Friday, April 1, 2011

One Eye on The Fed: 'Dual Mandate' is Camouflage

Today New York Fed President William Dudley spoke about the condition of the US economy. His record reflects that of a supporter of current Fed policy. Here is a brief statement from his speech that illustrates his overall sentiment about the economy and the need for the Fed to continue its money printing and intervention in certain asset markets.

"On the activity side, a wide range of indicators show a broadening and strengthening of demand by households and production by firms. For example, on the demand side, after an unusually deep retrenchment during the recession, consumer spending has begun to recover, and that recovery strengthened considerably in the final months of 2010. Not surprisingly, businesses' orders and production are following suit.
These factors led to a 3.1 percent growth rate in our most comprehensive measure of national output (real, or inflation-adjusted, gross domestic product or GDP) in the fourth quarter of 2010. Growth for the first quarter looks likely to be similar, near 3 percent. In my view, the revival in demand and production—while not as strong as desired—suggests that we may be much closer to establishing a virtuous circle that will support stronger growth. What I have in mind is a cycle in which rising household and business demand generate more rapid income and employment growth, which in turn bolsters confidence and leads to further increases in spending. This is why we upgraded our assessment of the economy at last month's FOMC meeting, noting the economy is now on a "firmer footing". The major missing piece of the puzzle has been the absence of strong payroll job growth. We will need to see sustained strong employment growth in order to be certain that this virtuous circle has become firmly established.
With respect to the labor market, we have seen some conflicting signals. On one hand, the unemployment rate has fallen sharply over the past four months, dropping to 8.8 percent from 9.8 percent in November. On the other hand, payroll employment gains have been relatively modest."

Dudley's message is that there is still work to be done by the Fed before he can feel assured of an economy that will sustain itself in terms of employment growth and consumer spending growth (maybe GDP above 3.0). This is camouflage to the real purpose of QE.

Last week I saw in Doug Noland's blog, The Credit Bubble Bulletin, some statistical measures from government sources that tell a different story, and is more timely to what is occurring in the banking system. For reference, assets are someone else's liability (debt). Here are some of the numbers form Noland's blog.

“With the government sector (Treasury and Fed) in the midst of historic expansion, it’s not so easy for others to make headway.  Banking system Assets contracted (nominal) $240bn during the quarter to $14.402 TN.  Bank Assets are little changed now over the past seven quarters.  On a seasonally-adjusted and annualized basis (SAAR), Bank Credit contracted a discouraging $755bn during the quarter to $9.5 TN.  Mortgages dropped SAAR $229bn, Consumer Credit fell SAAR $142bn, and corporate and foreign bonds sank SAAR $618bn.  On the growth side, Agency and GSE-backed securities expanded SAAR $151bn, Reserves at Fed SAAR $134bn, business Loans SAAR $16bn and Security Credit $15bn.”

The 'consumer debt' focused stats are of particular interest for evaluating the debt based US economy. Consumer spending, whether debt or cash based, is nearly 70% of US GDP. The US consumer is the lynchpin for a global economic rebound. Until the consumer recovers and begins spending again, or is replaced by another consuming source, the 'dual mandate' Fed is unable to justify an end of zero interest rates and at best a time-out for money printing.

Dudley's comments add to my conviction that the Fed is not ready to step aside and let markets establish fair values. They will not say openly that the primary focus of QE is to create enough capital at the big banks to enable them to charge-off their bad assets. Until the big banks get their out-of-balance sheets resolved well enough to use ‘mark to market’ accounting again, they will continue the extended period of zero interest rates and at best, a time-out for money printing. The real dual mandate of the Fed is avoid deflation, and save the TBTF banks. Current Fed policy is a plan most focused on rescuing the big banks from their toxic derivative securities. These securities cannot be unravelled and therefore must be charged off at an enormous financial loss. The Fed is consciously hiding behind the politically correct 'dual mandate' objectives message, low inflation and high employment participation (everyone working that wants to work), as camouflage for the real mission. Zero interest rates and money printing as a long way to go, IMHO. Will the currency last long enough?

Along the vein of Fed transparency of actions relating to the Fed release of discount window transactions data to Bloomberg, Matthew Winkler, editor-in-chief of Bloomberg news summed up his editorial today with these thoughts of his own. "While the notion that no U.S. institution is above accountability has been affirmed, we cannot wait patiently for government institutions to lift the veils of secrecy. We have to open them ourselves as part of the democratic process. The courts already acknowledged that the world doesn’t end when information is released so we have to question the motivations behind the Fed’s policy of secrecy and by extension the rationale of all government departments to resist disclosure. (emphasis added)
After all that has been said and done, we still don’t know whether the Fed was accepting unsuitable collateral to keep insolvent banks afloat. And we still don’t know why the Fed and the Obama administration so strenuously protected the identities of the discount window borrowers. All of us stakeholders, especially the historians among us, might like to know who borrowed from the discount window from 1914 to 2008 as well."