The RBA and Federal Reserve hope for the best: Kohler

To sum up: the Fed and the RBA have both declared victory over inflation, but not unemployment.

Actually, they haven’t been fighting inflation – the dark armies of the GFC did that. And they are out of ammo on unemployment.

In his Congressional testimony overnight, Ben Bernanke said the Fed expects inflation to “remain subdued over the next two years”, but that “job insecurity…is likely to limit gains in consumer spending, which is “an important downside risk to the outlook”.

Yesterday’s minutes from the RBA said: “Labour market indicators [are] likely to remain soft for some time”, but that “the inflation afforded scope for further easing of monetary policy”.

They might be wrong, of course – they’ve been wrong before. But at least it is perfectly clear what they think: inflation is not a problem but they are worried about employment, as well they might be.

‘Exit strategy’, in other words, is really not on the agenda – it’s only a plump source of market chatter. Market players are pointlessly falling over themselves to predict when the first rate hike will happen both here and in the US, and futures markets are now pricing in a ramping up of cash rates from either late this year (Australia) or early next year (US).

This is both irrelevant and misleading. The Fed’s big problem is that the US is in a liquidity trap, where it can’t cut rates any further while unemployment is still rising…”steeply” according to Bernanke last night.

As a result the Fed has been engaged in “quantitative easing”, in which it buys assets from banks (usually Treasury bonds) using newly printed money. The theory is that the bank goes out and uses these extra reserves to increase lending and thereby increase the supply of credit.

The trouble is that banks don’t want to lend and borrowers either won’t or can’t borrow. The money is simply being held on deposit at the Federal Reserve, earning interest.

As a result we have the paradox of a shortage of credit and an excess of reserves. Money supply has skyrocketed, but consumer prices are subdued or falling because the money is not circulating.

Meanwhile, governments have been massively increasing their budget deficits to replace private sector demand.

Consumer and business demand was fuelled by debt during the asset price boom. Asset prices have now fallen and credit has dried up, so naturally demand has too.

Both labour and capital are now in excess supply and output is contracting. Global GDP probably would have had to contract by 10% if governments had not stepped in with debt-fuelled demand of their own.

So now we have a situation where the global economy has been stabilised by the sheer weight of money printing and government demand, but there is now a massive oversupply of both cash and government debt, plus a liquidity trap in some countries, as a result.

In other words, authorities are out of the game. Printing more money is pointless – it has no velocity and can’t do any work. Increased budget deficits further would work, but that is now politically impossible.

So this morning’s testimony from Ben Bernanke and yesterday’s RBA minutes, were the jottings of coaches in the last quarter – hoping the team wins, but not really able to do anything about it.

This article first appeared on Business Spectator.