The Federal Reserve Must Change Its Ways In This New Economic Era

The Federal Reserve states that it has two policy goals, high employment and low inflation, but this has not been true for forty years or more.
What the Federal Reserve does has major implications in international markets and this cannot be ignored anymore.
It is time for officials at the Fed to face up to this and to inform the public that this is the case...and the sooner it does this, the better.
Has the United States, and the world, entered an era in which the Federal Reserve can no longer concentrate on just its own economy?

As Janet Yellen and the Federal Reserve continue to tell us, the two primary objectives of the monetary policy is to achieve high rates of employment and low rates of inflation for the United States.

Yet, at the press conference Fed Chair Janet Yellen held, where Ms. Yellen announced that the Federal Reserve was holding its target interest rate constant, China was mentioned several times and the problems emerging markets were having was also mentioned.

In fact, Roger Blitz and Jennifer Hughes write in the Financial Times about how Ms. Yellen was "rankled" about the Chinese as "she highlighted global concerns" but focused how China had managed its recent devaluation.

But concerns over emerging markets were making headlines as well; notice on the front page of the print Financial Times the lead "Alert on Emerging Markets Crisis and US Slowdown Despite Fed Rate Decision." The article speaks of hedge fund operator John Burbank "whose Passport Capital has placed a number of lucrative bets against commodities and emerging markets this year…"

The Federal Reserve cannot just focus upon the state of the domestic economy. But this begs the question because the United States has had major impacts on world markets going back to the late 1960s when inflation began to get out of hand because of the Keynesian stimulation originally begun during the Kennedy administration and carried through the Johnson and Nixon administrations.

The credit inflation at that time resulted in the floating of the US dollar and the destruction of the Bretton Woods system upon which the post-World War II era was based. Then, in the 1980s, after the credit tightening of the Paul Volcker-led Federal Reserve, some major international disruptions took place, particularly in Latin America.

In the 1994-95 period, there was the Asian crisis associated with movements at the Federal Reserve.

Paul Volcker, in his rehash of his time of involvement at the Fed, the Treasury, and as a consultant, claimed that the price of a country's currency in foreign exchange markets the most important price in that country's economy. See his book, "Changing Fortunes."

The Fed's importance in international finance during the recovery from the Great Recession cannot be ignored. During the first round of quantitative easing, most of the reserves the Fed pumped into the US banking system stayed there. But, in the second round of quantitative easing, the situation changed dramatically.

At that time, November 2010, the reserve balances of commercial banks at the Fed totaled just under $1.0 trillion. By the end of the third round of quantitative easing, October 2014, these reserve balances totaled over $2.7 trillion.

Parallel with this movement, we see on the Fed's H.8 release that cash balances on the books of commercial banks amounted to $1.1 billion at the earlier date and $2.9 billion at the later date.

Note: Cash assets at foreign-related institutions totaled $357 billion in November 2010, roughly one-third of the total cash assets in the US banking system. In October 2014, cash assets in foreign-related institutions amounted to $1.451 trillion, or almost fifty percent of the total cash assets of the US banking system.

But, listen to this. The "net deposits due to foreign-related offices" of these foreign-related institutions in the United States went from a negative $390 billion in November 2010 to a positive $584 billion in October 2014, an increase of almost $1.0 trillion.

While the Fed increased cash assets at banks in the US by $1.8 trillion over this time period, foreign-related institutions took $1.0 trillion offshore. And, during this time, commodities markets boomed and emerging market economies and securities took off. So did the value of their currencies in foreign-exchange markets.

Now, cash assets at commercial banks in the US have dropped in August 2015, but only to $2.731 trillion. Of these monies, the cash assets of foreign-related institutions dropped to $1.168 trillion or about 42 percent of total cash assets. "Net deposits due to foreign-related offices" have fallen to just $345 billion.

The point is that the Federal Reserve is heavily involved in foreign-related transactions and can be closely connected with events that are taking place in the foreign exchange markets. Yet, it has no explicit objectives in these areas.

Whatever the Fed does in the near future, it will have significant effects on world markets and the prices of currencies. George Magnus, senior economic advisor at UBS, writes about how long the Fed should be impacted by what is going on in China. Magnus questions "how long should the Fed cite China or emerging markets as a reason for keeping rates on hold, especially if the domestic case for not doing so becomes even more compelling?"

Mr. Magnus continues "If the Fed continued with financial market stability as the leitmotif of policy-making, a later but more disruptive policy adjustment and greater instability are the all too likely outcomes."

The Federal Reserve is not going to be able to ignore what is going on financially or economically in the world. It is not going to be able to just focus on domestic factors and it needs to stop kidding itself…and the world that this is the only game it is in.

This is the reality of the situation and, whether or not the Fed likes it, the international markets are going to be playing an even more important role in future Fed policy-making. It needs to grab hold of this reality and then it needs to make sure that the rest of the world knows about this reality as well.

A world engaged in currency wars benefits no one.

Santander Aims to Boost Capital Buffer

Move comes amid investors’ concerns about the strength of the Spanish bank’s balance sheet

By Jeannette Neumann

Concerns about Santander’s capital levels have dogged the Spanish bank’s Executive Chairman Ana Botín.  Concerns about Santander’s capital levels have dogged the Spanish bank’s Executive Chairman Ana Botín. Photo: Reuters

MADRID— Banco Santander SA SAN -1.61 % on Wednesday laid out financial targets for the next several years that were broadly in line with previous goals, disappointing some investors and analysts who had hoped for more ambitious objectives.

Santander, Europe’s second largest bank by market value, said it is targeting a capital ratio of more than 11% by 2018. Its common equity Tier 1 “fully loaded” capital ratio was 9.8% as of June and it had already set its sights on 10% to 11% over the next several years.

A bank’s capital ratio is the amount of equity it holds in relation to risk-weighted assets.

Concerns about Santander’s capital levels have dogged Executive Chairman Ana Botín and weighed on the bank’s stock despite a €7.5 billion share sale in January of this year.

That massive sale helped to momentarily assuage long-standing investor concerns that Ms. Botín’s predecessor as executive chairman, her late father Emilio Botín, had shirked the financial health of the bank’s balance sheet. But relief proved fleeting as analysts and investors look to the future and fret about mounting regulatory requirements, with Santander coming up short compared to its competitors.

“Santander has underperformed its peers year to date,” Carlos García González, an equity analyst at Société Générale SCGLY -1.81 % wrote in a recent research note, “due to a weak capital position.”

Santander’s goal of building its capital buffer to more than 11% over the next couple of years still leaves the bank playing catch up with its peers. The latest target is below the 11.8% that Exane BNP Paribas analyst Santiago López Díaz said he expects for the broader European banking sector this year.

“The problem is that the current capital position leaves, in our view, limited room for flexibility,” Mr. López Díaz wrote in a research report earlier this month.

Santander announced the 11% target in a regulatory filing Wednesday as it kicks off a two-day presentation in London with investors and analysts.

“We will consistently generate capital, to increase dividends per share and earnings per share,” Ms. Botín said in a statement. The bank is targeting a cash payout of 30 to 40%, she said.

Santander said Wednesday that it aims to have a return on tangible equity, a measure of profitability, of 13% by 2018. The bank had already set a goal of reaching between 12 to 14% by 2017.

The bank also restated its 2014 and 2015 accounts to redistribute losses from its corporate center unit in a bid to increase “transparency,” Santander said in a regulatory filing. The restatement does not affect the group’s consolidated figures, so reported net profit last year and in the first half of this year, for instance, remains the same.

Santander had reported losses at the corporate center of €1.33 billion in the first half of 2015, which will now be restated to a €981 million loss under the new criteria, the bank said.

Investors and analysts have said they are eager to hear details on Wednesday and Thursday from Ms. Botín about how the bank is coping with Brazil, whose economy has entered its deepest economic downturn since the global financial meltdown of 2008-09. The country is one of the bank’s biggest profit drivers.

To bolster its capital base, some analysts have said Santander should sell off units that haven’t performed as robustly in recent years. Also, investors and analysts have said they want Santander executives to clarify the bank’s strategy on mergers and acquisitions at the two-day London event.

“M&A has been the key driver of growth and capital generation at Santander in recent year,” Mr. García González wrote in a research note. He estimates that under Emilio Botín, Santander had spent more than $100 billion on acquisitions in the past decade-and-a-half. Ms. Botín has said she would focus on loan growth, rather than buying new banks, but still bid for smaller lenders in Brazil and Portugal.

“We believe guidance on the M&A strategy and the type of targets/markets of interest would reduce uncertainty,” Mr. García González wrote.

How to Break Up Your Bad Marriage with the Federal Reserve Before It’s Too Late

by Nick Giambruno, Senior Editor

After the president of the United States, the most powerful person on the planet is the chairman of the Federal Reserve.

Ask almost anyone on the street for the name of the U.S. president, and you’ll get a quick answer.

But if you ask the same person what the Federal Reserve is, you’ll likely get a blank stare.

They don’t know - partly due to the institution’s deliberately obscure name - that the Fed is really the third iteration of the country’s central bank. Or that the Fed manipulates the nation’s economic destiny by controlling the money supply.

And that’s just how the Fed likes it. They’d prefer Boobus americanus not understand the king-like power they wield.

By simply choosing to utter the right words, the chairman of the Fed can create or extinguish trillions of dollars of wealth both in and outside of the U.S. He holds the economic fate of billions of people in his hands.

So it’s no shocker that investors carefully parse everything he says. They have to, if they want to be successful. Some even go as far as to analyze the almighty chairman’s body language. Of course, the mainstream financial media revere the Fed.

You may recall the unhealthy spectacle that occurred in 1996. That’s when Alan Greenspan, the Fed chairman at the time, spoke the now famous phrase “irrational exuberance” in what should have otherwise been a dull and forgettable speech.

Investors heard Greenspan’s phrase to mean that the Fed would soon raise interest rates to slow the global economy.

It’s worth mentioning that Greenspan didn’t actually say the Fed would raise rates. Nor did he intend to signal that.

Nonetheless, the reaction was swift and panicky. U.S. markets were closed at the time, but stocks in Japan and Hong Kong dropped 3%. The German stock market fell 4%. When trading started in the U.S. market the next day, the market opened down 2%.

Billions of dollars of wealth vanished in a period of 16 hours.

That’s the absurd power over the global economy that the Federal Reserve gives to one human being.

The words of the chairman can make or break the fortunes of anyone with a brokerage account.

The Fed’s Alice in Wonderland Economy

I almost fell out of my chair when I heard it…

A journalist recently asked Janet Yellen, the current chair of the Federal Reserve, if the central bank would keep interest rates at 0% forever.

Her response: “I can’t completely rule it out.”

I was stunned.

The deferential financial media hurried to ignore the significance of that statement. Instead, it acted the way big city police might act after making a messy arrest on a busy sidewalk. “Move along folks, nothing to see here!”

Clearly, there was something to see. Something very important.

Yellen’s words came amidst one of the most anticipated economic pronouncements in a generation… whether the Fed would finally raise interest rates for the first time in nine years. Short-term rates have been at zero since the 2008 financial crisis.

Interest rates are simply the price of borrowing money. Setting them at an artificial level is nothing other than price fixing. Not surprisingly, it has led to enormous amounts of malinvestment and other distortions in the economy.

Malinvestment is the result of faulty decision-making. Any investor or business can make a mistake, but central bank manipulation of interest rates subsidizes bad, wasteful decisions.

Cheap borrowing costs trick companies. It causes them to plow money into plants, equipment, and other assets that appear profitable because borrowing costs are low. Only later, when the profits don’t show up, do they discover that the capital was wasted.

Seven years of quantitative easing (QE) and Fed-engineered zero interest rates have drawn the U.S. and much of the world into an unsustainable "Alice in Wonderland" bubble economy riddled with malinvestment.

The pundits had expected that, at this recent meeting, the Fed would move to raise rates just a little and give the global economy a tiny taste of sobriety.

Not even that nudge materialized.

Instead, the Fed sat on its hands. It kept interest rates at zero.

And Janet Yellen couldn’t even rule out that rates would stay at zero forever.

If she can’t even do that, how is she going to start a sustained series of rate hikes, as many of those same pundits now expect her to do a few months down the road?

The truth is, seven years of 0% yields and successive rounds of money printing has so distorted the U.S. economy that it can’t handle even the tiniest increase in interest rates. It would be the pin that pricks the biggest stock and bond market bubble in all of human history. The Fed cannot let that happen.

What Happens Next

It’s clear that the Fed can’t raise interest rates in any meaningful way. It would trigger a financial meltdown that would quickly force them to reverse course.

The Fed might be able to get away with a token increase, but that’s all.

In other words, the Fed has trapped itself.

Former Fed chairman Ben Bernanke admitted as much recently when he said he didn’t expect rates to normalize in his lifetime.

And then, we have the current chair Janet Yellen saying that rates might stay at zero forever!

Yellen’s belief that she has the power to suppress interest rates until the end of time is a frightening sign.

As powerful as the Fed is, it isn’t stronger than the markets. A crisis in the markets could force rates higher even if the Fed doesn’t want them to go there. And the longer the Fed tries to sustain abnormalities like QE and 0% interest rates, the more likely it is that the whole business will end with the markets crushing the Fed.

And that’s not even considering a collapse of the petrodollar system or China pushing the establishment of a New Silk Road in Eurasia…two catalysts that would likely force interest rates higher.

So I’ll go ahead and disagree with Yellen and rule out the possibility that rates might stay at zero forever. They won’t, because they can’t.

At the next sign of a market swoon or of a weakening economy, or with the next episode of deflationary jitters, the Fed will again ramp up the easy money. It could be another round of QE. Or the Fed could push interest rates into negative territory. If that fails, the Fed could go for the nuclear option and drop freshly printed money out of helicopters as Bernanke once infamously suggested – or, more likely, into everyone’s bank account. They’ll do whatever it takes, no matter what the eventual damage to the dollar’s value.

Whatever the details, one thing should be clear. This politburo of unaccountable central planners is the greatest risk to your financial wellbeing today.

What You Can Do About It

It’s a terrifying thought that the actions of a few people at the Fed so endanger your financial security.

But the facts are worse than that. There’s more to worry about than just the financial effects.

The social and political implications of the Fed’s actions are even more dangerous.

An economic depression and currency inflation (perhaps hyperinflation) are very much in the cards.

These things rarely lead to anything but bigger government, less freedom, and shrinking prosperity.

Sometimes they lead to much worse.

Fortunately, your destiny doesn’t need to be hostage to what’s coming.

We’ve published a groundbreaking step-by-step manual that sets out the three essential measures all Americans should take right now to protect themselves and their families.

These measures are easy and straightforward to implement. You just need to understand what they are and how they keep you safe. New York Times best-selling author Doug Casey and his team describe how you can do it all from home. And there’s still time to get it done without any extraordinary cost or effort.

Normally, this get-it-done manual retails for $99. But I believe it’s so important for you to act now to protect yourself and your family that I’ve arranged for anyone who is a resident of the U.S. to get a free copy. Click here to secure your free copy.

Until next time.

Why the Eurozone Isn’t Forcing the ECB’s Hand

The market’s appetite for more ECB easing won’t be sated while the economic data hold up.

By Richard Barley

ECB President Mario Draghi pictured in April. ECB officials will no doubt continue to strike a dovish tone.ECB President Mario Draghi pictured in April. ECB officials will no doubt continue to strike a dovish tone. Photo: Bloomberg

The clamor for further easing by the European Central Bank is building again as stock and credit markets sag. But the economic data don’t offer a really compelling reason for action.

Wednesday’s survey data is a case in point. Markit’s eurozone flash purchasing managers index dipped to 53.9 in September from 54.3 in August. But that still suggests continued growth at about the same pace as in the second quarter despite fears about the chill emanating from China and emerging markets.

The average for the third quarter stands at 54.0, the highest since the second quarter of 2011, Markit noted. And some of the underlying details were positive: employment continued to rise, new orders and backlogs of work grew at a faster pace and growth outside France and Germany held up.

The one caveat: September’s flash survey hasn’t captured the events at Volkswagen VLKAY 5.62 % . While the auto maker is only one company, it is huge—with 439,000 European employees in 2014, production plants in 20 European countries, and a wealth of suppliers—and its problems could yet dent confidence, particularly in Germany.

Other indicators have also suggested continued steady progress in the eurozone: unemployment is high but fell in July to 10.9%, down from 11.6% a year earlier. Headline inflation is way off target, at 0.1%, but was hit again in August by a big drag from energy, services and non-energy goods inflation were stable at 1.2% and 0.4% respectively. And low inflation means real wages are rising. In the second quarter, eurozone real wage growth in industry, construction and services of 1.9% from a year earlier was over one percentage point higher than the average for 2000-07, ING calculates.

Meanwhile, the euro has changed course: while in recent months it has often moved in the opposite direction to stocks, rising when risk appetite falls and vice versa, that relationship appears to have broken down. On Tuesday, when the Stoxx Europe 600 fell more than 3%, the euro fell half a cent against the dollar; Wednesday it traded just above $1.11.

That may be in expectation of expanded bond purchases by the ECB but, since the euro exchange rate is the most obvious channel for central bank policy to affect the economy, the market is easing for the ECB. Bond yields have declined again across the eurozone.

ECB officials will no doubt continue to strike a dovish tone. The risks from emerging economies and financial markets are rightly reason for concern. But so far, the eurozone economy is holding up despite the headwinds.

Op-Ed Contributor

Whatever Happened to German America?


Berlin — WHAT is America’s largest national ethnic group? If you said English, Italian or Mexican, you’re wrong. Today some 46 million Americans can claim German ancestry. The difference is, very few of them do.
Indeed, aside from Oktoberfest, German culture has largely disappeared from the American landscape. What happened?
At the turn of the last century, Germans were the predominant ethnic group in the United States — some eight million people, out of a population of 76 million. New York City had one of the world’s largest German-speaking populations, trailing only Berlin and Vienna, with about a quarter of its 3.4 million people conversing auf Deutsch. Entire communities, spreading from northern Wisconsin to rural Texas, consisted almost exclusively of German immigrants and their children.
As they spread through the country, they founded church denominations, singing societies, even whole industries — pre-Prohibition brewing was dominated by Germans, whose names live on in brands like Pabst, Busch and Miller. Their numbers shaped the media — there were 488 German-language daily and weekly newspapers around 1900 keeping the language and culture alive — and politics: Midwestern German-Americans were a backbone of the early Republican Party.
The enormous number of German-Americans was also a factor in keeping the United States out of World War I for so long — activists lobbied against intervening on the Allies’ side, while politicians worried about losing a sizable voting bloc.
Partly for that reason, when the United States did enter the war, German-Americans came under intense, and often violent, scrutiny, especially after the revelation of an ill-conceived German plan for Mexico to invade the United States.
There had long been doubts about the loyalty of German-Americans, especially in the myriad pockets of the Midwest where they were particularly dominant. Many had hoped to stave off assimilation by clinging to their language and dual loyalties — but that commitment to their culture suddenly became a vulnerability.
In what is a largely forgotten chapter of American history, during the roughly 18 months of American involvement in the war, people with German roots were falsely accused of being spies or saboteurs; hundreds were interned or convicted of sedition on trumped-up charges, or for offenses as trivial as making critical comments about the war. More than 30 were killed by vigilantes and anti-German mobs; hundreds of others were beaten or tarred and feathered.
Even the German music of Beethoven and Brahms, which had been assumed to be immune to the hysteria, came under attack. “It is the music of conquest, the music of the storm, of disorder and devastation,” wrote The Los Angeles Times in June 1918. “It is a combination of the howl of the cave man and the roaring of the north winds.” Sheet music, along with books by German authors, was burned in public spectacles.
Not surprisingly, those who could hid their Germanic roots; some switched their names; many others canceled their subscriptions to German newspapers, which virtually disappeared. Whatever vestige of German America remained after the 1910s was wiped out by similar pressures during World War II, not to mention the shame that came with German identity after it.
My grandfather Joseph Kirschbaum lived through this disruption. Born in New York to German immigrant parents in 1891, he didn’t start learning English until he went to school, and continued to speak German at home, with friends and in the shops and restaurants he would frequent with his parents. And yet, later in life, he claimed he couldn’t remember any of it.
In some parts of the United States, there might be appeals by politicians to win over the Hispanic-American vote, the Italian-American vote, the Jewish-American vote, the African-American vote or the Irish-American vote. But you will be hard-pressed to hear anyone — not even the speaker of the House, John A. Boehner, who has never tried to make any hay out of his German roots — canvassing for the support of the German-American vote.
Still, while German-American culture might be extinct, German-Americans have continued to make a mark on the country, from Neil Armstrong, the astronaut, to Robert B. Zoellick, a former president of the World Bank. Steinway pianos were first made by a German immigrant named Heinrich Steinweg (who became Henry Steinway). Chrysler was established by Walter P. Chrysler, whose family was of German descent, and Boeing was founded by William E. Boeing, the son of a German immigrant.
Yet as the centennial of World War I passes and the 25th anniversary of German unification nears, there are some tender shoots of a renascent German-American identity. A German-American congressional caucus was created in 2010 and now has 93 members. The popularity of craft beer has led to a resurgence in German-style Biergartens, while sports figures like the soccer coach Jürgen Klinsmann and the N.B.A. all-star Dirk Nowitzki celebrate their German identity.
It may be that an identity lost can never be regained. But why not try? It would be good for everyone, reminding millions of Americans that they too are the products of an immigrant culture, which not long ago was forced into silence by fear and intolerance.