Philadelphia Fed’s Charles Plosser Warns of Risks from QE Forever

In addition to Richmond Federal Reserve’s Jeffrey Lacker, the Fed’s recent QE ‘forever’ has elicited another dissenting insider opinion.

Federal Reserve Bank Bank of Philadelphia President Charles Plosser says that the FED’s measures will not only miss attaining the targeted economic goals but would lead to hefty unforeseen risks.

Here is why employment goals won’t be reached, from SFGate/ Bloomberg, (Bold emphasis mine)

Federal Reserve Bank of Philadelphia President Charles Plosser said new bond buying announced by the Fed this month probably won’t boost growth or hiring and may jeopardize the central bank’s credibility.

“We are unlikely to see much benefit to growth or to employment from further asset purchases,” Plosser said in a speech today at the district bank in Philadelphia. “Conveying the idea that such action will have a substantive impact on labor markets and the speed of the recovery risks the Fed’s credibility.”…

Plosser said today that central banks can’t effectively target employment levels the same way they can guide inflation rates because hiring also depends on variables unrelated to monetary policy, such as technology, education and tax rates.

“It doesn’t make sense to say that there is a particular unemployment rate that we can achieve,” Plosser told reporters after his speech. “The problem with the labor markets is there are many things that affect employment and unemployment that are beyond the control of the Fed.”

Mr. Plosser acknowledges that in a highly complex world, oversimplified centralized or political solutions can lead to unintended consequences.

Mr. Plosser fails to add that policies such as added taxes and regulations impact investments (aside from monetary policies) and thereby employment levels. The mainstream's favorite indicator, employment, represents an effect from business spending and not the cause.

Small businesses which make up the bulk of the source of US employment has been suffering from tax and regulatory policies (chart from advisor perspectives).

I would like to point out that while poor sales has also been an important concern, poor sales are symptoms of an underlying disease.

Relative economic freedom, the US has been on a decline since 2000 or when the FED began to massively inflate the system (chart from Cato Institute)

Mr. Plosser also believes that the Fed’s latest QE will lead to significant risk of consumer price inflation…

“I opposed the Committee’s actions in September because I believe that increasing monetary policy accommodation is neither appropriate nor likely to be effective in the current environment,” Plosser said. “Every monetary policy action has costs and benefits, and my assessment is that the potential costs and risks associated with these actions outweigh the potential meager benefits.”…

The Fed’s “hard-won credibility” is crucial because if the public doesn’t have confidence in policy makers, their ability to set effective monetary policy will be harmed, hurting households and businesses, Plosser said. If people believe the central bank will delay raising rates, they may “infer that the Fed is willing to tolerate considerably higher inflation,” spurring an increase in inflation expectations that would require a response from the FOMC, Plosser said.

“The Fed’s most recent actions carry with them significant risks,” Plosser said. “I am not forecasting that those risks will necessarily materialize and I hope they will not. But if they do, they could prove quite costly to the economy.”

And Mr. Plosser suggests that the Fed has been trapped, where exiting from current measures would likely be highly disruptive.

Plosser said in response to audience questions that he’s “worried that the actions we are taking to make our balance sheet bigger entail risks and those risks could be quite substantial.”

The central bank may “be forced into selling assets in the open market” when it needs to reduce stimulus, he said. Policy makers “must be aware of the consequences,” from their decisions.

In short, Mr. Plosser warns of two possible consequences from current the policy of QE forever: massive inflation or boom bust cycles, both of which would only destabilize the US and global economies.

Mr. Plosser’s warning eerily resonates with the admonitions of the great Professor Ludwig von Mises

The wavelike movement affecting the economic system, the recurrence of periods of boom which are followed by periods of depression, is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

Video: David Stockman: Lunatics at the FED

Former US Representative and Director of the Office of Management and Budget David Alan Stockman bashes the US Federal Reserve in the video below (source LewRockwell.com)

"Ron Paul is the only one who is right about the Fed, and the Fed is the heart of the problem. They have destroyed the capital markets and the money markets; interest rates mean nothing; everything is trading off the Fed and Wall Street isn't even home – as it's now a bunch of computers trading word-clouds emitted by this central banker and that"

"The Fed (and the lunatics that run it) are telling the whole world untruths about the cost of money and the price of risk."

When markets become disconnected with economic reality as I pointed out the other day, these are signs that capital markets have become dysfunctional or capital markets have been "destroyed" from mainly from central banking policies.

The popularity of what Mr. Stockman calls as "sugar" or clamor for the FED to further intervene by monetary inflation in order to further ease credit conditions reminds me of this stirring quote from the great Professor Ludwig von Mises.(bold added)

It is vain to object that the public favors the policy of cheap money. The masses are misled by the assertions of the pseudo-experts that cheap money can make them prosperous at no expense whatever. They do not realize that investment can be expanded only to the extent that more capital is accumulated by savings. They are deceived by the fairy tales of monetary cranks from John Law down to Major C.H. Douglas. Yet, what counts in reality is not fairy tales, but people's conduct. If men are not prepared to save more by cutting down their current consumption, the means for a substantial expansion of investment are lacking. These means cannot be provided by printing banknotes or by loans on the bank books.

In discussing the situation as it developed under the expansionist pressure on trade created by years of cheap interest rates policy, one must be fully aware of the fact that the termination of this policy will make visible the havoc it has spread. The incorrigible inflationists will cry out against alleged deflation and will advertise again their patent medicine, inflation, rebaptizing it re-deflation. What generates the evils is the expansionist policy. Its termination only makes the evils visible. This termination must at any rate come sooner or later, and the later it comes, the more severe are the damages which the artificial boom has caused. As things are now, after a long period of artificially low interest rates, the question is not how to avoid the hardships of the process of recovery altogether, but how to reduce them to a minimum. If one does not terminate the expansionist policy in time by a return to balanced budgets, by abstaining from government borrowing from the commercial banks and by letting the market determine the height of interest rates, one chooses the German way of 1923.

Economic reality will inevitably and eventually prevail.

ECB’s Mario Draghi Unleashes “Unlimited Bond Buying” Bazooka, Fed’s Ben Bernanke Next?

So finally, the ECB via president Mario Draghi unleashed what seems as the penultimate “shock and awe” rescue mechanism for the EU: the supposed “unlimited but sterilized” buying of bonds.

From Bloomberg, (bold added)

European Central Bank President Mario Draghi said policy makers agreed to an unlimited bond- purchase program to regain control of interest rates in the euro area and fight speculation of a currency breakup.

The program “will enable us to address severe distortions in government bond markets which originate from, in particular, unfounded fears on the part of investors of the reversibility of the euro,” Draghi said at a press conference in Frankfurt after the ECB held its benchmark rate at a record low of 0.75 percent. “Under appropriate conditions, we will have a fully effective backstop to avoid destructive scenarios with potentially severe challenges for price stability in the euro area.”

Draghi has staked his credibility on the bond plan, which is the most ambitious yet in the central bank’s fight to wrest back control of rates in a fragmented economy and save the euro after nearly three years of turmoil. Now it’s up to governments in Spain and Italy to trigger ECB bond purchases by requesting aid from Europe’s rescue fund and signing up to conditions

“Governments must stand ready to activate the EFSF/ESM in the bond market when exceptional financial-market circumstances and risks to financial stability exist -- with strict and effective conditionality,” Draghi said. The ECB reserves the right to terminate bond purchases if governments don’t fulfil their part of the bargain, he added…

The ECB’s program, called Outright Monetary Transactions, will target government bonds with maturities of one to three years, including longer-dated debt that has a residual maturity of that length, Draghi said. Purchases will be fully sterilized, meaning that the overall impact on the money supply will be neutral, and the ECB will not have seniority, he said.

Note that ECB bond purchases have not truly been “unlimited” as they supposedly conditional to the requested “aid” by crisis stricken nations from the ESM and will be “fully” sterilized. Aside from conditionality on reforms.

As usual political terminologies matter.

The idea of full sterilization means that money will be drained from the other sectors and will allegedly be neutral. This could be the reason behind the underperformance and the tepid gains of gold and other commodities as oil and copper despite the ECB's opening of the inflation spigot.

Moreover, perhaps too, the ECB assumes that need for bond buying may be checked or will have the desired effect of providing carrot and stick approach for governments to take appropriate corrective fiscal measures.

Unfortunately this won’t likely be the case.

Not only is the bond buying going to be an incentive for delaying the necessary reforms for the PIGS (out of moral hazard dilemma), but the ECB’s sterilization activities will likely be also restricted.

University of Chicago Professor John Cochrane at the Bloomberg explains…...

If past were to rhyme, in November of last year, the ECB has missed sterilizing her purchases.

So if the ECBs action to sterilize are encumbered, then this means either that the ECBs buying will have short run effects, or that designated conditions represents smoke and mirrors which may pave way for the massive unsterilized actions or monetary inflation.

Nonetheless, I think the ECB’s unlimited option has been coordinated with the US Federal Reserve.

Just a few days back, four Federal Reserve presidents discussed of the same open-ended buying option.

From another Bloomberg article,

Federal Reserve Chairman Ben S. Bernanke says the U.S. economy is “far from satisfactory.” His colleagues are moving to embrace policies that will stay in place until he’s satisfied.

Four Fed presidents have come out in favor of an open-ended strategy for bond buying, with three calling for the program to begin now. Rather than specify a fixed amount of bonds to purchase by a certain date, such a strategy would leave the Fed able to announce a pace of purchases that it could adjust as the economy gets closer to Bernanke’s goals.

“You would be able to react to the incoming data in an incremental way and not be in a situation where you have to either drop the bomb or do nothing,” St. Louis Fed President James Bullard said in an interview last week during the Fed’s annual monetary policy symposium in Jackson Hole, Wyoming.

Bernanke used the forum to defend unorthodox policies such as bond purchases and made the case for further action to reduce an unemployment rate that he called a “grave concern.” Stocks and Treasuries jumped after the speech as investors increased bets the Fed will opt for further easing as soon as its next meeting Sept. 12-13.

I am inclined to the view that the FED will move to compliment the ECB for political reasons. I think that Bernanke’s tenure depends on President Obama’s re-election and thus would work to ensure of policies that will be “stock market friendly”

And as I previously said, the combined actions by central banks will eventually lead to deepening stagflation manifested through high consumer prices and the real risks of a food crisis that amplifies risks of social instability, as well as, overseas bubbles.

Central bank fixes has only short term narcotic effects, that risks long term unintended consequences.

As the great Professor Ludwig von Mises presciently warned,

But the boom cannot continue indefinitely. There are two alternatives. Either the banks continue the credit expansion without restriction and thus cause constantly mounting price increases and an ever-growing orgy of speculation, which, as in all other cases of unlimited inflation, ends in a “crack-up boom” and in a collapse of the money and credit system. Or the banks stop before this point is reached, voluntarily renounce further credit expansion and thus bring about the crisis. The depression follows in both instances.

For now, the risk ON “orgy of speculation” environment may have been activated based on a partial fulfilment of market’s addiction for central bank steroids.

But given the vagueness of conditionalities from the ECB program and of the response by other central bankers to real economic events, the sustainability of such risk ON conditions remains unclear.

We are approaching the Mises moment.

Risk Of Food Crisis Creeping Back?

In a recent article Whatever happened to the food crisis?, The Economist drudges anew over the enigma of conflicting developments: rising food prices in a recessionary environment.

Nonetheless like us they see the risks of a food crisis creeping back.

(bold emphasis mine)

``If this was happening during a boom, it might be understandable. But recession would normally dampen down price rises. So what explains the return of food-price inflation? And does it mean that the so-called world food crisis is returning?

``There are two clusters of explanation: cyclical factors—features of the farm cycle and world economy that fluctuate from season to season—and secular, long-term factors. Cyclical influences include re-stocking: cereal stocks were run down as prices spiked and need to be replenished. In 2006 and 2007, stocks fell below 450m tonnes, about 20% of consumption; now they are back up over 520m, or 23%. That is one source of new demand. Another comes from ethanol. As oil prices rise, ethanol starts to be competitive again (as a rule of thumb, ethanol is profitable when petrol costs $3 a gallon in America, a level it has just reached in California). The fall in the dollar and in freight rates has also kept the local-currency costs of importing a tonne of cereals lower than dollar-denominated world prices. This has encouraged many countries to buy more.

``Lastly, it is possible that the widespread hunger brought about by soaring prices—the FAO says a billion people will go hungry this year—may have reached a peak and the poor may be back in the market for grain again. This may sound unlikely, as traditionally poor consumers have had little influence over world food prices, but economic growth has continued in the largest emerging markets (notably China and India) and governments in much of the developing world have been expanding aid programmes for the poor, such as conditional cash-transfer schemes. That may be boosting demand; it would explain why prices of grain, which everyone eats, have been rising this year while prices of meat—the food of the rich and aspiring middle classes—have continued to fall."


My comment: So cyclical factors of restocking, rising oil prices (transmitted via the ethanol channel) and low prices could have contributed to a demand boost, although the Economist admits that government programs-such as aid expenditures could have also been key variables.

And as we have long mentioned inflationary policies impact prices relatively. It affects sectors that are the primary beneficiaries of government programs- in this case, aid spending which could have resulted to the disparities between meat and grain price trends.

However, sustained government fiscal spending is likely to cause a diffusion of increases consumer which means that even meat prices will likely increase over time.

The Economist adds some important secular trend dynamics,

``But the world food crisis of 2007-08 showed that food prices are not influenced solely, or even mainly, by cyclical factors. They soared in large part because of slow, irreversible trends: population growth; urbanisation; shifting appetites from grain to meat in developing countries. There is no sign that these trends are abating."

Finally, the Economist imputes regulatory and political obstacles as substantially distorting the marketplace.

``The failure of farmers in poor countries to respond to price signals does not mean they are deaf to them. Rather the signals they get are often scrambled or muted. Farmers were frequently not paid the full world price for their crops, because governments were determined to keep local prices low in order to relieve hard-pressed consumers. Some governments also banned food exports.

``Even in rich countries, farmers are responding to many things other than food markets. Take oil prices, for example: these (and government subsidies) determine how much maize is planted for ethanol. That in turn influences how much land is planted to soyabeans, which for American farmers are interchangeable with maize. Growers are also responding to the flow of investment capital into farming as a result of the global financial meltdown. Food is recession-resistant, and farming has been one of the sectors least affected by the worldwide slump. The FAO’s Abdolreza Abbassian argues that increasing links between farming and other parts of the economy are making it more difficult for farmers to calculate in advance the profitability of any one crop, so the area they plant is tending to fluctuate more sharply from year to year. Farming—as the past two years have clearly demonstrated—is becoming a more volatile business, both in terms of price and area planted."

``On the face of things, markets last year were adjusting exactly as economic theory predicts they should: prices rose, drawing investment into farms; supplies then rose sharply, pushing prices down. But that was not the whole story. The price fluctuations of 2007-09 suggested that uncertainty in the world of agriculture was deepening under the influence both of oil prices and capital flows. The fact that prices are still well above their 2006 average, even in a recession, suggests that the spike of 2008 did not signal a mere bubble—but rather, a genuine mismatch of supply and demand. And this year’s price increase suggests that there is a long way to go before that underlying mismatch is eventually addressed. “I don’t see that anything has fundamentally changed,” says Mr Abbassian. “That means we cannot go back to where we were in 2007.”

While the Economist alludes to capital flows as another variable in passing, it didn't dwell on the influence of global monetary policies -where zero bound interest rates and a loosened credit policy environment have sparked credit booms in emerging markets as China and may have added further pressures on the demand side.

At the end of the day, the growing risks of a food crisis all boils down to extensive government intervention that has deadened market price signals, and severely distorted the balance of supply and demand.

Aside, this could also possibly signify a flight to commodities or the crack up boom phase of our Mises moment.