Slowly but surely

Note: additional information came in (January 28, 2009) requiring revision of the account of meetings between administration officials and the private sector detailed below.

Back in December, I wrote about the then-unreported loss of jobs in the Call Center industry, which some readers disputed as a “half-empty” sort of thing to say; still, hard news started trickling in (for example, Accenture Manila cuts hundreds of jobs).And while, indisputably, the industry itself is trying to maximize its potential (see BPO industry short by 20,000 jobs of its target last year) it has to do so while grappling with harsh global realities (see BPO industry sees consolidation amid uncertainty in US economy ). To be sure, if companies are nimble, there are actual opportunities:

Tholons Philippines country manager Jo-An Darlene Chua was quoted as saying that with the country’s BPO export value aggregating close to 50 percent of India’s, companies may well find the Philippines as a good alternative.

Tholons said the same for Vietnam ” a solid alternative to India on the IT side.”

Sanez said he can’t see any backlash yet on the US government’s move to generate domestic jobs that may impact the BPO industry.

“It doesn’t matter whether the policy of President-elect Barack Obama may rein in offshore activities because outsourcing and offshoring are business decisions.”

But as blogger Marocharim, over at Filipino Voices, recently wrote a timely reminder of the very human face of all these statistics: the layoffs are real, the concern among young Filipinos, acute.

Today’s headlines focus on the closing of Intel’s Philippine operations and disclose job loss figures that are disheartening, though also, confusing: Export drop affects 34,000 jobs; Gov’t fears 60,000 IT job losses (surely some overlap between these two separately-reported figures); and RP 2008 growth may be weakest in 7 years. No one doubts this year will be tough; the ongoing economic crisis is global and of course affects us, too (see Layoffs for January 2009 at America’s 500 largest public companies:71,450).

However, if the country is to weather the storm, or position itself to recover as quickly as possible, then it surely helps to see where the bad news has been fostered by existing conditions.

This Intel story, for example, began close to two years ago. On April 3, 2008, blogger SEAV, in Intel Cavite Closing Down, for Real? pointed to Yugatech first blogging about the possibility “almost one year ago,” and then mentioned information that surfaced in the comments section of an entry of his in another of his blogs, Vista Pinas (see Intel Philippines, Cavite Plant). One comment in SEAV’s blog (April 4, 2008; seconded by an April 7, 2008 comment) explained the closure as follows:

The complete story is that, and this has been extremely misrepresented in various circles thus far, there are issues with the current building where Intel CV is operating and given Intel’s utterly strict standards on safety and building code compliance, this is deemed more as a long-term move for safety reasons (think Hanjin and you know what I mean) rather than an immediate pull-out of busines operations. In order to sustain the business, a set of options have been formulated by Intel Corporation as a whole with the most promising being that a new building should be identified where all operations can be transferred to and resumed. This part of the story is still not resolved and a second announcement is due by end of June to finally roll-out the official plan, a full closure being one of the alternatives, if a building is not identified and the economic climate of the Philippines continue to be inferior versus Vietnam and China and the rest of the world.

According to Yugatech (in Intel to shut down Cavite facility by year-end), has been steadily paring down its workforce since April, 2008 (when SEAV’s entry came out), reducing it from 3,000 workers at the time, to the 800 who made the cut but who will now lose their jobs. It seems reasonable to deduce that the economic reversals of the company at present meant it had to dispense with finding a win-win solution for the problem it’s wrestled with for some time now:

According to a source who received the memo, Intel will no longer continue its plans to transfer its operations to Laguna (the one by NXP Semiconductors, formerly Philips Semiconductors, plant in Cabuyao as reported earlier). Intel has been taking bids and contracting 3rd party providers for the transfer but suddenly scrapped them altogether. The memo did not specifically indicate the reasons for the sudden reversal of decision.

Now there’s a moral to this story, and it is, that if we are to not only entice, but retain, foreign investments, you can’t muck around with “puwede na” slipshodness and that problems, once identified, ought to be resolved within a reasonable period of time, otherwise the window of opportunity might simply close, leaving ordinary employees in the lurch -and further retarding the competitiveness of the country (and other issues were raised concerning the waning enthusiasm of Intel: high taxes, high power rates, etc.).

In a letter to the editor today, Peter Wallace comes up with an answer to the ongoing debate about the 2007 economic figures touted by the government:

As to 2007 being a good year, we can’t fully agree. The reported growth of 7.2 percent was not because of a strongly growing economy but because of a numerical oddity. Import growth is subtracted in the equation for the gross domestic product (GDP). In 2007 imports fell by five percent, the double negative meant that this rate of fall was added to GDP – a double-negative becoming a plus. Had imports grown at their previous more normal rate of around five percent, GDP growth would have been about 4.8 percent, much more in line with anecdotal evidence.

One must ask: How could imports have fallen if the economy was growing strongly; intriguingly how could oil imports fall by some 6.6 percent? The only explanation we can think of is that smuggling must have been up.

But then the problem is that data is ever disputable. But Wallace’s letter, which ends with his opinion that the World Bank’s blacklisting of some domestic firms is a step in the right direction, brings me to another point related to my point concerning Intel’s shutting down its Philippine operations, and my blog entry, yesterday, on the government and its possible anxiety over the handling it will get at the hands of the new American administration.


Personally I think Amando Doronila is being alarmist (and if you want my view on the matter, there’s my commentary, New era of intervention ; the best overview, remains, to my mind, in Torn & Frayed‘s blog). So f what the country can expect is more assistance for development, but no encouragement for secession, and also, increased scrutiny on human rights, then this means the Palace had better nip all this talk of ex-Gen. Palparan being put in charge of the anti-drug agency of the government! And more to the point, it had better start finding some big fish to fry as far as corruption is concerned.

Philippine Commentary links to a Dow Jones Story, World Bank Bans 7 Firms, Some China Government-Owned, In Philippines:

Following a major investigation spanning several years by the Integrity Vice Presidency, the World Bank found evidence of a “major cartel involving and international firms bidding on contracts,” it said in a release.

That led to four Chinese state-run firms being barred for the first time from doing business with the World Bank for a period of between five and eight years – the China Road and Bridge Corp., China State Construction Corp., China Wu Yi Co. Ltd. and China Geo-Engineering Corp.

A Philippine firm E.C. de Luna Construction Corp. and its owner, Eduardo C. de Luna, were each banned indefinitely. Two other Philippine companies, Cavite Ideal International Construction and Development Corp. and CM Pancho Construction Inc., were each barred for four years.

“This is one of our most important and far-reaching cases, and it highlights the effectiveness of the World Bank’s investigative and sanctions process,” said Leonard McCarthy, vice president of the World Bank Integrity department, in the statement.

The investigation began in 2003 after the World Bank team grew suspicious about collusion in the bidding process for a contract during the first phase of the Philippines National Roads Improvement and Management Program. The road improvement program was partially financed by a $150 million World Bank loan, though none of the sanctioned firms received any money.

In August 2008, the inquiry led the bank to ban a South Korean firm working on the roads project, Dongsung Construction Co. Ltd., for four years.

The government, from what I’ve been able to glean, saw the writing on the wall as far back as October last year. In broad strokes, the story goes like this.

In October, the government got wind of the Millenium Challenge Corporation’s attitudes cooling towards the government. The government had gotten wind of the Millenium Challenge Corporation’s attitudes cooling towards the government. This US agency has been positive about anti-corruption efforts it was funding in the Philippines, and our government, in turn, has been trumpeting its support, proclaiming it to be a kind of Seal of Good Housekeeping. But the government was poised to fail, in terms of meeting the criteria set by MCC, for fighting corruption.

It seems some officials in the President’s official family decided that some sort of public to-do had to take place. The private sector was approached, in an effort to net, as the saying goes, a big fish or two. It seems some officials in the President’s official family decided that some sort of public to-do had to take place. The private sector was approached, roundabouts October, in an effort to net, as the saying goes, a big fish or two.

The idea, as proposed by the members of the President’s official family to representatives of the private sector with whom they met, was to mount some sort of investigation and undertake prosecutions to prove that the government was serious about curbing corruption.

The private sector suggested that one way would be to focus on issues that were festering, such as the such as the Megapacific vote-counting machines case, the Diosdado Macapagal Highway issue,  or even electoral fraud in the 2004 presidential elections or even the Fertilizer Scam. But the officials balked at this. But the officials, while receptive to the first two, balked at the third.

OK, so why not look into the National Road Improvement Project and the findings of the World Bank, the private sector suggested, by way of a compromise. Apparently the World Bank findings were already being discussed not just in government circles by this point.

Then the officials suggested, by way of a compromise, why not look into the National Road Improvement Project and the findings of the World Bank? The private sector replied that they were skeptical about progress being made on the cases under the auspices of the present Ombudsman. One of the officials said the Ombudsman’s cooperation would be sought.

But when the private sector asked for a copy of the World Bank report, the officials balked, although it seems the government was in possession of the report in full, and not just an executive summary of its findings. Along the way, the Ombudsman seems to have received a copy of the report, but with the interesting proviso, on the part of the World Bank, that the report not be used by the Ombudsman for prosecution: if a prosecution was to be undertaken, the Ombudsman would have to do her own investigating (interesting, because it suggests the World Bank didn’t want to get dragged into domestic politics, or had little confidence in the report being used for anything more than window-dressing by the Ombudsman).

Along the way, the private sector was able to receive a briefing on the World Bank report. The Ombudsman, it transpired, had received a copy of the report, but with the interesting proviso, on the part of the World Bank, that the report not be used by for prosecution: if a prosecution was to be undertaken, the Ombudsman would have to do her own investigating (interesting! Does this suggest the World Bank didn’t want to get dragged into domestic politics, or had little confidence in the report being used for anything more than window-dressing by the Ombudsman?).

So the whole thing fell apart because the private sector failed to be convinced of the good faith of the officials that made the approach; I wouldn’t be surprised if ongoing efforts in Congress will simply be written off as  the government deciding it would be better to go through the motions of doing something regarding the World Bank report rather than opening up other investigations. To be sure, the World Bank report deserves a congressionaly inquiry.

To test the sincerity of the officials who approached them, the private sector asked for a copy of the report. No copy was forthcoming. So the whole thing fell apart because the private sector failed to be convinced of the good faith of the officials that made the approach.

The World Bank’s report probably had an impact on the American government’s Millenium Challenge Account Philippine Threshold Program and its decision to cut funding for the Philippines. At first, it seemed that essentially what the country had was a P.R. problem. See Millennium Challenge Corp. cuts Philippines aid:

The Millennium Challenge Corporation (MCC), an American government aid agency, has restricted aid flowing to the Philippines due to concerns about corruption. The MCC is setting aside a prior decision to promote the country from “Threshold” to “Compact” aid status, which would have secured significant funding for development projects. The decision appears largely based on the World Bank Institute’s aggregation of corruption perception surveys, which report a worsening public perception of corruption problems.

After she’d taken great pride in the supportiveness of the Millenium Challenge Corporation, the President obviously knew she’d have a lot of explaining to do once news of this reversal leaked out. But more than perception, it seems, the problem of the government was that the Millenium Corporation seems to have been affected by the World Bank’s findings -and they were factual. Which pulls a rug from the government’s beloved “where is your proof? Prove it in the proper forum!” mantra.

After all, it could undertake precisely what’s going on -its own investigation, within the controllable parameters of congressional inquiries.

Still, the damage has been done. The charts above shows the inexorable slide, downwards, of the Philippines’ ratings concerning corruption. But if the Millenium Challenge Corporation hands you lemons, make lemonade.

If the government’s going to suffer a black eye -and a loss of funding and the accompanying erosion of its prestige- it could, at least, keep its China Card in play, as an antidote, fiscally, and politically, to its having lost the American Card. Which is what it’s doing.

Even if stories end up unfolding slowly but surely, so long as you keep the public distracted, it can’t detect the slow, inexorable, unfolding of events. So you can blame the closing of Intel’s plants on the global economic downturn (which is true, of course) while sweeping any domestic culpability for it, under the rug. You can thunder and shrill about the World Bank report while downplaying what you used to trumpet -the Millenium Challenge Corporation’s decision to put things, at the very least, on hold.

Manuel L. Quezon III.

79 thoughts on “Slowly but surely

  1. Economic concerns included

    May all of us have a Happy and Prosperous Chinese New Year.

    Manolo, nice new look though I miss the tally of replies.


    The few folks worried about a constitutional amendment to extend the years that GMA can stay in Malacanang can look to the strategies being implemented by progressive lefts of Latin America. For example, EVO MORALES of Bolivia (who I think is highly regarrded by cvj and Abe Margallo) want to modify their national constitution so he can stay longer “for the greater good” to pursue his socialist agenda and give more power to majority. In particular, the few worried Filipino citizens should look at the issues which may allow Evo Morales to do his power-play, e.g. recognize that there are 36 different ethnic groups, the Bolivia charter change will mean that a person can introduce a complaint to a government office in his or her native language; it will now be the government’s responsibility to understand. It also gives them greater representation in Congress and a new degree of autonomy, including the right to implement their own community justice.

    But battles raged over the economic and political issues in the charter, including more state control over natural resources, limits on how much land one can own, regional autonomy

  3. You can’t look to the USA for strategies on how to introduce constitutional changes because the USA has been one of the slowest in adding changes to their (federal) constitution.

    Constitutional changes are being approved more redily by the populations of Latin America and Eastern Europe — look to them for ideas on how the changes are getting presented to the population which results in changes being accepted. You can imagine that a number of political scientists who want to help GMA are already doing so — if you seriously believe that GMA will want to stay past 2010, then do a little bit of homework and might as well be ready for what the pro-GMA bloc may do in the next so many months. [And again, I again say that above are my personal thoughts on this matter. Of course, there is the simpler mantra to just “….follow the money”. [And my personal opinion is that GMA will step down in 2010 because those are the requirements of the Philippine Constitution.]

    But do beware those who believe GMA in Malacanang past 2010 is “…for the greater good”. History has a few instances of people causing great damage in the name of “…the greater good.”]

  4. I really think the corruption label will stick to GMA like sh*t on a fly’s legs. With this World Bank development, she has nary a shred of credibility or deniability left and is really flying on fumes now. – DJB

    The Guiness Book of World Records now also says: RP: Country with most killings in 2004 which it based on reports coming from the U.N. Boy, her accomplishments are certainly record-shattering.

  5. That Obama as savior is answered by J_AG…sort of

    Now for the Philippines which is still mainly a third world economy the mechanism behind macro economic fundamentals do not exist. When Intel shuts down its plant here due to a collapse in demand in the home country the Philippines very well cannot pump prime demand in the mother country to stimulate demand. The same with the lay offs in other export sectors. Macro economics is based on demand management through fiscal and monetary policies. How does GMA pump prime the slowdown in growth in Singapore, HK, M.E.?

  6. “Audacity of Hope” is the title of obama’s book.
    I have not read it yet. maybe in its sequel, he will tell us all how he saved america and the rest of the world.

  7. macro economics is based on demand management through fiscal and monetary policies.

    economist J-AG 🙂

    Philippines can create its own domestic demand but it lies on the understanding on taking a broad view of the situation abroad and domestically that challenges and opportunities exist.

    Manolo’s previous Bumbling in the dark wrote:

    But my point is that it may be reasonable to propose that government really lacks the information being asked of it by consumer advocates; that even if the data is there, it may not be collected in a timely manner; and that even if collected, may actually be beyond the competence of officialdom to use in a timely and effective manner, whether in terms of collections, regulation, or policy-making.

    Now this is just a hunch, but a hunch getting stronger all the time. It just seems to me that reliable information is beyond the grasp of officialdom, and that even if you grant that most officials are well-meaning, their good intentions are useless because it’s all basically bumbling in the dark.

    So how do the officials in this country manage fiscal and monetary policies if gathering data and even understanding the basic challenges and opportunities is beyond their competencies? When skills and job descriptions do not match, officialdom will surely be bumbling in the dark. It’s a myopic view. I am hoping that this global crisis is the end of too many wake up calls.

  8. “Krugman points out that has already been tried by the Fed in 2008 but has not worked.” CVJ

    Expanding the monetary base strictly through the banks has not provided an impetus to the resumption of bank lending since banks do not want to lend. They have to increase their capitalization and thus credit remains hard to get.

    In the U.S. from an almost 4% headline inflation rate in January the headline inflation rate dropped to less than 1% in December in the U.S. Where is the deflation? Coming soon. Growth in the U.S. in the fourth quarter will have contracted by 5%.

    The fed is battling deflation head on before it gets going. The difference in 1933 was the depression was well under way.

    In case people are wondering why there is all this flurry of Central banks rushing to move to zero rates to forestall a heavy crash is based on their reading of history – they do not want a repeat of the great depression.

    In the last quarter of 2008 the U.S. economy contracted by 4-5%. 5% of a $14 trillion dollar economy is $700B divided by the proper ratio of four quarters contribution to total.

    Coming soon if the expansion of the money base does not work. Monetary tools will switch to the Fed actually buying long term treasuries and target an inflation rate.

    The U.S. is projected to run a trillion dollar budget deficit probably for the next two years. (Lower tax collections and increased expenditures.)

    That will guarantee inflation down the road.

    Lag times in an economy is not like turning a faucet on and off.

    It is not business.

    When was expansion of the monetary base and inflation the same?

  9. Surge-the-gates news:

    RIGA, Latvia — On a frigid evening this month, more than 10,000 people gathered outside a 13th-century cathedral in this Baltic capital to protest the government’s handling of Latvia’s economic crisis and demand early elections. The demonstration was one of the largest here since the mass rallies against Soviet rule in the late 1980s, and a sign of both the public’s frustration and its faith in the political system.

    But at the end of the night, as the crowd dispersed, the protest turned into a riot. Hundreds of angry young people, many drunk and recently unemployed, rampaged through the historic Old Town, smashing shop windows, throwing rocks and eggs at police, even prying cobblestones from the streets to lob at the Parliament building.

    Similar outbursts of civil unrest have occurred in recent weeks across the periphery of Europe, where the global financial crisis has buffeted smaller countries with fewer resources to defend their economies. Especially in Eastern Europe, the turmoil reflects surging political discontent and threatens to topple shaky governments that have been the focus of popular resentment over corruption for years.

    Europeans have compared the unrest to events of the 1960s and even the 1930s, when the Great Depression fueled political upheaval across the continent and gave rise to isolationism and fascism.

    . . . Days after the riot, a demonstration by 7,000 protesters in neighboring Lithuania turned violent, leading police to respond with rubber bullets. Fifteen people were injured. Smaller protests and clashes have erupted in Bulgaria, the Czech Republic and Hungary, following weeks of street violence in Greece last month. On Thursday, police in Iceland used tear gas for the first time in half a century to disperse a crowd of 2,000 protesting outside Parliament in Reykjavik. The next day, Prime Minister Geir Haarde agreed to call early elections and said he would step down.


    So as pro-GMA study Evo Morales/others for con-con to keep GMA for additional years, Malacanang wannabe’s may want to study “surge-the-gate” possibilities presented by 2009 economic crisis.

  10. Coming soon if the expansion of the money base does not work. Monetary tools will switch to the Fed actually buying long term treasuries and target an inflation rate. – J_AG

    I’ve come across this statement before but i do not understand it. Can you explain how the Central Bank buying long term securities would encourage inflation?

  11. When all else fails the Fed actually goes to the printing press to create money out of nothing.

    Right now the Fed is simply giving guarantees on banks devalued assets and also buying back treasuries and other forms of debt paper from banks in exchange for liquidity.

    Unfortunately the regulatory framework for over-leveraging was removed. The problem now is this. If the government takes those distressed assets off banks books at .30 to .50 to the dollar the banks equity position will be exposed as to small and would require capital infusion. The problem of resuming lending or restarting credit marekets will still remain.

    Now with consumers cutting back the problem of retailers and real estate for commercial spaces is becoming another problem for banks which have mortgages on commercial spaces and office blocks.

    That is how the Fed has increased the monetary base drastically. But the problem of declining asset valuations is still ongoing and durables (cars and other high cost consumables) in the physical economy have all suffered a collapse in demand. Negative feedback loops are in evidence. It is spreading.

    In cases of extreme emergency the Fed actually monetizes new government debt.

    In cases of deflation where prices across the board move in negative territory you have to increase the money supply drastically since you have existing productive capacities that have been idled by the collapse in demand.
    (complete collapse in demand)

    The joke ongoing in Asia and most especially in China is that the U.S. is now practicing socialism with American characteristics.

    While we do not see de jure nationalization of the American financial system it is already de facto nationalized.

    Equity holders in problem banks are actually holding worthless paper. Bond holders of problem banks are actually holding worthless paper. Only depositors have guarantees today. Government can at any time take over and stockholders and bondholders would be wiped out. Just imagine Citi is worth $2-3 dollars a share from $54. They are close to becoming a penny stock.

    Unlike in the 30’s only Americans then held paper. Today there would be global implications as sovereign funds and pension funds would be wiped out.

    That is the major difference between today and the 30’s.

    The global implications. It would send a 100 meter tidal wave all over the world and crush the worlds economies.

    So in a severe case of moral hazard even emerging economies who cannot afford it have to subsidize the U.S. government with free money as a major part of Central Banks reserves are denominated in dollars.

  12. thanks justice league, layout is a work in progress, it’s a wonderful free theme, being tweaked by the webmaster. i too, miss tally of replies.

  13. J_ag@1:22pm, i take it that the first part of your explanation (first two paragraphs) on the Fed buying long term securities ties in with <a href=””Robert Lucas recommendation:

    The Fed can satisfy the demand for quality by using reserves — or “printing money” — to buy securities other than Treasury bills. This is the way the $600 billion got out into the private sector

    In short, the Central Bank issues cash in to the banks in exchange for the long term securities that the latter is holding? In that way, more cash available for lending gets into the system.

    The rest of your explanation seems to tie-in with the dilemma that Krugman posted in his NYTimes column on ‘Zombie’-banks (like Citigroup) and the need for nationalization.

  14. Not quite, if all fails (quantitative easing) you actually create cash out of future government debt. That is the most extreme form of quantitative easing. When that happens you already have a hard crash.

    The problem is now containment of diminishing expectations. Hence the need for BOLD MEASURES….

    Obama and Co. have a tough road as once it goes past the use of technical resources it all boils down to the psychology of confidence.

    In a sense the Austrian model of economics leaves no uncertainty. Allow for companies to fail no matter how big they are. The more disciplined companies will then take over.

    Everyone will know where the bottom is. The hit or miss solutions employed since Bear Sterns went down is still confusing markets.

  15. J_ag, thanks for responding. Concerning your statement…

    Not quite, if all fails (quantitative easing) you actually create cash out of future government debt – J_ag

    How does that work i.e. cash out of future government debt?

    In a sense the Austrian model of economics leaves no uncertainty. Allow for companies to fail no matter how big they are. The more disciplined companies will then take over. – J_ag

    Krugman has criticized the Austrian ‘Hangover theory here in its inability to explain why a collapse in investment demand would necessarily lead to a generalized collapse (aka recession), something which Keynes by contrast, was able to address.

  16. create cash out of future government debt = FED will print money to buy bond issued by Treasury

  17. Cash out of future government debt is simple —- the government guarantees debt of 60- or 80- or 120-quarterly-dollar-payments in return for a lump-sum dollar-amount now. The quarterly-payments is guaranteed (from future tax collections, but more likely from the printing press — the inflation-premium is lower the higher the projected GNP and tax-collections).

  18. supremo, upn, thanks. that’s how i understood it as well when i mentioned in my comment above (at 26th Jan 2009 1:46 pm)…

    ..the Central Bank issues cash in to the banks in exchange for the…securities that the latter is holding…In that way, more cash available for lending gets into the system.

    As Robert Lucas proposes in the essay i linked to (26th Jan 2009 1:48 pm), once interest rates of short term Treasury Bills go to zero, the FED can still choose to buy other securities from the banks.

  19. The only direct intervention the Fed has in its arsenal is the fixing of short term rates. The overnite lending rate. That rate is already close to zero…

    That is the extent of monetary policy in the hands of the Fed.

    It is the Treasury however who borrows money in the markets to fund government deficits. The financial markets determine the rates at which government borrows short term and long term. That also serves as the benchmark for commercial bond rates and mortgages.

    Congress is in charge of fiscal policy through the legislative process. The treasury executes the law – the budget.

    In times of severe economic stress the Fed has the power to influence long term rates by buying long dated securities from the treasury itself to help bring down long dated securities.

    When fiscal policy is to be used to pump prime economies headed for deflation the rationale is simple. The government has to step in in pump prime investments in public goods. That requires a long term horizon as business will not risk investing for the long term. In point of fact risk premiums go up for long term investments in a climate of fear.

    So the only so called agent in the economy is government who can afford to wait and is a patient investor.

    Keynesian playbook is primarily about government making long term investments when business refuses to do so. No one wants to lend long. Look at spreads between the ten year T-bill rate and the 30 year Fixed mortgage rates. It is almost double.

    The U.S. treasury is going to be issuing hundreds of billions of long dated treasuries to fund the stimulus package.

    The Fed can intervene to try to keep long dated notes low by buying Treasuries. The Fed creates the cash for the government and naturally competes with private funds thereby increasing the money supply and keeps long dated rates low to provide cheap funds for the government.

  20. A completely new ball game……….The U.S. government is scheduled to issue trillions in new debt paper. The Fed can move to influence long dated interest rates by buying directly from the Treasury. Will they or won’t they? Guess right and make money.

    “Faced with the danger of a deflationary decline in output, prices and wages, the Fed is considering steps to revive the moribund economy. On the table besides bond purchases: firming up a pledge to keep short-term interest rates low for an extended period and adopting some type of inflation target to underscore the Fed’s determination to avoid deflation.”

    “The central bank has been buying long-term Treasury debt off and on for years as part of its day-to-day management of reserves in the banking system. Yet it has always gone out of its way to avoid influencing prices. What it’s discussing now, says former Fed Governor Laurence Meyer, is deliberately trying to push long rates below where they otherwise might be.”

    Fed Purchases

    “Bernanke raised this possibility in a speech on Dec. 1. While he didn’t specify what maturities the Fed might buy, in the past he has suggested that purchases might include securities with three- to six-year terms.”

    Investors immediately took notice, with the yield on the 10-year note falling to 2.73 percent from 2.92 percent the day before. Yields fell further on Dec. 16, dropping to 2.26 percent from 2.51 percent the previous day, after the central bank’s policy-making Federal Open Market Committee said it was studying the issue.

    “Every time they mention it, the market reacts,” says Stephen Stanley, chief economist at RBS Greenwich Capital Markets in Greenwich, Connecticut.

    Yields have since risen, with the 10-year note ending last week at 2.62 percent. Behind the reversal: expectations of massive fresh supplies of Treasuries as the government is forced to finance an $825 billion economic-stimulus package and a possible new bank-bailout plan. This week alone, the Treasury is scheduled to auction $135 billion worth of securities.

    Jump in Yields

    David Rosenberg, chief North American economist for Merrill Lynch in New York, says the jump in yields may prompt the Fed to go ahead with Treasury purchases.

    This isn’t the first time Bernanke and the Fed have discussed buying longer-dated securities and ended up roiling the market. Bernanke touted the idea as a tool to fight deflation in speeches in November 2002 and May 2003.

    Egged on by his comments — and later remarks by then-Fed Chairman Alan Greenspan that the central bank needed to build a “firewall” against deflation — many investors became convinced the central bank was poised to buy bonds. The yield on the 10-year Treasury note fell to 3.11 percent in June 2003 from 3.81 percent at the start of the year.

    Traders quickly reversed course as it became clear the Fed had no such intentions, sending the 10-year Treasury yield soaring to 4.6 percent just three months later, on Sept. 2.


    Poole, who was then at the St. Louis Fed, was critical at the time of what he called the central bank’s “miscommunication.” He now sees the Fed making the same mistake with its latest suggestions that it might buy longer- dated securities.

    “If they do it, it’s going to be disruptive to the market,” says Poole, who is a contributor to Bloomberg News. “If they don’t do it, it will impair the Fed’s credibility and erode the confidence the market has in the statements that the Fed makes.”

    Meyer, now vice chairman of St. Louis-based Macroeconomic Advisers, says the Fed should, and probably will, go ahead with purchases as a way to lower borrowing costs. “The story is stop talking and start buying,” he says.

    Still, he notes that not everyone at the Fed is enthusiastic about the idea. One concern: Foreign central banks and sovereign-wealth funds, which are big holders of Treasuries, might cool to buying many more if they believe prices are artificially high.

    Undermine the Dollar

    That may undermine the dollar. “There’s no guarantee that international investors would switch to other dollar- denominated debt if flushed from the Treasury market,” says Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey.

    Tony Crescenzi, chief bond-market strategist at Miller Tabak & Co. in New York, says foreign investors might also get spooked if they conclude that the Fed is monetizing the government’s debt — in effect, printing money — by buying Treasuries.

    Bernanke himself, in his 2003 speech, said monetization of the debt risked faster inflation — something bond investors, foreign or domestic, wouldn’t like.

    Some economists argue the Fed would help the economy more if it bought other types of debt. Even after their recent rise, 10-year Treasury yields are still well below the 4.02 percent level at the start of last year.

    Corporate Bonds

    Yields on investment-grade corporate bonds, in contrast, stood at 8.24 percent on Jan. 22, the latest date for which information is available, compared with 6.45 percent at the start of 2008, according to data compiled by the Fed.

    Hawks at the Fed wouldn’t welcome such purchases. They are already uneasy that some of the central bank’s programs are effectively allocating credit to one part of the economy rather than others. Case in point: the Fed’s ongoing program to buy $500 billion of mortgage-backed securities, which Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, has called “credit policy” rather than monetary policy.

    J. Alfred Broaddus Jr., who was Richmond Fed president from 1993 to 2004, says the lesson from the early part of the decade isn’t that the Fed went too far in easing policy to avoid deflation — it’s that policy makers should have tightened more quickly afterwards and not allowed themselves to be boxed in by their pledge to keep interest rates low for a considerable period.

    In the current context, that means buying bonds “is something worth looking at,” he says. Still, the Fed “needs to be careful and be ready to reverse course, especially given all the money that it’s pumped into the system.”

  21. The only direct intervention the Fed has in its arsenal is the fixing of short term rates. The overnite lending rate. That rate is already close to zero…

    That is the extent of monetary policy in the hands of the Fed. – J_ag

    That’s how i initially understood it as well which is also how Paul Krugman explains it (which is why i asked my question at 26th Jan 2009 12:36 pm). However, Robert Lucas explained (in the linked essay) that it is not the case, i.e. even if short-term rates went to zero, the FED still has some room for action.

    When the Fed wants to stimulate spending in normal times, it uses reserves to buy Treasury bills in the federal-funds market, reducing the funds’ rate. But as the rate nears zero, Treasury bills become equivalent to cash, and such open-market operations have no more effect than trading a $20 bill for two $10s. There is no effect on the total supply of “quality” assets.

    A dead end? Not at all. The Fed can satisfy the demand for quality by using reserves — or “printing money” — to buy securities other than Treasury bills. This is the way the $600 billion got out into the private sector. – Robert Lucas

    He goes on to say that the availability of cash will discourage businesses from hoarding cash which is the main cause of the recession. However, as you have explained above (and as Krugman has also explained), it goes against the fact that the problem is that Banks are unable and/or unwilling to lend because they no longer have the capital to do so because of the amount of bad assets that they hold.

  22. In the 30’s the U.S. did not have to worry about the issue of pension funds and sovereign wealth funds.

    In today’s world the dollar is the de facto reserve currency of the emerging markets of the world.

    Whether we like it or not we are in Americas boat.

    By removing the objective standard of a physical commodity to a subjective standard of a fiat currency system which is determined by a political standard (national governments).

    Keynesian playbooks were designed mainly and exclusively for nation states and national financial systems. Bretton Woods was supposed to serve as the regulatory arm for national financial systems internationally.

    Austrian based economists believed that one could not trust national governments to police their own international behavior with regards to moving to fiat currency system or standard based on political standards.

    Nations will always be forced to protect national interest in times of strain and crisis.

    Hence we have the present rising political tensions arising from the global crisis.

    The beggar thy neighbor policies instituted by all governments including the U.S. in the 30’s led to the Second World war.

    What will happen going forward when it is clear that the U.S. is forcing a solution on the rest of the world.

    Will there be peaceful collaboration or will tensions rise?

    China will have to be less concentrated on their manufacturing export model and look inward to creating a viable and stronger domestic market. Will she continue to keep it relatively closed. The ironic part of her success is that all her purchases of resources are paid for in dollars. She should now switch and revalue her currency upward and use it to buy more resources instead of using devalued dollars.

    That is one way of correcting the reserve imbalances. The U.S. directly or indirectly is forcing her to make hard choices. It is like a game of chicken.

    That would give Asian countries a choice in moving out of the dollar reserve system. The Japanese should do the same thing with their yen. Asian countries then would have a basket of currencies to base their exchange rates on.

    The day is coming when the U.S. dollar system will be forced to accept other players in the game. As Obama said the world has changed. The U.S. has to change with it.

  23. If financial institutions are capital impaired then obviously the credit system will continue to be impaired which will continue to curtail private investments. In today’s modern societies that also means credit for consumption.

    Obamas plan for stimulus includes extending unemployment benefits and aid for states for infrastructure projects.

    So first you prop up the financial institutions who are holding all these assets (some bad and good) then you go and try to prop up expenditures by the government making long term investments in public goods. That is where the magical power of central banks can come in.

    The world cannot bear a shock restructuring of America’s debt burden when there is till no clear substitute to the dollar.

    Unfortunately Keynesian playbooks have been used for the wrong reasons. That is where corrupt governments come into play.

    That ability to create debt by governments is a powerful weapon in the hands of authoritarian and weak states.

    That is when the technocrats assume no ethical or moral responsibility in working for these governments.

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