Kasriel’
Paul Kasriel’s Parting Thoughts – Mary Matlin’s Economics
Friday, March 30th, 2012
Kasriel’s Parting Thoughts – Mary Matlin’s Economics
As many of you know, I will be retiring from The Northern Trust Company on April 30. In the few remaining days of my tenure, I will be sharing with you some of my parting thoughts with regard to economics as time permits and the spirit moves me. By the way, after April 30, my Northern Trust email address will disappear into the ether, but I hope I will not follow it there. If you feel the need to contact me after April 30, and I cannot imagine why you would, I have established a personal email address, which has gone live: econtrarian@gmail.com.
Now, on to Mary Matalin. I saw her on one of the cable news shows on Wednesday defending Republican presidential candidate Mitt Romney’s planned car “elevator” in his new La Jolla home in terms of job creation. Ms. Matalin argued that by installing this elevator, Romney would be creating new jobs for the economy. How might Bastiat, the 19th century French political economist, have reacted to Ms. Matalin’s argument? My suspicion is that he would have made a distinction between what Ms. Matalin “sees” and what is “unseen.” Ms. Matalin sees the additional workers manufacturing and installing the elevator. What she apparently does not see are the workers who otherwise would have been hired for some other unrelated project had Mr. Romney forgone the installation of the elevator and rather invested, or saved, these “elevator” funds. Ms. Matalin, a Republican partisan, appears to have bought into the Keynesian fallacy often trumpeted by Democratic (or is it Democrat?) partisans that an increase in saving implies less total spending in the economy and diminished job creation. If Mr. Romney chooses to forgo the installation of a car elevator in favor of, say, purchasing some additional financial assets, in effect, he is transferring some of his purchasing power to another entity – a business, another household or a governmental body – that has a greater urgency to spend currently than does Mr. Romney. So, although Mr. Romney would be hiring fewer workers to manufacture and install a car elevator, the recipient of Mr. Romney’s investment funds would be hiring additional workers to produce whatever they were purchasing. (This concept of transfer credit comes from the Austrian school of economics, whose pupils greatly admire Bastiat.)The only way Mr. Romney’s decision to forgo the installation of a car elevator would not lead to a creation of jobs is if Mr. Romney chose to increase his saving by holding more bank deposits and/or currency, in which case would result in a decline in the velocity of money.
So, boys and girls, like Bastiat, keep your eyes open. Try to see everything when analyzing economic issues. Ms. Matalin was not incorrect to argue that Mr. Romney’s decision to install a car elevator in his new abode would create new jobs. But what she apparently failed to see is that new jobs would have also been created if Mr. Romney had chosen to forgo the purchase of the car elevator and instead invested those funds. Increased saving in general does not result in decreased aggregate spending. Rather, it merely changes the composition of who is engaging in the new spending.
Copyright © Northern Trust
Tags: Cable News, Chief Economist, Elevator, Fallacy, Financial Assets, Job Creation, La Jolla, Mary Matalin, Mary Matlin, Mitt Romney, New Jobs, Northern Trust Company, Parting Thoughts, Partisan, Partisans, Paul Kasriel, Political Economist, Purchasing Power, Republican Presidential Candidate, Republican Presidential Candidate Mitt Romney
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Paul Kasriel: We’re All Keynesians Now – Except Me
Thursday, November 24th, 2011
This post is a guest contribution by Paul Kasriel, chief economist of The Northern Trust Company.
If you want federal debt reduction, you are going to get it Super-Committee “failure” or not. The recent debt-ceiling legislation calls for $1.0 trillion less-than-otherwise federal spending over the next 10 years. The “trigger” calls for $1.2 trillion less-than-otherwise federal spending over the next 10 years. And, with the return to the Clinton-era personal tax rates for all household income groups on January 1, 2013, revenues will increase by $3.5 trillion more-than-otherwise over the next 10 years. So, that is $5.7 trillion of less federal debt issuance than otherwise over the next 10 years. Now, that’s what I would call a grand bargain. And don’t forget, unless Congress acts before yearend 2011, an extra $168 billion of federal debt that otherwise would have been issued won’t be because of an expiring FICA tax “holiday” (just in time for the holidays?) and the expiration of extended unemployment insurance benefits. The U.S. as the next Greece? I beg your pardon. Try Canada, eh?
But most economists are not celebrating this significant prospective slower growth in federal debt. Rather, this dismal lot is busy marking down their real GDP forecasts. Why? Because they are partial-equilibrium Keynesians. Allow me to explain why I think they are too quick to reduce their forecasts of economic activity.
If the government borrows less than otherwise, then, all else the same, the demand for credit, at the margin, will have fallen. Entities that had intended to restrain their current spending in order to transfer that spending power to the government now find themselves with more spendable funds than planned. They may be able to entice someone else to borrow and spend if the interest rate at which they are willing to lend is lowered marginally. And/or, at a lower interest rate level, these lenders may decide to become spenders themselves. So, with the government demanding less credit over the next 10 years, private borrowers will step up to absorb the “excess” offered credit and/or lenders will become spenders themselves. So, why mark down your GDP forecast?
It could be a bit more complicated if we take into consideration Fed policy and banking system credit creation. And, this is where some markdown in the GDP forecast could be appropriate. Suppose the Fed is targeting the level of the federal funds rate when the government’s demand for credit is increasing more slowly. As I indicated, this weaker demand for credit would result in a decline in the interest-rate structure, all else the same. But all else is not the same if the Fed is targeting the level of the federal funds rate. If the Fed maintains the same target level of the federal funds rate in the face of weaker overall credit demand, then the interest-rate structure will not be permitted to fall fully to its new lower equilibrium level.
How does the Fed maintain the same level of the federal funds rate in the face of weaker overall credit demand? By draining cash reserves from the banking system. What happens to bank credit growth under these circumstances? It slows. Why? With the interest rate structure not being allowed to decline to its new lower equilibrium level, the quantity demanded of nongovernment credit (a movement along the credit demand curve) will not increase enough to offset the decline in the demand for government credit (shift back in the credit demand curve). Some of the credit demand that banks were providing is now being accommodated by the entities who were formerly lending to the government. Hence, with overall credit demand growing more slowly, bank credit growth slows. Why don’t banks lower their loan rates more to restore their loan growth? Because banks’ marginal cost of funds, the federal funds rate, has not declined even as their loan rates have. In effect, banks’ marginal return on capital has declined.
In this case, the slower growth in the demand for government credit will lead to a decline in the growth of bank credit. Remember, banking system credit, along with Fed credit, is credit created “out of thin air.” An increase in the growth of “thin air” credit results in a net increase in the growth in spending in the economy. Conversely, a decrease in the growth of “thin air” credit results in a net decrease in the growth in spending in the economy. Thus, to the extent that weaker growth in government credit demand results in weaker growth in bank credit, then the GDP forecast should be marked down. But because the decline in the dollar change in bank credit is likely to be of a smaller magnitude than the decline in the dollar change in government credit demand, the markdown in GDP growth would be much smaller than the Keynesian forecasters are contemplating.
If the Federal Reserve were targeting a rate of growth in bank credit (or even more radical, targeting a rate of growth in the sum of bank and Fed credit), then, in the face of weaker growth in government credit, the Fed would operate so as to maintain the growth rate in bank credit rather than passively allowing it to slow. In this case, weaker growth in government credit demand would not result in weaker bank credit growth. Thus, there is no reason to markdown one’s GDP forecast.
So, in my non-Keynesian (lonely) world, whether slower growth in government credit demand leads to slower growth in overall economic activity depends critically on the behavior of bank credit growth. If the Fed is targeting the federal funds rate, which it normally does, and does not lower its target rate so as to maintain the growth in bank credit, then the pace of future economic activity likely will be slower, but not nearly as slow as the Keynesians argue.
Note: The comments above are dedicated to the memory of Robert (Bob) Laurent, Milton Friedman’s most brilliant student (in my opinion) and my most brilliant “teacher.” If only Bob were here, someone would understand these comments. I miss you, man.
Are We about to Find Out that the Fed “Has no Clothes?”
From the minutes of the November 1-2 FOMC meeting, we learn that the Committee had an in depth discussion about policy communication. (I wonder if they brought in consultants and engaged in role playing.) As usual, no decisions on changing the FOMC’s communications policy were made. Below is a passage that caught my attention:
“More broadly, a majority of participants agreed that it could be beneficial to formulate and publish a statement that would elucidate the Committee’s policy approach, and participants generally expressed interest in providing additional information to the public about the likely future path of the target federal funds rate. The Chairman asked the subcommittee on communications to give consideration to a possible statement of the Committee’s longer-run goals and policy strategy, and he also encouraged the subcommittee to explore potential approaches for incorporating information about participants’ assessments of appropriate monetary policy into the Summary of Economic Projections.”
The first rule of economic forecasting is never give a date along with a numerical forecast for GDP/inflation/unemployment. The second rule of forecasting is that if you violate the first rule, never give a fed funds rate forecast with your GDP/inflation/unemployment forecast. This is sure to embarrass you if anyone keeps a record. Now, just after I read this passage from the FOMC minutes, I happened to catch this Reuters News headline:
“[Minneapolis Fed President] Kocherlakota [says] FOMC Forecasts Do Not Reveal ‘Special Information’ About Economy.”
Talk about an understatement! If the FOMC begins to lay out a federal funds rate forecast that it thinks is consistent with its economic forecast, the public is going to find out, indeed, that the FOMC has no “special information.” At a time when the American people are losing confidence in so many of our institutions, is wise for the Fed to expose itself to such public scrutiny?
The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.
Source: Paul Kasriel, Northern Trust – Daily Economic Commentary, November 22, 2011.
Tags: Chief Economist, Clinton Era, Congress Acts, Debt Ceiling, Debt Issuance, Federal Debt Reduction, Federal Spending, Fica Tax, Gdp Forecasts, Grand Bargain, Household Income, Income Groups, Keynesians, Northern Trust Company, Partial Equilibrium, Paul Kasriel, Personal Tax Rates, Real Gdp, Spending Power, Unemployment Insurance Benefits
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To QE or Not to QE? That is the Question
Sunday, March 27th, 2011
To QE or Not to QE? That is the Question
March 25, 2011
by Paul Kasriel and Asha Bangalore, Northern Trust
At its March 15 meeting, the FOMC decided to continue with its program of quantitative easing, which would result in a net increase of $600 billion of Federal Reserve holdings of securities by the end of June. Of course, the FOMC issued a proviso with its decision. To wit, “The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.” Upon what “incoming information” should the Committee base its decision to modify its quantitative easing policy between now and June or, as important, beyond June?
The conventional wisdom is that the FOMC should base its QE decision on incoming information related to the behavior of the real economy and inflation. The preponderance of recent incoming information with regard to the performance of the real economy has been good, if not better than expected. One exception is data related to the performance of the housing sector. Data relating to prices of goods and services show an acceleration in the rate of increase in general indices of these prices. To some degree, negative supply shocks, such as geopolitical and climatic events, have boosted the prices of energy and food prices. Nevertheless, these prices count in the ultimate “box score,” too. So, barring a near-term reversal of trends in incoming data with regard to real economic and goods/services price performance, conventional wisdom would suggest the FOMC should terminate its quantitative easing program at the end of June, if not sooner.
After having read our commentaries through the years, you will not be surprised that we have a criterion for deciding on the issue of continuing or ending quantitative easing that is out of the mainstream. We believe that the FOMC should look to the behavior of a credit aggregate we have called Monetary Financial Institution (MFI) credit for guidance with regard to its quantitative-easing decisions. To refresh your memory, MFI credit is the sum of the credit created by the Federal Reserve, the commercial banking system, the savings and loan system and the credit union system. All of these entities have the ability to create credit figuratively “out of thin air.” The Federal Reserve can theoretically create an unlimited amount of credit out of thin air. The commercial banking, savings and loan and credit union system’s ability to create credit out of thin air is limited by the amount of “seed” money provided them by the Federal Reserve. A unique characteristic of an increase in MFI credit is that no entity in the economy needs to cut back on its current spending when the recipients of MFI credit increase their current spending. This categorically cannot be said of increases in non-MFI credit. The genesis of MFI credit is the Austrian school of economic thought’s concept of created credit. A theoretical implication of the unique characteristic of MFI credit – recipients of MFI credit increase their current spending while no other entity need cut back on its current spending – is that changes in MFI credit would be positively correlated with changes in nominal GDP, the value of goods and services produced in the economy.
Chart 1 shows the relationship between year-over-year percent changes in MFI credit and year-over-year percent changes in nominal GDP. The observations are quarterly, starting in Q1:1960 and ending in Q4:2010. During this interval, the average year-over-year change in MFI credit was 7.6%. The year-over-year change in MFI credit in Q4:2010 was only 3.0%. The correlation between the two series is, in fact, positive and the correlation coefficient between the two series is 0.59. If the interval were truncated at Q4:2007, the correlation coefficient would rise to 0.64. In 2008, when Lehman Brothers failed, the commercial paper market shut down. In response, corporations drew down their credit lines at commercial banks for precautionary reasons, not for the purpose of current spending. As a result, MFI credit spiked as GDP growth contracted.
Chart 1
As mentioned above, the year-over-year change in total MFI credit was up by 3.0% — a relatively slow rate of growth in an historical context. We do not have monthly data for savings and loan and credit union credit. We do, however, have monthly data for Federal Reserve and commercial bank credit. As of Q4:2010, commercial banking system credit accounted for almost 84% of private MFI credit – i.e., the sum of commercial bank, savings and loan and credit union credit. Chart 2 shows the year-over-year percent change in monthly observations of the sum of Federal Reserve and commercial bank credit. As of February, the year-over-year change in this credit aggregate had risen to 4.5%. Chart 3 shows the year-over-year percent changes in monthly observations of Federal Reserve and commercial bank credit separately. Chart 2 shows that the recent acceleration in the growth of Federal Reserve credit is what accounts for the recent acceleration in growth in combined Federal Reserve and commercial bank credit. To further emphasize the point that increases in Federal Reserve credit are the driver behind recent increases in combined Federal Reserve and commercial bank credit, Chart 4 shows that in the 19 weeks ended March 9, approximately the time the FOMC has been engaged in its second round of quantitative easing, Federal Reserve credit has increased a net $283 billion and commercial bank credit has decreased a net $118 billion.
Chart 2
Chart 3
Chart 4
To summarize, historically, percent changes in MFI credit “explain” a large proportion of percent changes in nominal GDP. Commercial bank credit accounts for the largest component of private MFI credit. Since the FOMC commenced its second round of quantitative easing in early November 2010, the increase in combined Federal Reserve and commercial bank credit has been dominated by the increases in Federal Reserve credit. If the FOMC terminates its quantitative easing policy in June and private MFI credit creation does not pick up, then total MFI credit growth will slow, perhaps even contract. All else the same, this would augur poorly for nominal GDP growth in the second half of 2011.
The FOMC has given no public indication that its criterion for continuing or terminating quantitative easing beyond June is based on our concept of MFI credit. Regardless of the FOMC’s criterion, if the FOMC were to terminate quantitative easing after June and private MFI credit creation fails to pick up, we would be inclined to lower our second-half 2011 nominal GDP forecast with the real component of nominal GDP accounting for most of the lower growth forecast.
Another factor that might lead us lower our second-half real GDP forecast would be the rise in the price of crude oil. The price of crude oil had been trending higher since the late fall of 2010. Then, in middle of February 2011, the price of crude oil spiked higher in reaction to actual or anticipated declines in production, primarily from Libya, which accounts for about 2% of global crude oil production. All else the same, this would be stagflationary. An outright decline in the supply of crude oil would limit the global economy’s and the U.S. economy’s ability to grow because of supply-side constraints. If MFI credit growth remained the same in the face of slower short-run potential real GDP growth, then higher inflation would ensue. We are not yet prepared to revise down our second-half real GDP forecast or revise up our second-half CPI inflation forecast because we are not yet convinced that cutbacks in Libyan crude oil production will lead to corresponding cutbacks in global crude oil production in the second half of 2011. We assume that there is enough excess production capacity by other oil producers to make up for any Libyan shortfall. We would be more inclined to reduce our real GDP growth forecast and raise our CPI inflation forecast if civil unrest led to a decline in Saudi Arabia’s crude oil production.
The devastation to the Japanese economy as a result of the recent tsunami will limit that economy’s ability to grow in the immediate future due to the destruction of its capital stock. At the same time, if the Japanese central government increases its spending to rebuild destroyed infrastructure and the Bank of Japan and/or private Japanese MFIs create the credit to fund the increased Japanese government spending, then Japanese imports of raw materials, including petroleum products, will increase. All else the same, this will put upward pressure on global commodity prices and stimulate exports of raw materials from other economies. As mentioned, because of economic devastation from the tsunami, Japanese production of some goods has been adversely affected. To the degree that other economies produce the same or similar goods, these economies will experience increased demand for these goods. For example, in the U.S., we would expect the demand for Ford Motor Company’s hybrid automobiles to increase in the face of a reduced supply of the Toyota Prius model. To the degree that Japanese government spending increases to rebuild Japanese infrastructure and this increased Japanese government spending is financed by Japanese MFI credit, then an inflationary impulse would be transmitted to the global economy, including the economy of the U.S. As more information is forthcoming, we will make appropriate adjustments to our forecast.
*Paul Kasriel is the recipient of the Lawrence R. Klein Award for Blue Chip Forecasting Accuracy
The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.
Copyright © Northern Trust
Tags: Asha, Asset Purchase, Box Score, Climatic Events, Conventional Wisdom, energy, Federal Reserve, Fomc, Food prices, Incoming Data, Information With Regard, Infrastructure, Maximum Employment, Northern Trust, oil, Paul Kasriel, Preponderance, Price Performance, Price Stability, Proviso, Qe, Sector Data, Supply Shocks
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“Being shocked by the implications of QE2 re ‘printing money’ and ‘debt monetization’ hypocritical,” says Kasriel
Tuesday, November 16th, 2010
This post is a guest contribution by Paul Kasriel, Chief Economist of The Northern Trust Company.
Every student who took Econ 101 and stayed awake during the lectures learned that the Federal Reserve has the power to create credit figuratively “out of thin air”. The A-students also learned that the commercial banking system, not individual banks, under the fractional-reserve system that we and every other developed economy have, also has the power to figuratively create credit out of thin air if the Federal Reserve first provides the “seed” money to do so. This is not unique to the Federal Reserve and the U.S. commercial banking system. This holds wherever there are central banks and fractional-reserve commercial banking systems. So, when there is an increase in the sum of Federal Reserve credit and commercial banking system credit, credit is created out of thin air, which is akin to “printing money.” When there is an increase in the sum of Federal Reserve credit and commercial banking system credit, some entity’s debt is being “monetized.”
Until the first round of quantitative easing was initiated by the Fed at the end of November 2008, the Fed had mostly restricted its debt monetization to Federal debt. Then, in the first round of quantitative easing, the Fed began monetizing large amounts of private debt in the form of mortgage-backed securities. Because Treasury securities comprise a small proportion of commercial banking system credit, the bulk of debt monetized by the commercial banking system is private debt.
Chart 1 shows the history of “money printing“/“debt monetization” from 1953 through 2009 in the U.S. The median annual percentage change in money printing/debt monetization during this period was 7.5%. In 2009, for the first time during this period, money printing/debt monetization contracted. In the 12 months ended October 2010, the fastest three-month annualized growth in money printing/debt monetization was a paltry 1.1% (see Chart 2). The Fed has said that it plans to purchase $600 billion of Treasury securities by the end of June 2011. If Federal Reserve credit were to increase by $600 billion and commercial banking system credit were to remain unchanged between the end of October 2010 and the end of June 2011, then the sum of Federal Reserve credit and commercial banking system credit would have increased by 5.2%, at an annualized rate over this eight-month period of 7.9% and 5.6% over the June 2010 level.
So, here are the important take-aways (see, I’m hip to corporate lingo) from this commentary. Whenever the sum of Federal Reserve credit and commercial banking system credit increases, credit is being created out of thin air and some kind of debt is being monetized. Assuming that the commercial banking system does not create any net new credit between now and the end of June 2011, the magnitude of the credit creation being contemplated by the Fed is not extraordinary in an historical context. And, it is not an extraordinary increase in credit creation given the current amount of resource underutilization in the U.S. economy. So, being shocked by the implications of QE2 with respect to “printing money” and the “monetization of debt” would appear to be either naïve or hypocritical.
Source: Paul Kasriel, Northern Trust, Daily Global Commentary, November 15, 2010.
Tags: Banking System, Banking Systems, Central Banks, Chief Economist, Debt Chart, Federal Debt, Federal Reserve, Fractional Reserve System, History Of Money, Monetization, Money Printing, Mortgage Backed Securities, Northern Trust Company, Paul Kasriel, Percentage Change, Printing Money, Private Debt, Seed Money, Thin Air, Treasury Securities
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Quantitative Easing in the mid 1930s Appeared to Have Been Successful
Wednesday, November 10th, 2010
by Paul Kasriel, The Econtrarian, Northern Trust
There is much skepticism as to whether the Fed’s second round of quantitative easing, QE2, will be effective in stimulating the nominal demand for goods and services in the U.S. economy. It was explained in our November 4, 2010 US Economic and Interest Rate Outlook why the Fed’s first round of quantitative easing, which ran from the end of November 2008 through the end of March 2010, was rather unsuccessful in stimulating nominal aggregate demand and why we believe that the Fed’s just-announced second round will be more successful. Keying off Mark Twain’s aphorism that although history may not repeat, it often rhymes, perhaps we can get some guidance as to whether QE2 will be successful from the results of the quantitative easing that was initiated in the second half of 1933.
It was not the Federal Reserve that initiated quantitative easing in the second half of 1933, but the U.S. Treasury. In May 1933, Congress granted permission to the President of the United States to increase the U.S. dollar price of gold, which at that time was $20.67 per ounce. By January 1934, President Roosevelt had raised the dollar price of gold to $35.00 an ounce. By the stroke of a pen, the Treasury’s hoard of gold increased in value by 69%. This, in effect, increased the Treasury’s spendable funds by the increase in the value of its gold holdings. The Treasury could use these funds created figuratively “out of thin air” to pay some of its bills without having to raise taxes or issue new securities. Thus, the Treasury could increase its spending without any other entity in the economy having to cut back on its current spending. The upward revaluation of the Treasury’s gold holdings starting in the second half of 1933 was similar to today’s Federal Reserve purchases of securities. The upward revaluation of the Treasury’s gold holdings starting in the second half of 1933 increased the supply of money in the economy just as would have occurred if the Fed and the commercial banking system had increased their credit creation.
Chart 1 shows the behavior of the money supply — currency held by the nonbank public, commercial bank demand deposits and commercial bank time deposits — from 1929 through 1939. In the second quarter of 1933, the money supply contracted at an annualized rate of 25.3%. In the third quarter, after the dollar price of gold began rising, the money supply grew at an annualized rate of 3.0%. In each of the eight quarters ended 1935, the money supply grew at double-digit annualized rates.
Chart 2 shows the year-over-year percent changes in the annual averages of nominal GDP and the money supply. As money supply growth took off, so did nominal GDP growth (and real GDP growth, too.)
Different times and different magnitudes. But if the quantitative easing of the mid 1930s worked to stimulate nominal GDP, why wouldn’t the recently-announced quantitative easing by the Fed work similarly, assuming the Fed puts enough zeroes into the program?
Paul Kasriel is the recipient of the 2006 Lawrence R. Klein Award for Blue Chip Forecasting Accuracy
Copyright (c) Northern Trust
Tags: Aggregate Demand, Aphorism, Dollar Price, Federal Reserve, Gold Holdings, Hoard, Incr, Interest Rate Outlook, Mark Twain, Mid 1930s, Northern Trust, Ounce, Paul Kasriel, President Of The United States, President Roosevelt, Price Of Gold, Revaluation, Skepticism, Thin Air, U S Treasury
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QE2 Is Likely to Be More Successful than QE1
Friday, November 5th, 2010
QE2 Is Likely to Be More Successful than QE1
November 4, 2010
by Paul Kasriel and Asha Bangalore, Northern Trust
On November 3, the FOMC announced that it would increase the quantity of its outright holdings of securities by a net $600 billion by the end of the second quarter of 2011. Thus, the Fed has re-embarked on a policy of quantitative easing. Its first real “voyage” of quantitative easing, QE1, started at the end of November 2008 and ended in March 2010. The expected (hoped for?) outcome of a quantitative -easing policy is increased nominal demand for goods and services. Under normal circumstances when the commercial banking system is not constrained by actual or expected capital inadequacy, the Fed is able to stimulate the nominal demand for goods and services by lowering its key policy interest rate, the federal funds rate. The federal funds rate is the one-day cost of immediately available funds in the financial system and, therefore, represents the marginal cost at which banks can fund themselves. As banks’ cost of funds goes down, due to competition, banks pass on their lower cost of funds to their loan customers. The decline in loan rates leads to an increase in the quantity demanded of bank credit. The increase in bank credit supplied leads to increased nominal spending on goods, services and assets. When the banking system is constrained by actual or expected capital inadequacy, banks collectively are unable to increase their supply of credit even though their marginal cost of funds has fallen. This actual or expected banking- system capital inadequacy has been hampering the effectiveness of the Fed’s low interest-rate policy in stimulating the nominal demand for goods, services and assets. Thus, the Fed is now turning to a second round of quantitative easing.
There has been much misinterpretation in the media of how quantitative easing “works.” Indeed, we are not sure that even the Federal Reserve fully understands how quantitative easing works. The typical explanation of how quantitative easing works is that the Fed’s purchases of longer-maturity securities will bring down the interest rates on these securities. The lower interest rates on longer-maturity securities will then induce the nonbank private sector to borrow and spend more. Also, the lower interest rates on longer-maturity securities will make equities more attractive investments at the margin, thereby causing a rally in equity prices, which, in turn, will induce the private sector to increase its current spending on goods and services via a wealth effect. Lastly, the lower interest rates on longer-maturity securities and the expectation that the Fed will hold short-term interest rates at a very low level for a extended period of time will weaken the foreign –exchange value of the dollar, thereby making U.S. exports more price competitive in global markets. All else the same, we do not dispute that interest rates on longer-maturity securities would fall, that equities would become more attractive and that the foreign-exchange value of the dollar would decline with the implementation of quantitative easing on the part of the Fed. What we do dispute is that these are the main channels through which quantitative easing operates to stimulate the nominal demand for goods, services and assets.
Have you noticed by now that whenever we mention quantitative easing, we italicize quantitative? We have done this to emphasize that the main channel through which quantitative easing stimulates the nominal demand for goods, services and assets is through the quantity of credit created by the combined Federal Reserve System and commercial banking system, not the price of credit (the interest rate), not the price of equities and not the price of foreign exchange. If one were to review Econ 101 text books, one would discover that central banks are able to create credit figuratively “out of thin air.”
The important implication of this is that the recipients of central bank-created credit are able to purchase goods, services and assets without any other entity in the economy having to cut back on its current purchases of goods, services and assets. The Federal Reserve, of course, is the U.S. central bank. If one were to read a little further in the Econ 101 text, one would discover that the commercial banking system, not an individual bank, also is able to create credit figuratively “out of thin air,” providing that the central bank supplies the “seed money” for this to the commercial banking system. The important implication of the creation of credit by the commercial banking system, is the same as that of the creation of credit by the central bank: the recipients of this credit created by the commercial banking system are able to purchase goods, services and assets without any other entity in the economy having to cut back on its current spending on goods, services and assets.
Thus, if combined central bank and commercial banking system credit increases, there is a presumption that current nominal aggregate spending on goods, services and assets will increase. That same presumption with regard to an increase in nominal aggregate spending cannot be made when credit is granted by the nonbank sector. In this case, the presumption is that the grantors of credit will decrease their current nominal spending, transferring purchasing power to the recipients of the credit. Thus, when the nonbank sector extends credit, the presumption is that nominal aggregate spending does not increase. The exception to this presumption would occur if the quantity of currency and bank liabilities desired to be held by the nonbank public were to fall by an amount equal to or greater than the amount of nonbank credit extended.
Tags: Asha, Assets, Bangalore, Banking System, Banks, Decline, Federal Funds Rate, Federal Reserve, Fomc, Inadequacy, Interest Rate Policy, Loan Rates, Marginal Cost, Misinterpretation, Northern Trust, oil, Paul Kasriel, Policy Interest, Qe1, Qe2, Second Quarter
Posted in Energy & Natural Resources, Markets, Oil and Gas, Outlook | Comments Off
Are Corporations Sitting on Piles of Cash?
Monday, August 16th, 2010
This article is a guest contribution by Michael ‘Mish’ Shedlock, author of Global Economic Trends Analysis.
The Wall Street Journal claims U.S. Firms Build Up Record Cash Piles
U.S. companies are holding more cash in the bank than at any point on record, underscoring persistent worries about financial markets and about the sustainability of the economic recovery.
The Federal Reserve reported Thursday that nonfinancial companies had socked away $1.84 trillion in cash and other liquid assets as of the end of March, up 26% from a year earlier and the largest-ever increase in records going back to 1952. Cash made up about 7% of all company assets, including factories and financial investments, the highest level since 1963.
“Stockholders don’t want them to keep sitting on cash at a zero return,” said Paul Kasriel, an economist at Northern Trust. “They’re going to use it,” either to increase hiring and investment or to make payouts to shareholders in the form of dividends or share buybacks, he said.
Investors Punish Companies Spending Cash
The “companies are going to spend cash” theory sounds nice except for two things. The cash is not there in the first place (it’s really debt), and Investors Say No to ‘Let’s Expand’ Companies
Delta Air Lines executives spent much of an earnings conference call Monday parrying with analysts over the airline’s plans to increase capacity by 1% to 3% in 2011, on top of this year’s growth of 1% to 1.5%. Delta Chief Executive Richard Anderson said Delta is committed to “capacity restraint,” but the stock fell 2.9% that day. The shares lost 2.3% for the week, compared with a 5.4% gain by the NYSE Arca Airline index.
United Airlines parent UAL Corp. got a pat on the back from analysts for its plans to keep capacity additions relatively muted. Its shares jumped 4.8% on Tuesday after UAL released earnings.
Tags: Airline Index, Bill Gross, Capacity Additions, Company Assets, Delta Air Lines, Delta Chief, Earnings Conference, Financial Investments, Global Economic Trends, Liquid Assets, Michael Mish, Mish Shedlock, Nyse Arca, Paul Kasriel, Richard Anderson, Share Buybacks, Spending Cash, Ual Corp, United Airlines, Wall Street Journal, Zero Return
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Runaway Government Spending? You Decide (Kasriel)
Thursday, August 12th, 2010
This post is a guest contribution by Paul Kasriel, Chief Economist of The Northern Trust Company.
The U.S. Treasury released its budget status for July. As Chart 1 shows, the cumulative deficit in the 12 months ended July was $1.318 trillion – the lowest since June 2009’s $1.255 trillion. So far, the largest 12-month cumulative deficit reading has been $1.477 trillion in the 12 months ended February 2010.
The deficit is narrowing because total federal spending has begun to decline and because total federal receipts are declining at a slower pace. As shown in Chart 2, in the 12 months ended July 2010, total federal cumulative spending contracted by 1.94% vs. the cumulative spending in the 12 months ended July 2009. The fastest growth in 12-month cumulative federal spending was 19.17%, which occurred in July 2009. Also shown in Chart 2 is the slowing in the rate of decline of federal receipts. In the 12 months ended July 2010, cumulative federal receipts contracted by 2.42% vs. the 12 months ended 2009. This is the slowest rate of contraction in 12-month cumulative federal receipts since September 2008 at minus 1.71%. The most severe rate of contraction in 12-month cumulative receipts occurred in November 2009 at minus 17.59%.
On the receipts side of the Treasury’s ledger, two factors that are playing important roles in slowing down the rate of decline in federal receipts are corporate income taxes and Federal Reserve profits (see Chart 4). Now that corporations are once again earning profits after the largest contraction in corporate profits in the post-WWII era, corporate tax receipts have begun to grow again. And with the explosion of the Fed’s balance sheet from $877 billion at the end of 2007 to over $2 trillion today, the Fed is enjoying record profits, most of which it turns over to the Treasury. Hooray for seigniorage!
Source: Paul Kasriel, Northern Trust – Daily Global Commentary, August 11, 2010.
Tags: August 11, Balance Sheet, Budget Status, Chief Economist, Contraction, Corporate Income Taxes, Corporate Profits, Cumulative Deficit, Federal Receipts, Federal Reserve, Federal Spending, Global Commentary, government spending, Northern Trust Company, Paul Kasriel, Record Profits, Tax Receipts, Trillion, U S Treasury
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Recipe for a Lost Decade, or Two
Wednesday, June 23rd, 2010
This is article is a guest contribution by Paul Kasriel, Northern Trust.
There are legitimate concerns that the U.S. could catch the “Japanese” disease and endure a lost decade in terms of normal economic growth. What would be the recipe for such? Chart 1 shows the behavior of the 40-quarter (10-year) compound annual growth in Japanese nominal GDP and the 120-month (10-year) compound annual growth in the Japanese M-2 money supply. (The shaded areas are periods of economic recession in Japan.) Notice how the 10-year annualized growth in M-2 has been trending ever lower, especially between 1990 and 2000. Since September 2000, the 10-year annualized growth in Japanese M-2 has ranged only from about 3% to about 2%. Chart 2 shows that this downward trend in Japanese M-2 growth has been accompanied by an exceptionally low Bank of Japan policy interest rate.
Now, it is not as though Japanese real GDP did not grow in the past twenty years. It has, as shown in Chart 3. But, not surprisingly, similar to Japanese M-2 growth, trend Japanese real GDP growth has been slowing and has not been up to the 2% mark since 1997. Given a declining population and workforce, we should not expect a high rate of growth in aggregate Japanese real GDP. But as shown in Chart 4, trend real GDP growth in Japan has consistently been below the sum of trend growth in the Japanese labor force and the trend rate of growth in Japanese labor productivity since 1998. Thus, something else has been constraining Japanese economic growth.
I would argue that weak bank lending (see Chart 5), which is related to weak M-2 growth, bears a lot of the responsibility for the trend underperformance of the Japanese economy.
Although the U.S. M-2 money supply growth on a trend basis is currently nowhere near as weak as that of Japan (see Chart 6). On a year-over-year basis, however, U.S. M-2 growth is very slow, just under 2% (see also Chart 6). The reason for the recent weak year-over-year growth in U.S. M-2 is the recent contraction in U.S. commercial bank credit (see Chart 7). And, as has been the case in Japan, weak U.S. money and bank credit growth is occurring in the context of very low monetary policy interest rates. Something is wrong with the transmission mechanism between the Fed and the economy. The private financial system is not transforming the inexpensive credit being offered it by the Fed into credit for the private nonfinancial sector of the U.S. economy. Until this transmission mechanism between the Fed and the economy gets mended, we are unlikely to experience potential economic growth.
The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.
Copyright (c) Northern Trust
Tags: Bank Of Japan, Declining Population, Downward Trend, Economic Growth, Economic Recession, GDP, GDP Growth, Growth Trend, Japan Policy, Japanese Economy, Japanese Labor, Labor Productivity, Legitimate Concerns, Money Supply Growth, Nominal Gdp, Northern Trust, Paul Kasriel, Policy Interest, Real Gdp, Shaded Areas
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Paul Kasriel (Northern Trust): Airplane Musings, Part Deux
Tuesday, June 15th, 2010
This article is a guest contribution by Paul Kasriel, Chief Economist, Northern Trust.
These are some stream-of-consciousness thoughts that came to me at 35,000 feet.
The Federal Government Deficit – Congressman, Heal Thyself!
On one of this past Sunday’s morning political talk shows, I heard a congressman say that the runaway federal government spending had to stop. Congressman, sir, although the spending continues to increase, the rate of growth in that spending has slowed enormously. In the 12 months ended May 2010, the accumulated spending by the federal government totaled $3.437 trillion, enough to keep the late Senator Dirksen spinning in his grave for near eternity. Although an admittedly high level, this 12-month accumulated total federal spending was only 2.6% higher than the 12-month accumulated total federal spending for May 2009 (see Chart 1). This is quite a deceleration in growth from the 15.3% registered for the 12 months ended 2009 vs. 2008, near the trough of the last recession. Moreover, the 2.6% year-over-year growth in the 12-month accumulated total federal outlays in May 2010 is considerably lower than the 8.4% year-over-year growth in the 12-month accumulated total federal outlays in May 2006. Why do I mention May 2006? Because at that time, the congressman’s political party controlled Congress and the White House. Congressman, heal thyself!
Chart 1
At the same time that the growth in federal outlays has slowed dramatically, the rate of contraction in federal revenues also has slowed dramatically. The year-over-year percent change in the 12-month accumulated federal revenues in May 2010 was minus 6.6%, a slower rate of contraction than the 13.6% contraction for May 2009 (see Chart 2).
Chart 2
Why the slowdown in that rate of growth in federal spending and the rate of contraction in federal revenues? The economic recovery, for one thing. As the economy started to grow again in the second half of 2009, the rate of growth in government transfer payments to households, such as unemployment insurance benefits, has slowed sharply (see Chart 3). Also, as the economic recovery has set in, corporate profits and, thus, corporate tax receipts have picked up (see Chart 4). Again on the spending side, there has not been a repeat of the $500 billion+ in TARP expenditures in 2008.
Chart 3
Chart 4
Barring the economy slipping back into another recession, which I do not believe is likely, the worst of the cyclical deficit is behind us (see Chart 5). Now, if the aforementioned congressman will offer some constructive reforms to curb the projected increases in Medicare spending over the next 20 years, spending that he and his fellow baby boomers will be the beneficiaries of, then the structural deficit issue will have been solved. As an aside, it was when the congressman’s political party controlled Congress and the White House that legislation went into effect (January 1, 2006) increasing the “out-year” projections of Medicare spending, the unfunded entitlement program known as Medicare Part D. We are waiting for your constructive reform proposals on Medicare, Congressman.
Chart 5
U.S. Economy Still Starved for Credit Creation
Last week, the Fed finally got around to releasing its flow-of-funds data for the first quarter of 2010. Based on the Fed’s first guesstimates (regrettably, the Fed will keep revising these data over the coming years), the U.S. economy remained starved for credit emanating from the financial sector during the first quarter. Chart 6 shows that the most important of the financial intermediaries – commercial banks, money market mutual funds, ABS issuers and funding corporations (funding subsidiaries, nonbank financial holding companies, and custodial accounts for reinvested collateral of securities lending operations) – continued to contract their net lending in the first quarter to the tune of about $1.6 trillion at an annual rate. Although that is an improvement over last year’s fourth-quarter annualized contraction of $1.7 trillion, it still marks the fifth consecutive quarter of net credit contraction by this important group of intermediaries. Even when the entire financial sector is taken into consideration, including the Federal Reserve, net lending continued to contract through the first quarter of this years, albeit at a much reduced annualized rate of only $334.3 billion. But as Chart 7 shows, from 1952 through 2008, net lending by the entire financial system had never contracted. I consider this financial sector net credit contraction the major headwind for the economy, preventing a more normal robust cyclical recovery.
Chart 6
Chart 7
Money – Supply vs. Demand
Chart 8 shows the year-over-year percent change in currency, deposits and money market mutual funds held by U.S. households. It also shows this concept of money as a percent of total U.S. household financial assets. The year-over-year change represents the growth, or lack thereof, in the supply of money, which, by the way, is related to the amount lending banks are engaged in. Money held as a percent of total financial assets is related to the demand (to hold) for money. When households are more confident about expected returns on riskier financial assets, they reduce their demand for money and vice versa.
Chart 8
Notice that there was a steady downward trend in the ratio of money-to-total financial assets from the late 1980s through 1999, when the NASDAQ was topping out. Since then, there has been an uneven rise in this ratio, perhaps as investors have become more risk averse after the NASDAQ implosion and the recent bear market in equities. Now, let’s look at what has happened to the supply of money. In the first half of the 1990s, this concept of money was contracting. Similarly, this concept of money is contracting once again starting in the third quarter of 2009. In the early 1990s, when the supply of money was contracting, the demand for money (the ratio of money-to total financial assets) also was falling. Thus, the restrictive effect of a contracting household money supply was partially offset by a declining household demand for money. Today, the supply of money is contracting and, in recent quarters, the demand for money has declined. But the decline in the demand for money does not appear to be of the same trend nature as what occurred in the early 1990s. Moreover, with the recent correction in the global equities markets, U.S. households could become more risk averse, thus increasing their demand for money. If the supply of money does not start increasing soon and/or the demand for money does not continue declining, U.S. economic activity could slow significantly.
Now Is the Time to Buy a House, Not 2005-2006
By comparing the imputed rent on owner-occupied housing with the market value of that housing, a “yield” on owner-occupied housing can be calculated. That yield on owner-occupied housing is shown in Chart 9 along with the contract mortgage interest rate charged on loans for the purchase of existing homes. As shown in Chart 9, the norm is for the mortgage interest rate to be above the yield on owner-occupied housing. In the third quarter of 2008, however, the yield on housing rose above the mortgage rate and has remained so through the first quarter of 2010. Although the purchase of an owner-occupied house may be an even better investment in the coming quarters, that purchase was a much better-than-normal buy in the first quarter of 2010 – and a considerably better buy than it was in 2005 or 2006.
Chart 9
Deleveraging? Not Nonfinancial Corporations
We hear a lot of talk these days about private-sector deleveraging. Although household leverage ratios are falling – probably not voluntarily but because no one will lend to households – the ratio of debt to assets for nonfinancial corporations has climbed to a post-war record high (see Chart 10). Chart 11 illustrates what nonfinancial corporations were up to in the first quarter. They issued a net $289 billion of debt at an annualized rate and “retired” a net $208 billion of equity at an annualized rate. The solid line in Chart 10 represents corporate debt issuance as a percent of capital outlays. When the percentage is positive and rising, it indicates that corporations are issuing debt for reasons other than buying capital equipment. It is clear that in the first quarter, nonfinancial corporations were issuing debt to retire equity. This bit of financial engineering increases their earnings per share and rewards stockholders at the expense of bond holders.
Chart 10
Chart 11
Paul Kasriel is the recipient of the 2006 Lawrence R. Klein Award for Blue Chip Forecasting Accuracy
(c) Northern Trust
Tags: Chief Economist, Congressman, Contraction, Deceleration, Economic Recovery, Federal Government Spending, Federal Outlays, Federal Revenues, Federal Spending, Government Deficit, Musings, Northern Trust, Paul Kasriel, Percent Change, Recession, Senator Dirksen, Slowdown, Stream Of Consciousness, Trillion, Trough
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