LIVE VIDEO: Fed Chair Ben Bernanke Speaks 1:00PM EST

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Fed Chairman Ben Bernanke speaks live at the conference hosted by the Federal Reserve Bank of Atlanta on Resilience and Rebuilding for Low-Income Communities. 

Bernanke is delivering the lunch keynote speech. Comments made will be vigorously dissected for any indication of the Fed’s reaction to recent weak economic data including lower consumer confidence, weak jobs, declining PPI, and weak retail sales. Gold prices and equities have fallen but may find support on dovish comments by the Fed chair:

 

Bad Times For Gold Are Soon To End

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Gold’s lackluster performance has disappointed many gold investors, including myself, though the tide appears on the brink of changing in everything but the price. For the last couple quarters, we have heard how central banks are getting ready to unwind their unprecedented monetary efforts of the past. A global recovery has been the mainstream consensus since the new year, and stocks have not disappointed those touting the recovery.

The economic recovery justification, however, at least appears to be withering. Last Friday’s job numbers showed the lowest participation rate since 1979 and disappointed on the headline number, with only 88K jobs created, against a 200k market expectation.

Read the rest on SeekingAlpha

Debunking Popular Bitcoin Myths

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Prominent and respected gold investors, including the likes of Doug Casey and Peter Schiff, generally seem to have some resistance to bitcoin due possibly to flawed notions about the new digital currency now currently making waves.

Let’s review and debunk some of these misconceptions.

Myth #1: Bitcoin have no worth

In Austrian economics, a common theoretical foundation of gold advocates, monetary worth evolves from a value regression theorem originally proposed by the great economist Ludwig von Mises. Many gold proponents of the Austrian school have looked upon the regression theorem as reason to deny bitcoin any worth.

The basic theorem states that purchasing power must arise from somewhere. If we trace a currency’s ability to purchase items down the historical line, we must eventually find a value origination. This leads to the conclusion that all monies must have some value as a commodity prior to becoming a medium of exchange to justify a market value of worth thereafter.

The basic accusation then leveled at bitcoin by those attempting to interpret Mises’ theory is that they contain no utility outside of being a medium of exchange and, therefore, no worth.

Debunking the Myth

Its an odd thing to have to prove the purchasing power of bitcoin when items retail for them, and all major currencies have reasonably liquid markets into them. The more noble effort is describing the phenomenon at this point.

Nonetheless, the regression theorem is powerful and this theory was my first inclination as well when I initially learned about bitcoin. As much as a couple years later and a better reading of Mises and understanding of bitcoin have led me to realize the theorem is simply being misapplied as bitcoin are misunderstood.

Bitcoin are merely a free floating transaction environment that has evolved into a money. Bitcoin at the start were acquired not for cash, but were mined by those providing the computational needs and basic support of the network infrastructure. Once a trusted network was constructed, it was only then market makers bartered in and out at prevailing market rates of bitcoin services to cash or goods and services. And as the story of all monies go, since this bartered trade is inherently network friendly, the increased usage increases the attraction and the early self-propagating compounding effect of monetary development and domination gets underway.

Myth #2: Bitcoin are like fiat money

Bitcoin are digital in a similar nature as Federal Reserve liabilities and, therefore, harbor no supply restraints like gold.

Debunking the Myth

Bitcoin function under a highly encrypted algorithm which control the output of their creation at about 1 bitcoin every 10 minutes, and this rate is halving every four years until all coins are expectedly created in the year 2140. All spending of bitcoin updates a central ledger which the network verifies down the chain of all bitcoin ever spent. The bigger the trusted network grows the harder penetrating its chain will be. Bitcoin are about as difficult to recreate now as performing gold alchemy or stumbling on newly accessible mineral deposits for all intent and purposes.

The Federal Reserve, on the other hand, has no such network verifying against double spending. This gives ways to the Fed and bank’s practice of double spending money all the time. None of these features of central bank issued fiat money are present in the bitcoin network.

Myth #3: Bitcoin are a bubble on the brink of bursting

Bitcoin prices have been driven to astronomical heights in a short period. So the thinking goes, ‘I do not know many retailers dealing in bitcoin and therefore the market must be filled with hot air. Perhaps bitcoin are even a ponzi scheme, with early holders and buyers reselling promises for more money and so on’.

Debunking the Myth

The speed at which Bitcoin prices have risen is directly related to their market exposure. More interest has come into bitcoin from mainstream media and the demand to purchase them is heavily queued even still. Given the restrained supply, whose growth rate is halving this year, this spells price increases no matter how you look at it. The growth in bitcoin prices alone has improved the allure of the industry, with even wider coverage spawning by the day and more fundamental industry services and merchants popping up.

In today’s world bitcoin are particularly sought after for more than their general efficiency and anonymity. Central banks around the world are on a race to the bottom with respect to their sovereign currency value. Moreover growing fears of capital controls following the crises in Cyprus and Latin America have increased the need of a mobile anonymous transaction medium such as bitcoin.

Retail acceptance is just getting underway with merchant tools on the rise and if major inroads are made the current price will seem an extreme bargain. There is certainly nothing inherently unstable or ponzi about bitcoin.

What Bitcoin Mean for Investors

Bitcoin are definitely stealing some shine from precious metals like gold as they serve similar purposes. Bitcoin show superiority in some ways, however, given that they are cheaper to access, store and transact with. Bitcoin are still a very small market in comparison to gold or silver, however, and while this will mean increased volatility perhaps it also means increased opportunity.

I suspect we are in the early days of this market and there is a lot of catch up before bitcoin can be considered as overvalued relative to precious metals.

VIDEO: Watch Bernanke Q&A with Reporters

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Following the Fed’s 2:00pm monetary policy statement, Chairman Ben Bernanke delivered the central bank’s testimony to reporters followed by a Q&A. 

Watch the full video of the Fed’s news conference: 

See the Fed’s economic projections for the real GDP, unemployment rate, PCE inflation and the Fed’s projected policy targets:

Bernanke Claims Fed Bankruptcy is Irrelevant

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The most interesting part of yesterday’s testimony by Chairman Ben Bernanke before the House Financial Services Committee is unlikely to be reported anywhere else. Late into an unusually uneventful question and answer period with the Fed Chair, Congressmen Scott Garrett finally livened the room up with an excellent question regarding Fed solvency.

BACKGROUND: The Solvency Crises Facing the Fed

Many do not realize that to some extent the Fed reports a balance sheet in a similar fashion to any company, with assets, liabilities and capital/equity. The Fed takes unusually large liberties in how they value their assets, but nonetheless they concede some valuations on these financial line items.

The Fed’s balance sheet at present is precariously standing on a very low capital level (assets minus liabilities). While the Fed has massively expanded their asset holdings, from a few hundred billion before the crisis to now over $3 trillion, the Fed’s capital has failed to grow. This is partly because the Fed remits their excess earnings back to the Treasury and pays a dividend to the private banks who hold shares in the Fed. An added reason for the Fed’s low capital is due to the fact the Fed is frequently front run on their purchases as announcements predate action. The failure of the capital in the Fed to grow while outstanding assets rise leads to an increasing leverage within the Federal Reserve system.

Fed Balance Sheet at a Glance (values in millions of dollars)

Assets Liabilities
Gold certs 11,037 Federal Reserve Notes net of Banks Holdings 1,127,723
SDR certs 5,200 Reverse repos 93,121
Coin 2,206 Deposits 1,808,112
Securities, repos & loans 2,844,229 Deferred cash items 1,640
Maiden Lane, TALF Portfolios 1,990 Other liabilities and dividends 11,224
Items in collection process 573
Bank premises 2,308
Central Bank Swaps 5,192
Other Assets 224,068
Total Assets 3,096,802 Total Liabilities 3,041,820
Total Capital/Equity 54,982

Leverage is calculated by dividing equity by assets to determine by what multiple a percent change in assets will impact capital. Say the Fed was leveraged 10 to 1, having $1 billion in capital against $10 billion in assets. If the Fed loses 10% on their asset holdings, -$1 billion, then this wipes out 100% of their capital. Since 10% loss on assets led to 100% loss on capital, a 10 to 1 leverage ratio is used to describe this capital sensitivity to asset losses.

At present the Fed is leveraged a whopping 55 to 1. This means even a modest 2% loss on the Fed’s assets will wipe out their entire capital base:

Image shows Federal Reserve Leverage against the Average Leverage of Financial Institutions:
Federal Reserve leverage exceeds financial institution average

There has been a lot of uncertainty as to what the Fed going insolvent actually means. Traditionally central banks are supposed to be self-funded, their expenses are meant to be paid out of interest earnings. In times where the Fed has been or is anticipated to be short on capital, the Treasury has provided supplementary financing to the Fed.

The threat of a Fed insolvency is more a political issue than anything technically impairing to the Fed in terms of continuing operations. The Fed’s liabilities are not redeemable so they can never become cash flow insolvent in a bank run environment one normally associates with a bank bankruptcy. The Fed has infinite power to issue further liabilities so is in no way technically restrained by having their capital wiped clean. The Fed can easily fund their operations internally by issuing liabilities, though indirect routes are more likely to be taken to skirt the political mess associated with such a scenario.

Whether the Fed can legally operate without seeking financing from the Treasury in the event their capital is wiped thin is the biggest question that still remains. I wish this would be addressed to the Fed chairman, or preferably the Fed’s legal council directly so we can finally validate where the Fed stands given a capital deficiency.

Bernanke Says Insolvency Does Not Matter

In the video exchange below between Congressmen Scott Garrett and Fed Chairman Ben Bernanke, the Fed chair revealed that a defunct Fed capital base is ‘irrelevant’. The chairman claims the Fed is sitting on unrealized capital gains and some other mysterious source of funding that will assist the Fed given a capital shortage. Moreover, the Fed argues that even if the Fed has no capital, the issue is irrelevant as Fed liabilities are non redeemable. 

As for the Fed’s capital gains, this is really a meaningless factor. The Fed is the major purchaser of the assets they hold, so just because they are willing to pay higher prices for similar assets to what they own already, does not mean a major liquidation of those assets would fetch a similar price in the market outside the Fed. In fact, estimates are that the Fed may lose hundreds of billions upon liquidation of their assets based on the same stress test factors the Fed uses to analyze banks. 

See the full exchange between Scott Garrett and Ben Bernanke: 

A Fed Bankruptcy Can Destroy Fed Credibility, Impacting Asset Prices

Assuming there is no legal ramification, and the political environment is accepting of a bankrupt Fed, why should any of this matter? Simply put there is a grave impact on monetary policy operation based on whether or not the Fed has absorbed capital losses. The Fed’s asset levels in relation to their liabilities represent the prowess of the Fed in selling assets and absorbing back their liabilities. Should the Fed want to reign in liquidity by calling back their liabilities, they need to supply assets of equal worth to maintain full control over their liabilities. If the Fed’s asset won’t fetch an equal amount in liabilities in the market place, the liabilities issued by the Fed are then stuck in the system and the Fed is marginally more impotent in their conduct of a tightening policy.

With the Fed less able to tighten liquidity, the Fed’s credibility is likely to wither and inflation expectations are likely to rise. This can have a grave impact on asset prices and precious metals, like the price of gold, would certainly react strongly from their own perspective. 

Bernanke Solidifies Gold Path to $2,000/oz

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Following comments from the Federal Reserve Chairman Ben Bernanke before the senate banking committee, the price of gold rose significantly. The Fed Chairman was on an all out mission today to debunk fears of whether or not the current quantitative easing program underway by the Fed is likely to continue at full speed.

Questions about inflation were answered with appeals to emotions for the unemployed. Bernanke saw the risks to the Fed’s actions as mythical and his remarks were biased just enough to confirm that he is trying to persuade markets of the Fed’s convinction in their policy.

You Heard it Here First

I’ve been arguing since the Fed’s last two policy minutes releases that the notion of an early Fed exit from their record stimulus was unwarranted. The internal dissent over the Fed’s action was louder and more abundant than markets are used to but was all coming from Fed members who hold little influence over the effective policy. The chairman, Ben Bernanke, vice-chair Janet Yellen and NY Fed president Bill Dudley have been increasingly dovish and united so should be persuading markets of the chances of an incline in stimulus rather than a halting.

Senators and Fed Chairman Don’t Understand Monetary Policy

The ignorance over monetary policy by the leaders sitting on the banking committee is astounding. As a Fed critic myself, I normally enjoy when a critical member of Congress attacks the Fed but too frequently their attacks are improperly communicated and ripe with errors. Senators Bob Corker and Richard Shelby were perfect examples of committee members who attacked Bernanke without the right tools, but still managed to beget some added errors from Bernanke himself.

We’ll leave Shelby’s failure to understand what the Fed has purchased aside and instead focus on Corker. During an exchange with Senator Corker, Bernanke was asked about the Fed’s independence given their plan to pay interest on reserves as a means of taming inflation and gave two very odd answers.

For those who don’t know, basically the Fed plans to control inflation by paying an attractive interest rate to banks, sometimes called IOR, who store their money at the Federal Reserve. By doing so, the Fed ‘contains’ this money from being lent out and multiplying through credit markets which would pressure up aggregate prices otherwise.

Bernanke’s first answer is that the tax payer benefits from interest on reserves. Bernanke explains that on the one hand the Fed has reserves which represent their funding cost and the other hand they have securities which produce yields. If their securities yield more than their funding cost then the Fed garners a profit which they can remit to the Treasury.

All of this is fine except the first part, where Bernanke insinuates that the paying of reserves is part of the benefit to tax payers. The only conceivable benefit exists after the cost of funding is factored in, so who knows Bernanke is saying here. The higher the Fed’s cost of funding, the less the Fed can remit to the Treasury because their earnings spread diminishes. Moreover it is curious that Bernanke thinks the Fed’s cost of funding will be less than their securities. Keep in mind the Fed has accumulated their portfolio during historic lows for interest rates. If the Fed needs to raise the rate they pay on reserves to any substantive amount, the Fed will on net be accumulating losses on ongoing basis as their interest expense exceeds their earnings. The Chairman could retort that reserve balances are lower than their total assets, but this doesn’t factor what reserve balances might be during a period where the Fed is trying to attract higher reserve balances.

Corker then went at Bernanke saying that the Fed is threatening their independence by enriching banks with the interest that they paid only for Bernanke to respond that this is a myth. Bernanke said that the banks will get paid market rates, and not receive a subsidy in terms of their interest payments on their reserves. This is another highly questionable response by the Fed chairman and especially when done trying to debunk someone else’s supposed myth. The whole purpose of paying interest on reserves is to sway investors from engaging in risky market activities which are not represented by high enough yields following previous Fed stimulus. The Fed accomplishes this by offering risk free interest to banks which, if even at the same level as banks would receive elsewhere, is a subsidy given the risk free nature of the loan. Without an incentive over the market the Fed’s interest on reserve policy is impotent.

Bernanke basically made absolutely no sense in either of these responses and someone should seriously question his qualifications based on these answers.

See the full exchange referenced between Senator Bob Corker and Ben Bernanke:

The reality of interest on reserves, for those interested in the bigger picture, is that they are temporary measures. Its odd when they are listed as a part of the Fed’s exit strategy when in reality all they do is dig the Fed deeper into a bind. The policy simply persuades banks to hold their reserves at the Fed for the time being by allowing banks to walk away with more money than they deposited for doing so. Therefore interest on reserves really are inflationary as banks have no desire to donate money to the Fed and only hold cash at the Fed to defer future spending while earning an attractive interest rate in relation to the risks. How then does the Fed unwind from the build up in reserves which banks will eventually spend? What’s the exit strategy from the exit strategy? Seems like Bernanke has lost his totem to differentiate dream and reality.

Dollar Up, Stocks Up, Gold up

US dollar (USD) and Japanese Yen (JPY) rise throughout Bernanke’s testimony:The dollar and yen rise following Bernakne's testimony before the Senate.

Curiously the dollar performed well throughout Bernanke’s testimony even as gold ascended. This seems to be related to a risk off sentiment in the currency markets following the on going news from yesterday that Italy is presently unable to form a government. The risk off story seems to have weight as the dollar’s strength has been accompanied by strength in the yen as well, the other major funding currency. As swap lines draw down from the Fed, remember the Fed set up credit lines for the European Central Bank to use to supply dollars when they become scarce in Europe, the dollar will resume its decline. This is made more true by the Fed being the most expansionary major central bank, printing $85 billion a month on net, and will impact not only the dollar but all assets, most especially gold.

$2,000 Gold

I have noted this before and continue to target the gold price at $2,000/oz for the end of 2013. The number is not just a pretty whole number but is derived by my conservative estimate of the growth in the Fed’s balance sheet and applying a similar growth trajectory to the price of gold. The pretty number only plays a small part. Given that the market seems to expect little movement from the Fed and even a teetering off of Fed stimulus, the continued efforts by the Fed will surprise gold markets on the upside.

In the coming weeks Bernanke and the Fed leadership will likely reiterate their commitment to maintaining policy stimulus and slowly but surely the market will begin to believe them. I even believe there is a chance stimulus measures increase as early as the Fed’s next meeting at the end of March. In the least Bernanke will use his press conference following their next statement to solidify further the case for gold. Each appearance by the Fed Chairman seems targeted to this end now, and tomorrow’s testimony before the House Financial Services Committee should be no different.

Bernanke Testimony, Full Text

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See full text of Bernanke’s testimony before Congress below. Follow live gold prices in real time as Bernanke speaks.

Chairman Ben S. Bernanke
Semiannual Monetary Policy Report to the Congress
Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, Washington, D.C.
February 26, 2013
Chairman Johnson, Ranking Member Crapo, and other members of the Committee, I am pleased to present the Federal Reserve’s semiannual Monetary Policy Report. I will begin with a short summary of current economic conditions and then discuss aspects of monetary and fiscal policy.

Current Economic Conditions
Since I last reported to this Committee in mid-2012, economic activity in the United States has continued to expand at a moderate if somewhat uneven pace. In particular, real gross domestic product (GDP) is estimated to have risen at an annual rate of about 3 percent in the third quarter but to have been essentially flat in the fourth quarter.1 The pause in real GDP growth last quarter does not appear to reflect a stalling-out of the recovery. Rather, economic activity was temporarily restrained by weather-related disruptions and by transitory declines in a few volatile categories of spending, even as demand by U.S. households and businesses continued to expand. Available information suggests that economic growth has picked up again this year.

Consistent with the moderate pace of economic growth, conditions in the labor market have been improving gradually. Since July, nonfarm payroll employment has increased by 175,000 jobs per month on average, and the unemployment rate declined 0.3 percentage point to 7.9 percent over the same period. Cumulatively, private-sector payrolls have now grown by about 6.1 million jobs since their low point in early 2010, and the unemployment rate has fallen a bit more than 2 percentage points since its cyclical peak in late 2009. Despite these gains, however, the job market remains generally weak, with the unemployment rate well above its longer-run normal level. About 4.7 million of the unemployed have been without a job for six months or more, and millions more would like full-time employment but are able to find only part-time work. High unemployment has substantial costs, including not only the hardship faced by the unemployed and their families, but also the harm done to the vitality and productive potential of our economy as a whole. Lengthy periods of unemployment and underemployment can erode workers’ skills and attachment to the labor force or prevent young people from gaining skills and experience in the first place–developments that could significantly reduce their productivity and earnings in the longer term. The loss of output and earnings associated with high unemployment also reduces government revenues and increases spending, thereby leading to larger deficits and higher levels of debt.

The recent increase in gasoline prices, which reflects both higher crude oil prices and wider refining margins, is hitting family budgets. However, overall inflation remains low. Over the second half of 2012, the price index for personal consumption expenditures rose at an annual rate of 1-1/2 percent, similar to the rate of increase in the first half of the year. Measures of longer-term inflation expectations have remained in the narrow ranges seen over the past several years. Against this backdrop, the Federal Open Market Committee (FOMC) anticipates that inflation over the medium term likely will run at or below its 2 percent objective.

Monetary Policy
With unemployment well above normal levels and inflation subdued, progress toward the Federal Reserve’s mandated objectives of maximum employment and price stability has required a highly accommodative monetary policy. Under normal circumstances, policy accommodation would be provided through reductions in the FOMC’s target for the federal funds rate–the interest rate on overnight loans between banks. However, as this rate has been close to zero since December 2008, the Federal Reserve has had to use alternative policy tools.

These alternative tools have fallen into two categories. The first is “forward guidance” regarding the FOMC’s anticipated path for the federal funds rate. Since longer-term interest rates reflect market expectations for shorter-term rates over time, our guidance influences longer-term rates and thus supports a stronger recovery. The formulation of this guidance has evolved over time. Between August 2011 and December 2012, the Committee used calendar dates to indicate how long it expected economic conditions to warrant exceptionally low levels for the federal funds rate. At its December 2012 meeting, the FOMC agreed to shift to providing more explicit guidance on how it expects the policy rate to respond to economic developments. Specifically, the December postmeeting statement indicated that the current exceptionally low range for the federal funds rate “will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.”2 An advantage of the new formulation, relative to the previous date-based guidance, is that it allows market participants and the public to update their monetary policy expectations more accurately in response to new information about the economic outlook. The new guidance also serves to underscore the Committee’s intention to maintain accommodation as long as needed to promote a stronger economic recovery with stable prices.3

The second type of nontraditional policy tool employed by the FOMC is large-scale purchases of longer-term securities, which, like our forward guidance, are intended to support economic growth by putting downward pressure on longer-term interest rates. The Federal Reserve has engaged in several rounds of such purchases since late 2008. Last September the FOMC announced that it would purchase agency mortgage-backed securities at a pace of $40 billion per month, and in December the Committee stated that, in addition, beginning in January it would purchase longer-term Treasury securities at an initial pace of $45 billion per month.4 These additional purchases of longer-term Treasury securities replace the purchases we were conducting under our now-completed maturity extension program, which lengthened the maturity of our securities portfolio without increasing its size. The FOMC has indicated that it will continue purchases until it observes a substantial improvement in the outlook for the labor market in a context of price stability.

The Committee also stated that in determining the size, pace, and composition of its asset purchases, it will take appropriate account of their likely efficacy and costs. In other words, as with all of its policy decisions, the Committee continues to assess its program of asset purchases within a cost-benefit framework. In the current economic environment, the benefits of asset purchases, and of policy accommodation more generally, are clear: Monetary policy is providing important support to the recovery while keeping inflation close to the FOMC’s 2 percent objective. Notably, keeping longer-term interest rates low has helped spark recovery in the housing market and led to increased sales and production of automobiles and other durable goods. By raising employment and household wealth–for example, through higher home prices–these developments have in turn supported consumer sentiment and spending.

Highly accommodative monetary policy also has several potential costs and risks, which the Committee is monitoring closely. For example, if further expansion of the Federal Reserve’s balance sheet were to undermine public confidence in our ability to exit smoothly from our accommodative policies at the appropriate time, inflation expectations could rise, putting the FOMC’s price-stability objective at risk. However, the Committee remains confident that it has the tools necessary to tighten monetary policy when the time comes to do so. As I noted, inflation is currently subdued, and inflation expectations appear well anchored; neither the FOMC nor private forecasters are projecting the development of significant inflation pressures.

Another potential cost that the Committee takes very seriously is the possibility that very low interest rates, if maintained for a considerable time, could impair financial stability. For example, portfolio managers dissatisfied with low returns may “reach for yield” by taking on more credit risk, duration risk, or leverage. On the other hand, some risk-taking–such as when an entrepreneur takes out a loan to start a new business or an existing firm expands capacity–is a necessary element of a healthy economic recovery. Moreover, although accommodative monetary policies may increase certain types of risk-taking, in the present circumstances they also serve in some ways to reduce risk in the system, most importantly by strengthening the overall economy, but also by encouraging firms to rely more on longer-term funding, and by reducing debt service costs for households and businesses. In any case, the Federal Reserve is responding actively to financial stability concerns through substantially expanded monitoring of emerging risks in the financial system, an approach to the supervision of financial firms that takes a more systemic perspective, and the ongoing implementation of reforms to make the financial system more transparent and resilient. Although a long period of low rates could encourage excessive risk-taking, and continued close attention to such developments is certainly warranted, to this point we do not see the potential costs of the increased risk-taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery and more-rapid job creation.5

Another aspect of the Federal Reserve’s policies that has been discussed is their implications for the federal budget. The Federal Reserve earns substantial interest on the assets it holds in its portfolio, and, other than the amount needed to fund our cost of operations, all net income is remitted to the Treasury. With the expansion of the Federal Reserve’s balance sheet, yearly remittances have roughly tripled in recent years, with payments to the Treasury totaling approximately $290 billion between 2009 and 2012.6 However, if the economy continues to strengthen, as we anticipate, and policy accommodation is accordingly reduced, these remittances would likely decline in coming years. Federal Reserve analysis shows that remittances to the Treasury could be quite low for a time in some scenarios, particularly if interest rates were to rise quickly.7 However, even in such scenarios, it is highly likely that average annual remittances over the period affected by the Federal Reserve’s purchases will remain higher than the pre-crisis norm, perhaps substantially so. Moreover, to the extent that monetary policy promotes growth and job creation, the resulting reduction in the federal deficit would dwarf any variation in the Federal Reserve’s remittances to the Treasury.

Thoughts on Fiscal Policy
Although monetary policy is working to promote a more robust recovery, it cannot carry the entire burden of ensuring a speedier return to economic health. The economy’s performance both over the near term and in the longer run will depend importantly on the course of fiscal policy. The challenge for the Congress and the Administration is to put the federal budget on a sustainable long-run path that promotes economic growth and stability without unnecessarily impeding the current recovery.

Significant progress has been made recently toward reducing the federal budget deficit over the next few years. The projections released earlier this month by the Congressional Budget Office (CBO) indicate that, under current law, the federal deficit will narrow from 7 percent of GDP last year to 2-1/2 percent in fiscal year 2015.8 As a result, the federal debt held by the public (including that held by the Federal Reserve) is projected to remain roughly 75 percent of GDP through much of the current decade.

However, a substantial portion of the recent progress in lowering the deficit has been concentrated in near-term budget changes, which, taken together, could create a significant headwind for the economic recovery. The CBO estimates that deficit-reduction policies in current law will slow the pace of real GDP growth by about 1-1/2 percentage points this year, relative to what it would have been otherwise. A significant portion of this effect is related to the automatic spending sequestration that is scheduled to begin on March 1, which, according to the CBO’s estimates, will contribute about 0.6 percentage point to the fiscal drag on economic growth this year. Given the still-moderate underlying pace of economic growth, this additional near-term burden on the recovery is significant. Moreover, besides having adverse effects on jobs and incomes, a slower recovery would lead to less actual deficit reduction in the short run for any given set of fiscal actions.

At the same time, and despite progress in reducing near-term budget deficits, the difficult process of addressing longer-term fiscal imbalances has only begun. Indeed, the CBO projects that the federal deficit and debt as a percentage of GDP will begin rising again in the latter part of this decade, reflecting in large part the aging of the population and fast-rising health-care costs. To promote economic growth in the longer term, and to preserve economic and financial stability, fiscal policymakers will have to put the federal budget on a sustainable long-run path that first stabilizes the ratio of federal debt to GDP and, given the current elevated level of debt, eventually places that ratio on a downward trajectory. Between 1960 and the onset of the financial crisis, federal debt averaged less than 40 percent of GDP. This relatively low level of debt provided the nation much-needed flexibility to meet the economic challenges of the past few years. Replenishing this fiscal capacity will give future Congresses and Administrations greater scope to deal with unforeseen events.

To address both the near- and longer-term issues, the Congress and the Administration should consider replacing the sharp, frontloaded spending cuts required by the sequestration with policies that reduce the federal deficit more gradually in the near term but more substantially in the longer run. Such an approach could lessen the near-term fiscal headwinds facing the recovery while more effectively addressing the longer-term imbalances in the federal budget.

The sizes of deficits and debt matter, of course, but not all tax and spending programs are created equal with respect to their effects on the economy. To the greatest extent possible, in their efforts to achieve sound public finances, fiscal policymakers should not lose sight of the need for federal tax and spending policies that increase incentives to work and save, encourage investments in workforce skills, advance private capital formation, promote research and development, and provide necessary and productive public infrastructure. Although economic growth alone cannot eliminate federal budget imbalances, in either the short or longer term, a more rapidly expanding economic pie will ease the difficult choices we face.

1. Data for the fourth quarter of 2012 from the national income and product accounts reflect the advance estimate released on January 30, 2013. Return to text

2. See Board of Governors of the Federal Reserve System (2012), “Federal Reserve Issues FOMC Statement,” press release, December 12. Return to text

3. The numerical values for unemployment and inflation included in the guidance are thresholds, not triggers; that is, depending on economic circumstances at the time, the Committee may judge that it is not appropriate to begin raising its target for the federal funds rate as soon as one or both of the thresholds is reached. The 6-1/2 percent threshold for the unemployment rate should not be interpreted as the Committee’s longer-term objective for unemployment; because monetary policy affects the economy with a lag, the first increase in the target for the funds rate will likely have to occur when the unemployment rate is still above its longer-run normal level. Likewise, the Committee has not altered its longer-run goal for inflation of 2 percent, and it neither seeks nor expects a persistent increase in inflation above that target. Return to text

4. See Board of Governors of the Federal Reserve System (2012), “Federal Reserve Issues FOMC Statement,” press release, September 13; and Board of Governors, “FOMC Statement,” December 12, in note 2. Return to text

5. The Federal Reserve is also monitoring financial markets to ensure that asset purchases do not impair their functioning. Return to text

6. See Board of Governors of the Federal Reserve System (2013), “Reserve Bank Income and Expense Data and Transfers to the Treasury for 2012,” press release, January 10. Return to text

7. See Carpenter, Seth B., Jane E. Ihrig, Elizabeth C. Klee, Daniel W. Quinn, and Alexander H. Boote (2013), “The Federal Reserve’s Balance Sheet and Earnings: A Primer and Projections (PDF),” Finance and Economics Discussion Series 2013-01 (Washington: Federal Reserve Board, January). Return to text

8. See Congressional Budget Office (2013), The Budget and Economic Outlook: Fiscal Years 2013 to 2023 (Washington: CBO, February). Return to text

Fed Officials Try Remind Markets Stimulus Will Stay

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Its no wonder markets have been confused over Federal Reserve policy, with an unusual amount of vocal dissent from within the Fed hitting the public over the last couple months. Markets are used to a united Federal Reserve, with at most one fringe member voicing complaints. But if you read the latest Fed minutes, you would think a near majority of the Fed was fearful of the Fed’s aggressive policy actions and the pace of stimulus would soon begin to slow.

Bernanke Privately Tells the Real Story

In closed door meetings the Fed Chairman Ben Bernanke’s true intentions are revealed, according to a report out today from Bloomberg. Why private or even government entities are able to hear privileged monetary policy insight is a question in itself, but I’m more concerned with the reality that no one can stop them.

Bernanke has reportedly told unnamed people in a meeting with the Treasury Borrowing Advisory that asset bubbles are not a concern to the Fed, and do not pose worthy risk to the economy. These kind of comments are not that surprising coming from Bernanke. Bernanke’s view of the economy at present is that capacity utilization remains low considering the level of the unemployment rate. Moreover inflation is growing below the Fed’s 2.5% target according to their favored inflation measure, Personal Consumption Expenditures.

I’ve been arguing recently that the markets should stop focusing on the hawkish messages from non voting members, or voting members with little influence, and rather pay pure attention to what Bill Gross calls the three musketeers; Ben Bernanke, Janet Yellen and Bill Dudley. The three musketeers are all for one and for all in their plan to continue and perhaps increase stimulus levels, the markets should have no doubt, since they are at the helm of the Fed.

Bullard Clarifies Comments: ‘Fed Policy to Stay Easy for Long Time’

James Bullard of the St Louis Fed and an FOMC member went on CNBC saying his main message is to convey to markets that Fed policy will stay easy for a long time. He noted, as many already realize, that markets have not woken up to the Fed’s aggressive switch from operation twist to an outright quantitative easing, resulting in 10′s of billions being printed a week. Even last week $20 Billion in fresh cash was added to the Fed’s balance sheet.

This comes after a few weeks of media reports regarding Bullard’s apparent hawkish insight into the future of Fed policy, which fueled market fears that the Fed would end quantitative easing purchases as early as midway into the year. The gold price fell after comments from Bullard were initially released and continued falling on any corroborating news coming out of the Fed in the last while.

How Long will it take Gold Markets to Turn Back Up?

What most people forget is that following QE1 and QE2 the price of gold actually fell for the first couple months. Well into QE2 interest rates were also rising, despite massive Fed purchases, only to eventually drift down once the Fed’s easing measures got a handle. Why should QE3 be any different?

See gold prices falling three months into QE1 (Gold is in blue, Fed printing in Red):

Gold falls three months into QE1

See gold prices falling three months into QE2 (Gold is in blue, Fed printing in Red, 10Y Treasury Note in Orange):

Gold falls three months into QE2

See gold prices falling three months into QE3 (Gold is in blue, Fed printing in Red):

Gold falls three months into QE3

So how long will it take gold to react this time? If the three month historical cue has any meaning then the price of gold is already overdue for a rise. QE3, however, is the first QE that is arising in the midst of apparent dissent within the Fed which the markets are clearly buying into. This could be way gold’s decline has extended a bit past its due.

Since Bernanke et al are now out trying to debunk fears of Fed hawkishness, we can now expect prices to turn relatively soon. This Tuesday Bernanke testifies before congress which could serve as a catalyst for prices to turn. The Fed’s March 20th meeting may also prove to be the day gold prices turn around. Nonetheless, sooner or later gold markets will revive and interest rates will fall again, since the Fed is as determined as they were in the past to achieve such ends.

Why is Gold Rising Today?

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Treasury Prices Enter Upward Trend, Gold Follows

After the Federal Reserve’s minutes release the market consensus seemed to be that the Fed was turning a hawkish cheek. Most of the minutes release focused on the skepticism over quantitative easing measures’ continued efficacy and the possibility of varying their printing rate. Media outlets like Bloomberg and others instantly touted the report as signaling that the Fed would be lowering their purchase rate. The threat of slowing purchases of bonds weighed on the Treasury market immediately following the release. Gold suffered a similar fate, as treasury yields are deep drivers of the gold price.

See how treasury prices, as represented by the 10yr t-note front month future, dropped in the immediate aftermath of the minutes release:

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10 Year treasury note prices rise following Fed minutes release

Gold Prices and Treasury Prices Deeply Correlated Today

In the last 12hrs the gold market and longer term treasury market have been deeply correlated:

gold prices deeply correlate with treasury prices

Why did Treasuries Reverse?

Treasury prices have reversed yesterday’s trend and have been on the rise throughout the day. The question is then, are treasury prices being lifted by doubts over the Fed’s hawkish shift or simply because money is leaving the market?

The S&P500 has perpetually fallen since the Fed minutes were released yet Treasury prices fell as well initially. This means investors must have gone into cash before entering the Treasury market:

sp500 falls after fed minutes release

The question remains, however, what is driving people into Treasuries? If the belief is that the Fed is going to stimulate further then why did stock prices lose their buoyancy?

The moves in today’s market seem to indicate economic fears are reentering the picture. Investors are shying away from the stock market, cozying up to gold and treasuries as a measure of risk aversion, while still believing the Fed is behind the curve in trying to tame these risks.

The Fed’s Stimulus Certainty is Matter of When not If

Sooner or later a clear picture of the Fed’s desires will emerge. Economic releases between now and the Fed’s March 20th policy statement and conference will be big drivers of the market’s expectations over Fed policy. A nudge in the direction of continued Fed stimulus came in today as the Consumer Price Index (CPI) was released, indicating a 0% change for January, less than the 0.1% expectation. Remember, a tamer inflation outlook gets the Fed more comfortable with stimulus measures and empowers the FOMC’s doves. The big release to sway markets on the direction of Fed policy, however, will be February’s employment data. Anything but a strong payrolls number is likely to liven bets of Fed stimulus significantly.

There are additional headwinds weighing on the US economy that are likely to show up in near term economic figures as well. The payroll tax cut expiring is likely going to substantively impact consumer spending. As will the billions in sequestration, automatic fiscal spending cuts, should Congress not postpone these measures yet again. In any case the uncertainty over the issue, as was the case with the fiscal cliff of 2012, will weigh down on markets.

Fed Stimulus Surprise Means Higher Gold

Increased bets on Fed stimulus means higher precious metal prices as markets have not factored in the effect of a Fed with conviction to continue stimulating. Expect prices to mostly rise into the Fed’s next meeting, as the economic environment begins to persuade investors to bid down real yields and increase bets of Fed stimulus.

Analyzing the Fed Minutes

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Minutes from the Federal Reserve’s January meeting were released today at 2:00pm EST. The minutes indicate that the Fed plans to vary purchases based on the evolving economy.

At the time of the last meeting, the Fed believed the economy was mildly improving as a result of the fiscal cliffs partial resolution into the year’s end and strong corporate earnings. The big question then is how will the economy have changed between the last meeting and the next Fed statement on March 20th.

Quick Overview of the Minutes

*The minutes in general emphasized improving market conditions domestically and abroad and continually noted concerns by some Fed members regarding the risks of loose monetary policy.

*The committee affirmed the efficacy of monetary policy, despite vocal but not formal doubts by some members, except one, Jeremy Stein.

*The committee agreed inflation was on target and high risk bonds spreads narrowed in relation to investment grade bonds.

*The committee noted that monetary policy will vary, possibly meeting to meeting, based on current economic developments.

*Several participants made note of the risk associated with the Fed’s duration heavy portfolio and showed concern over the possible capital losses if these assets are unwound. One participant however, noted that capital losses to the Fed would not harm the conduct of monetary policy.

Who Says What Matters More than What is Said

What is interesting about the minutes is the discussion at the FOMC meeting consists of non voting and voting members. This means participants can often be quoted yet have no voting influence on the direction of monetary policy for the time being. This point is worth noting because despite a relatively hawkish minutes report, where the Fed sounds overwhelmingly enthused by the economic improvement and fearful of overheating risks, current voting members are overwhelmingly dovish. Moreover, the most dovish camp happens to be the Fed leadership who have permanent voting seats and the largest influence.

Can the Fed Go Bankrupt/Insolvent?

The last point in the overview regarding the one Fed member not being concerned about the impact of capital losses for the Fed is one of the more interesting yet easily overlooked parts of the minutes. The Fed is teetering on bankruptcy, with a mere $55 billion in capital compared to its massive $3.1 trillion dollar balance sheet. They are more than 500% more leveraged than the average financial institution:

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Federal Reserve Leverage vs Financial System Leverage

The Fed member’s point regarding the Fed not needing to worry about their precarious financial standing begs many questions.

Monetary policy watchers are quite aware that central banks don’t need to go bankrupt when their liabilities are denominated in their own currency. The central bank can never run short of cash at the point of redemption as dollars are non redeemable. Redemptions out of Fed accounts just transfer from one liability item to the next. The Fed can also create infinite liabilities which is effectively currency in its purest form.

This isn’t to say capital losses won’t effect the conduct of monetary policy. If the Fed has more liabilities than assets, that means the Fed is impotent to sell all their assets to absorb all their liabilities. On the margin, some money is in a sense stuck in the system, and cannot be absorbed by the Fed via asset sales. This has large implications with respect to inflation and the Fed’s credibility and prowess.

What then is securing the mind of the one nameless Fed member voicing calm over possible Fed losses and their impact on monetary policy? Perhaps accounting gimmicks are being considered, such as that instituted by the Fed in early January of 2011 which allow them to report capital losses as negative liabilities to the Treasury, whom they usually remit surpluses, instead of drawing against their capital account. This doesn’t impact the reality of the situation, however, which remains that Fed losses in real terms cannot be made up for in asset sales. Public perception of the Fed and its need to acquire financing from the Treasury might not be impacted by real capital losses given some accounting scams, but the conduct of monetary policy will not be immune.

Where are We Headed

Given the economy is headed towards another fiscal cliff of sorts, and interest rates have been on the rise, how should the forward outlook for the next meeting be seen? Given the economic headwinds, the continued rise in interest rates and its ability to threaten the Fed’s ‘recovery’, it seems likely the Fed will start to sound more dovish in upcoming meetings. Those genuinely expecting Fed policy to turn hawkish this year have not thoroughly considered the need for the Fed to cap interest rates. The US economy is highly sensitive to higher rates given massive outstanding public and household debt. As rates begin to impact debt servicing and force deleveraging, the Fed will most certainly come to the rescue of bonds and support their own book and the economic variables they are targeting. The only question of uncertainty is do they preempt the effect of higher rates and dampen the yields before they cause trouble or does the Fed wait for a collapse to justify their cause.

If the Fed is ahead of the curve, expect interest rates and the US dollar to fall, the stock market to do well, and precious metal prices to rise again. Should the Fed be behind the curve, rising rates will strengthen the dollar, increase the real value of US debts and send levered markets into a tailspin.

I’m guessing the Fed will get control sooner than later and risk trades will be formally back on. Seeing how bad the economic figures are between now and the Fed’s March meeting are key to forecasting the Fed’s next move. In any case, I see the Fed surprising markets in their resolve to maintain current policy and even strengthen their stimulus efforts at the first sign of economic disarray.