A Moment Of Truth For The Fed

Fed Has Done All It Can

Federal Reserve Bank of Kansas City President Thomas Hoenig said there’s a limit to how much more the central bank can help the U.S. economy and that the focus should now be on solving the country’s fiscal problems.

“We can’t do it all,” Hoenig, the central bank’s longest- serving policy maker, said in an interview with Bloomberg Television that airs today. “We have a problem in this country with debt” and “if we don’t turn to the long run, we will be dealing with overnight crises for as far as the eye can see.”

The regional bank chief, 64, joined colleagues like Dallas Fed President Richard Fisher by saying monetary policy can’t be expected to cure all that ails the economy, and shouldn’t be used to target high unemployment. Hoenig, who doesn’t vote on the Federal Open Market Committee this year, said it probably isn’t “a surprise” to learn that he would have dissented against the FOMC’s Aug. 9 decision to keep rates near zero through at least mid-2013.

“Monetary policy is an important tool, it is a valuable tool, but it is not an exclusive tool,” Hoenig said in the interview from Jackson Hole, Wyoming, where the Kansas City Fed is hosting the central bank’s annual symposium. Yet “it does not solve all problems.”

When asked whether he would support action like that of “Operation Twist,” the 1961 initiative by the central bank and President John F. Kennedy’s administration to spur growth by lowering long-term rates and keeping short-term ones unchanged, Hoenig told Bloomberg Television, “I don’t see any reason” why it would work.

“What’s the fundamental problem?” Hoenig said. “Is the fundamental problem a yield curve issue? Or is the fundamental problem that the United States and world have too much debt?”

“Would Operation Twist help solve the problem?” he said. “If the answer is yes, go for it. If the answer is no, let’s not.”

Comments:

An honest assessment of the limitations of the Fed comes from Thomas Hoenig, whom we referred to in a previous blog post "A true leader at the Fed".

It is refreshing to see someone at the Fed has an inkling that our present issues are with debt and not the yield curve.

I expect that support for QE3 will remain weak for some time, as mentioned in the previous post "It finally happened"

A number of economists are awakening to the fact that monetary policy in general, and quantitative easing in particular, are not the solution to every economic woe.

Sometimes an economy just has to man up and take its medicine.

What remains to be seen is if the United States and numerous western democracies will restrain spending and recalibrate the tax system to achieve the responsible fiscal policy of balanced budgets soon.

It is my view that we are already past the point of no return (greater than 90% debt to GDP) in terms of being able to repay the sovereign debt borrowed in these countries.

This can only mean one thing:

Default.

The timing of such a serious action with its accompanying consequences remains elusive.

While the US, Canada & European countries have attempted soft default by attempting to stoke inflation to drive down the cost of their debt, the bond market is beginning to place a choke hold on such action by increasing yields (interest rates) across the curve, at least on the less solvent European nations ie: PIIGS.

Therefore, soft default is not working.

This leaves two choices.

-Hard default and the consequences of deflation.

-Or massive QE with central banks buying their own debt to goose inflation to high and probably uncontrollable levels.

Will Helicopter Ben deliver on his loads of money commitment or will the bond market take the Fed and Congress to task and give them a good thrashing?

Either scenario will not be pleasant.

But for the god-like power that the Fed is alleged to have, it will a the moment of truth.