I suppose I should have expected this. When Ben Bernanke was nominated for the Chairmanship of the Federal Reserve, the nomination got a big thumbs up from Paul Krugman. Oh well, one academic from Princeton having nice things to say about another. Wrong. Central Bankers used to be thought of as exterminators and the cockroach they hunted remorselessly was inflation. Oh sure, our Fed as opposed to the Europeans always had the other job of helping out the economy through monetary action but even in this, the institution was fiercely independent and, while not ignorant of the political process, tended to chart it's own course. No longer. Whether on pure ideological grounds, a true concern as to the state of the economy, panic or merely an attempt to protect a second term from the long shadow of Larry Summers (unless Our Hero Tim gets thrown off the bus) Mr. Bernanke has become a full partner in the politics of the Obama Administration. The remarkable action of the Fed yesterday in announcing their intention to purchase mortgage related debt and newly issued Treasury securities in initial amounts of up to a trillion dollars marks a sea change in activity. In the past the Fed has purchased Treasuries and has always operated in the repo marrket, but yesterday's announcement, specific to longer dated issues, was more than surprising. The reaction was not surprising; the dollar tanked and yield on medium to long term issues sank, bringing the rate on new 30 year mortgages to below 5.00% in some areas. Great result, said many pundits, but of course there is the risk of a bit more inflation down the road explained away by the Fed statement today that if that were to be the case, they could always reverse the process. Somehow, this is beginning to feel like 1974, but there is another, even greater concern on my part as to what may be an additional major reason for this approach.
Do we remember Our Hero Tim's friends, the Chinese's reaction at the unfortunate statement during his congressional hearings on currency manipulation? They were not amused. Despite every indication that he was simply reading what was put in front of him (he's done only that since being confirmed) the Chinese remain unamused. More importantly, their confidence in the financial stability of this country seems also to be coming into question especially in their statements of the past few weeks. Most importantly, their holdings of U.S. debts which at this point total over $1.5 trillion have changed not only in their make-up but in their maturity profile. By the end of this year, the Chinese will be on track to hold $1 trillion of our debt that has an average maturity of approximately 300 days. If the mortgage on my house was in the form of a demand note, I wouldn't sleep well.
I have the very uncomfortable feeling that the Chinese have indicated that would not be buyers of our debt as in the past. I have the uncomfortable feeling that the Chinese view the purchasing power of the dollar as sharply deteriorating over the relatively near term. I would not be the least bit surprised if the Chinese would soon indicate that they would not be interested in any purchase of medium term U.S. dollar denominated securities that did not contain a hedge against inflation--think TIPS gang. I'm pretty sure we have a problem. With a now-projected deficit of $1.5 Trillion (Congressional Budget Office as of today) which is probably a couple of hundred billion too low but who cares anymore, can we expect the Fed to finance this alone or must they inevitably give up the and lose the impending with the Chinese and if so, can Japan be far behind? I can envision no scenario in which inflationary pressures do not merely tick up but head skyward in the fiscal environment this administration has created, I can also see no way that they can possibly achieve the 25% rise in GDP they assume which will be needed to reach their deficit target by 2013...wait that's not quite right...they can if the rise is all inflation. As I said it's really beginning to feel like the seventies. Then again, Tall Paul is still lurking but Reagan is gone. I HOPE I DON'T DIE PRONOUNCING IT.
Addendum. Our Hero has yet to come up with his banking solution. Sadly, given what has occurred in Congress the past few days he may never get the chance. But we must be thankful for one thing: Congress has demonstrated that when you pay peanuts, you get monkeys. Do you think they groom each other?
Back to the banks next week. A good weekend.
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