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Wednesday November 17, 2010 - 15:57:44 GMT
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Fed QE2 Critics Can't Have it Both Ways; Ireland Bank Bailout is Government Bailout by any Other Name (FXA)

Fed QE2 Critics Can't Have it Both Ways


With core US CPI running at a record low 0.6% year-over-year in October and falling, the Fed critics (including the 800 odd practitioners of economics who signed the letter to the Fed) who argue QE2 is ineffective and will only result in higher inflation demonstrate a major inconsistency in their argument.  If QE2 drives up inflation, then it is highly effective and yields a result the Fed is quite eager to achieve…pushing up the price level.  This is a case of ideologues with a political agenda taking on Fed pragmatists trying desperately to avoid a Japan lost decade (try two decades) of economic stagnation and in the worst case deflation.  The critics are quick to embrace “market-based” solutions to all that plagues the US economy, namely elevated unemployment and slow growth…it is better to just let the chips fall where they may and this applies to unemployment insurance extension (incentive to not work according to the ideologues) and government spending, though costly tax cuts the universal exception.  If the Fed critics are intellectually consistent then they must argue that QE2 will do nothing to prices (assets and or commodities), price expectations and the money multiplier (funds will end up on deposit at the Fed as excess reserves).  Moreover, the inflation hawks critical of the Fed decision to embark on QE2 now point to the sell off in US Treasuries as a reflection of a sea change in inflation risks.  If only this were true the Fed would be thrilled – the Fed has lots of firepower (endless in theory) to support bonds with QE and $600bln net new plus another $250-300bln from reinvesting QE1 proceeds means checking rising Tsy yields over time is not likely to be terribly difficult.  I think the purge in market positions in every asset class has been more about investors and speculators getting over their skis than a rational response to future inflation expectations.    Casual causality is in charge of group think and the ideologues like anyone preaching have no room for self doubt sound so sure that it has a tremendous capacity to drive the narrative.  How about one of these ideologues articulating the evil ways of government in the economy just once admit that over time, markets left to their own are prone to excesses and once in a generation to crippling excesses.  In the last 24 months government has been the market and has kept banking alive if not well.  Maybe for once bankers so quick to take the easy way of preaching free market ideology stop and think (see Buffett in NYT’s today) that when there is a massive market failure on the magnitude of the one we saw peak in late 2008 and is still with us pragmatism not ideology is the best servant of all parties in and out of government.


Ireland Bank Bailout is Government Bailout by any Other Name


Why are PM Cowen and FM Lenihan playing so hard to get when it comes to waving in a EU-IMF bailout program?  Well it has already secured government financing through June 2011 assuming it does not have to make above forecast capital injections into the banks in the next 9 months.  And because going to the EU and IMF means a loss of sovereignty…Brussels and Washington (IMF) will be making fiscal policy for Ireland.  No other Eurogroup finance minister is happy to see Ireland subsidize corporations to locate there with a very low tax rate (12.5% versus Germany’s average rate at 29.8% and France’s at 33.33%).  Brussels if not Washington (IMF) would demand Ireland raise the corporate tax rate and cut corporate subsidies to levels consistent with the rest of the Euro Zone which would reduce Ireland’s competitive advantage and threaten an even higher rate of unemployment over time.  Moreover, there is a political consideration in light of the ruling government’s narrow two seat majority in parliament which could disappear in the event that the government agrees to use the option to request state help.  So Ireland’s politicians are more inclined to request help for its banks…the government was running a surplus prior to the crisis and the bulk of the deficit (now 35% of GDP) has been due to support for the banks (making bondholders whole, insuring all deposits, adding capital to allow banks to stay solvent against a flood of bad loans).  But the government owns the banks for the most part and any aid that is earmarked for the banks is in essence a government bailout.  The only difference in a government request for aid and a government request for aid for Irish banks is the scale of the program…the latter would be considerably smaller.(EUR45-50bln versus EUR80-100bln).   Keep in mind that the UK government is also expected to pony up for either a full government request or a request for banks…which is likely to be a small as UK’s Cameron and Osborne can get away with given the government’s austerity program (not in Eurogroup but UK banks deeply exposed to Irish banks and mortgage market).  I could also not help but notice how very construct of Euro Zone means government rescue programs are awkward, face delays, are vulnerable to headline risk (see Austrian PM Proell impact on Greece this week and Irish officials steady denials last week of an imminent bailout) and often lag market reactions which tends to exacerbate volatility.  So I was not surprised to see US Treasury Secretary Geithner to point out that one of the lessons of the Greek debt crisis last May was to move early and quickly and avoid the kind of delays that allowed Greece’s debt crisis to put the global financial system and recovery at risk.  Nothing like stating the obvious, but context is everything…the Euro Zone can’t move decisively and hurriedly as it lacks political union.


David Gilmore     




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