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Monday, May 18, 2009
Japan Loses Top Foreign Rating
TOKYO (Reuters) - Moody's stripped Japan of its coveted AAA rating on its foreign currency debt on Monday, rekindling some speculation that other major economies may pay for their efforts to revive growth with credit downgrades.
Unlike many of its peers in the top triple-A category, the world's No.2 economy relies mainly on domestic funding and Moody's combined the cut in the largely symbolic foreign rating with an upgrade by a notch to domestic government bonds.
The move, which Moody's said would unify all Japanese government debt at a new Aa2 level, had limited impact on the Japanese bond market bracing for record debt supply to finance the government's record spending.
It coincided with a survey of Japanese manufacturers that showed sentiment edged up from record lows this month, keeping alive hopes that a disastrous first quarter marked a low point in Japan's and the world economy's worst recession in six decades.
But as governments from Beijing to Washington have committed trillions of dollars to kickstart their economies, ballooning debt and deficits raised questions about the ability of nations such as United States or Britain to keep their top credit grades.
"The move to lower Japan's foreign currency bond rating from Aaa opens the way for speculation about whether Moody's will take similar actions on other triple-A ratings," said Kenro Kawano, senior rates strategist at Credit Suisse in Tokyo.
Analysts, however, did not expect markets to change their view of the local debt market, with the Japan saddled with the biggest public debt among industrialized nations, but also able to tap a vast pool of domestic savings.
"What we are seeing is an appropriate normalization across Japan's various debt obligations. Given the size of Japan's overall public deficit it obviously should not enjoy the highest rating," said Glenn Maguire, economist with Societe Generale in Hong Kong.
LINGERING DOUBTS
Major stock markets in Europe and most of Asia fell on Monday, reflecting lingering doubts about the strength and timing of the long-awaited economic recovery as signs of improvement ahead go hand in hand with evidence of immediate pain.
Tokyo shares .N225 closed 2.4 percent down and the index of top European shares .FTEU3 was 1 percent lower tracking Wall Street losses on Friday. But a gauge of Asian markets outside of Japan .MIAPJ0000PUS rose 1.7 percent, pulled up by gains in India .BSESN, where stocks soared as much as 17 percent after a resounding election victory by the ruling Congress party.
Monday's monthly Reuters survey of Japan's top companies followed Friday's better-than-expected machinery orders data for April and a U.S. consumer survey showing confidence at its highest since last September's collapse of Lehman Brothers.
U.S. industrial output fell at a slower pace in April and a top European Central Bank policymaker also offered some encouragement on Monday, saying the ECB has already done enough to help the euro zone economy.
However, tentative signs of life came against a backdrop of deeper-than-feared first-quarter declines in the U.S. and euro zone economies and signs that companies around the world are still struggling with a slump in global trade and demand.
The euro area economy shrank 2.5 percent in January-March, more than forecast, dragged down by a sharp 3.8 percent slump in Germany, data showed on Friday.
By Rika Otsuka and Izumi Nakagawa
Read Entire Article
Unlike many of its peers in the top triple-A category, the world's No.2 economy relies mainly on domestic funding and Moody's combined the cut in the largely symbolic foreign rating with an upgrade by a notch to domestic government bonds.
The move, which Moody's said would unify all Japanese government debt at a new Aa2 level, had limited impact on the Japanese bond market bracing for record debt supply to finance the government's record spending.
It coincided with a survey of Japanese manufacturers that showed sentiment edged up from record lows this month, keeping alive hopes that a disastrous first quarter marked a low point in Japan's and the world economy's worst recession in six decades.
But as governments from Beijing to Washington have committed trillions of dollars to kickstart their economies, ballooning debt and deficits raised questions about the ability of nations such as United States or Britain to keep their top credit grades.
"The move to lower Japan's foreign currency bond rating from Aaa opens the way for speculation about whether Moody's will take similar actions on other triple-A ratings," said Kenro Kawano, senior rates strategist at Credit Suisse in Tokyo.
Analysts, however, did not expect markets to change their view of the local debt market, with the Japan saddled with the biggest public debt among industrialized nations, but also able to tap a vast pool of domestic savings.
"What we are seeing is an appropriate normalization across Japan's various debt obligations. Given the size of Japan's overall public deficit it obviously should not enjoy the highest rating," said Glenn Maguire, economist with Societe Generale in Hong Kong.
LINGERING DOUBTS
Major stock markets in Europe and most of Asia fell on Monday, reflecting lingering doubts about the strength and timing of the long-awaited economic recovery as signs of improvement ahead go hand in hand with evidence of immediate pain.
Tokyo shares .N225 closed 2.4 percent down and the index of top European shares .FTEU3 was 1 percent lower tracking Wall Street losses on Friday. But a gauge of Asian markets outside of Japan .MIAPJ0000PUS rose 1.7 percent, pulled up by gains in India .BSESN, where stocks soared as much as 17 percent after a resounding election victory by the ruling Congress party.
Monday's monthly Reuters survey of Japan's top companies followed Friday's better-than-expected machinery orders data for April and a U.S. consumer survey showing confidence at its highest since last September's collapse of Lehman Brothers.
U.S. industrial output fell at a slower pace in April and a top European Central Bank policymaker also offered some encouragement on Monday, saying the ECB has already done enough to help the euro zone economy.
However, tentative signs of life came against a backdrop of deeper-than-feared first-quarter declines in the U.S. and euro zone economies and signs that companies around the world are still struggling with a slump in global trade and demand.
The euro area economy shrank 2.5 percent in January-March, more than forecast, dragged down by a sharp 3.8 percent slump in Germany, data showed on Friday.
By Rika Otsuka and Izumi Nakagawa
Read Entire Article
Friday, May 15, 2009
Gold: 'It's a Bargain at $930 an Ounce'
London Telegraph
From a long-term perspective, gold is a bargain at recent prices in the $900 to $930 an ounce . . . and will remain so even as it begins to move into a higher trading range.
Recent gold-market developments and technical price action – along with broader economic and financial-market developments – suggest gold is bracing for a resumption of its long march upward and a retest of its historic high in the months ahead.
First and foremost, the bullish outlook for gold rests on the increasing likelihood of accelerating U.S. inflation in the years to come – and an associated unprecedented rise in investor demand for the yellow metal.
This nascent inflation has not yet been reflecting in world financial markets. But, judging from anecdotal evidence and the financial press – and the warnings of a growing number of institutional investment managers – we believe a gradual, subtle, but important, upward shift in inflation expectations is already under way.
Inflation doves (and others fearing imminent deflation) point to the currently low, almost negligible, rates of consumer price inflation and the narrow interest-rate spread between ordinary US Treasury securities and US Treasury Inflation-Protected Securities (TIPS) as evidence that inflation and inflation expectations remain subdued. This – along with other important factors that we'll discuss in subsequent posts – has helped keep gold prices down in recent months.
We think those looking at the US Consumer Price Index are focused on the wrong inflation indicator. Instead, a look at the gross domestic product price deflator, a broader, more reliable, and less volatile inflation indicator – rising at an annual rate of 2.9pc in this year's first quarter – should be enough to put fear in the hearts of economic policy-makers . . . but, as far as we can tell, they're looking at the CPI and still worrying more about deflation.
Importantly, in our view, if only a small percentage of investors become worried about inflation, gold could, and likely will, benefit long before any sign of a broad-based rise in inflation expectations appears in the interest-rate differential between ordinary Treasury securities and TIPS, the so-called TIPS spread.
Because of the relative size of the markets, a small shift of investor interest toward gold can have a magnified effect on the metal's price . . . but the same small shift in interest away from ordinary Treasury securities in favour of TIPS may have no noticeable impact on relative interest rates between the two types of securities.
By Jeffery Nichols
Read Entire Article
From a long-term perspective, gold is a bargain at recent prices in the $900 to $930 an ounce . . . and will remain so even as it begins to move into a higher trading range.
Recent gold-market developments and technical price action – along with broader economic and financial-market developments – suggest gold is bracing for a resumption of its long march upward and a retest of its historic high in the months ahead.
First and foremost, the bullish outlook for gold rests on the increasing likelihood of accelerating U.S. inflation in the years to come – and an associated unprecedented rise in investor demand for the yellow metal.
This nascent inflation has not yet been reflecting in world financial markets. But, judging from anecdotal evidence and the financial press – and the warnings of a growing number of institutional investment managers – we believe a gradual, subtle, but important, upward shift in inflation expectations is already under way.
Inflation doves (and others fearing imminent deflation) point to the currently low, almost negligible, rates of consumer price inflation and the narrow interest-rate spread between ordinary US Treasury securities and US Treasury Inflation-Protected Securities (TIPS) as evidence that inflation and inflation expectations remain subdued. This – along with other important factors that we'll discuss in subsequent posts – has helped keep gold prices down in recent months.
We think those looking at the US Consumer Price Index are focused on the wrong inflation indicator. Instead, a look at the gross domestic product price deflator, a broader, more reliable, and less volatile inflation indicator – rising at an annual rate of 2.9pc in this year's first quarter – should be enough to put fear in the hearts of economic policy-makers . . . but, as far as we can tell, they're looking at the CPI and still worrying more about deflation.
Importantly, in our view, if only a small percentage of investors become worried about inflation, gold could, and likely will, benefit long before any sign of a broad-based rise in inflation expectations appears in the interest-rate differential between ordinary Treasury securities and TIPS, the so-called TIPS spread.
Because of the relative size of the markets, a small shift of investor interest toward gold can have a magnified effect on the metal's price . . . but the same small shift in interest away from ordinary Treasury securities in favour of TIPS may have no noticeable impact on relative interest rates between the two types of securities.
By Jeffery Nichols
Read Entire Article
Congress Must Audit the Federal Reserve
On May 5, Rep. Alan Grayson (D-FL) grilled Federal Reserve inspector general Elizabeth Coleman. What knowledge did she have of Bloomberg's report that the Fed had made trillions of dollars in off-balance sheet transactions? Did she know who received the trillion dollars that was added to the Fed's balance sheets since last September? Was there any investigation into why the Fed didn't rescue Lehman Brothers, a move that sent shock waves through the financial sector?
To all of these questions, Coleman professed total ignorance, and assured the Congress there were presently no investigations taking place.
What madness is this? The economy is in shambles, and the group most responsible for keeping our financial system stable has no answers and doesn't care to find any. The Federal Reserve is accountable to no one. It has no budget, no Congressional committee monitors its operations, and although the Government Accountability Office (GAO) is tasked with auditing the Fed, it is so constrained as to be useless.
The GAO is prohibited from auditing: transactions for or with a foreign central bank, government, or government financing organization; deliberations, decisions, or actions on monetary policy matters; transactions made under the direction of the Federal Open Market Committee; and any communication among members of the Board of Governors and employees of the Fed related to the above.
When the Democratic Chairman of the House Banking Committee, Henry Gonzales, introduced a modest proposal for opening the Fed up to Congressional scrutiny in 1993, President Clinton rejected Gonzales' bill. The bill merely asked for a Congressional audit of the Fed's operations, with minutes and video of policy meetings released to Congress in a timely manner. Clinton argued that Gonzalez's reforms would "run the risk of undermining market confidence in the Fed."
Clinton's argument is hard to believe even on the surface: shouldn't the assurance that Congress has knowledge of the Fed's activities improve confidence in the market? Why should "market confidence" depend on more secrecy than is accorded to the Pentagon?
Since the government is not accountable to the market, but only to the public and Congress, if there is no Congressional oversight and no election, there is no accountability at all. Indeed, the Fed is essentially an oligarchy of the banking elite. When the President names a Fed chairman, it's from a list of people already approved by the Fed's Board of Governors. The Federal Reserve System, by the way, is privately owned.
As Congressman Barney Frank, a co-sponsor of the Gonzales bill, put it: "If you take the principles that people are talking about nowadays," such as "reforming government and opening up government—the Fed violates it more than any other branch of government."
That was 1993. Today, the Fed has no standpoint of credibility to claim that its secrecy protects market confidence. By all appearances, trillions of dollars are going missing. HR1207, and its companion bill in the Senate, S604, would amend the code to remove the restrictions on the GAO audits noted above, and mandate a full audit by the end of 2010. The bill has 134 co-sponsors in the House, with wide bi-partisan support, including Lynn Woolsey (D-CA), co-chair of the Progressive Caucus; Stephanie Sandlin (D-SD), chair of the Blue Dog Coalition; Ron Paul (R-TX), the bill's sponsor whose Rally for the Republic competed with the Republican National Convention in Minneapolis and drew 10,000 people; and Pete Sessions (R-TX), chair of the Republican Congressional Campaign Committee. In the Senate, the sponsor is Bernie Sanders.
Puzzlingly, Rep. Frank, who now heads the House Financial Services Committee, is stonewalling on the bill. And given their reputation for championing transparency and accountability, it's remarkable that none of Washtenaw County's representatives in Congress—Reps. Dingell and Shauer, Senators Stabenow and Levin—have co-sponsored the bill. As their constituents, it is our responsibility to get them on board. The collapse of our financial institutions has devastated our country, and it's unconscionable that Congress has abdicated its responsibility to protect the taxpayers from the irresponsible actions of the privately-owned, publicly-accountable central bank.
We are collecting signatures on an ongoing basis at www.campaignforliberty.com (there's a big banner on the home page) for a petition to Congressman Dingell to join the 149 members of Congress co-sponsoring this bill. Or, call or write his district office at 301 West Michigan, Suite 305, Ypsilanti, MI, 48197, tel (734) 481-1100. And feel free to drop Rep. Frank a line, too, and remind him the wisdom of his words in 1993.
By Adam DeAngeli
Read Entire Article
To all of these questions, Coleman professed total ignorance, and assured the Congress there were presently no investigations taking place.
What madness is this? The economy is in shambles, and the group most responsible for keeping our financial system stable has no answers and doesn't care to find any. The Federal Reserve is accountable to no one. It has no budget, no Congressional committee monitors its operations, and although the Government Accountability Office (GAO) is tasked with auditing the Fed, it is so constrained as to be useless.
The GAO is prohibited from auditing: transactions for or with a foreign central bank, government, or government financing organization; deliberations, decisions, or actions on monetary policy matters; transactions made under the direction of the Federal Open Market Committee; and any communication among members of the Board of Governors and employees of the Fed related to the above.
When the Democratic Chairman of the House Banking Committee, Henry Gonzales, introduced a modest proposal for opening the Fed up to Congressional scrutiny in 1993, President Clinton rejected Gonzales' bill. The bill merely asked for a Congressional audit of the Fed's operations, with minutes and video of policy meetings released to Congress in a timely manner. Clinton argued that Gonzalez's reforms would "run the risk of undermining market confidence in the Fed."
Clinton's argument is hard to believe even on the surface: shouldn't the assurance that Congress has knowledge of the Fed's activities improve confidence in the market? Why should "market confidence" depend on more secrecy than is accorded to the Pentagon?
Since the government is not accountable to the market, but only to the public and Congress, if there is no Congressional oversight and no election, there is no accountability at all. Indeed, the Fed is essentially an oligarchy of the banking elite. When the President names a Fed chairman, it's from a list of people already approved by the Fed's Board of Governors. The Federal Reserve System, by the way, is privately owned.
As Congressman Barney Frank, a co-sponsor of the Gonzales bill, put it: "If you take the principles that people are talking about nowadays," such as "reforming government and opening up government—the Fed violates it more than any other branch of government."
That was 1993. Today, the Fed has no standpoint of credibility to claim that its secrecy protects market confidence. By all appearances, trillions of dollars are going missing. HR1207, and its companion bill in the Senate, S604, would amend the code to remove the restrictions on the GAO audits noted above, and mandate a full audit by the end of 2010. The bill has 134 co-sponsors in the House, with wide bi-partisan support, including Lynn Woolsey (D-CA), co-chair of the Progressive Caucus; Stephanie Sandlin (D-SD), chair of the Blue Dog Coalition; Ron Paul (R-TX), the bill's sponsor whose Rally for the Republic competed with the Republican National Convention in Minneapolis and drew 10,000 people; and Pete Sessions (R-TX), chair of the Republican Congressional Campaign Committee. In the Senate, the sponsor is Bernie Sanders.
Puzzlingly, Rep. Frank, who now heads the House Financial Services Committee, is stonewalling on the bill. And given their reputation for championing transparency and accountability, it's remarkable that none of Washtenaw County's representatives in Congress—Reps. Dingell and Shauer, Senators Stabenow and Levin—have co-sponsored the bill. As their constituents, it is our responsibility to get them on board. The collapse of our financial institutions has devastated our country, and it's unconscionable that Congress has abdicated its responsibility to protect the taxpayers from the irresponsible actions of the privately-owned, publicly-accountable central bank.
We are collecting signatures on an ongoing basis at www.campaignforliberty.com (there's a big banner on the home page) for a petition to Congressman Dingell to join the 149 members of Congress co-sponsoring this bill. Or, call or write his district office at 301 West Michigan, Suite 305, Ypsilanti, MI, 48197, tel (734) 481-1100. And feel free to drop Rep. Frank a line, too, and remind him the wisdom of his words in 1993.
By Adam DeAngeli
Read Entire Article
Capitalism Could Fail Like Communism
CNBC
A sustainable recovery will occur only when the corporate system will be cleaned of losses and capitalism risks collapsing if this does not happen, Marc Faber, the author of “The Gloom, Boom & Doom Report,” told CNBC Friday.
The central banks will continue to print money at full speed, but long-term this strategy will lead to a fall in purchasing power and living standards, especially in developed countries, Faber said.
The years 2006 and 2007 were “the peak of prosperity” and the world economy is not likely to return soon to that level, he added.
“I think the final low in markets will occur when the system is cleaned out,” Faber said.
Unless the system is cleaned out of losses, “the way communism collapsed, capitalism will collapse,” according to Faber. “The best way to deal with any economic problem is to let the market work it through.”
US Will Go Bust
The Federal Reserve’s policy of printing money is destabilizing the markets and creating “enormous volatility” said Faber, who in his latest “Gloom, Boom & Doom Report” wrote that it was money printing that had pushed stock prices up.
Read Entire Article
A sustainable recovery will occur only when the corporate system will be cleaned of losses and capitalism risks collapsing if this does not happen, Marc Faber, the author of “The Gloom, Boom & Doom Report,” told CNBC Friday.
The central banks will continue to print money at full speed, but long-term this strategy will lead to a fall in purchasing power and living standards, especially in developed countries, Faber said.
The years 2006 and 2007 were “the peak of prosperity” and the world economy is not likely to return soon to that level, he added.
“I think the final low in markets will occur when the system is cleaned out,” Faber said.
Unless the system is cleaned out of losses, “the way communism collapsed, capitalism will collapse,” according to Faber. “The best way to deal with any economic problem is to let the market work it through.”
US Will Go Bust
The Federal Reserve’s policy of printing money is destabilizing the markets and creating “enormous volatility” said Faber, who in his latest “Gloom, Boom & Doom Report” wrote that it was money printing that had pushed stock prices up.
Read Entire Article
Thursday, May 14, 2009
FDIC Planning For Huge Bank Failure?
The Pragmatic Capitalist
Late reports this evening are citing an anonymous source that says the FDIC is preparing some sort of superfund that could handle the failure of a large “systemically important financial institution.”
Reuters reports:
“Another source familiar with the FDIC’s plans said on Tuesday that the agency was considering seeking to create a new fund to help deal with any resolution of systemically important financial institutions.”
The details on this story out of Reuters are very vague so this is mostly speculation, but such a development would not be shocking to anyone familiar with the state of the U.S. banking sector. FDIC losses are quickly mounting and they are certainly ill-prepared to handle a major failure. Shoring up the FDIC is a wise insurance policy if nothing else. Or they could be preparing some U.S. banks for the same fate as Chrysler and GM. A welcome development in my opinion.
As regular readers know, the recent government induced rally [4] created the perfect environment in which to raise capital [5], but these capital raises only place band aids on axe wounds. The patient is suffering from cancer and we’re performing chemo to no avail. The tumors must be removed. Instead, we continue to allow the banks to operate with the toxic assets on their balance sheets. The government knows real estate losses and credit card losses are mounting. They also know the TALF & PPIP will not succeed as the banks have no incentive to sell assets.
Is there a chance the economy rebounds sharply and these banks are able to earn their way out of this crisis? Certainly, but the odds of a prolonged and sluggish recovery are far too high in my opinion to allow these banks to operate in their current state. The government knows they can’t prop up 8,000 banks forever and I suspect they are none too pleased with the stress test results if the economy were to remain sluggish for longer than expected. The only resolution: FDIC receivership. In this case, perhaps a rather large one….
Read Entire Article
Late reports this evening are citing an anonymous source that says the FDIC is preparing some sort of superfund that could handle the failure of a large “systemically important financial institution.”
Reuters reports:
“Another source familiar with the FDIC’s plans said on Tuesday that the agency was considering seeking to create a new fund to help deal with any resolution of systemically important financial institutions.”
The details on this story out of Reuters are very vague so this is mostly speculation, but such a development would not be shocking to anyone familiar with the state of the U.S. banking sector. FDIC losses are quickly mounting and they are certainly ill-prepared to handle a major failure. Shoring up the FDIC is a wise insurance policy if nothing else. Or they could be preparing some U.S. banks for the same fate as Chrysler and GM. A welcome development in my opinion.
As regular readers know, the recent government induced rally [4] created the perfect environment in which to raise capital [5], but these capital raises only place band aids on axe wounds. The patient is suffering from cancer and we’re performing chemo to no avail. The tumors must be removed. Instead, we continue to allow the banks to operate with the toxic assets on their balance sheets. The government knows real estate losses and credit card losses are mounting. They also know the TALF & PPIP will not succeed as the banks have no incentive to sell assets.
Is there a chance the economy rebounds sharply and these banks are able to earn their way out of this crisis? Certainly, but the odds of a prolonged and sluggish recovery are far too high in my opinion to allow these banks to operate in their current state. The government knows they can’t prop up 8,000 banks forever and I suspect they are none too pleased with the stress test results if the economy were to remain sluggish for longer than expected. The only resolution: FDIC receivership. In this case, perhaps a rather large one….
Read Entire Article
Former Official Slams Fed for Inflation Risk
JEKYLL ISLAND, Georgia (Reuters) - A sharp critic of the Federal Reserve and prominent authority on monetary policy on Tuesday slammed the U.S. central bank for risking inflation and warned that government action had "caused, prolonged and worsened" the country's financial crisis.
John Taylor, a former undersecretary of the Treasury for international affairs and author of the widely cited Taylor Rule of central banking, ran his own numbers for the U.S. economy and said the Fed's monetary stance was way too loose.
"My calculation implies that we may not have as much time before the Fed has to remove excess reserves and raise the rate," he said in remarks prepared for a financial markets conference hosted by the Federal Reserve Bank of Atlanta.
"We don't know what will happen in the future, but there is a risk here and it is a systemic risk," he said.
He noted a recent Financial Times report of internal Fed estimates using the Taylor Rule. This found interest rates should be minus 5 percent at the moment to compensate for the headwinds on the U.S. economy.
But Taylor said that his own analysis suggested a rate of 0.5 percent, indicating that the Fed could have a lot less time to raise interest rates than it may currently think.
In addition, the Fed has pumped hundreds of billions of dollars into the economy to support credit markets in the face of a severe U.S. recession, and may find it very hard to remove this expansion by shrinking its balance sheet in the future.
"While Federal Reserve officials say that they will be able to sell newly acquired assets at a sufficient rate to prevent these reserves from igniting inflation, they or their successors may face political difficulties in doing so.
"That raises doubts and therefore risks. The risk is systemic because of the economy-wide harm such an outcome would cause," Taylor said.
Taylor used these cases to illustrate examples of where government intervention had magnified market failures and turned them into system-wide problems.
However, he saw much more risk coming from the planned U.S. government budget deficits, which could place the Fed under extreme pressure to allow inflation, as this would diminish the debt burden.
"The emphasis should be on proposals to stop the systemically risky budget deficits projected out as far as the eye can see, to exit from extraordinary monetary policy actions, and to end the bailout mentality," he said.
Giving the Fed formal responsibility for ensuring the soundness of the broader financial system would interfere with the Fed's task of ensuring stable and low inflation and sustainable economic growth, Taylor said. Congress is considering giving systemic risk oversight powers to a regulatory agency as a way to prevent the future financial crises.
"Locating a systemic risk regulator at the Fed is not a good idea because it would interfere with its essential monetary policy function," Taylor said.
Taylor questioned whether a systemic risk regulator would have been able to prevent the financial crisis in the first place. For example, a systemic regulator would not have been able to prevent the Fed from holding rates low for so long, he said.
By Mark Felsenthal and Alister Bull
Read Entire Article
John Taylor, a former undersecretary of the Treasury for international affairs and author of the widely cited Taylor Rule of central banking, ran his own numbers for the U.S. economy and said the Fed's monetary stance was way too loose.
"My calculation implies that we may not have as much time before the Fed has to remove excess reserves and raise the rate," he said in remarks prepared for a financial markets conference hosted by the Federal Reserve Bank of Atlanta.
"We don't know what will happen in the future, but there is a risk here and it is a systemic risk," he said.
He noted a recent Financial Times report of internal Fed estimates using the Taylor Rule. This found interest rates should be minus 5 percent at the moment to compensate for the headwinds on the U.S. economy.
But Taylor said that his own analysis suggested a rate of 0.5 percent, indicating that the Fed could have a lot less time to raise interest rates than it may currently think.
In addition, the Fed has pumped hundreds of billions of dollars into the economy to support credit markets in the face of a severe U.S. recession, and may find it very hard to remove this expansion by shrinking its balance sheet in the future.
"While Federal Reserve officials say that they will be able to sell newly acquired assets at a sufficient rate to prevent these reserves from igniting inflation, they or their successors may face political difficulties in doing so.
"That raises doubts and therefore risks. The risk is systemic because of the economy-wide harm such an outcome would cause," Taylor said.
Taylor used these cases to illustrate examples of where government intervention had magnified market failures and turned them into system-wide problems.
However, he saw much more risk coming from the planned U.S. government budget deficits, which could place the Fed under extreme pressure to allow inflation, as this would diminish the debt burden.
"The emphasis should be on proposals to stop the systemically risky budget deficits projected out as far as the eye can see, to exit from extraordinary monetary policy actions, and to end the bailout mentality," he said.
Giving the Fed formal responsibility for ensuring the soundness of the broader financial system would interfere with the Fed's task of ensuring stable and low inflation and sustainable economic growth, Taylor said. Congress is considering giving systemic risk oversight powers to a regulatory agency as a way to prevent the future financial crises.
"Locating a systemic risk regulator at the Fed is not a good idea because it would interfere with its essential monetary policy function," Taylor said.
Taylor questioned whether a systemic risk regulator would have been able to prevent the financial crisis in the first place. For example, a systemic regulator would not have been able to prevent the Fed from holding rates low for so long, he said.
By Mark Felsenthal and Alister Bull
Read Entire Article