Can Fed Avoid Inflation Danger?

Fears of inflation because of the Federal Reserve's massive quantitative easing measures are overblown, because the Fed has the ability to pull the liquidity out of the market fast enough to prevent price rises.

Since the onset of the financial crisis, the Fed has cut interest rates near zero and injected about $1 trillion in the markets to prevent credit from freezing up.

Many people have warned the measures carry a high risk of inflation and drive down the dollar value in long term. But William Dudley, New York Fed president, expressed his optimism on inflationary pressure.

His view is that Fed has tools to manage our balance sheet so that we'll not have an inflation outcome, they are far along in terms of having the interest on excess reserves and, just in case, developing other means of pulling out the excess reserves.

Some of the exit strategies are already happening as lots of liquidity facilities were introduced with penalty interest rates and as the economy is recovering, firms return the liquidity to escape the punishment of high rates.

The Fed is also looking into the idea of banks depositing excess reserves with the Fed on a term basis, and into that of launching repo operations - selling securities to the market and withdrawing liquidity that way.

But it might be too early to speak about launching the exit strategy, as the economy still isn't growing fast and unemployment is high. Besides, it is possible that inflation could decline for a while because of the slack in economy and the banking system will take time to heal itself.

Bernanke reappointed for second term

Ben Bernanke was reappointed on Tuesday by President Barack Obama for a second four-year term as chairman of the Federal Reserve. The president also hit back at Mr Bernanke’s critics, defending the central bank chief’s actions – and policies put in place by his own administration – as ”steps of necessity, not choice”.

It follows Mr Bernanke’s extraordinarily aggressive efforts to fight the economic crisis, including radical interest rate cuts, loans to non-bank financial institutions, Fed-led bail-outs of AIG and Bear Stearns and gigantic asset purchases – exploiting the Fed’s powers to their legal limits in an effort to prevent a second Great Depression.

Tuesday’s announcement could deflect attention from other less market-friendly news. The White House is set to raise its 10-year budget deficit projection by $2,000bn to approximately $9,000bn.

Economists, investors and fellow central bankers overwhelmingly favor Mr Bernanke’s reappointment. However, some others saw this is a very shortsighted decision. While America’s head central banker deserves credit for being creative and courageous in orchestrating an unusually aggressive monetary easing program, it is important to remember that his pre-crisis actions played an equally critical role in setting the stage for the most wrenching recession since the 1930s. It is as if a doctor guilty of malpractice is being given credit for inventing a miracle cure. Maybe the patient needs a new doctor.

Mr Bernanke made three critical mistakes in his pre-Lehman incarnation: First, and foremost, he was deeply wedded to the philosophical conviction that central banks should be agnostic when it comes to asset bubbles. Second, Mr Bernanke was the intellectual champion of the “global saving glut” defense that exonerated the US from its bubble-prone tendencies and pinned the blame on surplus savers in Asia. Third, Mr Bernanke is cut from the same market libertarian cloth that got the Fed into this mess. The derivatives’ explosion, extreme leverage of regulated and shadow banks and excesses of mortgage lending were all flagrant abuses that both Mr Bernanke and Mr Greenspan could have said no to.

Notwithstanding these mistakes, Mr Obama may be premature in giving Mr Bernanke credit for the great cure. No one knows for certain as to whether the Fed’s strategy will ultimately be successful. There is still good reason to believe that the US recovery will be anemic and fragile. US consumers are in the early stages of a multi-year retrenchment as they cut debt and rebuild retirement saving. The unusual breadth and synchronicity of the global recession will restrain US export demand from becoming a new growth engine.

The Bernanke reappointment is a welcome chance for a broader debate over the conduct and role of US monetary policy. Ultimately, these decisions boil down to the person – in this case, Mr Bernanke – who is being charged with the awesome responsibility as America’s chief economic policymaker. As a student of the Great Depression, he should have known better. Maybe the world needs central bankers who avoid problems, not those who specialize in post-crisis damage control.

Beijing Stimulus Damage

China’s vaunted stimulus package has exacerbated structural imbalances in the economy and may delay the country’s transition to a more sustainable growth model, according to some leading economists.

Most analysts regard the $585bn plan as an appropriate response to the crisis, and say it pulled the economy out of what could have been a much deeper slump.

However, as the effects of the stimulus fade, some now say the response was too aggressive and that the government’s focus on an unprecedented credit exp­ansion and a massive infrastructure boost has aggravated stark economic imbalances.

The economy’s structural problems have been made worse by the stimulus program. While there are resurgent asset bubbles in the stock and property markets and the fact that most of the stimulus had gone to the state sector, smaller private enterprises, which create the most jobs, however had been left largely to fend for themselves.

The stimulus package was a response to a crisis rather than aimed at rebalancing China’s growth model. In the short term, this stimulus and monetary policy are perpetuating the imbalances.

A report published on Friday by the McKinsey Global Institute points out that 89 per cent of the entire stimulus package is devoted to infrastructure investment such as roads and railways, while only 8 per cent is allocated to supporting consumption.

Private consumption in China has declined sharply as a share of overall gross domestic product since the mid-1980s, accounting for only 36 per cent – the lowest ratio of any major economy, reflecting China’s reliance on investment as its main growth driver.

And according to this report, today’s low consumption share is systemic, and China will not be able to tackle this issue without comprehensive reform that includes structural change.

China’s economic growth profile has been very employment-light and there is a need to rebalance investment away from the traditional emphasis on heavy industry and infrastructure towards smaller, private enterprises, especially in the services sector.

World Stock Market Leader - China

China’s stock market has foreshadowed moves in global equities the past two years. It peaked on Oct. 16, 2007, two weeks before the MSCI All-Country World Index. The Shanghai index fell 72 percent from its 2007 high and bottomed on Nov. 4, 2008, four months before the MSCI index. The Chinese measure reached its 2009 high on Aug. 4, seven trading days before the global index.

People are hanging their hopes on China pulling us out of a recession. China’s growth looks great, but things may be a bit overstated. There has been a lot more integration of global markets over the past couple of years.

The focus of global markets is what’s happening in China. But in the current stage, China will have to remove liquidity from the market, and it’s likely that commodities will suffer and it means worse sentiment towards risk in general.

CIC is ready to invest in PPIP

China's $200 billion sovereign wealth fund, which made big paper losses on stakes in Morgan Stanley and Blackstone, is set to invest up to $2 billion in U.S. mortgages as it eyes a property market recovery.

Under the Public-Private Investment Plan (PPIP) launched earlier this year, the U.S. government plans to seed a number of public-private investment funds that would combine taxpayer money with private capital to buy as much as $40 billion in toxic securities from banks.

Compared with TALF, the new and smaller PPIP program focuses on safer toxic securities, which must have so-called "Triple-A" ratings by at least two agencies, and are debts guaranteed by the FDIC.

Facing the market downturn for a long time, the Chinese government is always trying to seek a more ideal way to invest in U.S. assets rather than purely buying U.S. government bonds all the time.

This move is another demonstration that China is confident on its role to lead the global economy out of recession, with China seeking safer investment in the world’s leading economy. Early this year, some U.S. asset managers approached CIC to invest in their funds focused on the TALF, but the Chinese declined given the uncertain outlook at the time for U.S. economic recovery.

Early this week, China also trimmed the holdings of U.S. government bonds, which left much more room for CIC to manage its huge foreign reserves.