Goldman Says Bernanke Engineers `Substantial Pickup'
Goldman Sachs Group Inc. defended Federal Reserve Chairman Ben S. Bernanke’s decision to pump money into the U.S. economy after officials in Germany, China and Brazil criticized the plan.
The move will spur gross domestic product growth and reduce the risk of deflation, Jan Hatzius, the New York-based chief U.S. economist at the company, wrote in an e-mail to clients. Because the Fed’s target for overnight loans between banks is near zero, the central bank is doing “the next best thing,” according to Goldman, one of the 18 primary dealers that are authorized to trade directly with the central bank.
“The widespread hostility to the Fed’s actions is misplaced,” Hatzius wrote. “Downside risks to the economic outlook have declined significantly. U.S. inflation is unlikely to become a problem for years.”
Bernanke on Nov. 6 defended the central bank’s decision last week to buy an additional $600 billion of Treasuries and said he dismissed the idea that it will increase prices to higher levels than policy makers prefer. German Finance Minister Wolfgang Schaeuble said Nov. 5 in Berlin that the Fed’s move was “clueless.”
“I have rejected any notion that we are going to raise inflation to a super-normal level in order to have effects on the economy,” Bernanke said in a panel discussion at a Fed conference in Jekyll Island, Georgia. “It’s critical for us to maintain inflation at an appropriate level.”
‘Risks for Everyone’
Schaeuble said the Fed’s decision won’t revive growth.
“It’s our problem as well if the U.S. is no longer certain that the old recipes don’t work anymore,” he said. “We don’t have the least reason for schadenfreude. We only have reason to be worried.”
Brazil’s central bank president, Henrique Meirelles, said “excess liquidity” in the U.S. economy is creating “risks for everyone.” In China, Vice Foreign Minister Cui Tiankai said “many countries are worried about the impact of the policy on their economies.”
Fed Board Governor Kevin Warsh today conceded that further bond purchases risk distorting markets.
“The Fed’s increased presence in the market for long-term Treasury securities poses nontrivial risks that bear watching,” said Warsh, who voted for more stimulus last week, in an opinion piece in the Wall Street Journal. “As the Fed’s balance sheet expands, it becomes more of a price maker than a price taker,” and if investors doubt the values set for the securities, “risk premiums across asset classes” could shift unexpectedly around the world.
E. Gerald Corrigan, former Fed Bank of New York president, said at the Georgia conference that he’s concerned the central bank’s efforts risks causing price increases that are out of the Fed’s control.
“Even in the face of substantial margins of underutilization of human and capital resources, efforts to achieve an upward nudge in today’s very low inflation rate make me somewhat uncomfortable,” Corrigan, chairman of Goldman’s bank subsidiary, said in prepared remarks.
The difference between yields on 10-year notes and Treasury Inflation Protected Securities, a gauge of trader expectations for consumer prices over the life of the securities, widened to 2.13 percentage points from this year’s low of 1.47 percentage points set in August. The five-year average is 2.10 percentage points.
‘Next Best Thing’
The Fed can’t cut its benchmark interest rate any further after reducing it to a range of zero to 0.25 percent in December 2008, Hatzius wrote in his e-mail, which he distributed yesterday in New York.
Ten-year yields have declined about 18 basis points since Sept. 20, the day before the Fed announced it was prepared to provide additional support to the economy. A basis point is 0.01 percentage point. Two-year yields fell to 0.3118 percent on Nov. 4 and five-year rates declined to 1.0148 percent, both record lows.
“They are doing the next best thing, aiming to lower the bond term premium via purchases of longer-term securities,” Hatzius wrote. The strategy is known as quantitative easing because it targets the quantity of money in the economy. Traders have dubbed it “QE2” because the Fed also tried it last year.
“We also disagree with the criticism that the Fed is ‘flooding the world with money,’” Hatzius wrote. One risk of the decision is that it will boost currencies outside the U.S., he said, which makes the goods of exporting nations more expensive for their customers.
“But that is always true when regional cycles diverge, and it has little to do with QE2 per se.”
The difference between two- and 10-year yields was 2.16 percentage points, versus the five-year average of 1.28 percentage points.
Ten-year yields, a benchmark for consumer and company borrowing costs, rose one basis point today to 2.538 percent as of 11:49 a.m. in London, according to data compiled by Bloomberg. The yield on the two-year Treasury was unchanged at 0.367 percent.
Michael Burry, the former hedge-fund manager who predicted the housing market’s plunge, said Bernanke is trying to use “poison as the cure” by pumping more cash into the economy.
The attempt to bolster growth is reminiscent of Alan Greenspan’s actions to revive the economy after 2001, Burry said in comments published last week from a telephone interview. The former Fed chairman helped create an unsustainable boom in U.S. property prices with his policies, leading to the worst global financial crisis since the Great Depression, he said.
Hatzius said the outlook has improved from a month ago, when he said the U.S. economy faced two main scenarios, neither of them good:
“A fairly bad one in which the economy grows at a 1 1/2 percent to 2 percent rate through the middle of next year and the unemployment rate rises moderately to 10 percent, and a very bad one in which the economy returns to an outright recession,” he wrote to clients on Oct 6.
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