Relevant and even prescient commentary on news, politics and the economy.

Transmission Channels for the Fed’s QE2

What are the channels for QE2? In a recent post, David Beckworth outlines his frustration:

It has been frustrating to watch Fed officials explain QE2. The standard Fed story centers around the QE2 driving down long-term interest rates and stimulating more borrowing.

On the tip of my tongue, I can think of three direct channels: (1) the interest rate channel, which is the source of his frustration, (2) the wealth effect channel, and (3) the weak-dollar channel.

  1. The interest rate channel: the Fed lowers current and expected real borrowing costs to firms and households, thereby stimulating domestic demand via increased consumption and investment. Clearly, this is the most clogged channel, as it requires increased bank lending and leverage build.
  2. The wealth effect channel: the Fed drives up the price of riskless assets (bonds), forcing substitution toward risky assets (equities, corporate bonds, etc.), which raises household wealth (via asset price appreciation) and current consumption demand. This channel was highlighted publicly in October by Brian Sack at the 2010 CFA Fixed Income Management Conference:”Nevertheless, balance sheet policy can still lower longer-term borrowing costs for many households and businesses, and it adds to household wealth by keeping asset prices higher than they otherwise would be.” In my view (see chart below), this has been the strongest channel through which Fed policy has worked.
  3. The weak-dollar channel: the Fed prints money, thereby debasing the currency relative to global trading partners. The technicalities of a weak dollar policy prevent the Fed’s actions as directly being a weak-dollar policy; however, the short-term effect on the dollar was quite strong. In the end, though, we see that the Fed’s policy has had no accumulated impact on the dollar to date (see chart below). This policy still has some time to work through, since the Fed only recently initiated its quantitative easing program again. Furthermore, it’s unclear to me how the dollar will play out in 2011 (perhaps another post), since it’s really a relative game: Fed QE versus the European debt crisis, EM inflation expectations rising, or the like.

The chart below proxies the three channels using the 5y-5yr forward TIPS rate (1), the S&P 500 equity index (2), and the dollar spot index (3). The value of each channel is indexed to the September FOMC meeting for comparability.

The interest rate channel has been negative, as expected real yields increased 35% since the FOMC meeting, driving up expected borrowing costs. The wealth channel has been strong and positive. The S&P 500 gained 9% since the September FOMC meeting date, but the gains really started earlier, as speculators front-ran the Fed decision. Finally, the dollar channel fizzled out, as the dollar index (against major trading partners) is pretty much flat over the period.

I’d like to hear your input regarding other potential channels for Fed policy. But the data has, objectively, been surprising to the upside. Thus the growth outlook has improved. The chart below illustrates the Citigroup economic news surprise index (compared to Bloomberg consensus), which turned to the positive at the outset of November.

Many moving parts.

Rebecca Wilder

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Derivatives: greater transparency is needed

by Linda Beale

Derivatives: greater transparency is needed
crossposted with Ataxingmatter

The big banks got into considerable trouble doing derivatives trades–especially the credit default swaps where AIG was the major counterparty and the taxpayers ended up bailing out the Big Banks like Goldman Sachs.

So surely one of the results of “financial reform” in the wake of the casino banking financial crisis would be utter and complete transparency about derivatives, correct?  One would think so.  But it may not be so.

For a detailed picture of the way the Big Banks have controlled derivatives trading in order to make it a lucrative noncompetitive market for them and a costly market for derivatives endusers, read the article in the Saturday New York times:  Louise Story, A Secretive Banking Elite Rules Trading in Derivatives, New York Times, Dec. 11, 2010.

As Story notes, there is an exclusive group of bankers that has a great deal of say about derivatives trading.  The theoretical purpose is to “safeguard the integrity” of the derivatives market.  The real purposes is to “defend[] the dominance of the big banks” which the banksters do by thwarting efforts to create transparent markets where end users get real information on prices and fees and comparable trades.

The CFTC chair wants to push for more transparency about the derivatives clearinghouses, which will have more power under the Dodd-Frank bill.  But the banks don’t want transparency–in fact, the group of nine banksters that is the subject of the article meets monthly with the ICE Trust clearinghouse, and has enormous influence and power over them.

But Republicans in Congress aren’t exactly supportive of financial reform, unsurprisingly.  They’ve gotten big contributions and backing from Big Banks, and they plan to push back against banking reform.  Apparently they think another crisis like the one that hit us won’t be so bad.  After all, the banks survived this one just fine (and are making billions off the very low funding costs available to them through the Fed, while charging their depositors and customers huge fees).  As did most of the multimillionaires who own substantial financial assets.  Apparently, those who want to ease back on banking reform don’t care much for ordinary Americans who are paying through the nose for credit and getting nothing for their deposits.

Here’s an excerpt from the piece on the way the Big Banks control the derivatives market by keeping the facts about derivatives trades secret.

In the midst of the turmoil, regulators ordered banks to speed up plans — long in the making — to set up a clearinghouse to handle derivatives trading. The intent was to reduce risk and increase stability in the market.

Two established exchanges that trade commodities and futures, the InterContinentalExchange, or ICE, and the Chicago Mercantile Exchange, set up clearinghouses, and, so did Nasdaq.

Each of these new clearinghouses had to persuade big banks to join their efforts, and they doled out membership on their risk committees, which is where trading rules are written, as an incentive.

None of the three clearinghouses would divulge the members of their risk committees when asked by a reporter. But two people with direct knowledge of ICE’s committee said the bank members are: Thomas J. Benison of JPMorgan Chase & Company; James J. Hill of Morgan Stanley; Athanassios Diplas of Deutsche Bank; Paul Hamill of UBS; Paul Mitrokostas of Barclays; Andy Hubbard of Credit Suisse; Oliver Frankel of Goldman Sachs; Ali Balali of Bank of America; and Biswarup Chatterjee of Citigroup.

Through representatives, these bankers declined to discuss the committee or the derivatives market. Some of the spokesmen noted that the bankers have expertise that helps the clearinghouse.

Many of these same people hold influential positions at other clearinghouses, or on committees at the powerful International Swaps and Derivatives Association, which helps govern the market.

Critics have called these banks the “derivatives dealers club,” and they warn that the club is unlikely to give up ground easily.


For many, there is no central exchange, like the New York Stock Exchange or Nasdaq, where the prices of derivatives are listed. Instead, when a company or an investor wants to buy a derivative contract for, say, oil or wheat or securitized mortgages, an order is placed with a trader at a bank. The trader matches that order with someone selling the same type of derivative.

Banks explain that many derivatives trades have to work this way because they are often customized, unlike shares of stock. One share of Google is the same as any other. But the terms of an oil derivatives contract can vary greatly.

And the profits on most derivatives are masked. In most cases, buyers are told only what they have to pay for the derivative contract, say $25 million. That amount is more than the seller gets, but how much more — $5,000, $25,000 or $50,000 more — is unknown. That’s because the seller also is told only the amount he will receive. The difference between the two is the bank’s fee and profit. So, the bigger the difference, the better for the bank — and the worse for the customers.

It would be like a real estate agent selling a house, but the buyer knowing only what he paid and the seller knowing only what he received. The agent would pocket the difference as his fee, rather than disclose it. Moreover, only the real estate agent — and neither buyer nor seller — would have easy access to the prices paid recently for other homes on the same block.

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New tax law signed by Pres. Obama, DADT passes Senate

MSNBC reports Obama signs tax cut bill into law :

The Senate vote was 65-31. The House had passed an identical version of the bill, 250-175, on Wednesday.

Link to S4023 as passed by the Senate today.

Obama was expected to sign it next week, although the change wouldn’t take immediate effect. The legislation says the president and his top military advisers must certify that lifting the ban won’t hurt troops’ fighting ability. After that, there’s a 60-day waiting period for the military.

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Confusions and policies…let’s keep the players in mind all around

Chinese Confusions
by Paul Krugman

These days, China seems to play the same role in much of our discourse that Japan did two decades ago. We look at our own follies — which are immense — and then look at the Chinese, and ascribe to them all the virtues of foresight and determination we lack.

But just like the Japanese, the Chinese are human, and their policy makers are subject to the same kinds of confusion and inability to make hard choices that are part of the human condition. And Chinese macroeconomic policy is in the process of becoming a cautionary tale.

Basic economics says that by deciding to keep the renminbi undervalued, the Chinese put themselves under inflationary pressure; and sure enough, inflation is rapidly becoming a serious problem.

But political considerations seem to be ruling out all the reasonable responses. They won’t revalue, because that would hurt politically influential exporters. They’re reluctant to raise interest rates, because that would hurt politically influential real estate developers. They’re trying to impose quantitative limits on credit, but are finding that borrowers have enough influence to circumvent the limits. And now they’re trying price controls — which will inevitably come apart at the seams unless they do something about the underlying pressures.

It’s an edifying spectacle.

Now, schadenfreude should not lead to any complaceny on our part; China may be corrupt and unable to make sensible short-run choices, but in terms of fundamental inability to deal with long-term problems, we still have them beat hands down. Still, it’s worth remembering that all giants have feet of clay.

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Health Care thoughts: Hysterical Reporting

by Tom aka Rusty

Health Care: Hysterical Reporting

Fox News ran a screaming intro and a scary bottom summary line on a story on some survey of physicians, claiming a majority of physician will quit, retire or work part-time.

Link via Yahoo:

This is further proof that Fox News does not do journalism. The conversation eventually winds around and the expert really contradicts the story headline.

I have been spending a lot of time talking to people at the national level, and the one trend that is certain is the merger/sale of physician groups to hospitals and integrated networks, effectively making the physicians employees of a larger entity. The ownership of a private practice will fade like Marcus Welby MD (some of you may be too young to understand this popular culture reference).

PS: if you leave the link open you will see a story about Miley Cyrus puffing on a bong. Oh the horror.

Tom aka Rusty Rustbelt

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Opportunities in Detroit?

by Tom aka Rusty Rustbelt

Opportunities in Detroit?

Detroit has lost about 60% of its population since the 1950s peak of about 2 million.

About 50 square miles of Detroit is so thinly populated that the Mayor wants to pay for people to move to more densely populated neighborhoods so the area can be abandoned for municipal services. No trash pick up, no police patrols. The first and second ring of suburbs are facing much of the same plight, and some may be headed for bankruptcy..

One idea for reclamation is urban farming, but that assumes people will not move into Detroit any time soon.

So does the 50 square miles provide us with an opportunity? New neighborhoods? New types of communities? A special immigration zone? Homesteading by young people? Entrepreneurial zones? If so, where do we get the money (Detroit and Michigan both being in various stages of broke)? Who leads the charge?

This is a country full of smart people. We should be able to think of something creative here.

Tom aka Rusty Rustbelt

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Can Either James Kwak or Mark Thoma Build This Model?

Update: Brad DeLong looks at the data and suggests that the problem may be that the current President is as innumerate as the previous one.

Mark Thoma quotes James Kwak:

So no, I don’t think Obama is abandoning his principles for political advantage; I think these are his principles. And while I’m upset at him, I’m upset at him for being wrong on the policy level, not for abandoning anything or selling out…I always thought Obama was a moderate who looked like a progressive.

I’m with Kwak on that; it’s one of the reasons I supported the relatively-more-progressive Hillary through the primaries.*

Where I’m less sanguine is the base from which Mark let him start:

Obama is certainly in a decent position politically, and I would bet on him to be reelected comfortably in 2012.

In 1996, Bill Clinton had the advantage of Bob Dole—the 1996 equivalent of Newt Gingrich—being his opponent. Dole had been a known quantity to voters for over a decade (“Do you want Grits and Fritz or a Ford Dole?”) who supported Clarence Thomas, talked about Hideo Nomo of the Brooklyn Dodgers, and fell off the front of a stage—and still garnered more than 40% of the vote, losing the popular vote by only slightly more votes than Ross Perot won. And that was after the advantage of a virtually-uncontested primary, which Mr. Obama may not enjoy.**

Kwak later backtracks a bit:

I think two years would be enough time for labor markets to recover if we could expect policy supporting employment along the way. But we are likely to get just the opposite, deficit cutting measures and other policies that work against employment and hence work against electoral success for the Democrats. Toss in a compromise on Social Security that angers the Democratic base, a possibility that cannot be dismissed as Obama follows up on what appears to be a successful move to the center, and the future does not look as bright. Obama may think he is playing the game well now, but the game is far from over.

This is at least far more accurate than the declaration that Obama won when his opening g4 was followed by the Republican’s e5. And Thoma follows up with his expectation of Obama’s next move being f3:

That would put an end to any stimulus due to the tax compromise. Stimulating the economy was never the intent of the GOP when they agreed to the tax compromise, it was all about the estate tax and tax cuts for the wealthy. They will do what they can to decrease government spending over the next two years, starting in January, and if they are successful it will reverse any benefit the economy might have received from the compromise.

Given that we all agree on the likely next two years, it would be nice to see an economic model from either Mark or James Kwak that justifies the expectation that Obama is in a position “to be reelected comfortably in 2012.”

At the very least, I want to offer to bet with Mr. Kwak, at even odds, with proceeds to go to the charity of the winner’s choice. Here’s my choice.

*The other being that she would know from the start that she was hated, and be ready for bear at the outset. (As an aside: sorry, Scott, but hiring Mark Penn, while a mistake, is not a revelation of policy preferences. Or, if you want to argue it is, tell us what replacing Howard Dean and the 50-State Strategy with Tim Kaine and Suborning Democrats such as Sibelius and Napolitano into the Administration is.)

**I say this not only because I would like to see him challenged—his doing a Specter in 2011 is about the only hope for my grandchildren—but also because it makes sense to prepare the field for 2016 and beyond. It would be dumber of the Democrats not to have someone challenge him in the primary, leaving only HRC and Joe Biden as probably 2016 candidates, than it would be to unite behind him in the hope that Republicans nominate someone who is unelectable a la Dole in 1996.

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