What's the Fed Hiding?

Two Fed apologists, Alin Kashyap and former Fed governor Frederic Mishkin, are out with an Op-Ed in WSJ that claims the Fed is transparent enough, and that Ron Paul's Audit the Fed Bill is useless.

"It is completely appropriate to hold the Fed accountable for its decisions. But the [Ron] Paul bill, H.R. 1207, will only produce redundancies: Congress already has multiple ways of finding out what the Fed is doing and why," write the dynamic duo.

They also set up something of a strawman: Under the banner of increasing Federal Reserve transparency, Congressman Ron Paul has sponsored a bill that would subject the Fed's monetary policies to an audit by the Government Accountability Office (GAO). Paul has said repeatedly that the bill is not about auditing monetary policy.

They even hail, as Paul described it, the "gutting" of the bill: Fortunately, Congress is considering an amendment to the bill that would prevent the negative consequences of the original Paul legislation. This amendment, put forward by Rep. Mel Watt (D., N.C.) would change the focus of the bill by instructing the GAO to audit the new lending facilities at the Federal Reserve that were authorized under the 13(3) "unusual and exigent circumstances" clause of the Federal Reserve Act. The 13(3) lending authority, which had not been used by the Fed since the Great Depression, was the basis for many of the most controversial decisions made during the crisis, including the rescue of AIG and the establishment of new lending facilities.

This audit would involve oversight of the operational integrity of these facilities' accounting, internal controls, and protection against losses. It would also disclose the borrowers from these facilities one year after the facilities are closed. The audit would produce new, important information that is not otherwise available and would play to the strengths of the GAO. And the amendment would exempt the Fed's normal monetary policy actions from the audit. There's a lot to debate here about how much transparency the Watt Amendment would kill, but I am want to focus on one matter that was gutted, that is not addressed in any way by the Watt Amendment, and is not addressed, at all, by Kashyap and Mishkin. That is the international transactions of the Fed.

They are hiding something here that they don't want the general public to see. I suspect it might have to do with gold transactions. It's just a gut feeling, but my gut tells me the Fed leased out most of, if not all, of it's gold somewhere under $500 per ounce, probably under $350. Thus, in order for central banks, who borrowed the gold (and then sold it to raise cash), to pay the Fed back in gold, they would now have to go and buy gold back at three to four times the price they sold it at. In other words, a number of central banks aided and abetted by the Fed are now short huge amounts of gold and are losing more money everyday gold ticks up. And the Fed is in the embarrassing position of having loaned the gold out and is afraid to call in the gold loans, since it would put enormous pressure on parts of the central bank cabal and push the gold price much higher, the exact opposite of the Fed's intentions when they leased the gold out.

Could the recent purchase by India of 200 tons of gold from the IMF be an attempt by the central bank cabal to shovel gold to India because they are short huge amounts of gold that was leased from the Fed? The Fed has admitted it has leased out gold, but it has never said how much it leased out and to whom the gold was leased out.

A Fed audit of transactions with international banks and other foreign government entities would answer this question. Is this what the Fed is trying to hide? There is simply no honest reason to hide what the Fed has done with the gold it is/was holding? The public really needs to know if through convoluted leasing programs the Fed has mismanaged the entire quantity of gold.The public needs to know if the Fed has messed up to such a degree that it has become politically unfeasible by those at the Fed to demand from foreign central banks the return of the gold that rightfully belongs to the United States. Is this what the Fed is afraid an audit of international transactions will uncover?

Oh Boy, Dr. Mishkin has been a busy boy the last couple of days. The WSJ article that is referred to here and then in last night’s Financial Times, the following in which he says, sure, the Fed is Bubbleizing the markets, not to worry though, we know what we’re doing and it’s harmless!! LOL, the last scholarly paper Mishkin had published was late 2006, called “Financial Stability in Iceland” in which hje maintained “the fundamentals of Iceland’s economy are strong” Ahhhhhhh, we all know how that worked out!!

Here you go, from Financial Times:

Not all bubbles present a risk to the economy
By Frederic Mishkin
November 9 2009 20:08

There is increasing concern that we may be experiencing another round of asset-price bubbles that could pose great danger to the economy. Does this danger provide a case for the US Federal Reserve to exit from its zero-interest-rate policy sooner rather than later, as many commentators have suggested? The answer is no.

Are potential asset-price bubbles always dangerous? Asset-price bubbles can be separated into two categories. The first and dangerous category is one I call “a credit boom bubble”, in which exuberant expectations about economic prospects or structural changes in financial markets lead to a credit boom. The resulting increased demand for some assets raises their price and, in turn, encourages further lending against these assets, increasing demand, and hence their prices, even more, creating a positive feedback loop. This feedback loop involves increasing leverage, further easing of credit standards, then even higher leverage, and the cycle continues.

Eventually, the bubble bursts and asset prices collapse, leading to a reversal of the feedback loop. Loans go sour, the deleveraging begins, demand for the assets declines further and prices drop even more. The resulting loan losses and declines in asset prices erode the balance sheets at financial institutions, further diminishing credit and investment across a broad range of assets. The resulting deleveraging depresses business and household spending, which weakens economic activity and increases macroeconomic risk in credit markets. Indeed, this is what the recent crisis has been all about.

The second category of bubble, what I call the “pure irrational exuberance bubble”, is far less dangerous because it does not involve the cycle of leveraging against higher asset values. Without a credit boom, the bursting of the bubble does not cause the financial system to seize up and so does much less damage. For example, the bubble in technology stocks in the late 1990s was not fuelled by a feedback loop between bank lending and rising equity values; indeed, the bursting of the tech-stock bubble was not accompanied by a marked deterioration in bank balance sheets. This is one of the key reasons that the bursting of the bubble was followed by a relatively mild recession. Similarly, the bubble that burst in the stock market in 1987 did not put the financial system under great stress and the economy fared well in its aftermath.

Because the second category of bubble does not present the same dangers to the economy as a credit boom bubble, the case for tightening monetary policy to restrain a pure irrational exuberance bubble is much weaker. Asset-price bubbles of this type are hard to identify: after the fact is easy, but beforehand is not. (If policymakers were that smart, why aren’t they rich?) Tightening monetary policy to restrain a bubble that does not materialise will lead to much weaker economic growth than is warranted. Monetary policymakers, just like doctors, need to take a Hippocratic Oath to “do no harm”.

Nonetheless, if a bubble poses a sufficient danger to the economy as credit boom bubbles do, there might be a case for monetary policy to step in. However, there are also strong arguments against doing so, which is why there are active debates in academia and central banks about whether monetary policy should be used to restrain asset-price bubbles.

But if bubbles are a possibility now, does it look like they are of the dangerous, credit boom variety? At least in the US and Europe, the answer is clearly no. Our problem is not a credit boom, but that the deleveraging process has not fully ended. Credit markets are still tight and are presenting a serious drag on the economy.

Tightening monetary policy in the US or Europe to restrain a possible bubble makes no sense at the current juncture. The Fed decision to retain the language that the funds rate will be kept “exceptionally low” for an “extended period” makes sense given the tentativeness of the recovery, the enormous slack in the economy, current low inflation rates and stable inflation expectations. At this critical juncture, the Fed must not take its eye off the ball by focusing on possible asset-price bubbles that are not of the dangerous, credit boom variety.

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