My morning reads:

• Hulbert: 3 things not to worry about right now (MarketWatch)
• Gold U. Takes It on the Chin (WSJ) see also Risk of vicious circle for gold as hedging returns (Telegraph)
• A Keynesian Victory, but Austerity Stands Firm (NYT)
• Of Course Apple Avoids Billions in Taxes—and It Should (Atlantic) but see The seven craziest findings in the US investigation of Apple’s tax avoidance practices (Quartz)
• Blowing Bubbles in Japan (WSJ)
• We are technically offshore! For U.S. Companies, Money ‘Offshore’ Means Manhattan (NYT)
• Hiaasen: IRS Went After Small Fish, But Let The Big Ones Get Away (National Memo)
• Are these Pakistani men behind Facebook’s teen spam empire? (Daily Dot)
• Vitamins That Cost Pennies a Day Seen Delaying Dementia (Bloomberg)
• XBOX One Revealed (Wired)

What are you reading?

 

Caterpillar’s Doug Oberhelman: Manufacturing’s Mouthpiece

Source: Businessweek

Lessons at the Zero Bound: The Japanese and U.S. Experience
William C. Dudley, President and Chief Executive Officer, NY Fed
Remarks at the Japan Society, New York City May 21, 2013

 

 

It is a pleasure to have the opportunity to speak today at the Japan Society.1   Our countries have very close relations and this is particularly true at the central banker level.  I just got back from the BIS last week where I had a chance to spend some time with Governor Kuroda.

Today, I will discuss the challenge that we both have been working to solve—how best to conduct monetary policy when short-term interest rates are already pinned close to zero, but the economy is still operating well below its potential.   This has required considerable learning.  After all, until Japan’s experience began in the 1990s, no major country had actually faced this problem since the Great Depression of the 1930s.

As the first nation to experience the zero bound in modern times, Japan was an early pioneer in developing unconventional tools and strategies.  Its experiences, both good and bad, along with lessons from other periods such as the Great Depression, have helped to inform the policies adopted by the United States (U.S.) and other nations in recent years.  The evolution of policy in Japan, in turn, has been informed, in part, by the experience of the U.S. and other nations.

So what have we learned to date?  Let me highlight six key points.

First, and most importantly, managing expectations is critical in the execution of monetary policy at the zero bound.  This includes expectations about the central bank’s objectives for inflation and the economy, and expectations about how the central bank will use its tools in the future to achieve these goals.

Second, in managing expectations, good communication is essential.  Expectations will not be well anchored when communications are muddled or inconsistent, or when a central bank acts in ways that are not consistent with its guidance.

Third, actions speak louder than words alone.  Thus, there is an important role for asset purchases that ease financial conditions to support growth and keep inflation expectations well anchored.

Fourth, the policy instruments interact so that policy as a whole exceeds the sum of its parts.

Fifth, at the zero lower bound, risk management becomes extremely important.  In particular, because the costs of getting stuck in a liquidity trap with chronic deflation are high, a central bank should put substantial weight on avoiding this outcome.

Sixth, the constraints imposed by the zero bound limit what monetary policy can accomplish by itself.  This increases the importance of complementary fiscal, financial, and structural policy actions.  Credible fiscal policies, actions to ensure a healthy financial system, and structural reforms that lift the potential for growth are very important.

As always, what I will say here today represents my own views and not necessarily those of the Federal Open Market Committee (FOMC, Committee) or the Federal Reserve System.

Review of the experience in Japan and the United States

Let me start by briefly reviewing the experience of Japan and the United States.  As you all know, Japan’s rapid economic ascent and investment boom came to an abrupt halt in the early 1990s with the bursting of a gigantic bubble in equities and real estate.

Asset price deflation resulted in a huge decline in wealth.  This led to a sharp fall in demand, a balance sheet squeeze for both businesses and households, and a large increase in problem loans for Japanese financial intermediaries.  By some measures—such as the loss of wealth relative to the size of the economy—this was a bigger shock than the U.S. experienced in 2008.  Growth slowed sharply and inflation fell.

The Bank of Japan (BoJ) responded by reducing overnight interest rates from a peak of more than 8 percent in early 1991 to ½ a percent by the fall of 1995.2   Most studies of this period suggest that policy was generally appropriate given economic forecasts at the time, but too tight relative to the actual outcomes.3  Economic forecasts for Japan—both by the official community and by private sector agents—were consistently more optimistic than the actual outturns.   It is noteworthy that as late as January 1995—on the eve of deflation—10-year Japanese Government Bond (JGB) yields were still at 4.7 percent.

With the benefit of hindsight, we now understand that the disinflationary consequences of the asset price bust and financial stress where vastly more powerful than was widely realized at the time.  As we later saw in the U.S., the forces of contraction and disinflation operated through many different channels—not just directly on household wealth, for example, but also through the impact of the asset price bust on the health of financial intermediaries and the supply of credit to households and businesses.

Over time, the Japanese banking system came under mounting stress.  This was a slow-motion crisis, as the assets were mainly loans that were not marked-to-market.   Accounting practices and regulatory forbearance allowed banks to delay charging off bad loans and recapitalizing at the cost of impairing the availability of credit to new potential borrowers.   A full-blown banking crisis finally materialized in 1997.  Although some banks were recapitalized in 1999, the full regulatory response took several more years.

The monetary and fiscal stimulus that was provided helped Japan avoid a deep recession.  But expectations about future nominal income growth for both households and businesses ground lower over time.  With inflation expectations sinking, inflation-adjusted real interest rates rose, and Japan became mired in deflation.

While deflation is ultimately a monetary phenomenon, structural elements were also important.  Long-term demographic factors added to the deflationary pressures and structural rigidities, and credit supply problems constrained the reallocation of resources to growth sectors.  These structural factors made it substantially more difficult to escape the deflation trap.

The Bank of Japan was active during this period.   From the late 1990s onwards, it pioneered an extremely broad array of innovative tools—many of which were later adopted, in amended form, by the Fed and other major central banks.  These included forward guidance on the future path of the policy rate, quantitative easing through purchases of government securities and private assets including asset-backed securities, equities and real estate investment trusts (REITs), a more quantitative inflation objective, and funding for bank lending.

From my perspective, Japan’s experience with forward guidance for the policy rate, asset purchases  and a more formal inflation goal are particularly instructive, as this helped inform the later use of such tools in the United States.

In early 1999, the Bank of Japan said it would maintain its zero interest rate policy until “deflationary concerns” were “dispelled.”   This commitment was lifted in August 2000, and the BoJ raised the policy rate by a quarter-point.   However, the BoJ was subsequently obliged to reverse course, and reintroduced forward guidance in March 2001.  This guidance was tied to the realization of a new inflation objective.

With deflation intensifying, the Bank of Japan embarked on a quantitative easing (QE) program in 2001 designed to increase the size of the monetary base.  The Bank of Japan engaged in purchases of JGBs that were large in scale, but confined to short-dated maturities.  This reflected a view that such purchases primarily acted through the liabilities side of the central bank’s balance sheet—pushing up the amount of reserves in the banking system.  Because the growth of the monetary base was deemed the goal of policy, it was logical to purchase short-dated assets, which could be allowed to run off once a sustainable recovery was in place.

The downside of this approach was that the purchases did not change the composition of the private sector’s balance sheet very much because the policy essentially resulted in the exchange of one short-term risk-free asset for another.  As a consequence, the purchases had only modest direct effects on financial conditions.4

Starting in 2006, when the initial wave of QE ended, the BoJ began to formalize its inflation goal in numerical terms. This was initially expressed as an “understanding of medium- to long-term price stability” based on individual policymakers’ views. The inflation objective went through several iterations before being defined in 2012 as a Committee “goal” of a positive range of 2 percent or lower, with a lower interim goal of 1 percent.

Following the onset of the global financial crisis in 2007-2008, Japan resumed QE, and gradually tightened the link between its policy actions and its objectives.  By January 2012, the BoJ had committed to keep rates at the zero bound and to continue purchasing assets until the 1 percent goal was “in sight.”

Several prominent Japanese experts have argued that there was a “start-stop” aspect to monetary policy during the 1990s and 2000s with reversals in policy beginning before deflationary expectations were eliminated.5   Fiscal policy also reversed abruptly on several occasions before economic recovery was firmly established.  While Japan did enjoy a period of respectable real per capita growth in the mid-2000s, escape from deflation proved elusive.

More than a decade after Japan’s bubble burst, the U.S. housing bubble burst.  This exposed extensive vulnerabilities in our financial system and triggered a global financial crisis.6 Unlike Japan, we had the advantage of being able to learn from another nation’s recent experience.  We applied what we understood to be the lessons from Japan, though with hindsight, perhaps not in every respect as completely as we could have.

In particular, Japan’s experience reinforced the lessons of the Great Depression here in the U.S. and made us sensitive to the disinflationary force of an asset price bust and financial crisis. We recognized that we had to be very aggressive to prevent deflation and deflation expectations from becoming well entrenched.

The Federal Reserve reduced short-term interest rates to nearly zero by late 2008—a little over a year and a half after the initial shock hit in August 2007.   Immediately upon reaching the zero bound, we provided additional stimulus by expanding our balance sheet and deploying forward guidance on the policy rate. These actions, in the context of a strong commitment to both our inflation and employment mandates, succeeded in preventing deflation expectations from taking hold, even though real outcomes were disappointing.  We also took steps to formalize our 2 percent inflation objective.7

The Fed’s large-scale asset purchase programs differed from those originally undertaken in Japan both in theory and in practice.  They were concentrated in longer-term securities—Treasuries and agency mortgage-backed securities.  This reflected a different perspective on how purchases affect financial conditions and the economy, as well as the different structure of our financial system.

Our view is that asset purchases work primarily through the asset side of the balance sheet by transferring duration risk from the private sector to the central bank’s balance sheet.  This pushes down risk premia, and prompts private sector investors to move into riskier assets.  As a result, financial market conditions ease, supporting wealth and aggregate demand.  The fact that such purchases increase the amount of reserves in the banking system and the size of the monetary base is a byproduct—not the goal—of these actions.

The U.S. also moved relatively quickly to recapitalize core financial institutions—partly as a result of good judgment, but also because the intense pressures of a capital markets-based financial system forced us to confront these issues. The Supervisory Capital Assessment Program (SCAP) in early 2009 identified and addressed the potential capital shortfalls of the major U.S. bank holding companies in a stressed scenario.  The SCAP forced the banks to recapitalize either through the use of private funds or the injection of government convertible preferred equity from the TARP program.

However, our policy approach was far from perfect.  Comparing actual growth to the growth projections by FOMC participants in the Summary of Economic Projections shows that we were consistently too optimistic about growth over the 2009-2012 period.  As a result, with the benefit of hindsight, we did not provide enough stimulus.  Perhaps, if we had paid more attention to the persistent divergence between growth forecasts and outturns in Japan in the 1990s, we might have been more skeptical about the prospects for a strong economic recovery, even with a more aggressive monetary policy regime.

Also, we could have done better in communicating our intentions and goals.  We put too much emphasis, too early, on the exit.  At an earlier stage, we should have put greater emphasis on our commitment to use all our tools to the fullest extent possible for as long as needed to achieve our dual mandate objectives.

Our policies also had a “start-stop” aspect to them that may have undercut their effectiveness.  For example, until September 2012, our large-scale asset programs generally specified the total size of the program, with a purchase rate and an expected ending date.  This created a void when the programs ended and made our policy response sporadic and hard to forecast.  This limited the scope for market prices to adjust in anticipation of our future actions in ways that would help stabilize the economy.

Another shortcoming was in our use of forward guidance with respect to the path of short-term interest rates.  Although calendar-based guidance worked reasonably well in influencing expectations about the future path of short-term rates and thus the shape of the yield curve, it was clumsy in a number of respects.  For example, if we moved the forward date guidance out in time, did this reflect a change in our reaction function, the amount of desired policy stimulus or greater pessimism about the outlook?

Of course, as we have learned, we have acted to rectify these shortcomings.  For example, our asset purchases are now outcome based, tied to the goal of substantial improvement in the labor market outlook, and our forward guidance on short-term rates is tied to unemployment and inflation thresholds rather than to a calendar date.

The Japanese authorities have also capitalized on our joint experiences and actions.  Thus, we have witnessed a convergence in the monetary policy regimes of our two countries.

Today, the two regimes are quite similar in three important respects.  Both the Fed and the Bank of Japan place considerable emphasis on an explicit inflation objective, commit the central bank to use all available tools to achieve its objectives, and use forward guidance on interest rates and large scale purchases of long duration assets as the main tools to achieve these objectives.

Although there are still some important distinctions in how policy is conducted, much of these relate more to differences in legal frameworks and the current starting point for economic activity and inflation rather than fundamental differences in philosophy.  For example, the BoJ’s asset purchases are broader than the Fed’s, extending to equity ETFs (Exchange Traded Funds) and REITs.  This option is not available to the Federal Reserve because the Federal Reserve Act sets tighter limits as to the types of assets that the Federal Reserve can purchase.

Similarly, current circumstances in the two countries are different, with deflationary expectations still in the process of being dislodged in Japan.  The BoJ needs to push up inflation expectations, whereas in the U.S. the current level of inflation expectations is consistent with the long-term objective of the Fed. Therefore, the BoJ, relative to the respective sizes of the two economies, has adopted a purchase program that is more aggressive that the U.S. program.  This is true whether measured in terms of the amount of duration being pulled out of the market or purchases as a share of total issuance.

Lessons learned

As I mentioned earlier, there have been at least six major areas where there has been significant learning, which has influenced the evolution of policy.  Let me turn to them.

The importance of managing expectations

Managing expectations is always central to monetary policy.  However, at the zero bound this is even more critical than usual.

There are two aspects of this.   First, keeping inflation expectations anchored at levels consistent with the central bank’s medium-term inflation objective—2 percent on the personal consumption expenditures deflator in our case—is vitally important. Once deflation expectations become well entrenched, it is very difficult to change them.  And, because inflationary expectations are an important driver of actual inflation outcomes, deflationary expectations can be self-fulfilling in driving actual deflation outcomes.  Also, if inflation expectations were allowed to fall, this would raise the level of expected real interest rates, making monetary policy less accommodative.

Conversely, a central bank does not want medium-term inflation expectations to climb above levels consistent with its inflation objective.  If inflation expectations were to become unanchored to the upside, that could damage credibility and result in higher risk premia for financial assets and tighter financial market conditions.  Thus, a policy that maintains medium-term inflation expectations in line with our inflation objective is most consistent with our mandate.8

Second, at the zero bound, the ability to provide credible forward guidance—both in terms of the future path of the policy rate and the future path of the balance sheet— becomes the predominant vehicle by which a central bank’s actions affect financial market conditions.  If this expectations channel did not work, then it would be very difficult to provide additional monetary accommodation because short-term rates cannot be reduced materially.

In the U.S., in recent months we have communicated that short-term rates are likely to stay very low for a long time; our balance sheet is likely to increase further in size and then stay large for a long time; and that we will not be overly hasty in tightening monetary policy once the recovery gets well established.  By doing this, we are influencing expectations about the likely future path of short-term rates and the interest rate term premium.  By utilizing the expectations channel in this way, we have been able to make policy more accommodative and generate easier financial market conditions.

Good communication is essential

To manage expectations well, both credibility and good communication is essential.  This means explaining clearly the policy framework, the relationship between the use of tools and the central bank’s mandated objectives at the zero bound, and how the use of these tools will evolve with changes in the outlook.

In this regard, a central bank’s credibility is crucial.  Only if a central bank does what it promises to do will expectations be solidly anchored.  Of course, this does not mean mechanically following a set policy trajectory regardless of how the outlook changes, but it does mean that the stance of policy over time must evolve in ways consistent with the criteria established in the guidance.

It is important to communicate how policy will respond to changing economic circumstances over time.  This is particularly important when the outlook changes, because expectations about how policy will respond can be an important self-stabilizing element of monetary policy.   In this regard, a framework that ties the use of policy tools explicitly to economic outcomes has many advantages.

Good public communication is also important.   For example, press conferences offer an opportunity to ground the policy actions and stance in a framework that is explicit about how the central bank plans to achieve its mandated objectives.

Asset purchases are an effective tool

Credibility requires taking action in the present as well as providing guidance for the future, and we are fortunate to have learned that asset purchases can indeed be an effective tool to support growth, employment and inflation expectations at the zero bound. While I believe that managing expectations is crucial, I am somewhat skeptical of the view that forward guidance on the policy rate alone is sufficient in these circumstances.  This is particularly the case when guidance extends out several years in the future.  Promises about future actions may be seen as not fully credible given the potential for changes in a central bank’s leadership and policy committee and the degree of uncertainty about economic conditions that will prevail far out in the future.

In recent years, we have developed considerable positive experience providing accommodation through changes in the size and composition of the central bank balance sheet.  Taking interest rate risk and mortgage prepayment risk out of private hands has proven to be effective in easing financial conditions, increasing wealth and lowering private sector borrowing costs.9   The impact of purchases may be attenuated to some degree by deleveraging and ongoing adjustments in markets such as real estate. But it is material even in these circumstances, and builds over time as these needed adjustments proceed.

The sum is greater than its parts                                            

Another important insight is that each of the components of policy—the current stance in terms of the policy rate and the balance sheet, expectations about the future stance, the degree of commitment to future policy, and the clarity of communications—all interact.  Our tools are more powerful used in combination, and, when their use is explicitly tied to the outcomes we seek to achieve.  As a result, the sum is more powerful than the component parts.

Risk management is particularly important

Risk management is particularly important at the zero bound. At the zero lower bound, once you are caught in deflation, it is very hard to get out.  Thus, policymakers need to put considerable weight on this risk and conduct monetary policy with sufficient aggressiveness to ensure that they avoid such an outcome.

It is also true that we have less experience with the monetary policy tools used at the zero bound.  As a result, there is greater uncertainty around the efficacy and costs of these tools.   This pushes in the opposite direction of being more cautious.

This means that risk management is essential—what are the costs of being wrong in either direction?  Sometimes a cautious, incremental approach may not always be the right strategy.

Limits to monetary policy

At the zero bound, monetary policy encounters additional constraints.  These fall into three broad buckets.

First, there are costs associated with non-conventional tools.  This means they cannot simply be used without limit, though the appropriate limit will vary based on the outlook and balance of risks.   The most obvious example of this is our large-scale asset purchase program.  As the balance sheet increases in size, the potential costs increase in terms of market functioning, risks to financial stability, and the path of future remittances to the U.S. Treasury.

Second, there is a limit on how far the expectations channel can be exploited.  As I discussed earlier, since the current FOMC cannot bind future FOMCs and the economic outlook is highly uncertain, it isn’t reasonable to expect that policies that affect expectations many years in the future will have a powerful impact today.  I believe that the effectiveness of the expectations channel decays as the length of the horizon extends.

Third, monetary policy is only one leg of the stool necessary to generate a vibrant and sustained economic expansion.  In particular, as noted earlier, the health of the financial system is critical.  For without it, the monetary transmission channels will be impaired and monetary policy will be less effective in influencing the cost and availability of credit. Similarly, it is critical that fiscal policy be set appropriately.  This means the short-term impulse needs to be properly calibrated to the current set of economic circumstances (not too much restraint) and the long-run budget trajectory needs to credible and consistent with fiscal sustainability.  Finally, removing structural impediments that hinder growth and economic rebalancing are also important.  In the case of the U.S., this could include changes in immigration policy, infrastructure investments that remove bottlenecks and job training programs that improve the quality of human capital.

Implications for U.S. monetary policy

Undoubtedly, we will continue to learn as we seek to implement monetary policy most effectively.

Let me give a few examples of how my own thinking may evolve.  In terms of our asset purchase program, I believe we should be prepared to adjust the total amount of purchases to that needed to deliver a substantial improvement in the labor market outlook in the context of price stability.  In doing this, we might adjust the pace of purchases up or down as the labor market and inflation outlook changes in a material way. For me, the base case forecast is not the sole consideration—how confident we are about that outcome is also important.

Because the outlook is uncertain, I cannot be sure which way—up or down—the next change will be.  But at some point, I expect to see sufficient evidence to make me more confident about the prospect for substantial improvement in the labor market outlook. At that time, in my view, it will be appropriate to reduce the pace at which we are adding accommodation through asset purchases.  Over the coming months, how well the economy fights its way through the significant fiscal drag currently in force will be an important aspect of this judgment.

We are also learning about how best to prepare for the eventual normalization of monetary policy. For example, we may need to update our thinking with respect to the so-called exit principles that we published in June 2011 in order to bring them up to date with developments since then, and ensure they do not unnecessarily constrain our ability to conduct policy in the most effective way  today.

Those exit principles stated that we would first stop reinvesting, then raise short-term interest rates, and finally sell agency mortgage backed securities over a three-to-five year period. This seems stale in several respects.  In particular, how does one time the end of reinvestment given that we now have economic thresholds that govern the timing of liftoff?  Also, the thresholds are thresholds, not triggers.  Thus it is hard to link the timing of the end of reinvestment to the unknown liftoff date for short-term rates.

More broadly, it may be desirable to update our thinking around the path and composition of the balance sheet over time, in light of our capacity to shape this path in a way that mitigates potential costs and risks. For example, the agency MBS portfolio is substantially larger today than it was when the original exit principles were devised. To the extent that the Committee wants to reduce the risk of disrupting market functioning during normalization, it could decide to indicate that it will avoid selling the MBS portfolio during the early stages of the normalization process.  Moreover, to the extent that the Committee wants to mitigate the risk of a sharp increase in long-term rates, it could judge that it would prefer not to commit to agency MBS sales. Expectations about future MBS sales or actual sales have the potential to generate or amplify such an upward spike in long-term rates.  If the Committee believes that it could be costly in terms of credibility to incur a period of no remittances to Treasury—a notion I am personally somewhat skeptical about—avoiding MBS sales would also reduce this risk.  Indeed, the Committee might conclude that it was better on all three counts to allow the agency MBS securities to run off passively over time.10

An important challenge for us will be to think carefully about what combination of actions and communications will best ensure that when we do eventually judge that it is appropriate to begin normalizing policy, the initial tightening of financial market conditions is commensurate to what we desire. There is a risk is that market participants could overreact to any move in the process of normalization.  Indeed, there is some risk that market participants could overreact even before normalization begins, when the pace of purchases is adjusted but the level of accommodation is still increasing month by month.11 Not only could such responses threaten financial stability, but also they might make it harder to calibrate monetary policy appropriately to the economic situation. We will need to think long and hard about how best to develop policy in a way that enables us to respond flexibly to a changing economic outlook, but in a way that is not disruptive to the economy.12

Based on what we have learned to date at the zero bound, I believe that it will be important for us to anchor all our communication around the core principle: The path of the policy rate and the size and composition of the balance sheet over time will be driven by our unbending commitment to our dual mandate objectives of maximum sustainable employment in the context of price stability.

As you can see, there will be much more to learn as we go.  Thank you for your kind attention.  I would be happy to take a few questions.

1 Krishna Guha, Paolo Pesenti, Simon Potter, Jamie McAndrews, Jonathan McCarthy, Lorie Logan, John Clark, Eben Lazarus and others on my staff helped with the preparation of these remarks.

2 Actual overnight rates; the Bank of Japan did not publish its rate target until 1998.

3 See “Preventing Deflation: Lessons from Japan’s Experience in the 1990s, ” Alan Ahearn, Joseph Gagnon, Jane Haltmaier, and Steve Kamin et. al., International Finance Discussion Papers, No 729, June 2002, Board of Governors of the Federal Reserve System.

4However, research suggests that the purchases did reinforce the forward commitment.  See, for example, “Policy commitment and expectation formation: Japan’s experience under zero interest rates” Kunio Okina and Shigenori  Shiratsuka North American Journal of Economics and Finance, Vol 15, No 1, pp 75-100.

5 See, for example, “Deleveraging and Monetary Policy: Japan Since the 1990s and the United States Since 2007”, Kazuo Ueda, Journal of Economic Perspectives, Vol 26, No 3, Summer 2012, pp 177-202.

6 Some commentators prefer the term “North Atlantic financial crisis” as the failure and near-failure of financial institutions was concentrated in the U.S. and Europe. However, the crisis was global in the sense that financial markets transmitted the shock throughout the world and this resulted in a severe global economic downturn.

7 Committee members, through their submissions to the Summary of Economic Projections, had already indicated that their inflation objective was close to 2 percent as measured by the personal consumption expenditures deflator; in January 2012 the Committee formalized the inflation objective as a 2 percent “longer run goal” (see http://www.federalreserve.gov/newsevents/press/monetary/20120125c.htm).

8 In addition to acting to manage inflation expectations, the central bank can also support expectations about the outlook for growth and job creation.  This can be implemented by making it clear that, subject to medium-term price stability, it will seek to stabilize the economy and has the means to do so even at the zero bound.

9 With respect to borrowing costs, this is particularly true in real terms.

10This would also provide additional stimulus at the margin, since the degree of accommodation provided by our balance sheet holdings is related to how long the public expects us to hold the assets.

11 The move to economic thresholds-based guidance for the federal funds rate should help in this regard. While the thresholds are certainly not triggers, they should help market participants adjust expectations about the likely timing of lift-off in a relatively continuous manner and guard against these expectations being pulled further forward in time than is warranted by changes in the economic outlook.

12 Indeed, even when purchases of additional longer-term securities cease, the enlarged balance sheet will provide substantial ongoing stimulus. It is important to recognize that the Fed could remain in this posture with policy “on hold” for a significant period.

Source: NY Fed

Al Madrigal questions former MSNBC pundit Dylan Ratigan about leaving cable news for the less angry world of hydroponic farming.

The Daily Show with Jon Stewart
Get More: Daily Show Full Episodes,Indecision Political Humor,The Daily Show on Facebook

Tuesday May 21, 2013 (05:39)

Source:
Reflection Of Me

A brief reminder: Hurricane Sandy was the deadliest and most destructive hurricane in decades. It caused 285 total fatalities and was the second-costliest hurricane in United States history.

During the immediate aftermath of this act of Nature, these 2 dimwits were among many who decided to use the disaster as a political platform. They voted against a full FEMA / Army Corp of Engineer reconstruction, and repeatedly delayed votes to fund any for of rescue.

The claim that the rescue bill was any more pork laden than anything else that comes out of the sewer that is Washington D.C. was specious at best. Do a search for “Hurricane Sandy Pork” — what comes up are the same wingnut articles repeated over and over in various partisan outlets.

Media Matters noted in January that claims of money for “climate change for the EPA”  was actually money for wastewater treatment in damaged areas (Fox News’ Bogus Hunt For Pork In Sandy Bill Continues).

Even Forbes called foul — they noted that the “pork” came from having to bribe red state Republicans — including Texas — in order to get the package passed over their filibuster” (Pork Holding Up Senate Sandy Relief Bill Funneled Into The Troughs Of GOP Deficit Hawks? You Betcha).

The hypocrisy reached a point of such absurdity that the Republican Governor of New Jersey, a Conservative favorite, went postal against the GOP House members as well as these two Oklahoma Senators.

Which brings me to the recent tragedy in Oklahoma: Now that the disaster is on the other foot, the Oklahoma Senators/deficit hawks are claiming Tornado aid ‘totally different’ from Hurricane Sandy aid.

Want to know how its different?

A big chunk of the Sandy emergency package replenished FEMA, which had been underfunded by the usual suspects. The Sandy relief package replenished its coffers. The votes in favor of Sandy Aid ironically funded FEMA, and it is helping with the rescue and clean up efforts in Oklahoma.

I would suggest that the entire NY/NJ/CT Congressional Delegation, regardless of party, as well as Governors Christie, Cuomo, and Malloy should demand an apology from Senators Inhofe and Coburn. These two geniuses were voting against funding an agency that is now helping out their electorate.

 

My afternoon train reading:

• S&P 500 Returns to Record While U.S. Treasuries Advance (Bloomberg) but see S&P 500 Revenues Disappoint (Dr.Ed’s Blog)
• I Was Wrong: Doug Kass Gives Mea Culpa on Bearish Views (Moneybeat)
• The New Buyers of ETFs (Wealth Management)
• Alternative Marketing for Alternative Investments (Social Science Research Network)
• Interview With Estimize Founder Leigh Drogen (See It Market)
• Federal Rulings Could Make 5 Years Of Non-Judicial Foreclosures Unconstitutional (Mortgage Fraud Investigations )
• How to Humble a Wing Nut (Bloomberg)
• Is This Why TED Talks Seem So Convincing? (priceonomics)
• Why Rational People Buy Into Conspiracy Theories (NYT)
• Change Agents: Walter De Brouwer’s magical tricorder (lohud)

What are you reading?

 

Wall Street Giants Try a New Business Model

Source: WSJ

Click to enlarge

Source: NYT

 

Unbelievable chutzpah:

“Thanks to what lawmakers called “gimmicks” and “schemes,” Apple was able to largely sidestep taxes on tens of billions of dollars it earned outside the United States in recent years. Last year, international operations accounted for 61 percent of Apple’s total revenue.

Investigators have not accused Apple of breaking any laws and the company is hardly the only American multinational to face scrutiny for using complex corporate structures and tax havens to sidestep taxes. In recent months, revelations from European authorities about the tax avoidance strategies used by Google, Starbucks and Amazon have all stirred public anger and spurred several European governments, as well as the Organization for Economic Cooperation and Development, a Paris-based research organization for the world’s richest countries, to discuss measures to close the loopholes.

Still, the findings about Apple were remarkable both for the enormous amount of money involved and the audaciousness of the company’s assertion that its subsidiaries are beyond the reach of any taxing authority.

“There is a technical term economists like to use for behavior like this,” said Edward Kleinbard, a law professor at the University of Southern California in Los Angeles and a former staff director at the Congressional Joint Committee on Taxation. “Unbelievable chutzpah.”

 

 

Source:
Apple’s Web of Tax Shelters Saved It Billions, Panel Finds
NELSON D. SCHWARTZ and CHARLES DUHIGG
NYT, May 20, 2013
http://www.nytimes.com/2013/05/21/business/apple-avoided-billions-in-taxes-congressional-panel-says.html

From the Federal Reserve Bank of Chicago:

Source: Federal Reserve Bank of Chicago

 

“In 1752, Prime Minister Henry Pelham converted the entire outstanding stock of British debt into consolidated annuities that would become known as consols. The consols paid interest on an annual basis just like regular bonds, but with no requirement that the government ever redeem them by repaying the face value.”

-Slate

 

Today we look at the Consol, an 18th century debt issuance. Indeed, it is one of the earliest known debt issuances in recorded history.

Originally called consolidated annuities, the Consol is one of the earliest forms of government bonds. Primitive compared to the modern day 10 year bond, it had no maturity, and paid a coupon in perpetuity. It requires an act of the British Parliament to redeem them (likely not gonna happen with rates this low).

Originally issued with a coupon rate of 3.5%, the rates have been lowered throughout the 1800’s. In fact, it wasn’t until 1903 under the terms of the National Debt Conversion Act of 1888 that they lowered it to where it stands today at 2.5% (Parliament can redeem the debt at par).

They still trade today, but represent a tiny fraction of the UK’s total debt. Since 1958, the Brits moved to a traditional 10yr bond as their flagship debt instrument. Consol’s currently have a 200 basis point spread from the UK 10yr and trade at around 4.4%, paying a coupon four times a year.

 

UK 2.5% Consol Yield vs the Great Britain Governmental Debt to 1742
click for ginormous chart

Source: Global Financial Data

 

Here is a snapshot from the newspaper reporting the financial data on the Consol’s, original source, circa 1838:

 

Thanks to Ralph Dillon of Global Financial Data for charts.

 

Source:
Ralph Dillon
Global Financial Data, May 20, 2013
http://www.globalfinancialdata.com/
rdillon@globalfinancialdata.com

My morning reads:

• Kudlow: Has Bernanke Gotten the Story Right? (National Review)
• Are Market Valuations too High? (Turnkey Analyst) see also Equity Risk Premiums (ERP) and Stocks: Bullish or Bearish Indicator (Musings on Markets)
• As rich gain optimism, lawmakers lose economic urgency (Washington Post)
• Japan’s New Optimism Has Name: Abenomics (NYT) see also Fed Will Fuel Dollar Rally With More Confidence (Moneybeat)
• On Whose Research is the Case for Austerity Mistakenly Based? (Jeff Frankels Blog)
• Wall Street’s Giants Try ‘Flow Monster’ Formula (WSJ)
• The One-Person Product (Marco) see also A better, brighter Flickr (flickr)
• How the IRS’s Nonprofit Division Got So Dysfunctional (ProPublica)
• How to buy happiness (Los Angeles Times)
• 2013 National Geographic Traveler Photo Contest (Atlantic)

What are you reading?

 

Gold Making a Double Bottom?

Source: Bespoke

In our day job, we have a Fiduciary relationship with our clients. A Fiduciary has a legal obligation where all actions are performed for the benefit of the client. It is a much higher duty of care than the typical “Suitability” standard, which essentially says you cannot sell Facebook IPO shares to Grandma. We sit on the same side of the table as our investors, as opposed to adversaries looking to “monetize” clients.

So you can imagine our amusement when the prospectus for this fund made its way to our attention yesterday:

Goldman Sachs Multi-Manager Alternatives Fund (GMAMX)

It is a mutual fund of hedge funds, with all the layers of fees costs and taxes you might imagine.

According to a prospectus, the fund gives investors “exposure to common trading strategies of hedge funds including long-short-equity, event driven investments, relative value trading and opportunistic credit trading.”

The managers of the fund have already selected a number of hedge funds — Ares Capital Management, Brigade Capital Management, GAM International Management, Karsch Capital Management and Lateef Investment Management as the initial run of hedgie managers.

Note that the “Costs to execute those strategies will be borne by the fund’s investors.” These costs are include fees, plus the use of leverage, derivatives and (up to 15%) illiquid investments. (Sounds awesome).

Annual fees for the fund may reach as high at 3.3% for some classes of shares — not counting the A shares, which start off with a 5.5% upfront fee.
 

Source: Fund Pospectus

 

You only need $1,000 to get into this Goldman fund (Yay!). Why you would want to is another question entirely. In addition to the enormous drag high fees impose, there is the performance issue. As TheStreet.com noted, “According to the HFRX Global Hedge Fund Index, hedge funds returned just 3.5% in 2012, significantly underperforming a 16% gain posted by the S&P 500 Index. Over five years, the hedge fund index has lost about 13.6%, while the S&P gained 8.6%, as of year-end 2012.”

As Fiduciaries, we are always seeking ways to reduce cost and risk for clients’ without compromising performance. That means making sure that muppet investments like this will not be finding its way into any of our portfolios . . .

~~~

Prospectus, Factsheet, and more details on etc, can be found at GSAM

 

What will we do when machines do all the work?

Source: The Job Market of 2045 What will we do when machines do all the work?

 The Geography of Student Debt
Andrew Haughwout, Donghoon Lee, Wilbert van der Klaauw, and Joelle Scally
May 14, 2013

 

 

This morning, the New York Fed released its Quarterly Report on Household Debt and Credit for 2013 Q1. The report uses the FRBNY Consumer Credit Panel to show that outstanding household debt declined approximately $110 billion (about 1 percent) from the previous quarter. The drop was due in large part to a reduction in housing-related debt and credit card balances. Meanwhile, delinquency rates for each form of consumer debt declined, with the overall ninety-plus day delinquency rate dropping from 6.3 percent to 6.0 percent.

One of the unique aspects of the FRBNY Consumer Credit Panel, which is itself based on Equifax credit data, is the detail we obtain for each kind of household debt. This quarter, we have taken advantage of the geographic information available in the data set and are introducing a set of maps of our student loan data, which indicate regional variation in several dimensions of student debt. They depict:

• Student loan borrowers as a share of the population. The population with active student loan debts, or “SL borrowers,” as a share of the population with a credit record varies substantially over space. For example, in Hawaii, less than 12 percent of people with a credit report have student debt, while in the District of Columbia over 25 percent do.

• Student loan balances per SL borrower. Student indebtedness is significant for SL borrowers in virtually all states. Educational indebtedness per SL borrower ranges from a low of just under $21,000 in Wyoming to a high of over $28,000 in Maryland. Again, Washington, D.C., stands out: the average SL borrower there owes over $40,000. In general, we find SL-borrower debt levels are highest in California and along the Atlantic and Gulf coasts.

• Percent of balance ninety-plus days delinquent. Delinquency rates show a distinct regional pattern, with states in the south and southwest having generally higher rates than those in the north. The lowest delinquency rate is South Dakota, at just over 6.5 percent, while the highest is in West Virginia, at nearly 18 percent.

    Student loan indebtedness and delinquency continue to generate intense interest and we look forward to sharing data and perspectives that help define the scope of this important issue.

Disclaimer
The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

 

Andrew Haughwout is a vice president in the Research and Statistics Group.

Donghoon Lee is a senior economist in the Group.

Joelle Scally is an economic analyst in the Group.

Wilbert van der Klaauw is a senior vice president in the Group.

Source: Speed Kills

click for complete infographic

The editors at Best Psychology Degrees decided to research the topic of:
The United States of Conspiracy

12 of the weirder things Americans believe.

- Barack Obama is the anti-Christ (13%)
- A “New World Order” is conspiring to rule the world (28%)
- The government covered up a UFO crash at Roswell in 1947 (21%)
- Bigfoot and Sasquach (14%)
- The moon landing was faked (7%)
- Paul McCartney died in 1966 and was replaced by a lookalike so The Beatles could continue (5%)
- The government adds fluoride to the water supply for sinister (not health) reasons (9%)
- Shape-shifting reptile people control the world (4%)
- Exhaust seen in the sky behind airplanes is actually chemicals sprayed by the government for sinister reasons (5%)
- The sun revolves around the earth (18%)
- The media or the government add secret mind-controlling technology to TV broadcast signals (15%)
- The number 13 brings bad luck (18%)

 

 

Image compliments of Best Psychology Degrees

 

My afternoon train reading:

• Boom or Bubble? (The New Yorker) but see Is This the Best Time for Investors? Don’t Bet On It. (WSJ)
• How Benjamin Graham Revolutionized Shareholder Activism (Echoes)
• Dear NYSE: Canceling Trades Destroys The Integrity of The Market (Kid Dynamite’s World)
• Telling the Truth on Fees, Warts and All (NYT) see also Making your financial adviser measure up (MarketWatch)
• Gross to Buffett Omens Disregarded as Sales Soar (Bloomberg)
• What’s Holding Back Hiring? (Real Time Economics)
• Wall Street Deregulation Advances Despite Warnings Vote Could ‘Haunt’ Congress (HuffPo)
• How much? Samsung swipes 95% of Android profits (Digital Trends)
• Tesla’s fight with America’s car dealers (CNN Money)
• 12 reasons X-Prize billionaires are cheapskates (MarketWatch)

What are you reading?

 

Where International Migration Passes Natural Population Increase (Births ‐Deaths): 2012 to 2060

Source: Census

Here is a good valumentum (value + momentum) screen we came up with using FusionIQ
http://www.fusionmarketsite.com/?p=9501

It’s time for another installment of FusionIQ’s Screen Pass.  IQ Screen Pass utilizes FusionIO’s proprietary metrics along with widely followed industry metrics to create high level investing and trading screens.  Today’s edition of Screen Pass looks for stocks that combine both Value and Momentum, or as we like to call it … Valumentum.

The variables used in today’s screen are as follows: (1) Fusion Technical Scores (ETech) between 70 – 100; (2) Market Cap (EMC) of > $ 1 billion; (3) Trading Volume (EV) of 500,000 or >; (4) Closing Price (Price) of > $ 5; (5) Price to Sales Ratio (PSR) of < 1.9; (6) Forward P/E < 18; (7) Price to Growth Ratio (PEG) of < 1.5; and (8) out-performance vs. the S&P 500 (market) over the last 4 weeks of > 5 % (PM4W).

With the market rising a lot of late, we wanted to add a value component to our momentum inputs, to gives us the best of both worlds.

Eight stocks hit today’s list; E-Trade Financial (ETFC), Genworth Financial (GNW), Dresser-Rand Group (DRC), Eaton Corp (ETN), Dicks Sporting Goods (DKS), United Rentals (URI),Pier 1 Imports (PIR) and Foot Locker (FL).

Click to enlarge

Last week, I mentioned Merrill Lynch’s Market Analysis Technical Handbook. I was somewhat smitten by the wire house attempt to explain the basics of technicals to a broader layperson audience.

Several BP readers at Mother Merrill (as she used to be known) directed my attention to another annual release: US Quantitative Primer 2013. It is described thusly:

Everything you wanted to know about Quant
Our fourth publication of the Quantitative Primer includes historical charts and
explanations of the proprietary stock screens that we draw upon in our strategy
work, and which we use as a crucial input into our investment views. What’s new:

This year, we have added a few new features, including an in-depth focus on what drives market performance, an analysis of quantitative factor sensitivity to macro variables, and an update to our roadmap for stock pickers including historical intra-stock correlation charts for each industry group.

Again, color me impressed that a big firm would put out a document that at its heart challenges many of the fundamental principles the rest of the firm is built upon.

I do not see a public link for this one (either) but I have put in a request.

 

 

 

Source:
Everything you wanted to know about Quant
Savita Subramanian
Equity & Quant Strategist
MLPF&S