Thursday, April 11, 2013

An unprecedented move by the FED

In an unprecedented move, the Federal Reserve tied monetary policy to a specific social metric, an unemployment rate of 6.5%. Given stubbornly high unemployment levels, this new monetary policy target is entirely appropriate. Looks like its working.

Mr. Bernanke appears to be willing to risk his reputation as an inflation fighter in order to lower the unemployment rate. I think the Bernanke Gambit is good news for the unemployed and good news for the country as a whole.

Bernanke signaled that bondholders would no longer dominate monetary policy considerations. This is for their own good, since they will benefit, over the long term, from a fairer and more stable economy.

The majority of American citizens are bond sellers, not bondholders. In a downturn, government spending, required in order to get the economy out of a recession, is financed through the creation, by fiat, of new money. The resulting increase in the quantity of money gives rise to inflation, assuming the quantity of goods remains constant. (“Inflation is always and everywhere a monetary phenomenon.”) Bondholders are impacted primarily, since long term bondholders, those with bonds that mature in, say, ten years, face an increased risk that
the dollars they will receive as interest payments and principal will be worth less than anticipated. Most American I know value day to day social stability more than price increases that may or may not occur at some point in the future.

This is also a nod to the electorate and to political reality. There is no question that, had Romney won, this would not have happened. Romney's monetary policy supported capital owners. Capital owners fear inflation above all else (except a popular revolt by well informed citizens), since the spending power represented by investment cash flows, like those generated by bonds, decline in an inflationary environment.

Our Fully Adjusted Return ® Models show that societal benefits generated by higher employment far outweigh negative impacts of a potentially elevated inflation rate. Our models incorporate the new reality that sustained, high levels of unemployment contribute to social instability in a way we have not seen before. The ability of an
increasingly literate, technologically savvy population to coalesce and act quickly is new. We have seen, in Egypt, Syria, and Libya, the influence that rapidly forming communities have.

In the US, both the Tea Party and the Occupy Wall Street movements reflect this reality. The growing risk of a total breakdown in the ability of the US Government to function in the way that governments must in order to be considered legitimate is the big concern here. In other words, growing income inequality combined with new communication technology that increases the ability of activists to, well, act, have significantly lowered the rationality of traditional monetary policy targets and heightened the risk that normal economic policy mechanisms will fail. This is why the Fed has turned to unconventional monetary policy tools, like Quantitative Easing. Unemployment targeting is simply an acknowledgement and extension of this work.

This may also be a contributing factor to Germany’s recently announced move to reclaim and repatriate $36 billion in gold reserves. As the political side of the US Government fails to anticipate and manage risks associated with growing income inequality, the monetary side of the government finds itself unable to manage policy in a rational way. Hence the growing risk of default. If the US Government defaults on its debt, creditors could try to seize assets, including gold reserves belonging to others but held in the US. The risk that an extremist domestic political faction might support these efforts, previously unthinkable, has also grown. The sensible thing for any foreign government to do  in anticipation of  this situation is to reclaim their assets, quickly and quietly, using whatever excuse they need to do so. Thus, Germany’s recent  action.

That the unemployment rate has become the primary measure used to evaluate the effectiveness of monetary policy is significant. It sends a strong, unmistakable signal to corporations and investors that if they want to protect the value of their investments, they better start hiring. They can start by using some of the cash they have been hoarding, created by falling real wages and increasing productivity, resulting in record profits. This means that they, and the wealthy, now have one more incentive to drive the unemployment rate down. It also signals to politicians that if they want to protect wealthy contributors, they should solve the fiscal crisis now, since the
crisis threatens to increase unemployment.

Already, key corporate entities, like WalMart, have started moving production back to the US. As the New York Times noted, “A number of companies, including Apple, General Electric and Brooks Brothers, are..making more products in the United States.” Corporate social returns, materializing first as positive reputational impacts, will
increase as a result. This is not inconsequential. Expect an employment boom.

The move also doesn't hurt Mr. Bernanke’s chance of being reappointed for a third term.

Looks like we all win.

Bravo, Mr. Chairman.
William Michael Cunningham is an economist and social investing advisor. On June 18, 1998, he opposed the application, approved by the Federal Reserve Board on September 23, 1998, by Travelers Group Inc., New York, New York, to become a bank holding company.. In 2003, five years before the financial meltdown, Mr. Cunningham told the Securities and Exchange Commission that his economic models indicated a growing risk of systemic failure. He is the author of The JOBS Act: Crowdfunding for Small Businesses and Startups.
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