Living La Vida Nada

From the Federal Open Market Committee’s (FOMC) policy statement earlier today:

Information received since the Federal Open Market Committee met in January indicates that the economy continues to contract.  Job losses, declining equity and housing wealth, and tight credit conditions have weighed on consumer sentiment and spending.  Weaker sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories and fixed investment.  U.S. exports have slumped as a number of major trading partners have also fallen into recession.  Although the near-term economic outlook is weak, the Committee anticipates that policy actions to stabilize financial markets and institutions, together with fiscal and monetary stimulus, will contribute to a gradual resumption of sustainable economic growth.

In light of increasing economic slack here and abroad, the Committee expects that inflation will remain subdued.  Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability.  The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

It goes on to state that its goal is to bring long term rates down farther by buying “up to an additional $750 billion of agency mortgage-backed securities”, “$300 billion of longer-term Treasury securities over the next six months” and  “agency debt this year by up to $100 billion”.  The Fed is aggressively using its balance sheet to inject liquidity into the financial system since the already low fed funds rate target is technically as low as it can get now.  The Fed is hinting that we may be looking at the recession’s trough soon.  Given the release of today’s 1st Quarter GDP, we can only hope and pray.

From Market Watch:

The central bank’s Federal Open Market Committee said that spending has stabilized and that the pace of the downturn appeared to be somewhat slower. The economy could remain weak in coming month but policy actions and “market forces” were aligned to create a gradual upturn, the statement said.

Fed watchers saw little drama in today’s announcement.

“The only major difference between today’s statement and the previous one on March 18 is that today’s cited the fact that most evidence points to a slowing rate of economic decline. Anyone with two eyes and a brain knows this to be the case,” wrote Josh Shapiro, chief U.S. economist at MFR Inc. in a note to clients.

Economists had expected the policy-setting panel to maintain the status quo. The FOMC kept its target interest rate unchanged at an ultra-low 0%-to-0.25% range.

The economy has fared dismally over the past six months — collapsing by the sharpest rate in more than 50 years. The unemployment rate has spiked and business investment has slowed.

I don’t think I have to tell you that that’s those are signs of an incredibly bad economy.  I really was surprised the market didn’t react badly today than a worse than expected dive in GDP for the first quarter, but then, the markets are supposed to be more forward looking according to the literature and every one is beginning to the end is near.  Oh, that would be of the recession,mind you.

Real gross domestic product — the inflation-adjusted, seasonally adjusted value of all goods and services produced in the United States — fell at a 6.1% annualized rate in the first quarter, nearly matching the 6.3% decline in the fourth quarter of 2008. Read the full report.

Despite the disastrous results, many economists said the report hinted that the worst of the declines may be over. The data on investment “have a capitulatory feel to them,” said Stephen Stanley, chief economist for RBS Securities.

The two-quarter contraction was the worst in more than 50 years. Since 1947, the economy had never contracted by more than 5% for two consecutive quarters. With a 0.5% drop in the third quarter of 2008, it’s the first time the economy has contracted for three  consecutive quarters since 1975.

In the past four quarters, the economy has fallen 2.6%, the biggest year-over-year decline since 1982.

The big story for the first quarter was in the business sector, where firms halted new investments, and shed workers and inventories at a dizzying pace to bring down production and stockpiles to match the lower demand from U.S. and foreign markets.

“The traditional patterns of a business cycle are emerging,” wrote John Silvia, chief economist for Wachovia. “After a sharp decline in demand in the fourth quarter we are now witnessing the inventory correction. Ahead is rising demand and recovery at a slower, but still positive, pace.”

I’m still inclined to think that this is going to be a long, slow, slog across the bottom and Martin Wolf agrees.   This is because the banking and financial system has not been challenged to correct its systemic problems.  His concerns are analyzed at Naked Capitalism.

We appear to be less than halfway through writedowns, and the fundraising and recapitalizations to date are falling short of the equity hits. Wolf thinks the ability to raise funds privately is nada.Banks also have significant maturing debt in 2010 and 2011. If they can’t roll it at an attractive price, that means balance sheet shrinkage. And believe it or not, the myriad of lending support programs represents only 1/3 of the IMF’s estimate of total needs. Yes, the US has the FDIC guaranteeing bank bond issues; it will probably expand that program further. But if that continues (likely) it again continues the dangerous pretense that banks are private concerns that claim the need to give employees decent pay, when they are in fact wards of the state and should be regulated as utilities. or put into receivership and restructured.

The gloomy calculus does not include the implosion of the shadow banking system, a bigger source of credit than the banking system. Unless private securitization can be restored (ahem, no progress on the needed reforms), even more capital in the banking system is needed.

He has major concerns about zombie bank problem.  He’s guessing that  keeping  them on government infusions will eventually amount to about 13% of GDP and that is becoming increasingly difficult to do under the current political system.  You can also read about FT’s  Willem Buiter concern’s about the ever expanding role of the FED and its potential to become some type of quasi agent of the Treasury. Independence of the Fed or any Central Bank has been the subject of many studies.  In the past, the lack of independence of a central bank with political leaders has been shown to be correlated with slower growth of GDP and high levels of inflation.

Buiter also has a major article up on the front page of VOX.  If none of the above information has you reaching for your cocktails yet, consider the impact of the flu pandemic on the global economy.

I am not going to use this opportunity to deepen the gloom by exploring at length the possible consequences of a worldwide pandemic of a virulent form of swine flu. Just a few depressing words will have to suffice. From an economic perspective, a flu pandemic amounts to at least a temporary reduction in the effective supply of labour. If flu-related mortality is high, there will be a permanent reduction in labour supply. The dependency ratio rises (temporarily or permanently, depending on whether mortality increases). Trade and travel are interrupted. A flu pandemic therefore represents an adverse supply shock. Notional consumption demand need not decline materially, but effective consumption demand may well be depressed if many would-be shoppers cannot reach the sellers of goods and services or arrange for delivery. Investment is bound to suffer.

A flu pandemic therefore also represents an adverse shock to aggregate demand. It is bad news on both the demand and supply side. It will however, impact favourably on global warming. Now you know.

However, since we just spoke of the zombie bank problem, let’s continue with that thought from the same piece.

US authorities doing everything to emulating Japan’s lost decade

There is little reason to assume the US will do better than the average achieved post-world war II. Its room for discretionary fiscal stimuli has been more than exhausted.

Almost two years have been wasted since the beginning of the financial crisis as regards getting past toxic assets off the balance sheets of the banks. The US regulators and Treasury have put the interests of the unsecured creditors of the banking system ahead of those of current and future tax payers and beneficiaries of public spending. Worse than that, by failing to come up with the required amount of up-front fiscal resources to clean the balance sheets of the zombie banks, recapitalise the banks and, where necessary, guarantee new lending and borrowing, the US authorities have relegated most of the banking system to a state of limbo in which far too little new lending to the real economy is undertaken.

The sloth-like speed of the stress tests and the six months grace period granted banks deemed short of capital to come up with new capital on their own, contribute further to my sense that the authorities in the US are doing everything they can to make sure that the US gets as close as possible to emulating Japan’s lost decade.

I guess we should not dust off our recordings of “Happy Days are Here Again!” quite yet.   However, if there’s a Chinese version, it appears they can start spinning the turntables and turning up the IPODS.  Everything there is pointing at a V-shaped recovery.  The U.S. and Europe will spend some more time living the Vida Nada.