Paul Samuelson on the central banks' roles

Balancing market freedoms

Paul Samuelson

(IHT) All through the years of the Great Depression, Wall Street publicists and President Herbert Hoover would repeatedly declare: "Recovery is just around the corner."

They were wrong. And history repeats itself.

Today, Federal Reserve Chairman Ben Bernanke admits that nobody, including him, is able to guess how near to bankruptcy the biggest banks in New York, London, Frankfort and Tokyo might be as a result of the real estate crisis.

As one of the economists who helped create today's newfangled securities, I must plead guilty: These new mechanisms both mask transparency and tempt to rash over-leveraging.

Why should non-economist readers care about these technicalities?

Because the policy tools that served so well for Alan Greenspan's Federal Reserve and for the Bank of England now have to be changed.

It used to be enough for a central bank to "lean against the wind." That means lower interest rates when unemployment is too high and when deflation threatens. And when business growth is too brisk, central banks are supposed to raise their interest rates to dampen growth and to forestall price-level inflation that threatens to exceed 2 percent per year.

Today, central bankers and U.S. Treasury cabinet officers cannot know whether current interest rates are too high or too low. This is surprising, but true. The safest bond interest rates are indeed low. But financial panic engendered by the burst bubble of unsound U.S. and foreign mortgage lending means that even a mammoth corporation like General Electric would find it expensive now to finance a loan needed to build a new and efficient factory.

The situation is not hopeless. New, rational regulations that discourage predatory lending and rash borrowing could help a lot. Also, as we learned during the Great Depression, the government's treasury and its central bank must be both the lenders of last resort and the spenders of last resort. Speculative markets will not stabilize themselves.

The best policy is actually the middle way: not too much freedom for market forces, and definitely not too little freedom.

Global markets have moved into a new epoch. China, India and even Russia and Ireland are currently growing at almost twice the pace of the United States and the core countries of the European Union. Gone are the days when an American president could command ocean tides to come in and go out.

The U.S. population is 5 percent of the global total, yet it enjoys per person about 20 percent of total global output. That's the picture now. Will this last?

When I come to write a newspaper article like this 10 years from now, I believe America may still be leading the pack in per-capita affluence. But in all probability, the China that has already displaced Japan as the economy with the second biggest total gross domestic product will likely have a total GDP equal to America's.

When that happens, a typical Chinese family will still be a lot poorer than a family in the United States or even Ireland. Remember, China's population is several times that of America or any European country. Don't even ask me what the U.S. dollar in 2017 will be worth.

President George W. Bush and Vice President Dick Cheney will have long retired on their respective ranches, but their rash 2000-2007 tax-cut-and-spend policies will by then have harvested the follies that they sowed.

Since we live ever in the short run, global leaders must make their best guesses about what to be doing in 2008. Here are my tentative suggestions:

Watch developments closely. If America's Christmas retail sales fail badly - as they could when high energy prices and high mortgage costs pinch consumers' pocket books - then be prepared to accelerate credit infusions by central banks on the three main continents.

Keep in mind threats of excessive inflation. But be aware that the skies will not fall if the price-level indices blip up from 1.9 to 2.6 percent per annum. What worsens the public's expectations about price instability are excessive spikes in the cost of living.

Finally, to reduce the burden of mass foreclosures of over-expensive mortgages, we should explore new quasi-public agencies, as we did with the Depression-era Reconstruction Finance Corp., that specialize in supplementing for-profit ordinary lenders. This suggests expanding in a controlled way the lending powers of quasi-public agencies such as Fannie May and Freddie Mac. Better that they should lose a bit when they help homeowners of modest means fend off foreclosures on their onerous mortgages.

Maybe such innovations will turn out not to be needed. But keeping in mind worst-case scenarios of the freezing-up of banks and other lending agencies, exploratory planning is worthwhile insurance.

What the world does not need now is tolerance for any persistent weakness in global Main Street growth. It is better when physicians worry too much about a patient's health than when they worry too little.

A weak dollar to depreciate away obligations and maintain trade balance

Paulson's Weak Dollar Boosts Growth Without Fueling Inflation
By Matthew Benjamin and Vivien Lou Chen

Oct. 8 (Bloomberg) -- Treasury Secretary Henry Paulson, whose signature appears on every new dollar bill, may find the weak currency with his name on it helps the U.S. economy more than the strong one he publicly endorses.

The dollar's 8 percent slide during Paulson's 15 months in office is good news on the docks of Long Beach, California, where shipping containers are making their return trip to Asia filled with U.S.-made computer, auto and aircraft parts whose prices have become more competitive abroad. What's more, economists don't foresee the weaker currency generating higher import prices and accelerating inflation.

``The dollar is in a quasi-sweet spot,'' says Joseph Quinlan, chief market strategist at Bank of America Corp. in Charlotte, North Carolina. ``It's dropped enough that it's creating an earnings upside for U.S. multinationals, while I expect many foreign companies to hold the line on prices they charge U.S. consumers.''

Exports by General Motors Corp., Boeing Co. and other U.S. companies were up 11 percent in the second quarter from a year earlier, shrinking the nation's trade deficit in goods for the first half by $14 billion, to $405 billion, and helping the economy weather the housing bust.

According to estimates by Goldman Sachs Group Inc., that's the biggest improvement in 20 years; exports of goods grew more than twice as fast as imports in the first half of 2007.

Further Narrowing
The government will report August trade figures on Oct. 11, and a Bloomberg survey of economists says they will show a further narrowing of the gap.

Asked how Paulson, 61, views the dollar's recent slide, his spokeswoman, Brookly McLaughlin, refers to recent statements from him that reiterate the official U.S. policy since Robert Rubin ran the Treasury under President Bill Clinton: ``I feel very strongly that a strong dollar is in our nation's interest.''

As Treasury secretary, he can't be expected to say anything else, says Tom Fitzpatrick, global head of currency strategy at Citigroup Inc. in New York.

``The U.S. needs external capital to fund its deficits,'' he says. ``So you have to say a strong currency is in your interest, because if you go the other way, why the hell would anyone want to invest here?''

At the same time, Paulson has good reason to be privately pleased with the dollar's decline, says Sophia Drossos, currency strategist at Morgan Stanley in New York and a former Federal Reserve economist.

Protectionist Pressures
Noting that Congress is considering sanctions to redress the trade imbalance with China, she says, ``If you are the U.S. administration and you don't want to see protectionism take hold, what is your incentive to change anything? It doesn't seem like it's in the interest of the U.S. Treasury to arrest the decline of the dollar. They are accepting it as a move based on fundamentals.''

The impact of the dollar's weakness is evident at the port of Long Beach -- the nation's second-busiest behind Los Angeles -- where exports jumped 34 percent in August from a year earlier.

Larry Cottrill, the port's director of master planning, says the number of unfilled containers leaving the port dropped 14.5 percent in August and was down 4.5 percent for first 11 months of the year ended Sept. 30. That's a turnaround from the last decade, when the fastest-growing container category was outbound empties, he says.

Fewer Empty Containers
In the past year, Cottrill says he's seen a decline in empty-container shipments ``up and down the West Coast.''

The cheaper dollar isn't just attracting overseas buyers; it's luring business to U.S. shores as well. Foreign visitors to New York City are taking advantage of their increased buying power to snap up diamonds and gold at Tiffany & Co. stores, helping the luxury jeweler to its biggest sales gain in seven years during the second quarter.

In San Francisco, George Chairakakis, a 30-year-old naval architect from Athens, said last week he bought ``20 percent to 30 percent'' more than he'd intended during a 10-day visit.

``I've exceeded my budget because of cheaper prices,'' he said while walking through Union Square carrying bags of clothes and shoes.
The demand from overseas is a welcome boost to the U.S. economy as the two-year housing recession and tighter credit standards threaten to suppress consumer spending.

Adding to Growth
Trade added 1.3 percentage points to growth in the second quarter, the most since 1996 and the first time since 1991 that exports contributed more than consumer spending to the economic expansion.

``The U.S. is becoming like the old Japan,'' says Jim O'Neill, head of global economic research at Goldman Sachs. ``Domestic demand is soft, but exports and fixed investment spending are very strong, which people have been crying out for from the U.S. for years.''

In Schaumburg, Illinois, west of Chicago, Jason Speer of Quality Float Works Inc. says ```sizzling' would be a perfect word'' to describe demand from China to Mexico for his company's products, which are used in portable water dispensers and tanks.

He says export sales are up 10-fold since 2003 and represent 26 percent of the firm's revenue, compared with 3 percent four years ago.

`Tremendous Opportunity'
``We are getting inquiries on a daily basis from all over the globe,'' says Speer, vice president and general manager. ``The dollar is so weak now that there's tremendous opportunity for manufacturers.''

GM, the largest U.S. automaker, will sell $800 million worth of Buicks and auto parts to its joint venture in China during the next four years, the Detroit-based company announced last month.

Farm-equipment maker Deere & Co. of Moline, Illinois, predicts revenue from South America will climb 30 percent this year. Seven of every 10 commercial planes on Boeing's backlog of orders are going to foreign markets, up from a third just six years ago.

``Clearly, the dollar hasn't hurt us,'' says Randy Tinseth, vice president of marketing for the Chicago-based company.

Meanwhile, his main competitor is suffering as the euro nears record levels. Toulouse, France-based Airbus SAS faces extra costs of $1.41 billion for every 10-cent increase in the euro against the dollar, Chief Operating Officer Fabrice Bregier estimates.

Absorbing the Hit
When faced with a falling dollar, foreign companies tend to absorb the hit to profits or try to cut costs rather than charging more, according to a September study by three Federal Reserve economists.

Official statistics support that view. U.S. import prices excluding fuel were up 2.2 percent in August from a year earlier, compared with a 2.9 percent rate at the end of last year. The Fed's preferred measure of inflation, the personal consumption expenditures core price index, rose 1.8 percent in August from a year ago, the smallest gain since February 2004 and within Fed Chairman Ben S. Bernanke's stated comfort zone.

``Even when the dollar is weakening, they don't raise prices in the U.S.,'' says Fed economist Joseph Gagnon, one of the paper's authors. Often, businesses make that choice to defend their U.S. market share, he says.

Shifting Production
Rainer Schmueckle, chief operating officer at Daimler AG's Mercedes Car Group, said at a Sept. 25 press conference that the Stuttgart, Germany-based company would have to consider shifting more of its production to the United States if the euro, currently at about $1.41, were to rise above $1.45 and remain there.

In Canada, whose dollar has risen to near-parity with the U.S. currency for the first time in 31 years, the biggest software maker, Cognos Inc., is holding the line on prices even as the exchange rate eats away at its profits.

Second-quarter license sales at the Ottawa-based company, which exports more than half of its products to the U.S., missed analysts' targets, partly because of the exchange rate, according to Chief Executive Officer Robert Ashe. ``It's affected our outlook a little bit because of that squeeze from the foreign currency,'' Ashe said in a Sept. 28 interview.

European policy makers are signaling growing alarm as the strengthening euro threatens to undermine growth in the 13- nation bloc that shares it.

Group of Seven
Paulson is likely to hear about that when he hosts a meeting of finance ministers and central bankers from the Group of Seven industrialized nations in Washington next week.

``The euro exchange rate is starting to concern us,'' Luxembourg Prime Minister Jean-Claude Juncker said Oct. 1. European Central Bank President Jean-Claude Trichet said three days later that ``we appreciate'' the U.S. government's stated preference for a strong dollar.
Alison Moritz, tending a hot dog stand in San Francisco's Union Square, doesn't seem to agree as she happily watches her tip jar fill up with dollar bills and coins from European tourists.

``Before, they were not known for being good tippers,'' says Moritz, 23, who figures she's collecting as much as $90 a day at Stanley's Steamers Old Fashioned Beef Franks. ``Now, they're throwing in $2 at a time.''

Fed Keeps Rate at 5.25%

Fed Keeps Rate at 5.25%; Inflation Is Main Concern (Update6)
By Scott Lanman

Aug. 7 (Bloomberg) -- The Federal Reserve, keeping interest rates unchanged, said inflation is still the biggest danger to the economy and that the six-year economic expansion won't be undone by ``tighter'' credit conditions.

``Although the downside risks to growth have increased somewhat, the committee's predominant policy concern remains the risk that inflation will fail to moderate as expected,'' the Federal Open Market Committee said today after meeting in Washington, where it left the benchmark rate at 5.25 percent.

Some investors read the remarks to mean that Chairman Ben S. Bernanke won't rush to cut rates in response to a rout in the subprime mortgage market that's prompted lenders to restrict borrowers' access to credit with higher rates and fewer downpayment concessions. The world's largest economy will survive the tumult, the central bank added.

``Financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses, and the housing correction is ongoing,'' the Fed said. ``Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy.''

Traders pared bets on the chance the Fed will lower rates in the next few months, according to futures prices on the Chicago Board of Trade. The Dow Jones Industrial Average fell in the minutes after the decision, before rebounding. The Dow rose 35.52 points to 13,504.30 and the dollar strengthened against the euro. Treasury notes declined, sending yields on benchmark 10-year notes to 4.78 percent, from 4.74 percent late yesterday.

`Sticking to Guns'
``They are sticking to their guns,'' said David Kelly, an economic adviser at Putnam Investments LLC in Boston, which manages $193 billion in assets. ``They think the economy is fundamentally healthy and it will get through the credit-market issue. They don't want to do anything to panic.''

Several economists predicted the Fed would say risks were balanced between prices and slacker growth, foreshadowing a possible rate reduction.

``A sustained moderation in inflation pressures has yet to be convincingly demonstrated,'' the FOMC said, repeating a sentence from the last statement on June 28.

The mention of inflation as the ``predominant'' concern has appeared in each Fed statement since March and meeting minutes starting with last December's session.

The Fed statement comes less than three weeks after Bernanke delivered semiannual testimony to Congress, an event that usually sets the tone of central bank discussions for several months. He told lawmakers on July 18 and 19 that U.S. economic growth would pick up ``a bit'' and inflation recede.

Shift in Sentiment
Investor sentiment has shifted since benchmark stock indexes reached records in mid-July. The Standard & Poor's 500 Index dropped 5.7 percent from its all-time high on July 16 through yesterday.

The culprit: subprime mortgages that customers have been unable to repay, making securities linked to the loans less attractive. At Bear Stearns Cos., where two hedge funds failed in June, the firm's chief financial officer said Aug. 3 that the fixed-income market is in the worst shape in 22 years.

At least 70 mortgage firms have halted operations, gone bankrupt or sought buyers since the start of 2006. In addition, lenders such as Wells Fargo & Co. and Wachovia Corp. are raising rates and imposing stricter standards on some of their most creditworthy borrowers.
The Fed may be reluctant to reduce its benchmark interest rate, though, unless officials see inflation as under control.

Productivity
Slower productivity growth may boost inflation because it means companies have less cushion to absorb wage increases without raising prices. A government report today showed productivity rose at an annual rate of 1.8 percent in the second quarter, less than the 2 percent gain expected, based on the median forecast in a Bloomberg News survey.

Price increases have slowed for four straight months under the Fed's preferred gauge, which excludes food and energy costs. The core personal consumption expenditures price index rose 1.9 percent in June after a revised 2 percent gain in May, the Commerce Department said July 31.

The government also said on July 27 that the U.S. economy expanded at a 3.4 percent annual pace in the second quarter, the fastest in more than a year, after a revised gain of 0.6 percent in the three months ending March.

Economists and Fed officials anticipate a slacker expansion in the second half. For the year, Fed governors and presidents expect growth, on average, of about 2.25 percent to 2.5 percent, Bernanke told Congress last month. The projections are about a quarter-point below the previous round in February, mainly because of the weakness in homebuilding.

Consumer spending, which Bernanke said last month was ``likely to continue growing at a moderate pace, aided by a strong labor market,'' is showing signs of slowing. Auto sales last month were at their lowest July level in nine years. In addition, job growth slowed and the unemployment rate inched up to 4.6 percent, tying the highest rate since last August.

Global bond selldown may reduce expectations for faster rate hikes

Bernanke, Trichet Get Inflation Help From Surging Bond Yields
By John Fraher and Scott Lanman

June 15 (Bloomberg) -- The six-week global bond market-rout may be doing Ben S. Bernanke and Jean-Claude Trichet a favor.
The higher market rates, if they continue, mean pricier loans for homes and credit cards, and will make it more expensive for companies to invest and make acquisitions.

That in turn may limit the need for Federal Reserve Chairman Bernanke and European Central Bank President Trichet to raise interest rates to cool inflation pressures amid the strongest global economy in a generation.

``It's certainly helping do their job for them,'' said Keith Hembre, who used to work at the Fed and is now chief economist at Minneapolis-based U.S. Bancorp's FAF Advisors Inc., which manages $105 billion. ``It's really, in essence, the equivalent of an additional Fed tightening.''

Hembre estimates that a 30 basis-point rise in the yield on 10-year Treasury notes may be equal to increasing the Fed's benchmark rate by 1 percentage point to 6.25 percent, according to a computer model used by the central bank's staff.

``When we're seeing this backup in rates even without the Fed moving, it's sort of a tightening in and of itself,'' said Kevin Flanagan, a fixed-income strategist at Morgan Stanley in New York.

After years of failing to move in tandem with rates set by central banks, U.S. and European yields have surged to their highest levels since 2002. The yield on the U.S. 10-year note has climbed 52 basis points in the past month and rose to 5.32 percent on June 13, the highest since April 2002.

German Yields
The yield on Germany's 10-year bond, a benchmark for Europe, has risen 34 basis points in the same period and climbed to 4.7 percent two days ago.

Mickey Levy, New York-based chief economist at Bank of America Corp., disputes the idea that higher bond yields may reduce the need for central-bank action. While the housing slump may worsen, there's ``absolutely'' no way to quantify the link between yields and the Fed's benchmark rate, he said.

``It shouldn't have that big of an impact,'' Levy said. In major industrialized countries such as the U.S. and Germany, ``real bond yields have been well below their longer-term average'' and are now moving toward that average. ``It's just an adjustment,'' he said.
Bernanke, 53, and predecessor Alan Greenspan raised the Fed's target rate on overnight loans between banks 17 times, from 1 percent in June 2004 to 5.25 percent a year ago.

Greenspan's `Conundrum'
During that period, the 10-year Treasury yield fell to 4.18 percent from 4.58 percent. The failure of long-term rates to increase prompted Greenspan to tell Congress in February 2005 that ``the broadly unanticipated behavior of world bond markets remains a conundrum.''
After two years of raising their benchmark rate, Fed officials decided in August to stop, partly to wait for the previous increases to have their intended effect. At the same time, officials retained a stance that inflation is the principal economic risk facing the U.S. economy.

``Their general feeling is at 5 1/4 percent, the fed funds rate is probably slightly restrictive,'' said Peter Hooper, chief economist at Deutsche Bank Securities Inc. in New York. ``Other financial conditions have been quite accommodative, and now we're seeing some unwinding of that.''

Bruce Kasman, chief economist at JPMorgan Chase & Co. in New York, said he recently lowered his forecast for the housing market to reflect more-expensive mortgages. He maintains that the Fed will raise its target rate on overnight bank loans next year, reaching 6 percent by mid-2008.

Stronger Growth
``Part of what's happening is growth is stronger, and higher rates are reflecting it,'' Kasman said.

In the euro region, where the ECB has raised its rate by 2 percentage points since December 2005, the move in bond yields might persuade Trichet, 64, to curtail his tightening, according to Robert Barrie of Credit Suisse Group.

While some economists expect the ECB to raise its main rate to 5 percent by next year from the current 4 percent, tighter financial conditions might allow it to stop before then.

``The market's making the ECB's job easier,'' said Barrie, the bank's chief European economist in London, who expects the central bank's rate to peak at 4.5 percent. ``The risks to the forecast were on the upside, but are now to the downside because of what the markets are doing.''

Judging the impact of higher yields on monetary policy may depend on what caused the move in the first place, said Jonathan Loynes, chief U.K. economist at Capital Economics Ltd.

Asian Central Banks
A decline in demand from Asian central banks for U.S. Treasuries may make it easier for the Fed to influence long-term bond yields because it will lessen the downward pressure that emerging-market purchases exerted in recent years.

On the other hand, if the increase was caused by investor expectations for central-bank rate increases, policy makers may have to follow through.

``I don't expect the move in yields to have a large impact on policy,'' said Loynes, who is based in London. ``The relations are too complex, and they can't necessarily count on these moves being sustained.''