Author: WSJ.com: Real Time Economics

Economists and others weigh in on Fed Chairman Ben Bernanke’s testimony on the central bank’s exit strategy.

• While Bernanke provided more detail on the exit process, he did not provide much more insight into the timing. Indeed, he reiterated that the Fed expects conditions to warrant exceptionally low levels of the fed funds rate for an extended period. –Michelle Meyer, Barclays Capital
• Given the economic populism that has infected the body politic, this is sure to gain the attention of political actors on Capital Hill and the White House that would prefer the central bank adopt an implicit inflationary bias heading into what will be a contentious mid-term election. The major takeaway from the statement is that the Fed has begun to embark on a campaign to rebuild its credibility. –Joseph Brusuelas
• Mr. Bernanke’s written testimony at the House makes it clear he does not expect to tighten policy in any meaningful way anytime soon. He repeated the FOMC mantra that the economy needs “exceptionally low level of the federal funds rate for an extended period.” He set out the Fed’s current thinking on how policy will eventually be tightened, “at the appropriate time … None of this will happen soon, though, and the likely near-term hike in the discount rate “should not be interpreted” as a policy signal. –Ian Shepherdson, High Frequency Economics
• Bernanke explicitly throws out the possibility that the Fed will switch its rate tool from the funds rate to the interest on excess reserves rate. We covered this idea extensively in the Fed Monitor piece. We believe the Fed has no choice but to do this, because it will have little direct control over the funds rate until reserves are normalized. Bernanke suggests that the Fed could target the interest on reserves rate coupled with a reserves target (back to Volcker rules!). The Chairman underscores that when the reserves situation gets back to normal, the Fed would return to a funds rate targeting regime. The footnote on this issue explicitly mentions a corridor scheme, with the funds rate bracketed by a discount rate ceiling and an interest on reserves rate floor. In practice, the existence of a corridor would be largely irrelevant for everyone but money market traders once the operating regime is able to return to normal. –Stephen Stanley, RBS
• Bernanke’s testimony contained lots of interesting tidbits and reinforced the notion that the progress toward an eventual Fed exit is underway. But, he didn’t provide much insight with regard to the timing of the exit and it’s clear that the Fed is still engaged in internal debate on a lot of the specific strategies that will be employed. We continue to believe that the exit process will unfold fairly quickly during the second half of 2010, spurred by market-based indications of rising inflation expectations as the economic recovery takes hold. The time lag between actions aimed at draining a significant volume of excess reserves and the hiking of the policy rates is likely to be relatively brief, putting the IOR program to the test. –David Greenlaw, Morgan Stanley
• Interest on excess reserves … will provide an incentive to banks to not put all their excess reserves to work but these reserves are very cyclical and any interest rate would have to be more attractive than what banks can earn on lending. This is contradictory to the message for banks to increase their lending. Reserve targeting? We did that in the early 1980s and that led to higher interest rate volatility. –John Silvia, Wells Fargo
• Bernanke anticipates that the paring of excess reserves will help restore the Fed’s ability to control the funds rate. We generally agree, but suspect that the paring of excess reserves will have to be enormous before any meaningful impact is apparent on the funds rate. We don’t think paring excess reserves from $1.1 trillion to say $500 bln would have much effect. We suspect that the adjustment will have to be of a magnitude of roundly $1 trillion, before normal supply/demand dynamic provides for control of the funds rate. –Ray Stone, Stone & McCarthy
• The Fed could sell some of its Treasury, agency, or mortgage-backed securities to drain reserves from the banking system, but he did not anticipate doing so in the near term. The Fed will allow agencies and MBS to run off as they mature or are prepaid, and it could sell outright if the recovery becomes sufficiently advanced, but officials are content with normal run off for the time being. The Fed is rolling over its holdings of Treasuries into new securities, but at some point in the future it may decide to allow some of these to run off as well. – Michael Moran, Daiwa Securities America
• The problem after the Fed implemented quantitative easing after Lehman was that players in the funds market who could not earn interest on reserves drove the funds rate below the target rate. Also the Fed appears to have no intentions of selling assets to reduce its balance sheet for a long while (meaning it will focus on draining and locking up reserves rather than shrinking its balance sheet). We stand by our forecast that the Fed will not materially tighten policy in 2010 in the sense that (i) the funds rate target will be unchanged at year end and there will be no hike in interest paid on reserves and (ii) the Fed will have a balance sheet that is north of $2 trillion. –RDQ Economics

Compiled by Phil Izzo

The U.S. Treasury Department plans to send more advisors to Afghanistan in the months ahead, a top official said Wednesday, part of the Obama administration’s effort to bolster the war-torn country’s financial management system.

Men trade currency in a Kabul money market. (Getty Images)

In remarks prepared for delivery at the American University of Afghanistan in Kabul, Deputy Secretary of the Treasury Neal S. Wolin said Treasury advisors have helped Afghanistan restructure its debt, streamline its budget process, improve its payment system for government employees and create a new Debt Management Unit.

“The U.S. Treasury has made building and reforming the system of public financial management in Afghanistan a priority,” Wolin said. “There is much work still to do, but — again — there has been progress,” he added, pointing to a revenue action plan designed to limit corruption and new powers to audit Ministry of Finance expenditures.

Wolin also said Treasury is taking steps to help Afghanistan’s central bank, which was one of several targets in a recent Taliban attack. He said the department’s technical adviser at the central bank’s financial intelligence unit has helped establish systems to track financial transactions. Another advisor will arrive in the country in the coming days to help the central bank regulate the financial sector, Wolin said.

A roundup of economic news from around the Web.

• U.S. Rating: Bloomberg’s David Reilly wonders whether losing its AAA rating would be good for the U.S. “Geithner shouldn’t have fought Moody’s report [saying the U.S. debt rating could come under pressure]. He should have embraced it. What better way to impress upon Congress that the U.S. is very much in crisis and needs to face up to its problems. That reality has yet to set in on Capitol Hill. Two weeks ago, for example, the Senate shot down a proposal to create a deficit-reduction commission. The measure failed because the Left worries such a committee will cut spending, while the Right is afraid it will call for tax hikes.So no spending cuts or tax hikes, which is what we need — just deficits as far as the eye can see. Let’s break out the fiddles already and watch Rome burn.
• European, U.S. States: Barry Ritholtz compares debt in U.S. states to European nations. “All by itself, the insolvent nation-state of California is the 8th largest economy in the world. Its the size of France. According to the CIA Factbook, Greece is number 34. That is a lot of hyperventilating about a relatively small impact to global GDP. Italy is 11, Spain is 13, Portugal is 50, and Ireland is 56. Additionally, in the US, we have 43 of the 50 states in some form of financial distress. Perhaps the solution to California’s woes is for Arnold (who is from Austria) to have California join the EU. Then, they might qualify for a bailout from Germany.”
• Deficits and Taxes: On the Tax Policy Center’s TaxVox blog, Howard Gleckman sees the argument for higher taxes in a Republican budget proposal. “There are 40 million Americans 65 and older and we spend almost one-third of the budget on seniors. By mid-century, more than 70 million will be 65-plus. There is no doubt we need to slow the growth of spending for aging Baby Boomers. But freezing programs such as Medicare and Social Security at current levels while the population eligible for benefits nearly doubles seems unrealistic at best. [Rep. Paul] Ryan is absolutely right to suggest that any long-term budget deal must address these entitlements. But his plan is also powerful evidence that it must include new revenues as well.”

Compiled by Phil Izzo

This column, which originally ran as the Ahead of the Tape, has been updated with the actual figures.

U.S. export growth is running up against a Big Fat Greek Problem.

The Commerce Department reported Wednesday that the U.S. trade deficit widened in December to $40.2 billion, compared with $36.4 billion in November.

The widening reflects faster growth in imports than exports at year-end, an unwelcome side effect of the U.S. economic recovery. It also is a reminder that export-led growth, which nations are pursuing as a path out of recession, is easier said than done.

President Barack Obama has called for a doubling of U.S. exports over the next five years to help narrow the trade deficit and spur economic growth. The quickest way of doing so is a weaker dollar, which makes U.S. goods and services cheaper in the global market.

But lately, the dollar is moving in the other direction. Worries over the fiscal health of Greece and other nations have dogged the rival euro currency, which hit an eight-month low on Tuesday before closing a few cents higher.

The U.S. dollar index, which tracks the greenback against a trade-weighted basket of currencies, has risen about 7.5% since last November to close Tuesday at 79.79.

Goldman Sachs economist Sven Jari Stehn calculates that even with above-consensus global growth of 4.5% over the next five years, the dollar still would need to depreciate in inflation-adjusted terms by about 30% for U.S. exports to double to about $3.1 trillion.

If instead the strengthening continues, “it would wipe out all the other bits and pieces [the president] is putting together to encourage exports,” said Simon Johnson, a professor at the Massachusetts Institute of Technology’s Sloan School of Management.

And while investors focus on whether the big European nations will come to their smaller neighbors’ rescue, Mr. Johnson points out that Germany, the world’s biggest exporter until China surpassed it last year, is reaping the benefits to its own exports that come from a weaker currency.

European nations mightn’t be in as much of a hurry as investors assume to halt their currency’s downward slide. That could make an export-led U.S. recovery its own Greek myth.

A new index aimed at divining the current and future state of the U.S. economy took a disappointing turn in January, according to a report released Wednesday.

The Ceridian-UCLA Pulse of Commerce seasonally adjusted January index fell to 104.53 last month, from 108.60 in December, a 36.8% annualized decrease. The three-month moving average, which aims to tame month-to-month volatility, ticked up slightly to 105.83 from 105.55 in December, while the year-over-year change in the index stood at 3.6% in January, from 3.4% the month before. That was the first year-over-year increase since April 2008.

The index relies on “real time” data on fuel consumption by the trucking industry, in a bid to create a gauge that will say where the U.S. economy is right now, and where it will be going. The report’s authors believe tracking the movement of goods over U.S. roads does a good job at accomplishing this mission.

The report comes at a time where most economists agree the economy is recovering, albeit without much vigor and with no job gains. Most also believe that, after inventory-related factors powered decent gains in the nation’s gross domestic product over the final months of 2009, growth will moderate, although they do expect job losses to soon give way to modest increases.

“A consensus has also emerged that the recovery we are currently experiencing will be a weak one, with GDP growth in the range of 2-3% per year, too low to drive down the unemployment rate,” the report said. “The disappointing January value of the Ceridian-UCLA Pulse of Commerce Index is compatible with the lower end of that range, and does not portend the kind of economic growth that can offer significant improvements in the labor market.”

“We will need better PCI [Pulse of Commerce Index] levels in February and March to support optimism again,” the report said.

Former Treasury Secretary Henry Paulson got down on bended knee in front of House Speaker Nancy Pelosi to “break the tension and to get a smile or laughter” during the darkest days of the financial crisis but said “it didn’t really have its desired effect.”

Paulson, in a wide-ranging interview conducted by billionaire investor Warren Buffett, recounted a key meeting last fall between balky Republican and Democratic lawmakers — including Pelosi and then-presidential candidates John McCain and Barack Obama. “People didn’t come to physical blows but there were verbal blows,” Paulson said of the meeting, which was held to gain approval of TARP.

In a session before the Omaha Chamber of Commerce, Paulson said Wall Street pay is “out of whack,” the economy is recovering and he’s keeping his money in fixed-income and money market accounts.

“One of the things I learned during my career is I’m not a great investor,” said Paulson, the former head of Goldman Sachs Group Inc. “A lot of what I have is in fixed-income markets, money markets, cash … growth equities.”

Paulson details his handling of the financial crisis in his new book “On the Brink,” including how Obama stopped talking to him the day after the 2008 election. He made reference to that again after Buffett recounted how “Obama sort of stopped talking to you” after the election.

“Take out the ‘sort of’,” Paulson quipped.

As for what would have happened if Bank of America hadn’t bought Merrill Lynch, he says Merrill “wouldn’t have lasted a week.”

Several prominent policy makers rallied Tuesday to support the creation of an independent Consumer Financial Protection Agency, as anticipation mounts over the details of legislation that Senate Banking Committee Chairman Christopher Dodd (D., Conn.) is drafting to overhaul financial regulation.

1) Harvard’s Elizabeth Warren, whom many credit with coming up with the idea of an independent CFPA, penned an editorial in The Wall Street Journal. She blasted the banking industry for lobbying so aggressively to kill the creation of an independent consumer agency:

“This generation of Wall Street CEOs could be the ones to forfeit America’s trust. When the history of the Great Recession is written, they can be singled out as the bonus babies who were so short-sighted that they put the economy at risk and contributed to the destruction of their own companies. Or they can acknowledge how Americans’ trust has been lost and take the first steps to earn it back.”

2) Several state attorneys general, Tom Miller of Iowa, Lisa Madigan of Illinois, and Dick Blumenthal of Connecticut, held a conference call and pushed for the creation of an independent CFPA.

“A vote against a strong and independent CFPA is a vote for the big banks and Wall Street and a vote against consumers,” Mr. Miller said. “Americans are rightfully concerned and angry about the near-collapse of the economy largely caused by irresponsible banks, Wall Street and other financial firms.”

3) House Financial Services Committee Chairman Barney Frank (D., Mass.) followed up with his own harsh words for those in the banking industry lobbying against the creation of a CFPA.

“Those who cite safety and soundness as a major reason to oppose increased consumer protection have it exactly backwards,” Mr. Frank said. “In fact, the inability to protect consumers from abuse was a major cause of the financial crisis from which we are just emerging.  Professor Warren importantly notes the example of Citigroup’s unsuccessful and unilateral attempt to bring fairness to credit card practices.  This experience demonstrates that competitive pressures will obstruct reform unless it is done by thoughtful legislation and regulation that applies to all.”

The U.S. financial system is in “much better shape,” although small and medium-sized financial institutions are under pressure, which will put a damper on credit availability in the U.S. economy, a top Federal Reserve official said Monday.

“The capital markets are generally open for business–with the important exception of some securitization markets–and the major securities dealers that survived the crisis have seen a sharp recovery in profitability,” Federal Reserve Bank of New York President William Dudley said.

But, “many smaller and medium-sized banks remain under significant pressure,” he noted. “Loan losses in commercial real estate and consumer and mortgage loans seem likely to continue to pressure smaller banks for some time to come,” which means “credit availability to households and small businesses will still be curtailed.”

Dudley’s comments came from the text of a speech given at an event held by the Reserve Bank of Australia in Sydney. The gathering is closed to the press.

The official is vice-chairman of the interest-rate-setting Federal Open Market Committee. His comments arrive at a significant time for the central bank, as it mulls how it will unwind its highly stimulative monetary policy stance in the face of a fairly tepid recovery, and as Congress mulls changes to the financial regulatory system that could have major implications for how the central bank does business.

Dudley’s speech was primarily about the financial crisis, in terms of its causes and remedies. As such, he had little to say about the current state of the economy and nothing to say about the outlook for monetary policy.

Much of his speech covered the familiar territory of acknowledging the fact that while policy makers dropped the ball and missed much of what ultimately drove the financial crisis, it was Wall Street practices–primarily excessive bank borrowing– that started all the trouble.

Dudley’s remedies were familiar as well. He said to avoid future crises, regulators need to look at more than just individual firms and try to understand the linkages that exist between financial companies. Financial infrastructure also needs to be made more robust, in particular in the tri-party repo sector, where banks go to finance their trading positions.

The official also said “we need to strengthen bank capital requirements” and create “global capital standards that put more emphasis on common equity, establish an overall leverage limit and better capture all of the sources of risk in the capital assessment process.” He said he sees value in debt that can convert to equity in times of stress, otherwise known as contingent capital.

Dudley also said the financial system’s too-big-to-fail problem must be addressed. Having some firms be so large they operate with the belief their bad investments will be bailed out by the government must be countered by creating an official mechanism to resolve and wind down a major failed firm. The central banker said higher capital standards will also help prevent firms from growing to a threatening size.

Dudley flagged as a sign of the recovering financial system the recent end of a host of Fed emergency lending programs.

Despite fears to the contrary, those programs have been moneymakers for the Fed, with the official saying “when a full accounting of the special liquidity facilities is complete, it seems likely that the facilities will have generated substantial incremental earnings that the Federal Reserve will remit to the Treasury.”

Federal Reserve Chairman Ben Bernanke’s Wednesday appearance before a U.S. House panel has been postponed because of the ongoing weather issues in the nation’s capital.

Bernanke

The House Financial Services Committee said Tuesday it was canceling all of its hearings for the week. The panel was supposed to hear Wednesday from Bernanke on how the Fed planned to unwind the many liquidity programs put in place during the financial crisis.

Bernanke is also expected to appear later this month to give his semiannual monetary policy report to Congress.

The Fed plans to release Bernanke’s testimony as prepared for delivery Wednesday even though the Fed chairman’s actual appearance has been postponed.

A roundup of economic news from around the Web.

• Consumer Agency: Writing for the Journal, TARP watchdog Elizabeth Warren argues for creation of a Consumer Financial Protection Agency. “The consumer agency is a watchdog that would root out gimmicks and traps and slim down paperwork, giving families a fighting chance to hang on to some of their money. So far, Wall Street CEOs seem determined to stop any kind of watchdog. They seem to think that they can run their businesses forever without our trust. This is a bad calculation. It’s a bad calculation because shareholders suffer enormously from the long-term cost of the boom-and- bust cycles that accompany a poorly regulated market. J.P. Morgan CEO Jamie Dimon recently explained this brave new world, saying that crises should be expected “every five to seven years.” He is wrong. New laws that came out of the Great Depression ended 150 years of boom-and-bust cycles and gave us 50 years with virtually no financial meltdowns. The stability ended as we dismantled those laws and failed to replace them with new laws that reflected modern business practices.”
• Euro Zone Debt Crisis: On voxeu Charles Wyplosz aims to present facts and myths about the debt crisis in the euro zone. “Myth No.5: Contagion, already under way, would be destructive. This statement is too vague. It cannot destroy the monetary union, as argued above. But contagion can bring the value of the euro down – but this would be mostly good news for the Eurozone as it is suffering from an overvalued exchange rate at a time of anaemic domestic demand. Fact No.5: The real worry is the banking system. Some European banks hold part of the Greek debt and, if still saddled with unrecognized losses from the subprime crisis, some might become bankrupt. Many governments have simply not pushed their banks to straighten up their accounts and they are now discovering some of the unforeseen consequences of supervisory forbearance.”
• Climate Change: Harvard’s Robert Stavins looks at the current state of climate-change policy. “It is interesting to note that many – perhaps most – economists have long favored the variant of cap-and-trade whereby allowances are auctioned and the auction revenue is used to cut distortionary taxes (on capital and/or labor), thereby reducing the net social cost of the policy. Cap-and-Dividend moves in another direction. This system (which was introduced several years ago in the “Sky Trust” proposal) has some merits compared with the economist’s favorite approach of tax cuts, namely that the Cap-and-Dividend scheme addresses some of the distributional issues that would be raised by using the auction revenue to fund tax cuts (which could favor higher income households). On the other hand, it eliminates the efficiency (cost-effectiveness) gains associated with the tax-cut approach. In fact, Stanford’s Larry Goulder has estimated that the tax-and-dividend approach would cost 40% more than an approach of combining an auction of allowances with ideal income tax rate cuts. (By “ideal,” I mean focusing on tax cuts that would lead to the lowest net cost.) In general, there are sound reasons to seek to compensate consumers for the energy price increases that will be brought about by a cap-and-trade system, or any meaningful climate change policy. But it is important not to insulate consumers from those price increases, as diluting the price signal reduces the effectiveness and drives up the cost of the overall policy. Thus, “compensation” as in Cap-and-Dividend is fine, but “insulation” is not.”

Compiled by Phil Izzo

Small-business owners in the first month of the new year remained pessimistic about the economy, according to a report released Tuesday.

The Small Business Optimism Index has now posted seven quarterly readings below the 90 mark as small business owners entered 2010 the same way they left 2009: still downbeat on the economy. The index, though, in January did post a small gain, of 1.3 points over December, rising to 89.3, reported the National Federation of Independent Business in a press release Tuesday. Seven of the index’s components posted gains and one remained unchanged. Two components — plans to increase employment and invest in inventories — remained negative, but became less negative.

The NFIB noted that the current month’s index was 8.3 points higher than the survey’s second lowest reading reached in March 2009; the lowest reading was 80.1 in the early 1980s.

However, “optimism has clearly stalled in spite of the improvements in the economy in the second half of 2009,” according to the press release, which is “indicative of the severity and pervasiveness of this recession.”

The report said there was no improvement in the job creation statistics for January, as the government’s nonfarm payrolls report confirmed. The decline in the unemployment rate to 9.7% also squares with the NFIB forecast, which hasn’t anticipated a run up over 10%. Owners reported workforce reductions that average 0.52 workers per firm, basically unchanged for the past several months. About 9% of the owners surveyed increased employment by an average of 3.0 workers per firm, but 19% reduced employment an average of 3.9 workers per firm, seasonally adjusted.

Owners complained that poor sales was their top problem, and said that there is no need to hire additional employees with no new customers.

The report also showed that the frequency of reported capital outlays over the past six months rose three percentage points to 47% of all firms, an improvement from December’s record low reading, but historically very weak. Capital spending is on the sidelines, as is the demand for loans to finance these activities.

Expectations for business conditions six months out faded, and very few owners felt that growth opportunities were solid enough to warrant expansion, only 5% in comparison to readings above 25% at the beginning of prior expansions. About 31% of owners said poor sales was their top business problem.

The report also indicated that inflationary pressures were still tame, with the weak economy continuing to put downward pressure on prices. Just 11% of the owners reported raising average selling prices, while 27% reported average price reductions.

The president of the Federal Reserve Bank of St. Louis said Monday the U.S. central bank should begin gradually selling its mortgage securities holdings later this year despite concerns from some investors the move would raise mortgage rates.

James Bullard said in an interview the asset sales should happen before the Fed hikes short-term interest rates, a sequencing that is still being debated within the central bank. He also said the market was putting too high the odds that the Fed’s first rate hike will come in November.

To be sure, the Fed has yet to complete the purchase of $1.25 trillion in mortgage-backed securities that it plans by the end of March — part of the extraordinary measures put in place to counter the financial crisis — and is still at least several months away from tightening policy. But the central bank is already looking ahead to when the economy will be strong enough to warrant tighter credit.

“If the economy stays on track, I’d expect that at some point we’d entertain the possibility of asset sales,” said Mr. Bullard, a 2010 voting member of the Fed’s policy-making arm, adding it could happen later this year. The Fed official said the asset sales should be very slow at first to test markets.

As the Fed prepares a blueprint for a credit tightening for when the economy has recovered enough, officials agree on the need, over time, to shrink the size of the central bank’s bloated balance sheet. They also agree that if they start selling mortgage backed securities, it should be done in a gradual way aimed at minimizing damage to the housing market. But they’re divided on the timing and the sequence of the steps.

Mr. Bullard may not get a lot of support for his view on the latter point. He did admit that at the last meeting of the Federal Open Market Committee “a lot” of officials thought higher short-term rates should come before asset sales. Other Fed officials are concerned that selling mortgage-backed securities could hurt the housing market, which remains weak even as the U.S. economy shows increasing signs of a recovery.

Following a strong fourth quarter last year, Mr. Bullard said the recovery was on track and there was no longer a risk of a double-dip recession in the U.S. Although it will take some time for unemployment to come down, Mr. Bullard said the economy should begin to add jobs in the coming months.

However, when asked if the Fed funds futures market was correct in pricing a 90% chance of a hike by November, Mr. Bullard said the recovery likely won’t be strong enough for that.

“Frankly I think the economy would have to recover pretty strongly this year — better than expected — before (a rate hike) could happen in the fall,” he said.

As part of the Fed’s plans to end its liquidity programs, Mr. Bullard said the discount rate it charges banks for emergency loans could go up relatively soon in small steps.  But he declined to comment on whether the St. Louis Fed had already made a request to the Fed Board in Washington for such a move.

For years, researchers have known that there’s a link between children’s participation in high school sports and success later in life. Problem is, they haven’t understood exactly what that link is.

Sports participation is linked to economic success. (Getty Images)

That’s because children who participate in athletics may have other things going for them before they lace up their cleats. If they’re already aggressive, goal-oriented extroverts with physical attributes, such as height, that improve their chances of doing well later, the effect of sports may be negligible.

But Wharton economist Betsey Stevenson may have found a way to untangle the lines of cause and effect. She examined what happened after Title IX — the 1972 law that banned gender discrimination at federally-funded schools.

Title IX’s most pronounced effect was on athletics. Girls’ participation in high school sports went from 1 in 27 in 1972 to 1 in 4 in 1978. But it’s effect wasn’t uniform because states where boys’ participation in athletics was high were forced to increase girls’ participation the most. Ms. Stevenson was able to use the variation between states to tease out the effect of girls participation in sports from other factors. That allowed her to see how playing sports affected girls’ success later in life.

Her conclusion: A 10 percentage-point rise in girls’ participation in high school sports leads to a 1 percentage point increase in female college attendance and a 1 to 2 percentage point increase in female labor-force participation.

Maybe athletics should be added to reading, writing and arithmetic.

A top Federal Reserve official said Monday U.S. monetary policy is too hot for China and Hong Kong and explained any trouble those nations ultimately face because of this situation arises from their own foreign exchange policies.

Yellen

“Because both the Chinese and Hong Kong economies are further along in their recovery phases than the U.S. economy, current U.S. monetary policy is likely to be excessively stimulatory for them,” Federal Reserve Bank of San Francisco President Janet Yellen said. “However, as both Hong Kong and the mainland are currently pegging to the dollar, they are both to some extent stuck with the policy the Federal Reserve has chosen to promote recovery,” she wrote in a bank Economic Letter published Monday.

The central banker said that if China wants to prevent U.S. policies from overheating its economy and driving inflation, it will have to do something about its foreign exchange policy.

“Increased exchange rate flexibility could mitigate growing inflationary concerns, and also act toward easing global imbalances and encouraging the development of the household sector, a shift the Chinese government now officially says it wants,” Yellen said.

The current stance of Federal Reserve monetary policy is very aggressive by any measure, with short-term interest rates set essentially at zero. The Fed also will until the end of March be buying mortgage assets to help keep borrowing rates down. While a recovering economy is driving the Fed to think about ways to unwind its current policy stance, there are questions whether mortgage buying will continue beyond March. Meanwhile, most economists don’t believe the Fed will rates rates until much later this year.

China’s economy is recovering more rapidly than the U.S., and there have been widespread worries that its economy may be growing at an unsustainable rate. Fed rate policy and what it does to global borrowing patterns plays a part in that scenario. Fed officials, however, have downplayed the matter and said that they must set U.S. policy to deal with U.S. economic realities. They’ve also said Chinese policy makers are responsible for dealing with their own economy.

The bank said Yellen’s comments were adapted from a report by Yellen based on a visit to China and Hong Kong on Nov. 15 to Nov. 21, 2009.

The U.S. job picture improved for the fifth consecutive month in January, according to a report released Monday.

The Conference Board said that its January employment trends index rose to 93.2 from December’s upwardly revised 92.3, but was still down by 0.7% compared to January 2009. December was originally reported as 91.8.

“The continued rise in the ETI makes us more optimistic that job growth will resume in the first quarter of 2010,” Gad Levanon, senior economist at the Conference Board.

The improvement was widespread across all eight components. Friday’s large drop in the number of involuntary part-time workers was the first time that this component showed a strong signal of improvement, Levanon said.

Last Friday’s government report on January employment showed that the U.S. labor market lost more jobs than expected, 20,000. Economists surveyed by Dow Jones Newswires expected the report to show the economy neither lost nor gained jobs in January. The unemployment rate though unexpectedly declined, suggesting the labor market may be coming out of its worst downturn since the Great Depression. It fell to 9.7% from 10% in December. Economists had expected it to tick up to 10.1%. Data also showed the economy lost a revised 150,000 jobs in December. That number was originally reported at a decline of 85,000.

The Conference Board’s index is an aggregate of eight labor-market indicators, including jobless claims, job openings data from the Bureau of Labor Statistics and industrial production figures from the Federal Reserve. It seeks to facilitate forecasts for employment, unemployment and wages by filtering out the noise and volatility of monthly labor market indicators and showing underlying trends more clearly.

The employment trends index is published every Monday following the government’s monthly jobs report.

A roundup of economic news from around the Web.

• Taxis and the Fed: Writing for Forbes, John Tamny makes a connection between Washington’s fixed-price taxis in the snow and the Fed’s low rates. “What happens when government attempts to shield markets from reality is much the same as what revealed itself with the cab example. Those lucky enough to borrow at low rates (usually the largest, least risky companies) are not forced to be circumspect in their accession of a scarce good. As such, they borrow more than they otherwise would due to central bank market distortions that obscure the true value of what they’re borrowing. As for the riskier, often smaller firms that really need capital in order to simply get by, they’re to some degree shut out of the capital markets due to the scarcity of capital wrought by the Fed’s price controls. But just as cabdrivers need extra room for profit in snowy, treacherous conditions, speculative investors require high rates of interest during stormy periods so that they can be paid for taking risks at a time when no one else will. Ultimately, prices are what organize a market-based economy. And happily for the consumer in unregulated markets, high prices ensure lower prices in the future as new entrants seek profits. The problem is that as long as governments and central banks attempt to shield us from market-clearing prices, there will be no incentive for the bold to relieve the scarcity reflected in higher prices.”
• More on Jobs: On the Atlanta Fed’s macroblog, David Altig looks at the employment report. “The outsized negative employment effect in the United States relative to most other developed countries is a striking feature of the labor market data of the past two years… The outsized drop in employment in the United States is the mirror image of another crucial feature of the last several years: outsized productivity growth in the United States. What are we to make of the productivity gains in the United States relative to other countries? Does this difference merely reflect labor hoarding in other countries, implying that the productivity levels will become more consistent among advanced economies as employment recovers in the United States? Or is there something more fundamental at play, as Professor Becker seems to imply? Have businesses in the United States found ways to permanently enhance efficiency, locking relatively high productivity growth—and perhaps a slower recovery in employment levels—into the future?” Separately, Jeff Frankel says the lag in job growth isn’t worse in this recession. “Although the [recession-dating] Committee looks at many indicators in reaching its decisions, the most important overall are measures of output, particularly quarterly GDP. GDP shows growth turning from negative in the first half of 2009 to positive in the 3rd quarter of the year, and now strongly positive in the 4th quarter. That suggests that the trough will probably turn out to have been in the middle of last year.” Econbrowser adds four key charts.
• Economist Malpractice: Maxine Udall wonders whether economists should be sued for malpractice. “How did it come to pass that many people cannot tell the difference between cynical posturing and serious economic argument? I lay much of the blame at the feet of my own discipline, but how did the discipline of economics manage to accomplish this potentially tragic result? … Economics provided the theory and language that supported the drive to the ditch we find ourselves in. We did it by allowing economics to become divorced from moral philosophy. Now the economy is on life support and most people in this democracy can’t tell the “difference between cynical posturing and serious economic argument,” but they can and will vote. If economists were physicians, we would be sued for malpractice.”

Compiled by Phil Izzo

David Wessel, The Wall Street Journal’ economics editor and author of “In Fed We Trust: Ben Bernanke’s War on the Great Panic,” recently finished “On the Brink,” the new book by former Treasury Secretary Henry Paulson, which covers much of the same time period from a different vantage point. Wessel says he’ll leave the book reviewing to other more neutral observers, but offered this list of nuggets he gleaned from Paulson’s account.

Former Treasury Secretary Henry Paulson (AFP/Getty Images)

1. Paulson says that ever since high school he has had occasional bouts of “dry heaves” at moments of exhaustion, of which there were several during his tenure as Treasury secretary. During contentious September 2008 negotiations on Capitol Hill over the Troubled Asset Relief Program’s restrictions on executive compensation, he recalls: “Exhausted, I went back to the small office I was using and had a bout of the dry heaves in front of Judd Gregg [a Republican senator from New Hampshire.] I wasn’t that sick, but I made a lot of noise, which seemed to galvanize Rahm Emanuel. ‘We need to get everyone back together again and get this thing done,’ he said. Harry Reid [the Senator majority leader] came in and asked if I needed a doctor. I said no, I was just tired.”

2. When Bank of America bought Countrywide Financial, the subprime mortgage lender, for $4.1 billion, it expected to get some relief from regulatory capital requirements from the Federal Reserve for saving Countrywide. But in September 2008, the Federal Reserve Bank of Richmond instead was putting pressure on Bank of America to redo its capital plan and cut its dividend. When Paulson encouraged Bank of America CEO Ken Lewis to buy Lehman Brothers, Lewis asked for help in getting the Fed off his back. Paulson agreed to talk to Fed Chairman Ben Bernanke and New York Federal Reserve Bank President Tim Geithner, though the issue became moot when BoA decided against buying Lehman. Bank of America went on to buy Merrill Lynch. In October 2008, after the government had pumped money into BofA, Merrill and other big banks, Lewis confided to Paulson that he was worried Merrill CEO John Thain would try to wiggle out of the deal; he wanted Paulson to insist that Thain go through with it. Paulson says he never mentioned the call to Thain. Less than three months later, of course, Lewis would talk about backing out of the deal, completing the purchase under pressure from Paulson and Bernanke.

3. The day after Lehman went into bankruptcy, Paulson told the press: “I never once considered it appropriate to put taxpayer money on the line in resolving Lehman Brothers.” But with the benefit of hindsight, he says, he realizes “I ought to be have been more careful with my words,” he writes. “Some interpreted them to mean that we were drawing a strict line in the sand… and that we didn’t care about a Lehman collapse or its consequences. Nothing could have been further from the truth. I had worked hard for months to ward off the nightmare we foresaw with Lehman. But few understood what we did — that the government had no authority to put in capital, and a Fed loan by itself wouldn’t have prevented a bankruptcy.”

4. Paulson is full of praise for most government officials with whom he worked — with a couple of exceptions, among them Chris Dodd, the Connecticut Democrat who chairs the Senate Banking Committee, among them. About Dodd and his House counterpart, Barney Frank, Paulson writes, “Barney was scary-smart, ready with a quip, and usually a pleasure to work with….Dodd was more of a challenge. We’d worked together on Fannie and Freddie reform, but he had been distracted by his unsuccessful campaign for the Democratic presidential nomination and seemed exhausted afterwards. Though personable and knowledgeable, he was not as consistent or predictable as Barney.”

5. Another exception is Sheila Bair: “I respected Sheila… (B)ut sometimes she said things that made my jaw drop. That morning she had said she wasn’t sure that Citi’s failure would constitute a systemic risk,” the threshold for extraordinary federal action. “She spoke as if Citi were just another failing bank and not a world leader — with $3 trillion in assets, both on and off its balance sheet — imploding in the midst of the worst economic conditions since the Great Depression… Although I believed she was simply posturing, I replied, ‘If Citi isn’t systemic, I don’t know what is.’”

6. Toward the end of the Bush presidency, Paulson heard more than once from Bob Rubin, the former Clinton Treasury secretary and former colleague of Paulson’s at Goldman Sachs who was then among those at the top of Citigroup. “Bob Rubin… called to tell me that short sellers were attacking the bank… Always calm and measured, Bob put the public interest ahead of everything else. He rarely called me, and the urgency in his voice that afternoon left me without doubt that Citi was in grave danger.”

7. The federal rescue of Citi led directly to the rescue of General Motors and Chrysler. “Nancy Pelosi [the speaker of the House]… told me point-blank that it was politically impossible to rescue Citi and not help the automakers. She had until recently opposed bailouts for the car companies, which she considered poorly managed.”

8. Jeff Immelt, CEO of General Electric, frightened Paulson in early September by calling to say GE, which Paulson describes as “an American business icon,” was having trouble borrowing money by selling IOUs known as commercial paper, and visited Paulson several days later in person. In mid-October, Paulson called Immelt to discuss imminent plans for a Federal Deposit Insurance Corp. guarantee of all new bank debt, but not GE’s. Immelt told him not to worry, GE would manage and would benefit indirectly by a more stable banking system. The next day, Immelt called back and said the bank guarantees were hurting GE’s finance unit because banks could borrow with U.S. government guarantees and GE couldn’t. And on Oct. 16, 2008, Immelt came in person to press the matter with Paulson. Over the following weeks, Paulson and Treasury official David Nason “worked hard to get Sheila [Bair] comfortable” with extending the guarantee to GE. In November, she did. GE’s finance unit, along with Citi, became one of the biggest users of the program.

The Chinese and the Russians love to dump on the dollar. The International Monetary Fund dreams that some day its unofficial currency, the SDR, may become the world’s reserve currency. But for now, at least, the dollar is still king.

According to a study by Linda Goldberg, an international economist at the New York Fed, the dollar remains the world’s top currency by a long shot when measured in a number of different ways. Those include: foreign currency reserve holdings, foreign exchange transactions, international trade financing and international bond sales. The dollar had about an 86% share of foreign exchange transactions in 2007, for instance, slightly higher than in 1995.

“Overall, despite market turbulence and substantial movements in the value of the dollar over the past decade, the dollar has not declined in prominence either as a central currency for exchange rate arrangements or as an international reserve currency,” she writes. The euro, which was touted as a big rival to the dollar, hasn’t been much of a challenger—at least so far.

That’s good news for the U.S. Having the dollar as the international reserve helps “insulate the U.S. economy from foreign shocks and reduces transaction costs in trade and finance,” Ms. Goldberg writes. A big shift away from the dollar, at its most extreme, could spur a crisis featuring a “destabilizing fall in the value of the currency and sharp rise in U.S. interest rates.”

Why the dollar’s strength?. Some of it is “inertia,” she writes – it’s tough for traders and central banks to switch to other currencies. Also many countries formally link their currencies to dollar, and the greenback is used to price oil, metals and other commodities.

Don’t be smug, though, she warns Americans. Changes do occur. Early last century, the British pound was number one.

Federal Reserve Bank of Kansas City President Thomas Hoenig became a voter on the Federal Open Market Committee last week, and right off the bat he became the first central banker in a year to dissent on policy. He wanted the Fed to remove language from its statement saying that rates would stay low for “an extended period.”

Hoenig

On Friday, Mr. Hoenig explained his dissent for the first time. “I think policy makers need to have the broadest options possible and the language that we use that is ‘very low for an extended period’ was appropriate during the height of the crisis to assure that we were not going to make any changes,” he said in an interview with PBS’s “Nightly Business Report,” according to a transcript released by the program. “But now the economy is beginning to recover. It has been in recovery now for two quarters. We have to be thinking a little bit longer ahead and that’s really what my admonition was … that we need to broaden options at this point.”

Mr. Hoenig, one of the most hawkish regional bank presidents, didn’t say that the Fed’s interest-rate target should be increased now. But he said the central bank should have more flexibility to raise rates as economic data improve. “Let’s say the economy grows more quickly that I even anticipate. We should be prepared to have the ability to make changes. Or if it does grow slower, then we can always extend this very low interest rate environment. The main thing is to be able to make choices in a timely manner and that’s what it’s all about.”

The Fed’s target eventually should be “at least higher than 3%,” Mr. Hoenig said. “That’s quarters or maybe even years ahead depending on how the economy recovery goes. But that’s not something … that I think that should be the rate tomorrow.”

After Friday’s employment numbers, Mr. Hoenig said he expects “modest but consistently improving” job growth in 2010 due to a “relatively systematic but modest recovery.” But with monetary policy already loose, he warned about trying to do more to spur job growth because “if you try and do more in a rush to get outcomes, you can sometimes do damage.”

He added later, “You can create conditions that increase the risks of bubbles down the road. We’ve learned that from history and so what you want to do is to be very mindful of that and not allow your policy to go on in a highly accommodative way too long so that you create the conditions for the next bubble. That’s what you want to avoid and that’s what we have the opportunity to avoid as we maximize our options for policy.”

Senate Republicans had mixed reaction to the move from Senate Banking Committee Chairman Christopher Dodd (D., Conn.) to move ahead on a bill to rework financial rules without the support of Sen. Richard Shelby (R., Ala.), the panel’s top Republican.

Sen. David Vitter (R., La.), a member of the panel:

“I think it’s a shame, because we were making progress towards a bipartisan bill.”

“I think Dodd’s been pulled back by the White House and pushed to take a pure partisan bill.”

“If he sticks to this, I think its going to be stuck in the mud on the Senate floor.”

Mr. Vitter called the creation of an independent, standalone Consumer Financial Protection Agency a “complete nonstarter.” He said no Republicans on the Senate Banking Committee would support it.

Sen. Bob Corker (R., Tenn.), a member of the panel.

“While I’m disappointed that Chairman Dodd and Ranking Member Shelby have reached an impasse, it won’t alter my efforts toward a bipartisan bill. Senator Warner and I continue to make significant progress in negotiating the resolution authority and systemic risk pieces of the legislation, and Chairman Dodd has assured us that our work will be included in the bill. My staff and I will continue working over the weekend with Senator Warner and others in hopes that we will be able to work out a bipartisan bill in committee.”

When asked on a conference call with reporters whether he could envision a scenario where he was the only Republican on the panel to support a bill advanced by Mr. Dodd, he said he “started this process” to put together a “very strong” bill “that addressed the issues… If we end up with a bill that meets that end, I plan on supporting it.”

He said he would not, though, support any bill that would create an independent, standalone Consumer Financial Protection Agency.