David Swensen, CIO of Yale’s endowment, talks to Charlie Rose.
Archive for January, 2009
Some really good graphs. I don't need to say more. The last two graphs are especially interesting. If you are interested in the deeper analysis of the graphs, read this NBER research paper.
(graph courtesy of Bespoke Investments)
(graph courtesy of NBER and author: Thomas Philippon and Ariell Reshef)
David Altig, senior vice president and research director at the Altanta Fed explains how he looks at the rapidly expanding Fed’s balance sheet and its implications to inflation. Mr. Altig clarifies many confusions in the media, espeically on 1) what is exactly the monteary base? One thing for sure is that Fed’s balance sheet (asset side) and monetary base are not the same thing; 2) what is money multiplier and money supply: expanding Fed’s balance sheet does not necessarily lead to rapidly expanding money supply of the same level, albeit a fast increase. It’s a very good piece.
On expanding balance sheets and inflationary policy
Here’s a question I hear a lot (most recently during the Q&A portion of a speech delivered yesterday by my boss, Atlanta Fed president Dennis Lockhart): Has monetary policy become so expansive that the central bank’s mandate to maintain price stability has been fundamentally compromised? Is the increase in the scale of the Federal Reserve’s balance sheet inherently inflationary?
Jim Hamilton covered much of the territory implied by these questions in a very extensive Econbrowser post not too long ago, but the distinction between money creation and Fed balance sheet expansion continues to be confounded. Here, for example, is a passage from the Wall Street Journal’s Real Time Economics coverage of Stanford professor John Taylor’s (not exactly glowing) review of recent Federal Reserve action, delivered at this year’s annual meeting of the American Economic Association:
“The Fed has launched nearly a dozen new programs in the past year to address the crisis. Its strategy is to target specific markets in distress—from commercial paper to asset backed securities to money market mutual funds and stresses overseas—with programs tailored to their problems. It also has gotten deeply involved in rescues of individual firms like Bear Stearns, American International Group and Citigroup.
“The Fed has funded these programs by pumping reserves into the banking system—essentially creating new money. In the process, its balance sheet has ballooned from less than $900 billion to more than $2 trillion.”
The record though, as the article goes on to note, is that not all of that $2 trillion represents an increase in the money supply:
Only the blue portion of the graph above represents “pumping reserves into the banking system”—a fact that was covered pretty well in the aforementioned Econbrowser post—and in an even earlier post at News N Economics. In simple terms, the size of the Fed’s balance sheet is not the same thing as the size of the monetary base (the sum of currency in circulation and reserve balances kept by banks with the Federal Reserve).
Of course, John Taylor’s point was not that all of the increase in the balance sheet has amounted to pumping in reserves, just that a lot of it has, which is clearly true. But even here there may be less to the potential inflationary impact than meets the eye. In his speech at the London School of Economics earlier today, Chairman Bernanke explained:
“Some observers have expressed the concern that, by expanding its balance sheet, the Federal Reserve is effectively printing money, an action that will ultimately be inflationary. The Fed’s lending activities have indeed resulted in a large increase in the excess reserves held by banks. Bank reserves, together with currency, make up the narrowest definition of money, the monetary base; as you would expect, this measure of money has risen significantly as the Fed’s balance sheet has expanded. However, banks are choosing to leave the great bulk of their excess reserves idle, in most cases on deposit with the Fed. Consequently, the rates of growth of broader monetary aggregates, such as M1 and M2, have been much lower than that of the monetary base.”
Last week Greg Mankiw had a nifty graph (courtesy of Professor Bill Seyfried of Rollins College) of the so-called money multiplier precisely illustrating the point:
The money multiplier measures the amount of money in the hands of the public—the M1 measure in this case, which is composed mainly of cash and demand deposits (i.e., checking and debit accounts)—that are created by a dollar of monetary base. That amount fell considerably when the Fed introduced the payment of interest on bank reserves.
That said, despite the fall in the money multiplier, the M1 measure of money has also expanded fairly noticeably since late summer:
The increase in M2—a slightly broader measure of money that adds to M1 items like savings accounts and time deposits—has been somewhat slower but still on the rise:
From December 2007 through August of last year, M1 and M2 grew by about 1.2 percent and 3.9 percent respectively. Since September—after which the rapid expansion of the Fed’s balance sheet began and the Fed began to pay interest on reserves—the corresponding growth rates have been 13.4 percent and 5.9 percent.
Are those growth rates substantial? That is a tricky question—whether a particular growth rate of money is substantial or not can only be determined in relation to the pace of money demand (which has almost certainly accelerated as interest rates have fallen and the taste for safe and liquid assets risen). But I take two lessons from our early experience with the asset-oriented policies emphasized in the Bernanke and Lockhart speeches. First, expansions of the balance sheet need not imply expansions of the money supply. Furthermore, as Chairman Bernanke emphasized, the Fed has the capacity to contract reserves going forward:
“… the Treasury could resume its recent practice of issuing supplementary financing bills and placing the funds with the Federal Reserve; the issuance of these bills effectively drains reserves from the banking system, improving monetary control. Longer-term assets can be financed through repurchase agreements and other methods, which also drain reserves from the system.”
The second lesson, clear in the M1 and M2 charts above, is that despite the payment of interest on reserves and near-zero federal funds rates, it is still possible to induce increases in the broad money supply through the standard channel of injecting reserves into the banking system.
Whatever direction you think the money supply ought to go, these observations should come as comforting news.
WSJ's article today (see below) echoes my earlier post on the difficulty to get Chinese consumers spending, especially during global recession. In short, changing consumer's behavior in the short term is inherently difficult, if not impossible. It can't be done overnight — just consider the unaffordable healthcare cost in China and its lack of social security system in the rural area.
China's Need for Self-Reliance
China needs its consumers to spend. Actually getting that to happen, though, is another story.
The country's long export and investment-led boom has stalled. Fourth-quarter growth in gross domestic product slid to 6.8% on-year, well below habitual double-digit levels.
Beijing's response, so far, has been on beefing up the government's role as consumer, notably through a nearly $600 billion fiscal stimulus plan. Part of its aim is to create jobs to replace those lost in the country's factories.
But that alone won't incentivize Chinese consumers to spend more, and offset a decline in spending on China's exports by recession struck Americans and Europeans.
With Chinese households holding a collective $3.3 trillion in savings, but debt of only $835 billion, China has the opposite problem to the U.S. — an excess of savings instead of too much debt. Household consumption as a percentage of GDP remains well below that in developed countries and many of China's Asian neighbors.
China's statistics bureau chief Thursday suggested households are starting to eat into those savings to support consumption. But other signs suggest otherwise.
Retail sales growth rates have slipped for six consecutive months now. That figure — unadjusted for inflation — isn't widely trusted, but slowing sales of cars and air travel, as well as anecdotal evidence of empty shopping malls, also suggest the trend is downward.
Near-term, consumer confidence is being hit by fear of job losses and pay cuts. The possibility of deflation soon could harm spending also.
Longer term, China's citizens have good reason to hang on to their spare cash, given the lack of an adequate welfare and pension system.
Belatedly, Beijing is responding. A recent cut in the car sales tax, and a three-year plan to spend $124 billion on revamping health care are steps in the right direction. Rural dwellers are being given financial help to buy more household appliances.
Interest rates offered on bank deposits are coming down as well, though this has had little effect in the past. Consumers continued to save diligently even with interest rates below inflation rates in 2007.
So, Beijing will have to do more. A cut in income taxes may not have much effect — many Chinese are exempt already, while others find ways to dodge payments. Instead, China might benefit from following other Asian countries by offering shopping vouchers, particularly to urban residents.
Whatever the answer, the question is becoming more urgent, if China's growth is to get back on the 8%-plus track so important to its leaders.
Bank nationalization may stop the bank run, but it poses two fundamental questions: 1) Is government efficient and competent than private sector to run the financial system? 2) If the government grabs more and more of the economy, how will it impact the economic dynamism (Ed. Phelps’ words) and entrepreneur spirit that makes America so great?
Still I would prefer the bad-bank-good-bank rescue model, i.e., strip off all bad assets from bank’s balance sheet, let them have a fresh start and get lending going; meanwhile, government sets up a special entity to safe-keep these bad assets — with market confidence coming back in coming months, and when housing prices stop falling, the prices of these bad assets will come back. Remember a lot of these bad assets are long-term mortgage related securities and you don’t want to fire sell those assets during market panic. Government may eventually make money out of this.
The bottom line is: government should stop acting in ad hoc fashion. What is needed is a comprehensive and swift plan to get banks, the vital part of the modern economy, back on track.
Drastic solutions always appeal in times of crisis. Witness the growing number of calls for the government to nationalize banks.
Indeed, the recent bank-stock massacre was prompted in part by fears the Obama administration may nationalize part of the financial system.
Granted, nationalization — the government seizing banks and restructuring them — may be the best solution for certain lenders. But used for large parts of the banking system, nationalization carries its own problems.
First, there is cost. Governments typically take big losses when they seize banks. To unload assets quickly, they have to sell at fire-sale prices. That can create yet more mark-to-market losses at other banks.
Nationalization could be cheaper if it forced losses on the seized bank’s creditors. But that is high-risk. And the U.S. has made it difficult by guaranteeing tranches of bank debt. Creditors were made whole in the Swedish bank nationalization — often cited as a model for the U.S.
Then there is the problem of finding competent people to run seized institutions. With so many executives tarnished by the crisis, there isn’t a long list of seasoned candidates ready to step into the financial storm.
Nationalization also can cause market distortions. The longer banks remain in government hands, the more likely they will be used to further government policies, such as keeping people in homes. That could make them harder to reprivatize.
Propping up a bank with more equity until the economy recovers looks cheaper, at least short term, and easier. Some might respond that such an approach hasn’t cleared the instability hanging over markets and the economy. Take Citigroup. Its stock slump suggests the market believes it isn’t viable — even after two government capital injections and a generous loss-sharing agreement. Rather than leave Citi in limbo, why not assume active control and speed up repairs, pro-nationalization people ask.
Recent government actions, like the seizure of Washington Mutual, came after their stock prices flamed out. But policy makers shouldn’t assume a stricken stock price means a bank can’t make it. Banks can simultaneously have adequate capital and low stock prices, particularly given the government funding guarantees they enjoy. If that is the case, regulators should make it clear for healthy banks under pressure.
Of course, if banks lose large amounts of deposits or access to credit, they need to be seized. And they must still build up more conservative measures of capital like tangible common equity. If that requires a big check from the government, de-facto nationalization might be unavoidable.
But even though the idea of mass bank seizures has a strong emotional appeal — punish those who got us into this mess — it provides no easy solution.