Richard W. Fisher, president and CEO of the Federal Reserve Bank of Dallas, who is rightly considered as the biggest inflation hawk on the Federal Open Market Committee gave, in my opinion, very important remarks in China before the famous Tsinghua University School of Economics and Management, in Beijing.
On the issue of inflation and deflation, Fisher said: “It is clear to me that in this environment, inflation is unlikely to present a serious threat, given the pervasive bias in the U.S. economy toward wage cuts and freezes, rising unemployment, the widespread loss in wealth that has resulted from both the housing and equity market corrections, continually declining consumption and business investment, and the anemic condition of the banking and credit system, all of which reinforce downside price pressures in a global economy groaning with excess capacity. … Presently, the risk is deflationary job destruction. ... (Far ahead), the problem with regard to maintaining price stability most certainly is not inflation.”
On what will define the future attractiveness of Treasury debt, he said: “The net new supply of Treasury debt is predicted to expand by $2.5 trillion in the current fiscal year. … My point is that demand for Treasuries and other official paper of U.S. government issuers will be determined by their attractiveness relative to alternatives, and they may well be judged more, rather than less, attractive under most reasonable future scenarios. … Both the fate of budget imbalances and the potential for total returns earned by investing in U.S. securities depend on the efficacy of the fiscal policies Congress has advanced.”
If Mr. Fisher’s forecast of no inflation threat through 2010 is right, this should be taken very seriously.
Under these conditions, Treasuries' placement could also be defined by the effectiveness of Congress’ fiscal policies for turning the economy around efficiently and as quickly as possible.
Of course, that’s easier said than done. There is actually a real danger growing that what has been announced for stimulating the economy and jumpstarting the credit markets will not be sufficient. By itself, that shouldn’t be such a big problem if there weren’t these emerging signs of too-early relaxation in policy while on the other hand we see growing signs of political unwillingness for further substantial stimulus expansions.
We should not overlook the fact that the actual “attractiveness” of Treasury debt could easily be downgraded because of a too-slow recovery that in turn would provoke further, growing budget imbalances.
Under such a scenario, Treasury could rapidly be obliged to upgrade issuing conditions, which would mean lower prices and higher yields. No doubt this in turn could threaten any precocious recovery, because raising interest rates in a non-inflationary environment is an important depressing factor.
By the way, Nouriel Roubini just released higher loss expectations for the global banking sector, with $3.6 trillion for the United States and $1 trillion for the rest of the world, thereby underscoring the fact that lots of problems are still ahead for the financial sector, and that bad news in a depression traditionally come in stages.
Also, investors should keep in mind that recessions don’t end when they are officially over. If history can be of any use, we have seen the 1930s and in Japan’s during the 1990s, when policy relaxation halfway through those depressions artificially prolonged the downturns.
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