Key News
• China's Manufacturing Index Gains at Fastest Pace in More Than Five Years.
• Japan Return to 1991 GDP Gives Credit Markets Hatoyama's Mega Risk Crisis.
• Liu Says China's Banks Have Sufficient Capital, Urges Loans to Consumers.

“I am not sure Chinese policymakers fully understand how vulnerable China is to trade war. This is perhaps because the “success” of the stimulus package has convinced them that they are less vulnerable to external demand than they originally thought. But this would be a serious misreading. The stimulus package has postponed the effect of declining net foreign demand on Chinese unemployment, but has actually increased its vulnerability by increasing the future gap between what China produces and what it consumes. China needs foreign demand to keep absorbing its excess capacity for several more years while it engineers the difficult transition to domestic consumption-led growth, but I don’t see either China taking the necessary steps to force the transition or foreigners looking very eager to help China through the process.”

     Michael Pettis

FX Trading – Bernanke Setting a Bad Precedent?

How badly does Ben Bernanke want to keep his job?

Frankly, I’m surprised he’d even sign-up for all the responsibilities and criticisms that come with being Fed chairman; just seems like it’s not worth it.

But so it goes for so many politicians and power-mongers in the upper echelon of social influence.

Former Fed Chairman Alan Greenspan – you might know him as The Maestro – obviously soaked up the fame and glory that came with his command over all things monetary. But since stepping down from his role as economic front-man for the “private” sector, Greenspan has been slammed for his role in creating and harboring asset bubbles.

It was the abnormally low interest rates that fueled the money growth that inflated assets, especially the housing bubble; at least that’s how the story goes. But then again, Greenspan’s replacement recently had this to say:

Stronger regulation and supervision aimed at problems with underwriting practices and lenders’ risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates.

So, Ben, did the low rates lead to the housing bubble, even though higher rates weren’t necessarily the best way to contain it? Ahhh, whatever – I guess it doesn’t really matter anyway. You’re putting your cards on regulation ... since such actions “must be better and smarter.”

It would be so easy to regulate if only we knew before hand where the abusers of regulation would find loopholes and bypasses.

So here we are. I suppose we can take a couple things from these comments.

1) Mr. Bernanke is happy to side with the powers-that-be who are looking for more regulatory influence. After all, his future as Fed chairman still rests in the hands of the Senate.
2) Mr. Bernanke has no problem leaving rates low right now. After all, he is a “student” of the Great Depression ... and never will he let an economy in distress fall into depression from a lack of access to credit, regardless of the consequences. Warm up the helicopters.
3) Regulation is most important now to prevent bubbles from inflating; this reduces the need for monetary action as a preventative tool. Forget the fact that overregulation can be a hindrance to economic growth and positive economic innovation.

Assuming Mr. Bernanke is reappointed, and barring any substantial data that reduces the risk of a falling into double-dip recession/depression, then the likely scenario is for rates to sit where they are for a while.

And when there have been a lot of fresh expectations for an improving US yield differential, if the Fed Funds rate or the Fed rhetoric does not take a turn toward hawkish, then there could be a quick change in sentiment; last month’s dramatic turn toward dollar strength could be in jeopardy.

For now the buck is holding up based on a move out of the Japanese yen (a shift in carry trades) and uncertainty involving the euro’s reaction to growing debt problems in the Eurozone.

I’ll leave you with a comment from Richard Alford, former economist at the New York Fed:

Given the current willingness to provide counter-cyclical fiscal stimulus and likely growth in the structural fiscal deficits, it seems that it would incumbent on the Fed to remove the monetary stimulus not only faster than it has in the past, but faster than it should have in the past.

However, the Fed is now committed to keeping rates low for an extended period of time. The Fed has signaled the market that it will not commence tightening until the economy has achieved a self-reinforcing recovery. The statement is aimed at reassuring the household and political sectors and may be supportive of asset prices. However, assuming a recovery and given the long and variable lags, it will have committed to remaining easy for too long-especially given the likely course of fiscal policy. It has also implicitly stated that it does not have sufficient faith in its own forecast to use it for policy purposes.