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ART CASHIN: These Are The Warning Signs Of Contagion

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Contagion Gweneth Paltrow

UBS's Art Cashin offered his take on what contagion would look like in the eurozone if Greece is forced to abandon the euro in favor of its own currency.

The decision to move back to the drachma would not follow some internal parliamentary debate, Cashin argues.

Instead, it would happen from some trigger event, that would force the country to self fund itself.

And that could cause a ripple effect in other euro states.

From today's Cashin Comments:

How Contagion Might Happen - Various self-styled experts are holding forth on how and why the Greeks will leave the Eurozone. From blog sites to TV screens, they tend to portray it as a topic being resolved in a manner fit for the Oxford Debating Society.

From the perspective of watching financial markets for over a half a century (and a student of many centuries before) that’s not usually the way currency conversions occur. They tend to be forced by events.

A country could come to the bond market and find no takers. A collapsed bond sale of huge proportions could produce a crisis induced change.

Another such event could be an inability to meet a significant debt payment.

Yet another process could be a bank run. This is part of what’s going on in Greece. There has been a steady, but now accelerating, run on the banks with people shifting money out of the country.

If you are a Greek citizen who is lucky enough to have some money in the bank, you might want to take it out. If you take it now, you would be withdrawing Euros. That’s something you know the purchasing power of. If over the weekend, they switch to drachma, you likely would not have the same purchasing power.

So Greek citizens have been pulling out Euros and sending them to banks, or very trustworthy relatives, beyond the border. There, the value will not be affected by a shift to the drachma.

That’s the greatest danger of contagion. If Italians or Spaniards see Greece about to exit the EU, they will fear for their assets. Do they want to risk an overnight conversion to the Lira or the Peseta?

It is important to watch the bond yields of the European periphery. It may be more important to watch the bank flows. That’s what I’ll be watching.

SEE ALSO: 5 Brain Teasers From UBS's Art Cashin That Will Drive You Nuts

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Art Cashin: These Are The Two Questions Wall Street Is Asking About JPMorgan

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art cashin amanda drury

From the latest note of UBS floor guy Art Cashin, some comments about the JPMorgan debacle...

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A Dimon In The Rough - Wall Street watering holes turned a little livelier than normal last evening as news of the JPMorgan trading loss spread like wild fire. In today’s age of iPhones, there was a frenzied scramble to get on the conference call. Those who claimed to get through, portrayed Mr. Dimon as seething, and rightly so.

Those not on the phones mumbled questions. If I recall correctly, they ran something like this:

1. Who has the other side of the trade? Is there a big winner or spread among many?

2. If this was a hedge, it was to some degree the opposite of an existing position. So, if the hedge went bad, did the position they were hedging do very well? If not, was it really a hedge? Was it badly structured?

There was also a concern that this was bad for the industry. Mr. Dimon had been the leading spokesman against over-regulation and counterproductive rules. Some saw the hedging loss being seized upon to try to make rules even more onerous.

Late in the evening (at least for me), there was speculation that the bank may have become the dominant force in a handful of products and when they paused, the market moved into the vacuum, going against their existing positions. Lots of speculation but no facts. Nonetheless, a hint of Greek theater. Let’s hope it works out well.

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For more on what JPMorgan's big loss means, see here >

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5 Trivia Questions From UBS's Art Cashin That Will Drive You Bananas

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Art CashinArt Cashin, UBS Financial Services' director of floor operations at the NYSE, is an icon on the trading floor.

He's also known for his daily newsletter Cashin's Comments

One of the best parts of his daily-must read newsletter is he never forgets to include a fun piece of trivia at the end. 

The questions are usually a piece of logic or math or history related. 

We think they're a ton of fun, but it can get frustrating since he doesn't reveal the answer until the following day. 

We've compiled this week's trivia questions.  If you're a fan of math, we think you'll enjoy this week's set of questions.

We'll begin with last Friday's question. As always, the answer is posted on each subsequent slide. (Google is for cheaters!)

Last Friday's Question

Tommy is bringing sandwiches to the game, but is stopped by 3 bullies.  The first takes half the sandwiches in the bag plus half a sandwich.  The second takes half of what's left plus half a sandwich.  The third takes half of what Tom has left plus half a sandwich.  Tom then discovers the bag is empty.  How many sandwiches did he start with?

Source: Cashin's Comments





Last Friday's Answer

Tom started with 7 sandwiches.  The first bully took half (3.5) plus half a sandwich (.5) which makes 4 in all.  Etc., etc. Today's Question - An old riddle - the one who makes it doesn't want to use it.  The one who buys it doesn't use it.  The one who uses it never sees it.  What is it?

Source: Cashin's Comments



Monday's Question

An old riddle - the one who makes it doesn't want to use it.  The one who buys it doesn't use it.  The one who uses it never sees it.  What is it?

Source: Cashin's Comments



See the rest of the story at Business Insider

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ART CASHIN: The Greek Elections Could Finally Cancel Out The 'Rationality Put'

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art cashin amanda drury

A pretty key point from UBS floor guy Art Cashin.

Basically, ever since Lehman, markets have operated with an implied "put" from governments, as they believe that if things get really bad, then authorities will step in to stop the carnage.

But the Greek elections threaten that for the first time, as governments may not be able to thwart the will of the people any longer.

Here's what Cashin has to say today.

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Could The Greek Elections Cancel The “Rationality Put” - Many floor types think that there is a kind of “rationality put” in the markets. It evolved in the post-Lehman chaos. The premise goes something like this: world leaders were shocked and stunned by the scope and size of the nearly instant damage from Lehman’s fall. That shock caused them to rescue AIG, a far, far bigger project than Lehman.

Since then, central banks and governments have stepped in quickly as each new crisis emerged. (Think things like QE; LTRO; the first Greek bailout, etc., etc). As long as the crises remained in the financial arena, they could be softened and postponed (not cured). Now it is likely there will be a new Greek election and the risk that the Greeks may see it as a chance to make a loud and clear anti-austerity statement. Others, however, seeing the proximity of payment deadlines, and such, may see it as a vote on exiting the Euro.

As my very sage UBS associate in London, Paul Donovan, succinctly put it:

The elections are really about default or not default, but the risk is that they are cast as Euro or not Euro. That is a risk, because if it seems that parties characterised as "not Euro" are going to do well, investors, bank depositors and exporters to Greece may react as if Greece were leaving the single currency.

That presents a problem for governments and central banks. If people begin to believe that Greece will soon exit the Euro and the Eurozone, as we noted last week, it could ignite runs on the banks. First in Greece then quickly Spain and Italy. Would there be a rush to things like capital controls?

It’s hard to exercise a “rationality put” if things turn irrational beyond your control.

SEE ALSO: 5 Trivia Questions From UBS's Art Cashin That Will Drive You Bananas

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ART CASHIN: Here's How PT Barnum Would Describe A Greek Exit

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So, Greece continues to move closer and closer to the brink.

At this point, the consensus seems to be that Greece will exit the eurozone.

However, Art Cashin thinks that the Greek's desire to leave comes with little understanding of what exiting would actually entail.

Cashin, UBS Financial Services' director of floor operations, was reminded of how P.T. Barnum used to run his museum.

From today's Cashin's Comments:

This Way To The Egress - One of the more famous stories about the showman, P.T. Barnum, concerned a ploy he used at his American Museum.

The museum was hugely popular back in the 1800’s.  The trouble was that it was so popular that visitors would revisit exhibits over and over again.  Some would spend nearly the whole day there.

That frustrated Barnum on two levels.  The dawdlers had paid only one fee so Barnum wasn’t making any more money, regardless of how long they stayed.  Second, and more importantly, the dawdlers kept the museum so crowded, that new clients (and their new money) could not get in.

Barnum’s solution was to set up a series of signs reading “This way to the Egress”.  Most clients were poor immigrants with limited vocabularies.  Not knowing that egress was a fancy word for “exit”, they followed the trail thinking it was some exotic animal.

When they followed the signs and pushed through the door marked Egress, they found themselves outside and a locked “Egress” door behind them.  If they wanted to see more, they would have to pay another fee and they had made from for new clients.

Cashin noted that the traders' take on Greece's desire to head to the exits were a lot like the Barnum's clients heading toward the egress.  "Frustrated with austerity, they might find themselves suddenly locked out of the Euro and the Eurozone."

However, Cashin also reminded us that a Greek exit would not be easy.

But, as noted earlier, Greece cannot exit cleanly.  The contagion risk is evident.  There are reports of plans to control currency flows.  Banks would be closed for a week while drachmas are printed and distributed to replace current Euro deposits.  There are discussions of how to deploy the police to protect the shuttered banks.  ATMs would be restricted to allow de minimis daily distributions (20 Euros?) to meet daily needs.  Transfers outside the border would be forbidden.

Like Barnum’s clients, the Greeks don’t want to leave the building, but an accidental slip on the wrong path could find them suddenly outside with the door locked behind them.  Beware of the Egress.

See Also – 5 Trivia Questions From UBS's Art Cashin That Will Drive You Bananas >

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ART CASHIN: Facebook May Be The Bulls' Best Shot For A Bounce (FB)

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art cashin

Stocks have hit a rough patch.  Since the April 2 high of 1,419, the S&P 500 is down 8 percent.

Markets weren't helped yesterday after being hit by successive waves of bad political news from Greece, and worries about Spanish banks. A weak Philly Fed survey didn't help.

But today might be an inflection point writes Art Cashin, UBS Financial Services' floor guy.  He points to an IPO you may have heard about.

From today's Cashin's Comments:

"G8 meeting over the weekend may worry Eurozone shorts. Facebook frenzy may lift animal spirits. May be bulls best shot for a bounce. Nevertheless, stay alert and very nimble."

See Also – 5 Trivia Questions From UBS's Art Cashin That Will Drive You Bananas >

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5 Art Cashin Brain Teasers That Will Make You Feel Like An Idiot

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Art CashinArt CashinUBS Financial Services' director of floor operations at the NYSE, never forgets to include a fun trivia question at the end of his daily newsletter, Cashin's Comments.

The questions are will typically test your logic, math or history skills, and can get a bit frustrating because Cashin won't release the answer until his newsletter the next day.

We collected the questions and answers from this week. Can you figure them out before you click the "next" button?

Last Friday's Question

It was for a good cause anyway - Half the floor turned out to watch a charity mini-marathon.  The runners were Mike, Pete, Rich, Dan and Ed.  Mike finished in front of Pete but behind Rich.  Dan finished in front of Ed but behind Pete.  What was the order of finish?

Source: Cashin's Comments



Last Friday's Answer

The order of finish was Rich, Mike, Pete, Dan and Ed.

Source: Cashin's Comments



Monday's Question

Work smarter not harder - If 6 people can paint 9 landscapes in a day and a half.....how many people would it take to paint 270 landscapes in 30 day??

Source: Cashin's Comments



See the rest of the story at Business Insider

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ART CASHIN: This Month's Jobs Report May Have Been Distorted By Lehman Brothers

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By now, you've probably heard about the horrific May jobs report that exacerbated the global risk asset sell-off.

Analysts are scrambling to figure out if this was a noisy one-off that we can blissfully ignore, or if it's something more serious.

There's some chatter among Wall Streeters that we may be able to go with the former.  And it has something to do with what Art Cashin describes as the Lehman distortion.

Basically, when Lehman Brothers went bankrupt in 2008, the effects were so devastating that it distorted all of the seasonal adjustments that we've come to accept in the monthly jobs data.

Cashin wrote about it in his Cashin's Comments before the release of this morning's disappointing May jobs report:

Will Lehman Affect Payroll Data? - The mainstream media refers to it as the summer slump.  Over the past two years, firming economic data from October through April has tended to suddenly soften and weaken over the next several months.

That phenomenon has been attributed to everything from warm winters, to currency shifts or even cycle shifts.

In Wall Street watering holes, there is a small coterie who contend it may be the aftereffects of the Lehman failure.

The theory claims that the effect on the economy after Lehman failed in September of 2008 is that it may have distorted seasonal adjustments in 2010, 2011 and, maybe, even now.

There are no scholarly papers on the thesis that we know of, but the contentions continue.

The thinking is that the negative impact on the data from October 2008 through April/May of 2009 was so devastating that when it was factored into the adjustment data for subsequent years, it warped the data, causing larger than normal adjustments for those months...

SEE ALSO: Presenting The Most Unemployed City In Every State >

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5 Art Cashin Brain Teasers That Will Make You Feel Dumb

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Art CashinArt Cashin, UBS Financial Services' director of floor operations at the NYSE, is known for his daily newsletter Cashin's Comments

In his must-read newsletter he never forgets to include a fun piece of trivia at the end.

The questions are usually logic, math or history related. 

We think they're a ton of fun, but it can get frustrating since he doesn't release the answer until the following day. 

We've compiled his last seven trivia questions beginning with May 18th because of the Memorial Day holiday.

The answer is posted on each subsequent slide. (Google is for cheaters!)

Question 5/18

Much to his parents' delight, Throckmorton has been accepted to a very competitive college. However, he must attend a pre semester prep - which he dubbed "dumber summer." As he picked up his books at the bookstore, he noted an odd thing - which he called to point out to his folks. He said - "All but two of my books have blue covers. All but two have red covers and all but two have green covers. Since you're so smart Dad - how many text books do I have?" Well - how many does he have? 

Source: Cashin's Comments 



Answer

Throckmorton had 3 textbooks: 1 red; 1 blue and 1 green.  Thus - all but 2 were red; all but 2 were green and all but 2 were blue.

Source: Cashin's Comments 



Question 5/21

Census Reports indicate that the most frequent family name in the U.S. is "Smith."  What family name (surname) fills that role worldwide?

Source: Cashin's Comments 



See the rest of the story at Business Insider

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5 Art Cashin Brain Teasers That Will Drive You Bananas

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art cashinArt CashinUBS Financial Services' director of floor operations at the NYSE, is known for his daily newsletter Cashin's Comments

In his must-read newsletter he never forgets to include a fun piece of trivia at the end.

The questions are usually logic, math or history related. 

We think they're a ton of fun, but it can get frustrating since he doesn't release the answer until the following day. 

We've compiled his latest trivia questions and will kick things off with last Friday's question.

The answer is posted on each subsequent slide. Good luck! 

Last Friday's Question

Get the number of that car! - A few years back Parade Magazine ran a contest on zany license plates.  Here are some of the winners.  Can you translate?

        IRIGHTI=                                          

RUD14ME?=                                    

XQQSME =                                          

AXN28D+=                                    

H2OUUP2 =                                        

IM12XL=  

Source: Cashin's Comments 



Last Friday's Answer

IRIGHTI               =              Right between the eyes                      

RUD14ME?          =              Are you the one for me?

XQQSME             =              Excuse me                                            

AXN28D+             =              Accentuate the positive

H2OUUP2             =              What are you up to                              

IM12XL                 =              I'm one to excel

Source: Cashin's Comments



Monday's Question

"She loves me; She loves me not!" - pluck one letter from each word and use the remaining letters to spell the name of a flower. A) Stared; B) Openly; C) Snappy; D) Store; E) Dismay

Source: Cashin's Comments 



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Art Cashin On Spain: 'BEWARE OF THE INVISIBLE'

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ghost haunted invisible house old

All of the experts are sounding off on the massive Spanish bank bailout announcement.

Art Cashin, UBS Financial Services director of floor operations, notes that traders are still haunted by the AIG surprise in the wake of the Lehman Brothers bankruptcy.

Cashin thinks that we should be weary of one aspect of the Lehman/AIG experience.

From this morning's Cashin's Comments:

Spanish Banks And The “AIG Syndrome” - Around Wall Street watering holes, there’s a thesis passed around almost nightly.  It contends that when world leaders were shocked and stunned by the extensive and virtually instantaneous collateral damaged caused by the Lehman failure, they automatically resolved to prevent anything like it from recurring.

Folklore says that as AIG’s global exposure began to be revealed, the phones at the Fed and at the Treasury began ringing off the hook.  The calls were thought to come from Frankfurt, London, Paris, Milan and virtually every financial center on the planet.  The calls purportedly (via rumors) had a similar tone - “if you think Lehman was bad, a failure here could be Lehman on steroids”.  Swamped with such calls, a rescue effort was quickly cobbled together.

Most Americans assume that the Spanish banking crisis is due to a lot of local banks loaded down with national debt and some regional real estate exposure.

Not widely discussed is that Spanish banks have been leveraging real estate for over a decade.  They compounded that leverage by being among the most aggressive at bundling mortgages in CMOs, CDOs and the like.  A failure in Spain could be felt immediately from South America to Asia and around the globe.  Beware of the invisible.

SEE ALSO: 5 Art Cashin Brain Teasers That Will Drive You Bananas >

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ART CASHIN: Traders Everywhere Are Reading This Famous Ben Bernanke Speech

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art cashin amanda drury

In his morning note, UBS floor guy Art Cashin says traders are feverishly trying to figure out Bernanke's next move by looking at what Bernanke said in the past.

“Rommel, You Magnificent Bastard, I Read Your Book” - That, as you may recall, were the words spoken by George C. Scott in the title roll of the award winning movie, “Patton”. Patton was looking out on a field with Rommel’s tanks advancing. Patton felt he knew what Rommel would do since the latter had outlined his tactics in a manual.

Traders are taking a similar approach to another assumed tactical genius - Ben Bernanke.

As Wall Street ponders what form or format the next level of quantitative easing might take, some savvy traders are digging down into Bernanke’s earlier speeches. One in particular has become the focus - “Deflation: Making Sure “It” Doesn’t Happen Here”. It was delivered back at the National Economists Club in November 2002 (Before Bernanke became Fed Chair).

Economists and Fed scholars have been mining the speech ever since Bernanke became Fed Chairman. Several, including David Rosenberg, were able to project “Operation Twist” by parsing and re-parsing the speech.

With the current uncertainty, lots of folks, including yours truly, are back sifting through the speech, looking for clues to the next Fed move.

The primary complication is the turmoil in the European banking system. That may force Mr. B to include things like currency swap facilities in any new comprehensive easing effort.

We’ll keep digging and hope to report back before the weekend. But, you don’t have to wait for us; the speech is available on line. Dig it out and look for clues yourself.

The "It" speech has been much discussed since the start of the crisis, and we've posted the whole thing below.

We'd note that a lot of the criticism of Bernanke these days -- especially those coming from the Krugman wing of economists -- is that Bernanke has forgotten his own lessons from "it" and that he hasn't taken the 'throw everything against the problem' approach that he seemed to previously believe in.

Still it's a classic read.

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Since World War II, inflation--the apparently inexorable rise in the prices of goods and services--has been the bane of central bankers. Economists of various stripes have argued that inflation is the inevitable result of (pick your favorite) the abandonment of metallic monetary standards, a lack of fiscal discipline, shocks to the price of oil and other commodities, struggles over the distribution of income, excessive money creation, self-confirming inflation expectations, an "inflation bias" in the policies of central banks, and still others. Despite widespread "inflation pessimism," however, during the 1980s and 1990s most industrial-country central banks were able to cage, if not entirely tame, the inflation dragon. Although a number of factors converged to make this happy outcome possible, an essential element was the heightened understanding by central bankers and, equally as important, by political leaders and the public at large of the very high costs of allowing the economy to stray too far from price stability.

With inflation rates now quite low in the United States, however, some have expressed concern that we may soon face a new problem--the danger of deflation, or falling prices. That this concern is not purely hypothetical is brought home to us whenever we read newspaper reports about Japan, where what seems to be a relatively moderate deflation--a decline in consumer prices of about 1 percent per year--has been associated with years of painfully slow growth, rising joblessness, and apparently intractable financial problems in the banking and corporate sectors. While it is difficult to sort out cause from effect, the consensus view is that deflation has been an important negative factor in the Japanese slump.

So, is deflation a threat to the economic health of the United States? Not to leave you in suspense, I believe that the chance of significant deflation in the United States in the foreseeable future is extremely small, for two principal reasons. The first is the resilience and structural stability of the U.S. economy itself. Over the years, the U.S. economy has shown a remarkable ability to absorb shocks of all kinds, to recover, and to continue to grow. Flexible and efficient markets for labor and capital, an entrepreneurial tradition, and a general willingness to tolerate and even embrace technological and economic change all contribute to this resiliency. A particularly important protective factor in the current environment is the strength of our financial system: Despite the adverse shocks of the past year, our banking system remains healthy and well-regulated, and firm and household balance sheets are for the most part in good shape. Also helpful is that inflation has recently been not only low but quite stable, with one result being that inflation expectations seem well anchored. For example, according to the University of Michigan survey that underlies the index of consumer sentiment, the median expected rate of inflation during the next five to ten years among those interviewed was 2.9 percent in October 2002, as compared with 2.7 percent a year earlier and 3.0 percent two years earlier--a stable record indeed.

The second bulwark against deflation in the United States, and the one that will be the focus of my remarks today, is the Federal Reserve System itself. The Congress has given the Fed the responsibility of preserving price stability (among other objectives), which most definitely implies avoiding deflation as well as inflation. I am confident that the Fed would take whatever means necessary to prevent significant deflation in the United States and, moreover, that the U.S. central bank, in cooperation with other parts of the government as needed, has sufficient policy instruments to ensure that any deflation that might occur would be both mild and brief.

Of course, we must take care lest confidence become over-confidence. Deflationary episodes are rare, and generalization about them is difficult. Indeed, a recent Federal Reserve study of the Japanese experience concluded that the deflation there was almost entirely unexpected, by both foreign and Japanese observers alike (Ahearne et al., 2002). So, having said that deflation in the United States is highly unlikely, I would be imprudent to rule out the possibility altogether. Accordingly, I want to turn to a further exploration of the causes of deflation, its economic effects, and the policy instruments that can be deployed against it. Before going further I should say that my comments today reflect my own views only and are not necessarily those of my colleagues on the Board of Governors or the Federal Open Market Committee.

Deflation: Its Causes and Effects
Deflation is defined as a general decline in prices, with emphasis on the word "general." At any given time, especially in a low-inflation economy like that of our recent experience, prices of some goods and services will be falling. Price declines in a specific sector may occur because productivity is rising and costs are falling more quickly in that sector than elsewhere or because the demand for the output of that sector is weak relative to the demand for other goods and services. Sector-specific price declines, uncomfortable as they may be for producers in that sector, are generally not a problem for the economy as a whole and do not constitute deflation. Deflation per se occurs only when price declines are so widespread that broad-based indexes of prices, such as the consumer price index, register ongoing declines.

The sources of deflation are not a mystery. Deflation is in almost all cases a side effect of a collapse of aggregate demand--a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers.1 Likewise, the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending--namely, recession, rising unemployment, and financial stress.

However, a deflationary recession may differ in one respect from "normal" recessions in which the inflation rate is at least modestly positive: Deflation of sufficient magnitude may result in the nominal interest rate declining to zero or very close to zero.2 Once the nominal interest rate is at zero, no further downward adjustment in the rate can occur, since lenders generally will not accept a negative nominal interest rate when it is possible instead to hold cash. At this point, the nominal interest rate is said to have hit the "zero bound."

Deflation great enough to bring the nominal interest rate close to zero poses special problems for the economy and for policy. First, when the nominal interest rate has been reduced to zero, the real interest rate paid by borrowers equals the expected rate of deflation, however large that may be.3 To take what might seem like an extreme example (though in fact it occurred in the United States in the early 1930s), suppose that deflation is proceeding at a clip of 10 percent per year. Then someone who borrows for a year at a nominal interest rate of zero actually faces a 10 percent real cost of funds, as the loan must be repaid in dollars whose purchasing power is 10 percent greater than that of the dollars borrowed originally. In a period of sufficiently severe deflation, the real cost of borrowing becomes prohibitive. Capital investment, purchases of new homes, and other types of spending decline accordingly, worsening the economic downturn.

Although deflation and the zero bound on nominal interest rates create a significant problem for those seeking to borrow, they impose an even greater burden on households and firms that had accumulated substantial debt before the onset of the deflation. This burden arises because, even if debtors are able to refinance their existing obligations at low nominal interest rates, with prices falling they must still repay the principal in dollars of increasing (perhaps rapidly increasing) real value. When William Jennings Bryan made his famous "cross of gold" speech in his 1896 presidential campaign, he was speaking on behalf of heavily mortgaged farmers whose debt burdens were growing ever larger in real terms, the result of a sustained deflation that followed America's post-Civil-War return to the gold standard.4 The financial distress of debtors can, in turn, increase the fragility of the nation's financial system--for example, by leading to a rapid increase in the share of bank loans that are delinquent or in default. Japan in recent years has certainly faced the problem of "debt-deflation"--the deflation-induced, ever-increasing real value of debts. Closer to home, massive financial problems, including defaults, bankruptcies, and bank failures, were endemic in America's worst encounter with deflation, in the years 1930-33--a period in which (as I mentioned) the U.S. price level fell about 10 percent per year.

Beyond its adverse effects in financial markets and on borrowers, the zero bound on the nominal interest rate raises another concern--the limitation that it places on conventional monetary policy. Under normal conditions, the Fed and most other central banks implement policy by setting a target for a short-term interest rate--the overnight federal funds rate in the United States--and enforcing that target by buying and selling securities in open capital markets. When the short-term interest rate hits zero, the central bank can no longer ease policy by lowering its usual interest-rate target.5

Because central banks conventionally conduct monetary policy by manipulating the short-term nominal interest rate, some observers have concluded that when that key rate stands at or near zero, the central bank has "run out of ammunition"--that is, it no longer has the power to expand aggregate demand and hence economic activity. It is true that once the policy rate has been driven down to zero, a central bank can no longer use its traditional means of stimulating aggregate demand and thus will be operating in less familiar territory. The central bank's inability to use its traditional methods may complicate the policymaking process and introduce uncertainty in the size and timing of the economy's response to policy actions. Hence I agree that the situation is one to be avoided if possible.

However, a principal message of my talk today is that a central bank whose accustomed policy rate has been forced down to zero has most definitely not run out of ammunition. As I will discuss, a central bank, either alone or in cooperation with other parts of the government, retains considerable power to expand aggregate demand and economic activity even when its accustomed policy rate is at zero. In the remainder of my talk, I will first discuss measures for preventing deflation--the preferable option if feasible. I will then turn to policy measures that the Fed and other government authorities can take if prevention efforts fail and deflation appears to be gaining a foothold in the economy.

Preventing Deflation
As I have already emphasized, deflation is generally the result of low and falling aggregate demand. The basic prescription for preventing deflation is therefore straightforward, at least in principle: Use monetary and fiscal policy as needed to support aggregate spending, in a manner as nearly consistent as possible with full utilization of economic resources and low and stable inflation. In other words, the best way to get out of trouble is not to get into it in the first place. Beyond this commonsense injunction, however, there are several measures that the Fed (or any central bank) can take to reduce the risk of falling into deflation.

First, the Fed should try to preserve a buffer zone for the inflation rate, that is, during normal times it should not try to push inflation down all the way to zero.6 Most central banks seem to understand the need for a buffer zone. For example, central banks with explicit inflation targets almost invariably set their target for inflation above zero, generally between 1 and 3 percent per year. Maintaining an inflation buffer zone reduces the risk that a large, unanticipated drop in aggregate demand will drive the economy far enough into deflationary territory to lower the nominal interest rate to zero. Of course, this benefit of having a buffer zone for inflation must be weighed against the costs associated with allowing a higher inflation rate in normal times.

Second, the Fed should take most seriously--as of course it does--its responsibility to ensure financial stability in the economy. Irving Fisher (1933) was perhaps the first economist to emphasize the potential connections between violent financial crises, which lead to "fire sales" of assets and falling asset prices, with general declines in aggregate demand and the price level. A healthy, well capitalized banking system and smoothly functioning capital markets are an important line of defense against deflationary shocks. The Fed should and does use its regulatory and supervisory powers to ensure that the financial system will remain resilient if financial conditions change rapidly. And at times of extreme threat to financial stability, the Federal Reserve stands ready to use the discount window and other tools to protect the financial system, as it did during the 1987 stock market crash and the September 11, 2001, terrorist attacks.

Third, as suggested by a number of studies, when inflation is already low and the fundamentals of the economy suddenly deteriorate, the central bank should act more preemptively and more aggressively than usual in cutting rates (Orphanides and Wieland, 2000; Reifschneider and Williams, 2000; Ahearne et al., 2002). By moving decisively and early, the Fed may be able to prevent the economy from slipping into deflation, with the special problems that entails.

As I have indicated, I believe that the combination of strong economic fundamentals and policymakers that are attentive to downside as well as upside risks to inflation make significant deflation in the United States in the foreseeable future quite unlikely. But suppose that, despite all precautions, deflation were to take hold in the U.S. economy and, moreover, that the Fed's policy instrument--the federal funds rate--were to fall to zero. What then? In the remainder of my talk I will discuss some possible options for stopping a deflation once it has gotten under way. I should emphasize that my comments on this topic are necessarily speculative, as the modern Federal Reserve has never faced this situation nor has it pre-committed itself formally to any specific course of action should deflation arise. Furthermore, the specific responses the Fed would undertake would presumably depend on a number of factors, including its assessment of the whole range of risks to the economy and any complementary policies being undertaken by other parts of the U.S. government.7

Curing Deflation
Let me start with some general observations about monetary policy at the zero bound, sweeping under the rug for the moment some technical and operational issues.

As I have mentioned, some observers have concluded that when the central bank's policy rate falls to zero--its practical minimum--monetary policy loses its ability to further stimulate aggregate demand and the economy. At a broad conceptual level, and in my view in practice as well, this conclusion is clearly mistaken. Indeed, under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero.

The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning. A little parable may prove useful: Today an ounce of gold sells for $300, more or less. Now suppose that a modern alchemist solves his subject's oldest problem by finding a way to produce unlimited amounts of new gold at essentially no cost. Moreover, his invention is widely publicized and scientifically verified, and he announces his intention to begin massive production of gold within days. What would happen to the price of gold? Presumably, the potentially unlimited supply of cheap gold would cause the market price of gold to plummet. Indeed, if the market for gold is to any degree efficient, the price of gold would collapse immediately after the announcement of the invention, before the alchemist had produced and marketed a single ounce of yellow metal.

What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

Of course, the U.S. government is not going to print money and distribute it willy-nilly (although as we will see later, there are practical policies that approximate this behavior).8 Normally, money is injected into the economy through asset purchases by the Federal Reserve. To stimulate aggregate spending when short-term interest rates have reached zero, the Fed must expand the scale of its asset purchases or, possibly, expand the menu of assets that it buys. Alternatively, the Fed could find other ways of injecting money into the system--for example, by making low-interest-rate loans to banks or cooperating with the fiscal authorities. Each method of adding money to the economy has advantages and drawbacks, both technical and economic. One important concern in practice is that calibrating the economic effects of nonstandard means of injecting money may be difficult, given our relative lack of experience with such policies. Thus, as I have stressed already, prevention of deflation remains preferable to having to cure it. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.

So what then might the Fed do if its target interest rate, the overnight federal funds rate, fell to zero? One relatively straightforward extension of current procedures would be to try to stimulate spending by lowering rates further out along the Treasury term structure--that is, rates on government bonds of longer maturities.9 There are at least two ways of bringing down longer-term rates, which are complementary and could be employed separately or in combination. One approach, similar to an action taken in the past couple of years by the Bank of Japan, would be for the Fed to commit to holding the overnight rate at zero for some specified period. Because long-term interest rates represent averages of current and expected future short-term rates, plus a term premium, a commitment to keep short-term rates at zero for some time--if it were credible--would induce a decline in longer-term rates. A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years). The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields. If this program were successful, not only would yields on medium-term Treasury securities fall, but (because of links operating through expectations of future interest rates) yields on longer-term public and private debt (such as mortgages) would likely fall as well.

Lower rates over the maturity spectrum of public and private securities should strengthen aggregate demand in the usual ways and thus help to end deflation. Of course, if operating in relatively short-dated Treasury debt proved insufficient, the Fed could also attempt to cap yields of Treasury securities at still longer maturities, say three to six years. Yet another option would be for the Fed to use its existing authority to operate in the markets for agency debt (for example, mortgage-backed securities issued by Ginnie Mae, the Government National Mortgage Association).

Historical experience tends to support the proposition that a sufficiently determined Fed can peg or cap Treasury bond prices and yields at other than the shortest maturities. The most striking episode of bond-price pegging occurred during the years before the Federal Reserve-Treasury Accord of 1951.10 Prior to that agreement, which freed the Fed from its responsibility to fix yields on government debt, the Fed maintained a ceiling of 2-1/2 percent on long-term Treasury bonds for nearly a decade. Moreover, it simultaneously established a ceiling on the twelve-month Treasury certificate of between 7/8 percent to 1-1/4 percent and, during the first half of that period, a rate of 3/8 percent on the 90-day Treasury bill. The Fed was able to achieve these low interest rates despite a level of outstanding government debt (relative to GDP) significantly greater than we have today, as well as inflation rates substantially more variable. At times, in order to enforce these low rates, the Fed had actually to purchase the bulk of outstanding 90-day bills. Interestingly, though, the Fed enforced the 2-1/2 percent ceiling on long-term bond yields for nearly a decade without ever holding a substantial share of long-maturity bonds outstanding.11 For example, the Fed held 7.0 percent of outstanding Treasury securities in 1945 and 9.2 percent in 1951 (the year of the Accord), almost entirely in the form of 90-day bills. For comparison, in 2001 the Fed held 9.7 percent of the stock of outstanding Treasury debt.

To repeat, I suspect that operating on rates on longer-term Treasuries would provide sufficient leverage for the Fed to achieve its goals in most plausible scenarios. If lowering yields on longer-dated Treasury securities proved insufficient to restart spending, however, the Fed might next consider attempting to influence directly the yields on privately issued securities. Unlike some central banks, and barring changes to current law, the Fed is relatively restricted in its ability to buy private securities directly.12 However, the Fed does have broad powers to lend to the private sector indirectly via banks, through the discount window.13 Therefore a second policy option, complementary to operating in the markets for Treasury and agency debt, would be for the Fed to offer fixed-term loans to banks at low or zero interest, with a wide range of private assets (including, among others, corporate bonds, commercial paper, bank loans, and mortgages) deemed eligible as collateral.14 For example, the Fed might make 90-day or 180-day zero-interest loans to banks, taking corporate commercial paper of the same maturity as collateral. Pursued aggressively, such a program could significantly reduce liquidity and term premiums on the assets used as collateral. Reductions in these premiums would lower the cost of capital both to banks and the nonbank private sector, over and above the beneficial effect already conferred by lower interest rates on government securities.15

The Fed can inject money into the economy in still other ways. For example, the Fed has the authority to buy foreign government debt, as well as domestic government debt. Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchase by the Fed is several times the stock of U.S. government debt.16

I need to tread carefully here. Because the economy is a complex and interconnected system, Fed purchases of the liabilities of foreign governments have the potential to affect a number of financial markets, including the market for foreign exchange. In the United States, the Department of the Treasury, not the Federal Reserve, is the lead agency for making international economic policy, including policy toward the dollar; and the Secretary of the Treasury has expressed the view that the determination of the value of the U.S. dollar should be left to free market forces. Moreover, since the United States is a large, relatively closed economy, manipulating the exchange value of the dollar would not be a particularly desirable way to fight domestic deflation, particularly given the range of other options available. Thus, I want to be absolutely clear that I am today neither forecasting nor recommending any attempt by U.S. policymakers to target the international value of the dollar.

Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934.17 The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation.

Fiscal Policy
Each of the policy options I have discussed so far involves the Fed's acting on its own. In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman's famous "helicopter drop" of money.18

Of course, in lieu of tax cuts or increases in transfers the government could increase spending on current goods and services or even acquire existing real or financial assets. If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets.

Japan
The claim that deflation can be ended by sufficiently strong action has no doubt led you to wonder, if that is the case, why has Japan not ended its deflation? The Japanese situation is a complex one that I cannot fully discuss today. I will just make two brief, general points.

First, as you know, Japan's economy faces some significant barriers to growth besides deflation, including massive financial problems in the banking and corporate sectors and a large overhang of government debt. Plausibly, private-sector financial problems have muted the effects of the monetary policies that have been tried in Japan, even as the heavy overhang of government debt has made Japanese policymakers more reluctant to use aggressive fiscal policies (for evidence see, for example, Posen, 1998). Fortunately, the U.S. economy does not share these problems, at least not to anything like the same degree, suggesting that anti-deflationary monetary and fiscal policies would be more potent here than they have been in Japan.

Second, and more important, I believe that, when all is said and done, the failure to end deflation in Japan does not necessarily reflect any technical infeasibility of achieving that goal. Rather, it is a byproduct of a longstanding political debate about how best to address Japan's overall economic problems. As the Japanese certainly realize, both restoring banks and corporations to solvency and implementing significant structural change are necessary for Japan's long-run economic health. But in the short run, comprehensive economic reform will likely impose large costs on many, for example, in the form of unemployment or bankruptcy. As a natural result, politicians, economists, businesspeople, and the general public in Japan have sharply disagreed about competing proposals for reform. In the resulting political deadlock, strong policy actions are discouraged, and cooperation among policymakers is difficult to achieve.

In short, Japan's deflation problem is real and serious; but, in my view, political constraints, rather than a lack of policy instruments, explain why its deflation has persisted for as long as it has. Thus, I do not view the Japanese experience as evidence against the general conclusion that U.S. policymakers have the tools they need to prevent, and, if necessary, to cure a deflationary recession in the United States.

Conclusion
Sustained deflation can be highly destructive to a modern economy and should be strongly resisted. Fortunately, for the foreseeable future, the chances of a serious deflation in the United States appear remote indeed, in large part because of our economy's underlying strengths but also because of the determination of the Federal Reserve and other U.S. policymakers to act preemptively against deflationary pressures. Moreover, as I have discussed today, a variety of policy responses are available should deflation appear to be taking hold. Because some of these alternative policy tools are relatively less familiar, they may raise practical problems of implementation and of calibration of their likely economic effects. For this reason, as I have emphasized, prevention of deflation is preferable to cure. Nevertheless, I hope to have persuaded you that the Federal Reserve and other economic policymakers would be far from helpless in the face of deflation, even should the federal funds rate hit its zero bound.19



References

Ahearne, Alan, Joseph Gagnon, Jane Haltmaier, Steve Kamin, and others, "Preventing Deflation: Lessons from Japan's Experiences in the 1990s," Board of Governors, International Finance Discussion Paper No. 729, June 2002.

Clouse, James, Dale Henderson, Athanasios Orphanides, David Small, and Peter Tinsley, "Monetary Policy When the Nominal Short-term Interest Rate Is Zero," Board of Governors of the Federal Reserve System, Finance and Economics Discussion Series No. 2000-51, November 2000.

Eichengreen, Barry, and Peter M. Garber, "Before the Accord: U.S. Monetary-Financial Policy, 1945-51," in R. Glenn Hubbard, ed., Financial Markets and Financial Crises, Chicago: University of Chicago Press for NBER, 1991.

Eggertson, Gauti, "How to Fight Deflation in a Liquidity Trap: Committing to Being Irresponsible," unpublished paper, International Monetary Fund, October 2002.

Fisher, Irving, "The Debt-Deflation Theory of Great Depressions," Econometrica (March 1933) pp. 337-57.

Hetzel, Robert L. and Ralph F. Leach, "The Treasury-Fed Accord: A New Narrative Account," Federal Reserve Bank of Richmond, Economic Quarterly (Winter 2001) pp. 33-55.

Orphanides, Athanasios and Volker Wieland, "Efficient Monetary Design Near Price Stability," Journal of the Japanese and International Economies (2000) pp. 327-65.

Posen, Adam S., Restoring Japan's Economic Growth, Washington, D.C.: Institute for International Economics, 1998.

Reifschneider, David, and John C. Williams, "Three Lessons for Monetary Policy in a Low-Inflation Era," Journal of Money, Credit, and Banking (November 2000) Part 2 pp. 936-66.

Toma, Mark, "Interest Rate Controls: The United States in the 1940s," Journal of Economic History (September 1992) pp. 631-50.

 

 


Footnotes

 

1. Conceivably, deflation could also be caused by a sudden, large expansion in aggregate supply arising, for example, from rapid gains in productivity and broadly declining costs. I don't know of any unambiguous example of a supply-side deflation, although China in recent years is a possible case. Note that a supply-side deflation would be associated with an economic boom rather than a recession. Return to text

2. The nominal interest rate is the sum of the real interest rate and expected inflation. If expected inflation moves with actual inflation, and the real interest rate is not too variable, then the nominal interest rate declines when inflation declines--an effect known as the Fisher effect, after the early twentieth-century economist Irving Fisher. If the rate of deflation is equal to or greater than the real interest rate, the Fisher effect predicts that the nominal interest rate will equal zero. Return to text

3. The real interest rate equals the nominal interest rate minus the expected rate of inflation (see the previous footnote). The real interest rate measures the real (that is, inflation-adjusted) cost of borrowing or lending. Return to text

4. Throughout the latter part of the nineteenth century, a worldwide gold shortage was forcing down prices in all countries tied to the gold standard. Ironically, however, by the time that Bryan made his famous speech, a new cyanide-based method for extracting gold from ore had greatly increased world gold supplies, ending the deflationary pressure. Return to text

5. A rather different, but historically important, problem associated with the zero bound is the possibility that policymakers may mistakenly interpret the zero nominal interest rate as signaling conditions of "easy money." The Federal Reserve apparently made this error in the 1930s. In fact, when prices are falling, the real interest rate may be high and monetary policy tight, despite a nominal interest rate at or near zero. Return to text

6. Several studies have concluded that the measured rate of inflation overstates the "true" rate of inflation, because of several biases in standard price indexes that are difficult to eliminate in practice. The upward bias in the measurement of true inflation is another reason to aim for a measured inflation rate above zero. Return to text

7. See Clouse et al. (2000) for a more detailed discussion of monetary policy options when the nominal short-term interest rate is zero. Return to text

8. Keynes, however, once semi-seriously proposed, as an anti-deflationary measure, that the government fill bottles with currency and bury them in mine shafts to be dug up by the public. Return to text

9. Because the term structure is normally upward sloping, especially during periods of economic weakness, longer-term rates could be significantly above zero even when the overnight rate is at the zero bound. Return to text

10. S See Hetzel and Leach (2001) for a fascinating account of the events leading to the Accord. Return to text

11. See Eichengreen and Garber (1991) and Toma (1992) for descriptions and analyses of the pre-Accord period. Both articles conclude that the Fed's commitment to low inflation helped convince investors to hold long-term bonds at low rates in the 1940s and 1950s. (A similar dynamic would work in the Fed's favor today.) The rate-pegging policy finally collapsed because the money creation associated with buying Treasury securities was generating inflationary pressures. Of course, in a deflationary situation, generating inflationary pressure is precisely what the policy is trying to accomplish.

An episode apparently less favorable to the view that the Fed can manipulate Treasury yields was the so-called Operation Twist of the 1960s, during which an attempt was made to raise short-term yields and lower long-term yields simultaneously by selling at the short end and buying at the long end. Academic opinion on the effectiveness of Operation Twist is divided. In any case, this episode was rather small in scale, did not involve explicit announcement of target rates, and occurred when interest rates were not close to zero. Return to text

12. The Fed is allowed to buy certain short-term private instruments, such as bankers' acceptances, that are not much used today. It is also permitted to make IPC (individual, partnership, and corporation) loans directly to the private sector, but only under stringent criteria. This latter power has not been used since the Great Depression but could be invoked in an emergency deemed sufficiently serious by the Board of Governors. Return to text

13. Effective January 9, 2003, the discount window will be restructured into a so-called Lombard facility, from which well-capitalized banks will be able to borrow freely at a rate above the federal funds rate. These changes have no important bearing on the present discussion. Return to text

14. By statute, the Fed has considerable leeway to determine what assets to accept as collateral. Return to text

15. In carrying out normal discount window operations, the Fed absorbs virtually no credit risk because the borrowing bank remains responsible for repaying the discount window loan even if the issuer of the asset used as collateral defaults. Hence both the private issuer of the asset and the bank itself would have to fail nearly simultaneously for the Fed to take a loss. The fact that the Fed bears no credit risk places a limit on how far down the Fed can drive the cost of capital to private nonbank borrowers. For various reasons the Fed might well be reluctant to incur credit risk, as would happen if it bought assets directly from the private nonbank sector. However, should this additional measure become necessary, the Fed could of course always go to the Congress to ask for the requisite powers to buy private assets. The Fed also has emergency powers to make loans to the private sector (see footnote 12), which could be brought to bear if necessary. Return to text

16. The Fed has committed to the Congress that it will not use this power to "bail out" foreign governments; hence in practice it would purchase only highly rated foreign government debt. Return to text

17. U.S. Bureau of the Census, Historical Statistics of the United States, Colonial Times to 1970, Washington, D.C.: 1976. Return to text

18. A tax cut financed by money creation is the equivalent of a bond-financed tax cut plus an open-market operation in bonds by the Fed, and so arguably no explicit coordination is needed. However, a pledge by the Fed to keep the Treasury's borrowing costs low, as would be the case under my preferred alternative of fixing portions of the Treasury yield curve, might increase the willingness of the fiscal authorities to cut taxes.

Some have argued (on theoretical rather than empirical grounds) that a money-financed tax cut might not stimulate people to spend more because the public might fear that future tax increases will just "take back" the money they have received. Eggertson (2002) provides a theoretical analysis showing that, if government bonds are not indexed to inflation and certain other conditions apply, a money-financed tax cut will in fact raise spending and inflation. In brief, the reason is that people know that inflation erodes the real value of the government's debt and, therefore, that it is in the interest of the government to create some inflation. Hence they will believe the government's promise not to "take back" in future taxes the money distributed by means of the tax cut. Return to text

19. Some recent academic literature has warned of the possibility of an "uncontrolled deflationary spiral," in which deflation feeds on itself and becomes inevitably more severe. To the best of my knowledge, none of these analyses consider feasible policies of the type that I have described today. I have argued here that these policies would eliminate the possibility of uncontrollable deflation. Return to text

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ART CASHIN: Watch Out For The $71 Trillion JP Morgan Red Herring

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All eyes will be on Jamie Dimon's hearing in Washington in front of the Senate Banking Committee.  The JP Morgan CEO is expected to get grilled by congressman on the matter of the bank's surprise $2 billion trading loss.

Art Cashin, UBS Financial Services' director of floor operations, expects a lot of political theatre.

In fact, he argues that the more important thing to watch today is Europe via German bond yields.

But if you're following the JP Morgan matter, be careful about what people tell you about.

Specifically, a lot of critics will throw around the number $71 trillion, which is the notional value of the derivatives that JP Morgan is exposed to.  But that's an incomplete, misleading number since most of that exposure is offset by hedges.

From this morning's Cashin's Comments:

Congress, JPMorgan And The Financials - Today, Jamie Dimon will be called to Capitol Hill, purportedly to answer questions on a hedge trade that might have gone sour to the tune of $2 billion, or more.  Hearings of this type tend to be a typically American political minuet.  Each of the elected officials will be offered a set time (e.g. 10 minutes) in which to ask questions.  After checking to be sure that the cameras are rolling, each will use up probably seven of those minutes making a statement (just to set up the question we are sure).  Some cynics think a primary goal is sometimes to set your name in a headline for the next day.  Please, please these are elected representatives of the people.

Folks in the financials hope the questioning sticks to the announced topic.  Traders fear that some of the folks may use the opportunity to pillory Wall Street and the financials.

JPM has a large notional exposure to derivatives.  The firm claims that it only looks large but that most of it is “paired off”.  (Think - half buyers and half sellers).  Further, they claim these are heavily very low risk interest rate derivatives.

But bloggers and some political types use the sheer dollar volume of the notional values.  They note that the notional value of derivatives pointed out in the 10K report is a whopping $71 trillion.  Then they giddily point out that $71 trillion is larger than the GDP of the entire United States - in fact about five times larger.  Then they deliver the punch line, noting that $71 trillion is larger than the GDP for the entire globe.  That’s usually followed by table pounding about how reckless and dangerous Wall Street is.  Let’s hope they stick to the hedge trade as advertised.

Consensus - Dimon testimony will dominate TV screens but Europe is still the key.  Watch those German Bunds and stay very nimble.

SEE ALSO: 5 Art Cashin Brain Teasers That Will Drive You Bananas >

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ART CASHIN: The Most Important Election This Weekend Won't Be In Greece

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All eyes will be on Greece as it elects new leadership that may or may not be good for the country's prospects for staying in the euro.

But the biggest election this weekend will not be in Greece, writes Art Cashin, UBS Director of Floor Operations.

Cashin says you need to look across the Mediterranean for the real action that will determine U.S. policy in the Middle East over the next few years.

"The most important election this weekend may have nothing to do with the Eurozone - at least directly," Cashin says. "The election in Egypt may change the face of the Middle East.  The implications to Israel, Iran and Saudi Arabia are enormous.  Will the most populous Arab nation become a theocracy?  This will be some weekend."

On June 16 and 17, Egyptians will head to the poll to vote in a runoff contest between Muslim Brotherhood candidate Mohammed Morsi and ex-Prime Minister Ahmed Shafiq.

SEE ALSO: The 20 Countries Most Likely To Default >

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5 Art Cashin Brain Teasers That Will Drive You Nuts

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Art Cashin

Markets guru Art CashinUBS Financial Services' director of floor operations at the NYSE, is a legend on the floor of the Big Board.

He's also known for his daily newsletter Cashin's Comments

And in this Wall Street must-read he never forgets to include a fun piece of trivia at the end.

The questions are usually logic, math or history related. 

They're really fun, but they can get frustrating because he doesn't reveal the answer until the following day.  Of course, everyone knows Google is for cheaters.  

We've compiled his latest trivia questions and will kick things off with last Friday's question.

The answer is posted on each subsequent slide. Have fun!

Last Friday's Question

Winkin, Blinkin and Nod had a total of 60 silver dollars to buy a pig.  The pig cost $72.  They asked Barnaby for a loan. He agreed only if they could guess how many silver dollars he had.  His hint - I have 3 fewer than the average if we took all our coins and divided them equally.  How many did he have?

Source: Cashin's Comments



Answer

Trial and error and a little logic will lead to the answer - 19 was the average among the four.

Source: Cashin's Comments



Monday's Question

Alphabets and states (yet again).  There are four state capitals that begin with the same letter as their state.  What are they??

Source: Cashin's Comments



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Art Cashin Has The Best Preview Of Today's Fed Meeting That We've Seen

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art cashin amanda drury

UBS floor guy Art Cashin has a great preview of today's Fed announcement.

Here are the key points:

  • The conventional wisdom is that the Fed will only extend Operation Twist (selling short end bonds, buying more long end, and keeping the balance sheet the same size.
  • The market will sell off on the news.
  • At 2:00 PM, the Fed will significantly lower its economic outlook.
  • At his 2:30 press conference, Bernanke will be very explicit about his willlingness to do more in the imminent future.

Below is Cashin's full comment, and you can see here for a full preview of what Wall Street expects >

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May I Have The Envelope, Please – This afternoon the FOMC will announce its decision on policy.  At 2:30, Chairman Bernanke will hold a press conference to expand on that and take questions from reporters.  The conventional wisdom is that the Fed will extend Operation Twist.

If that were so, we think the market would be disappointed.  We also think that Mr. Bernanke knows that.  Mr. Bernanke, throughout his tenure has scrupulously tried not to surprise the market.  He has tried to make the Fed more transparent in order to avoid the risk of surprise.

 Yet, Mr. Bernanke also knows that every Fed initiative is not greeted universally with open arms.  The QE initiatives and even Twist have been criticized by some for producing spikes in commodities and even food prices.  Within the FOMC itself, there are said to be critics who feel the recent efforts have run into the law of diminishing returns.

So, Mr. Bernanke is in a bit of a quandary.  The economy may need some easing.  The markets want more easing.  Prior efforts, however, have not achieved the desired effect and may even have produced some unintended negative consequences.

 That quandary was very much like the one that Bernanke was addressing in that speech back in 2002.  So, once again we went to the file to go over the checklist.  On page 5 of the speech, after introducing the concept of ultimately addressing deflation by the process of printing more dollars, Mr. B went back to monetary policy:

 Of course, the U.S. government is not going to print money and distribute it willy-nilly (although as we will see later, there are practical policies that approximate this behavior).8 Normally, money is injected into the economy through asset purchases by the Federal Reserve. To stimulate aggregate spending when short-term interest rates have reached zero, the Fed must expand the scale of its asset purchases or, possibly, expand the menu of assets that it buys. Alternatively, the Fed could find other ways of injecting money into the system--for example, by making low-interest-rate loans to banks or cooperating with the fiscal authorities. Each method of adding money to the economy has advantages and drawbacks, both technical and economic. One important concern in practice is that calibrating the economic effects of nonstandard means of injecting money may be difficult, given our relative lack of experience with such policies. Thus, as I have stressed already, prevention of deflation remains preferable to having to cure it. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.

Mr. Bernanke then details other means to lower rates further out in the yield curve (Operation Twist) and suggests buying mortgage paper along the curve.

If those measures fail, the bank could circuitously get money to private companies.  The means would be to lend money to banks, interest free for 90 days or 180 days, taking as collateral private paper of the same duration.  He then returns to the concept of devaluing the dollar and cites success of that effort in the early 1930’s.

And, finally, in a separate speech back then, Mr. Bernanke suggested that the Fed might announce a wider tolerance for inflation.  That might spur some of the money to mobilize as folks bought “stuff” fearing the price might rise.

 So where will we go today?

 Look for the Fed to lower its forecasts, perhaps significantly, at 2:00.  Then at the 2:30 press conference (or maybe even in the statement) look for the Fed to dangle a big carrot - some semi-specific course of action that would be put in place if the labor markets continue to worsen.

Net/net, he needs to keep the door wide open and maybe outline certain milestone “triggers” that will allow the Fed to act later in an election year without being accused of being overtly political.

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ART CASHIN: The Stock Market Has A Habit Of Doing Weird Things During New Moons

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orange moon over new zealand

Yesterday's massive sell-off may not have been caused by rumors of the pending Moody's downgrade, Art Cashin says in his Cashin's Comments today.

It's "a good looking thesis but a bit hard to fit with the $50 plunge in gold and the stunning 4 percent implosion in crude," he says.

But a thesis out of another group of traders caught his attention.

He writes:

The rabbit’s foot and stargazing division of traders pointed skyward.  They claim the market was merely shifting direction based on Tuesday evening’s new moon.  They note that the market has a frequent, rather uncanny habit of making highs, lows and turns at new moons and full moons.  The moon chart guys think the next key turn might come around the July 3rd full moon.  (Just reporting the facts, folks.)

SEE ALSO: The 'Energy Cliff' Is The Surest Sign That Central Banks Are Keeping Money Way Too Tight >

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You'll Rip Your Hair Out Trying To Solve These 5 Art Cashin Brain Teasers

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Art CashinMarkets guru Art CashinUBS Financial Services' director of floor operations at the NYSE, is a legend on the floor of the Big Board.

He's also known for his daily newsletter Cashin's Comments

And in this Wall Street must-read he never forgets to include a fun piece of trivia at the end.

The questions are usually logic, math or history related. 

They're really fun, but they can get frustrating because he doesn't reveal the answer until the following day.  Of course, everyone knows Google is for cheaters.  

We've compiled his latest trivia questions and will kick things off with last Friday's question.

The answer is posted on each subsequent slide. Good luck!

Last Friday's Question

David was on a sales trip and wound up eating dinner alone.  He had a good steak and a wonderful but expensive bottle of wine (at least for eating alone).  The bill before tax and tip came to $85.  If 5 times the cost of the wine equaled 12 times the cost of the steak - how much did each cost?

Source: Cashin's Comments



Last Friday's Answer

David's meal for $85 was a $25 steak and a $60 bottle of wine. 

Source: Cashin's Comments



Monday's Question

Quick, call Bill Gates!  Much computer logic is based on a binary system in which there are only 2 digits - 0 and 1.  (This allows one digit to equal "open" and the other "closed" - among other things.)  Our ordinary system is decimal (meaning any digit from 0 through 9 can reside in the far right spot.  Once you go past 9, you go to 2 spots "10" meaning 1 "ten" and 0 "ones").  In binary systems, the far right can contain a "1" or an "0".  Thus, in binary placement: 0 = 0; 1 = 1; 10 = 2; 11 = 3; etc.  How would you write "29" in binary numbers?

Source: Cashin's Comments 



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This Is What Keeps Central Bankers Up At Night

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sleeping glasses

UBS's Art Cashin thinks the world's central banks are suffering from the same sleepless nights that plagued their compatriots in the 1930s.

He turns almost all of his note to clients this morning to Liaquat Ahamed, author of the award winning book, Lords of Finance.

"What really keeps this generation of central bankers up at night is not whether the unconventional monetary tools that they are contemplating will work," Ahamed writes. "It is that some of the same intractable factors that their predecessors of the 1930s had to contend with will overwhelm them once again."

More from Ahamed via Cashin:

The situation in Europe today bears an eerie similarity to that of Europe in the 1930s. Ironically, Germany was then in the po­sition of the peripheral European countries to­day. It was weighed down with government debt because of reparations imposed at Versailles; its banking system was severely undercapital­ised, the result of the hyperinflation of the early 1920s; and it had become dependent on for­eign borrowing. It was locked into a rigid fixed exchange rate system, the gold standard, which it dared not tamper with for fear of provoking a gigantic crisis of confidence. And so when the Depression hit and international capital markets essentially closed down, Germany had no choice but to impose brutal austerity. Eventually, unem­ployment rose to 35 per cent.

Like today, in the 1930s there was one major economy in Europe doing well. It was France. While the rest of Europe was suffering, unem­ployment in France, as in Germany today, was in the low single figures. And France, again like Germany today, had large current-account sur­pluses and was in a financial position to act as the locomotive for the rest of Europe. But the French authorities of the 1930s, refusing to ac­cept responsibility for what was happening elsewhere in Europe, would not adopt expan­sionary policies. Nor would they lend directly to Germany, fearing that they would be throwing good money after bad. The effect of French pol­icy eventually brought down the whole financial system of western Europe.

Deja vu.

SEE ALSO: Credit Suisse Presents The 25 Best Stocks In America >

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TUNGUSKA: 104 Years Ago, A Mysterious Explosion 1000x More Powerful Than The Hiroshima Bomb Rocked Siberia

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tunguska fallen trees

Today is the 104th anniversary of a historic explosion that still has no clear explanation.

It happened in Tunguska, a remote forest area in the middle of Siberia.

The blast had the power of 15 megatons of TNT, roughly a thousand times that of the atomic bomb dropped on Hiroshima Japan.  The event was so powerful that it was felt and heard a thousand miles away.

Locals believed the blast was supernatural, caused by a god that was punishing people for their wickedness.

Scientists, on the other hand, believed it was a meteor.

Here's Where It Gets Weird

20 years passed before the first Russian scientists went to the site to investigate.

If it was a meteor, there would be a crater and meteorite fragments.

However, there was no crater. And there were no fragments.

In fact, at the epicenter of the explosion was a grove of untouched, fully grown trees.  Surrounding that tiny grove was around 800 square miles of leveled trees.

The blast had the hallmarks of an atomic bomb-like explosion.  However, no scientific progress had been made in the area of nuclear weapons until the 1930s, more than two decades after the event.

Two Theories

Scientists believe that a football field-sized, solid ice chunk of a comet entered the earth atmosphere.  When it encountered earth's intense atmospheric pressure, it immediately exploded miles above the forest.  Because it was made of ice, it left no extraterrestrial evidence.

Others believe it was caused by something much smaller: a nuclear-powered alien spaceship that crashed into the earth.

A hundred years later, neither side seems to have fully convinced the other camp.

But in yesterday's Cashin's Comments, Art Cashin pointed to a problem with the scientists' theory:

But science seems to miss a key point at the time.  There were lots of astronomers and telescopes.  They were busy finding new planets, like Pluto.  Or they were plotting new comet paths and the like.  If they were all so smart, how did all these clever astronomers miss something so large headed for the earth.

Mystery, unsolved.

SEE ALSO: Business Insider's Brand New Science Vertical >

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