The big fear for policymakers is a recession happening before they have stopped fighting the last war.
With interest rates at the zero-lower-bound a deflationary depression would leave them with only one real option-print money. A buyers strike on U.S. debt would force the full Monty of monetization.Back in 2008 when things were at their bleakest we linked to a couple Federal Reserve papers that laid out the "unconventional" measures. More after the jump.
From Barron's:
Interview
David A. Levy sees more trouble looming for the American economy. The bull case for Treasury bonds.See, for example:
There's a widely held view that the U.S. economy will continue to generate decent growth, even if there's an occasional step backward. David A. Levy, chairman of the Jerome Levy Forecasting Center in Mount Kisco, N.Y., isn't so sure. Skeptical about the underlying strength of the U.S. economy, Levy says investors should brace for a recession in the near term. He worries that shaky profit growth in the U.S., slowing economic growth in China, and weak fundamentals in Europe all could squeeze the U.S. Barron's readers will recognize the Levy name: His late father, Jay Levy, frequently offered us his insights. The younger Levy, 58, has some strong views of his own.
Barron's: We read that you think Treasury bonds are a Buy, contrary to the popular view. Most people think yields are ready to rise, possibly to 4% from 2.6% now, as the economy picks up some steam. You doubt that?
Levy: This economy, with its debt structure, could not support a 4%-plus Treasury yield. We still have way too much vulnerability in the housing market, to name one sector. There is way more leverage in the business sector as a whole than people who focus on large corporations realize. In fact, the overall nonfinancial business sector debt-to-output ratio is higher than it was at the beginning of the 2008 recession. So this is not an economy that would tolerate high rates without a lot of things breaking down. And even before that, we see very serious problems in emerging markets and elsewhere if yields move to that level.
And all that makes Treasuries looks pretty good?
We are still in a disinflationary and balance-sheet adjusting phase in the U.S. and globally, and that is going to bring, at some point, another recession. It could be sooner rather than later, and when that happens, we'll probably get a little bit of deflation. At some point, we'll see the 10-year Treasury yielding well under 1%, much as we have seen in Japan.
So, you just don't believe the economy is improving?
The economy is improving cyclically. And there are areas where corrections have been made, and there certainly are some good trends in parts of the economy. But the big picture is that we still have way too much debt relative to income. The total value of assets in our economy is still unusually high and very hard to justify with this slow growth. People talk about the low interest rates, but the very low nominal growth has to be factored in, as well.
What's your take on corporate profit growth?
It is very hard to make the case for profits to do better than maintain the rough plateau they've been on for the past couple of years. We'll see what they look like, but there is a lot of downside risk, much of it coming from overseas.
Do you think profit estimates are too rosy?
The most optimistic case we could make for the economy is that we would get a little bit of firming in profits toward the end of the year, if a lot of things go right, although that is still going to be short of what Wall Street is looking for. We've seen this quarter after quarter; people are looking for profits to resume some sort of normal rise, but it is very difficult for that to happen. We are looking for domestic profits to be flat year over year. Profits in a private economy are basically reflecting increases in wealth, which largely come from two drivers: fixed investment creating more fixed assets or from inflating values of the existing assets. You can also get it from accumulating claims against other countries through a trade surplus, which we are not doing. Right now, the rest of the world is weak, so even though the U.S. is improving its trade deficit on a secular basis, I don't anticipate much, if any, improvement this year, which means that U.S. trade performance will not boost second-half corporate profits. Meanwhile, we have a tiring fixed-investment trend, especially in capital expenditures, which means diminishing contributions to profits growth.
Long-term Treasury yields are up about a percentage point since May. What impact is that having on the economy?
Traditionally, a 100-basis-point move in the 10-year Treasury will be reflected fairly quickly in a cessation of any rise in home sales.
Even if that increase is coming off such a low base that we have today?
You can argue even more so, because the percentage increase in a mortgage-loan payment is even greater when you are talking about very low interest rates going from, say, 3% to 4%, rather than 8% to 9%. If you look at the improvement in housing, which has been significant over the past year or so, mortgage originations really haven't picked up. It has been the improvement in cash sales, which reflect other sorts of financing, whether it is individuals or hedge funds or whoever is buying houses. This is not a market where the first-time buyers are now coming in and more households are being formed....MUCH MORE
Feb 8, 2008
Doom and Gloom: What Can the Federal Reserve Do?
Feb 2008
Depression risk might force U.S. to buy assets
July 2008
Federal Reserve: Send in the Helicopters, No GSE Left Behind (FNM; FRE)
The papers:
Nov. 2000
Monetary Policy When the Nominal Short-Term Interest Rate is Zero.
...8.1 Money Rains
Money rains are a clean way to study theoretically the effects of increases in the supply of money. In practice, it seems a bit difficult to envision how the Federal Reserve could literally implement a money rain that is give money away either through directly disbursing currency to the public or by disbursing it through the banking system. The political difficulties that are likely to arise from the Federal Reserve determining the distribution of this new wealth would be daunting. Even if the Federal Reserve were to and a way to physically conduct a money rain, the Federal Reserve Act does not appear to provide authorization for such activities. Under section 7 of the Federal Reserve Act, After all necessary expenses of a Federal reserve bank have been paid or provided for, the stockholders of the bank shall be entitled to receive an annual dividend of 6 percent on paid-in capital. That portion of net earnings of each Federal reserve bank which remains after dividend claims ... have been fully met shall be deposited in the surplus fund of the bank. Thus, any transfers to the public must either be claimed to be "expenses" or be transfers from the surplus fund....
Another paper, "Monetary Policy in a Zero-Interest-Rate Economy" from the Dallas Fed, addresses the same issues with a distinctly different tone, e.g.
...Bold, but impractical–eliminating the bound altogetherMore should the need arise and yeah, you read that right, the helicopter picture is in a Fed paper.
The most daring suggestion for escaping the zero-interest-rate trap is one that eliminates the zero lower bound altogether. How can this be done? As noted in the first part of the presentation, the zero bound on interest rates exists because money pays a sure nominal interest rate of zero. No one would be willing to hold any asset that pays a negative nominal rate, as long as zero-interest money is available as a store of value. The strategy for eliminating the zero bound, therefore, is to make money pay a negative nominal interest rate, by imposing some type of ‘carry tax’ on currency and deposits....
More workable modifications to standard policy
...We will consider three possible candidates:
1. Foreign exchangeStrategies which target the first two candidates, as we’ll see, can only succeed if the Fed coordinates its policy actions with those of other actors–namely, foreign central banks or domestic fiscal policy-makers. A strategy targeting the third is something the Fed can do today, unilaterally, within the constraints imposed by the Federal Reserve Act.
2. Real goods and services
3. Other domestic securities-such as longer-term Treasuries.
...The goods & services solution
Why not have the Fed just conduct an open market purchase of real goods and services? Even more so than exchange rate intervention, this strategy would represent a direct stimulus to aggregate demand. As posed, though, the strategy has a major drawback: it violates the Federal Reserve Act. The Fed isn’t authorized to purchase goods and services, apart from those needed for the operation of the Federal Reserve System. The strategy can be implemented, however, by coordination with fiscal policy-makers. The Federal government, for example, could purchase goods and services and finance the purchases with new debt, which the Fed in turn would buy–in technical terminology, the Fed would ‘monetize’ the resulting debt....
