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Tuesday July 21, 2009 - 20:13:22 GMT
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Forex Blog - Bernanke and Burning Down the House

If there any “modern” song that comes to my mind when watching Humphrey Hawkins Testimony explain how bad the world got last fall I can’t help but hear David Byrne of the Talking Heads singing Burning Down the House in an oversized suit in the Stop making Sense Tour (captured in posterity in film and here though sans suit )…the ultimate metaphor for the housing crisis, policy response, Bernanke fighting fire with fire, Congressional blowhards, and the out option for more than a handful of underwater homeowners – Burning Down the House (for insurance).  Guess I date myself calling an 80’s tune modern…but it still sounds fresh.


However, I did find Bernanke a lot more genuine than the mocking David Byrne in his larger than life beige suit (Beige Book?).  Compared to where I am on the economic outlook, Bernanke is downright euphoric.  So where is the equity market?  I think in a different dimension or maybe tripping on ecstasy to some techno drone beat.  The typically upbeat Bernanke even said those worried about inflation risks in the near term are misguided.  That is being polite…more like moronic (sorry in advance to all the TV talking heads I keep hearing chant Milton Friedman parables. 


And policy for the assumed (asserted) recovery is simple – don’t take away the punchbowl away too soon and soon looks very much like the next 2 to 3 quarters.  It was also interesting the hear Bernanke mention commercial and residential real estate problems are still a serious threat – as is weak consumption on high unemployment.  Yes the Fed can take the punchbowl away when it is time to do so (when the recovery is sustainable) but not now.  We learned (well most knew this) the Fed can use the deposit rate (new authority to pay interest to banks leaving funds with the Fed) as a base for cost of funds with the discount rate the ceiling and Fed funds target the primary policy signal…deposit rate will give the Fed more control over short-term rates.  We learned the Fed may issue CD’s to banks to keep reserves out of the banking system.  It sounded almost as if the last thing the Fed will get around to is selling the $300bln in assets purchased from the market (Tsys, agency MBS and debt).


Which reminded me of what BOE Deputy Governor Bean said last week about the option of normalizing rates before unwinding quantitative easing…a prescription the Fed may well deploy given the uncertainty over the lags in credit or quantitative easing and the ease at which a central bank could reverse rate hikes if they were too early in the cycle and threaten a Japan outcome (BOJ tightened too soon in the lost decade). 


The Fed may well choose not to renew its asset purchase program (monetization today and some future sterilization), but unwinding it (selling the assets) is not really an early policy tightening response I think. 


If there is a policy risk that could fan inflation, it is more likely to come from fiscal policy and huge deficit spending programs (I bet there is a second stimulus – really #4) ahead and investors sense the government is going to devalue its way out of its debt problem like an Argentina.  Frankly I don’t think this is a high probability…rating agencies, investors and multilaterals will have a lot to say about the capacity of the US government to throw caution to the wind with all in fiscal policy.  Yes trillion dollar deficits are troubling and unsustainable, but on relative basis entitlement liabilities is a much greater threat to US fiscal soundness than the current fiscal stimulus.  If anything there is a serious risk that the fiscal stimulus was too small and impacted with too much of a lag to be very helpful.  If anything, the uproar over the stimulus and still rising unemployment rate probably makes another stimulus package (or TARP fund) politically impossible and sadly ironic. 


My last important takeaway from today’s headlines were the full throated endorsement of a weak GBP by Bean and the Bank of Canada underscoring again, with somewhat reduced urgency, the threat posed by the rise in the C$.  BOJ and SNB are on board keeping their currencies from rising even though it is only the SNB pulling the intervention trigger (saw its EUR and USD reserves each rise 50% in Q2).  RBNZ is as well.  It may not qualify as a competitive devaluation race but it is curious nonetheless in a world where global trade has suffered a huge setback.  Some also are talking about US NEC Director Summers noting exports could play a leading role in a US recovery (doubt Summers is eager for much USD upside if looking for exports to soften the decline and help restore growth).


David Gilmore   



Here are the lyrics from the Talking Heads Burning Down the House…


Watch out you might get what you're after
Cool baby strange but not a stranger
I'm an ordinary guy
Burning down the house

Hold tight wait 'til the party's over
Hold tight we're in for nasty weather
There has got to be a way
Burning down the house

Here's your ticket pack your bag; time for jumpin' overboard
Transportation is here
Close enough but not too far, maybe you know where you are
Fightin' fire with fire

All wet yeah you might need a raincoat
Shakedown thieves walking in broad daylight
Three hundred sixty five degrees
Burning down the house

It was once upon a place sometimes I listen to myself
Gonna come in first place
People on their way to work say baby what did you expect
Gonna burst into flame

My house S'out of the ordinary
That's right Don't want to hurt nobody
Some things sure can sweep me off my feet
Burning down the house

No visible means of support and you have not seen nothing yet
Everything's stuck together
I don't know what you expect staring into the TV set
Fighting fire with fire

Burning down the house



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