Money/inflation, the Fed, Banking, Monetary Policy, Dollar, BTC, crypto, Gold

[G M]

I just got back from shopping and note the roasted chicken my wife loves has jumped from about 5 bucks to almost 8.


Frack.

[Crafty_Dog]

Lets define our terms here.  Question:  Is the bursting of a bubble a deflation?

[G M]

Lets define our terms here.  Question:  Is the bursting of a bubble a deflation?

Well, it's a deflation of the bubble. I'm not sure that it applies to the broader definition of deflation as previously cited by Doug.

As an example, the gov't interference in the housing market created the distortion in housing prices and the end of the bubble is good when the houses return to an authentic demand based price. If it's a systemic deflation, I'd think it's not a good thing.

[Crafty_Dog]

What would be the cause of "systemic deflation" be if it weren't the bursting of a bubble?

[Hello Kitty]

What would be the cause of "systemic deflation" be if it weren't the bursting of a bubble?

The willfull destruction of an economy and/or national sovereignty by those in control of the banking industries?

[Crafty_Dog]

Forgive me DF, but are you guessing or have you thought about this aspect of economic theory?

[Hello Kitty]

Forgive me DF, but are you guessing or have you thought about this aspect of economic theory?

I'll admit that I'm not much of an economist. Simply put, I am not. Nor am I much of a conspiracy theorist. It would explain some entity's wating a viable option for driving a singular world government. Tri-lateral Commission or what have you. I don't know. That was the nature of my question. It was an honest one.

[Crafty_Dog]

The usual suspects here are curious about my dalliance with economic heresy.  As they begin to question me, I seek to pin down the definition of "deflation".  As such my question is not really a question-- it is a request that they define what the word "deflation" will mean in this conversation.  If it results only after a bubble bursts, that is one thing-- and arguably it is but a return to the mean. OTOH, if there are other situations that constitute a deflation, then I am asking them to describe and define them. 

What I am not doing is asking for random guesses. 

[Hello Kitty]

Fair enough.

[DougMacG]

"Lets define our terms here.  Question:  Is the bursting of a bubble a deflation?"
-----------------
Yes, that is where it starts, at least in the case of the two examples I gave: America in the 1930s and Japan in the 1990s.

The problem is the spiral and that we don't know any easy fixes to snap an economy out of it.

In today's economy the bubble started with housing.  We don't face deflation, but the fear of it was one big reason why we have this 6 trillion plus stimulus/quantitative expansion of debt and dilution will haunt us perhaps forever.  Even with the multi-trillion dollar injection, the momentum is stalled.  Wait, don't buy, don't hire, don't invest is what the smart money is doing.  A sad state of affairs.

If bursting a bubble is a necessary evil, two questions come to mind: what were we doing that made the bubble worse than it needed to be (everything), and what are we doing now that is making the correction take longer than it needs to (pretty much everything).

If we didn't try so hard to stave off corrections maybe the expectation of continued falling prices wouldn't set in for so long and so deeply.

How does someone buy a house today if they know the price will be lower tomorrow?  They don't.  Consistently falling prices are a bad thing.

Back to you.  

[G M]

"The problem is the spiral and that we don't know any easy fixes to snap an economy out of it."

I see us heading for a "hard reboot" at some point in the future. It's not going to be pretty.

"How does someone buy a house today if they know the price will be lower tomorrow?  They don't.  Consistently falling prices are a bad thing."

Buying houses is like polyester bellbottoms for the most part. Houses are a place to live. Houses as an investment (in most circumstances) are as dead as "Hope and change".

[Crafty_Dog]

"If we didn't try so hard to stave off corrections maybe the expectation of continued falling prices wouldn't set in for so long and so deeply.  How does someone buy a house today if they know the price will be lower tomorrow?  They don't.  Consistently falling prices are a bad thing.  Back to you."

I'm not sure if it is your intention but as best as I can tell, you make a telling argument against the theory of fighting deflation.   If I understand correctly you are saying the feared dynamic of postponing purchases is actually lengthened by slowing the process down with "anti-deflationary" efforts-- is this your point?

Simultaneously the flood of money creates inflationary bubbles anew in other sectors e.g. food and other commodities.

So, as best as I can tell my doubts about fighting deflation are sound.

Yes?

[G M]

I'd think that trying to cure market distortions by creating more market distortions is not good policy, and with any complex system, will tend to result in unintended consequences.

[Crafty_Dog]

By RON PAUL
To know what is wrong with the Federal Reserve, one must first understand the nature of money. Money is like any other good in our economy that emerges from the market to satisfy the needs and wants of consumers. Its particular usefulness is that it helps facilitate indirect exchange, making it easier for us to buy and sell goods because there is a common way of measuring their value. Money is not a government phenomenon, and it need not and should not be managed by government. When central banks like the Fed manage money they are engaging in price fixing, which leads not to prosperity but to disaster.

The Federal Reserve has caused every single boom and bust that has occurred in this country since the bank's creation in 1913. It pumps new money into the financial system to lower interest rates and spur the economy. Adding new money increases the supply of money, making the price of money over time—the interest rate—lower than the market would make it. These lower interest rates affect the allocation of resources, causing capital to be malinvested throughout the economy. So certain projects and ventures that appear profitable when funded at artificially low interest rates are not in fact the best use of those resources.

Eventually, the economic boom created by the Fed's actions is found to be unsustainable, and the bust ensues as this malinvested capital manifests itself in a surplus of capital goods, inventory overhangs, etc. Until these misdirected resources are put to a more productive use—the uses the free market actually desires—the economy stagnates.

Enlarge Image

CloseBloomberg
 
Fed Chairman Ben Bernanke
.The great contribution of the Austrian school of economics to economic theory was in its description of this business cycle: the process of booms and busts, and their origins in monetary intervention by the government in cooperation with the banking system. Yet policy makers at the Federal Reserve still fail to understand the causes of our most recent financial crisis. So they find themselves unable to come up with an adequate solution.

In many respects the governors of the Federal Reserve System and the members of the Federal Open Market Committee are like all other high-ranking powerful officials. Because they make decisions that profoundly affect the workings of the economy and because they have hundreds of bright economists working for them doing research and collecting data, they buy into the pretense of knowledge—the illusion that because they have all these resources at their fingertips they therefore have the ability to guide the economy as they see fit.

Nothing could be further from the truth. No attitude could be more destructive. What the Austrian economists Ludwig von Mises and Friedrich von Hayek victoriously asserted in the socialist calculation debate of the 1920s and 1930s—the notion that the marketplace, where people freely decide what they need and want to pay for, is the only effective way to allocate resources—may be obvious to many ordinary Americans. But it has not influenced government leaders today, who do not seem to see the importance of prices to the functioning of a market economy.

The manner of thinking of the Federal Reserve now is no different than that of the former Soviet Union, which employed hundreds of thousands of people to perform research and provide calculations in an attempt to mimic the price system of the West's (relatively) free markets. Despite the obvious lesson to be drawn from the Soviet collapse, the U.S. still has not fully absorbed it.


The Fed fails to grasp that an interest rate is a price—the price of time—and that attempting to manipulate that price is as destructive as any other government price control. It fails to see that the price of housing was artificially inflated through the Fed's monetary pumping during the early 2000s, and that the only way to restore soundness to the housing sector is to allow prices to return to sustainable market levels. Instead, the Fed's actions have had one aim—to keep prices elevated at bubble levels—thus ensuring that bad debt remains on the books and failing firms remain in business, albatrosses around the market's neck.

The Fed's quantitative easing programs increased the national debt by trillions of dollars. The debt is now so large that if the central bank begins to move away from its zero interest-rate policy, the rise in interest rates will result in the U.S. government having to pay hundreds of billions of dollars in additional interest on the national debt each year. Thus there is significant political pressure being placed on the Fed to keep interest rates low. The Fed has painted itself so far into a corner now that even if it wanted to raise interest rates, as a practical matter it might not be able to do so. But it will do something, we know, because the pressure to "just do something" often outweighs all other considerations.

What exactly the Fed will do is anyone's guess, and it is no surprise that markets continue to founder as anticipation mounts. If the Fed would stop intervening and distorting the market, and would allow the functioning of a truly free market that deals with profit and loss, our economy could recover. The continued existence of an organization that can create trillions of dollars out of thin air to purchase financial assets and prop up a fundamentally insolvent banking system is a black mark on an economy that professes to be free.

Mr. Paul, a congressman from Texas, is seeking the Republican presidential nomination.

[TB]

The Ron Paul post is the shortest possible discussion of this issue. The Fed was created to establish a profit enhancing bank cartel. It's a long story, read the Creature from Jekyll Island or Rothbard's History of Money and Banking in the US for a detailed explanation of this point of view.

Ron Paul is briefly explaining the Austrian School of economics thesis. A market economy is simply a division of labor economy in which the factors of production are privately owned -- with markets to facilitate the free exchange of goods and services. Such a market economy is a self organizing system and the prices that emerge from buying and selling on free markets provide all participants with the information they need to effective employ our scarce resources.

Paul is right, the interest rate is a particular market price, or actually a ratio of prices. With free markets, the interest rate will represent the price of a current good divided by the price of an identical good in the future (say one year out). Humans have a "time preference"  ... they prefer a good now more than the same good later. That preference can vary from individual to individual and from time to time. It is arguably the most important price within a market economy.

When a central bank manipulates the interest rate, it distorts the economy in fundamental ways. The "price level" is not the principal issue. The problem with Fed manipulation is that RELATIVE prices change and that alters human decisions concerning both consumption and production. When the Fed forcibly lowers interest rates below the market level that causes people to invest more heavily in durable goods (like houses) and capital goods. Trouble is, an economy is finite in size and resources -- even an economy as large as the US. A lowered interest rate induces people to launch many projects that prove later to be uneconomic because there are simply inadequate resources in the economy to complete those projects.

We all love the expansion phase, the boom. That is a period of inflation -- money is being generated by the fractional reserve banking system and everybody goes gaga over whatever the particular boom is elevating. Forget about the Fed's definitions of inflation and deflation. It's not even possible to measure "the price level." Inflation used to be defined as an increase in the supply of money and credit. Deflation was defined as a decrease in the supply of money and credit.

According to the Austrian School business cycle theory, the damage is done during the boom. The deflationary recession follows as a period during which market prices reassert themselves so that all economic participants will once again have good information -- so they can make intelligent and effective choices regarding their consumption and production efforts. As some contemporary Austrian School devotees say: "fear the boom, not the bust."

A deflation can be painful, for sure, but it cannot spiral out of control. The money supply and credit can contract by at most the amount it previously expanded during the boom. And the deflation can be avoided only by a central bank determined to pile market distortions on top of market distortions. Carried too far, a central bank can definitely destroy a currency -- and our current Fed Head has a belief system ideally suited to destroying the US dollar.

Tom

[Crafty_Dog]

Folks:

Tom is a serious, well-informed advocate of the Austrian school.  We are fortunate to have him drop in.

Marc

[DougMacG]

"Folks: Tom is a serious, well-informed advocate of the Austrian school.  We are fortunate to have him drop in.  Marc"

Absolutely!

First to Crafty, I was partially agreeing with you and still wanting to draw your view out further.  Overlap or agreement with me doesn't make either of us right. 

Ron Paul's view has evolved from 'end the fed' (he wrote the book) to the one posted which I think is stop mis-managing the Fed, a view we can probably all agree on.  His first point though is a bit simplistic and partly wrong to me.  "Money is like any other good in our economy that emerges from the market to satisfy the needs and wants of consumers." 

Yes money has the characteristics of other goods but it is a public good with a government monopoly as much as it is a private good.  If the oil price (or corn or lumber) is too high, too low or too volatile, that screws up other industries.  When money is high, low or unstable, it screws up all enterprise.  Not only the relative price is important but also the general price level IMO.

TB, that is a great post, much more detailed than Ron Paul! I agree about with nearly all but pick out a couple of points for followup. 

"deflation can be painful, for sure, but it cannot spiral out of control."

Good point, there are of course limits to a downward movement in price.  It isn't that it would spiral out of control, but that it can develop a self-sustaining momentum difficult to break - at least that way in a couple of cases.

"The Fed was created to establish a profit enhancing bank cartel."

A muddled institution, the Fed is both public and private, owned by the member banks, managed by government appointed and confirmed technocrats.  The Fed returns its own direct profits to the Treasury other than a statutory return to its owners, yet no doubt it serves to enable profits to its member institutions. The banks themselves are also public-private entities in a sense due to the deposit insurance guarantee relationship and the all-encompassing regulation aspect.
-----
The real error we are committing now in my view comes from congress assigning a dual mission to the Fed.  Besides the function of managing a stable money supply, the Fed is charged with alleviating unemployment caused by policy errors that were not monetary in the first place.  The Fed is supposed cover for the 40% excesses in federal spending, and 'stimulate' our way through economic damages caused by regulatory and tax policies.  That doesn't make any sense.  It enables rather than soves the other policy errors, and sets up a high likelihood of new inflation coming if or when the current stagnation ends.

[Crafty_Dog]

I'm still waiting for any examples of deflations that weren't post bubble returns to the mean.

[TB]

Well, DougMacG, I think we have enough overlap of positions for a discussion. But we are miles apart. I have read Keynes and some other elements of mainstream economics, but I must say I have found the economics articulated by Mises and a few other "Austrians" to be absolutely compelling. Keynes' General Theory, on the other hand, should have been laughed off the stage as a bad joke. Within that book, at least, Keynes could not even apply consistency let alone logic.

It's true that governments have used their coercive powers to give themselves a monopoly position in the production of money. But that isn't the way it has always been, nor is it the way it should be. Mises has argued that money began as people simply looked for better ways to conduct indirect exchange. People naturally found they could exchange their product for a good that was highly marketable and then exchange that good for the things they needed. This process doesn't require government and, in fact, benefits from government's absence. All of our problems with money, in fact, are the result of government. Governments rarely do anything positive for the concept of money.

I can't agree with this statement at all: "If the oil price (or corn or lumber) is too high, too low or too volatile, that screws up other industries." First of all, if markets are free, there can be no such thing as a price "too high" or "too low."  Prices just "are."  The price of one good rising or falling dramatically, on a free market, can only happen if there is a large change in supply or demand for that good. Instead of "screwing up" other industries, a suddenly high price simply allocates the supply of that good to the people who value it most highly. Those people who are unwilling or unable to buy at the higher price will naturally shift their attention to substitutes which they now find more appealing. All prices will adjust dynamically to market clearing levels, giving both producers and consumers appropriate signals. If a higher price for one good also results in higher profit, entrepreneurs will shift resources toward its production. This is the principal reason why capitalism works as well as it does to produce the right mix of goods.

As to the "general price level" -- it is actually impossible to measure. Consider the equation of exchange: MV = PT (one variation of the theme). The total physical product of the economy, T, cannot be defined in any sense whatever. Irving Fisher didn't even try to define the elements of this equation, demonstrating how smart he was -- because it can't be done. There are no common units with which to add up the total physical product. Given that you can't define T, the price level P is undefined as well. I have been pushing to have everybody take a look at a newly written book that beautifully addresses many of these questions in a compact form. Take a look at Paper Money Collapse by Detlev Schlichter.

Now, of course, this problem with the price level is ignored by our mainstream economists. They just take a relatively short list of consumer products, apply arbitrary weights, and calculate a price index and ... presto, they have "the price level."  Well, a little thought should tell you that the CPI and other various deflators give us very, very little information about anything important. Read Schlichter, please. However, I agree that when monetary inflation is significant the value of money is materially reduced and that certainly is a problem for everybody. The reason I am de-emphasizing price level rises is simply is that mainstream economists want us to believe that they can beneficially manage the money supply with reference to the silly price index. They cannot do that at all. There are very long lags before monetary inflation results in broad based price increases -- and there is no reason to suppose that price increases will EVER be spread uniformly over all products.

And finally, I believe the "dual mission" problem you cite comes from Keynesian and macro-economic thinking that I find to be just plain foolish. Full employment is easy to achieve if you run a totalitarian government. Just force people to stop using trains and trucks, for example. Let everything be carried on human backs. That will surely put everybody to work! What we need as a goal, instead, is an economy that meets all consumer needs as well as can be accomplished in a world of limited resources. There is only one way to achieve that goal -- a division of labor economy with privately owned factors of production and totally free markets. Including the market for money. A sound money is the only money consistent with any country's proper economic goal.

Tom

[Crafty_Dog]

I think what he means by "dual mission" refers to the Humphrey-Hawkins law which added maximizing employment to price stability as a mission for the Fed.

Tom, short of private money, what is the appropriate way for the Fed to determine money/interest rates etc?

[G M]

http://clinton2.nara.gov/WH/kids/inside/html/spring98-2.html

When the United States Secret Service (USSS) was established, its main duty was to prevent the illegal production, or counterfeiting, of money. In the 1800s, America's monetary system was very disorganized. Bills and coins were issued by each state through individual banks, which generated many types of legal currency. With so many different kinds of bills in circulation, it was easy for people to counterfeit money. During President Lincoln's Administration, more than a third of the nation's money was counterfeit. On the advice of Secretary of the Treasury Hugh McCulloch, President Lincoln established a commission to stop this rapidly growing problem that was destroying the nation's economy, and on April 14, 1865, he created the United States Secret Service to carry out the commission's recommendations.

I'm not sure returning to this would work out well.

[TB]

Yes, that is the dual mission that I tried to comment upon. As I said, "full employment" is not a valid economic goal and there is no conflict between the goals except in the minds of Keynesian-influenced economists.

Central planning does not work. There should not be any institution setting interest rates or manipulating markets in an attempt to set interest rates at some preferred level. No human being can know where interest rates should be set. Having a Fed empowered to control interest rates makes no more sense than having a commission to set the price of oil, or cantaloupes. The problems created by the Fed, however, are dramatically greater than would be caused by a narrow price setting commission.  

If you want to keep the Fed then eliminate all open market operations and strive to keep the money supply unchanging. Do not let the Fed loan money to banks or set interbank lending rates. If you are going to insist on continuing fractional reserve banking with minuscule required reserves, then there should never, ever be a bailout. Insolvent banks should be immediately subject to bankruptcy -- that should motivate bankers to voluntarily watch the extent to which they narrow their operating reserves. Under those conditions we could still have credit expansion booms (and busts), but they would be inherently far more limited.

It's fascinating how many economists are drawn to the concept of free markets but, for some reason, think in terms of centrally managing money. Milton Friedman is probably the most prominent of those -- but many mainstream economists fall into that broad category, including our so-called supply-side economists. Frankly, I think the reason for this (well explained by Schlichter, by the way) is simply that government benefits dramatically from a monopoly on money and economists benefit dramatically from going along. The entire banking and Wall Street contingent all benefit from ongoing inflation. Most economists are employed by government or the financial industry. The Austrian School thinking basically says: "we don't need no stinking economists trying to invent policy responses for the government." Not too surprising that so many economists choose another path.

Tom

[TB]

GM,

This may seem completely flippant, but as it stands now virtually ALL of our money might as well be counterfeit. When the Fed creates a few extra trillion dollars in a few months, that has a tremendously negative impact on all dollar holders. The process is indistinguishable from counterfeiting except that the beneficiaries are usually government and financial industry personnel instead of a bunch of misfits slaving over a press in the basement.

Money was not a free market creation in the 19th century. Far from it. There were many government players passing laws that limited the rights of money users. State sanctioned banks were encouraged to lend a greater percentage of their reserves, for example, to create a boom -- and then state governments gave those banks the right to suspend specie payments when they were found out. Lincoln dumped unbacked "Green Backs" on the people. There were lots of legal tender laws and other market interventions. Problems needed to be addressed, but we certainly didn't need to follow the path we have traveled.

Tom

[G M]

TB,

Yes, when we magically create all these dollars, it makes the NorK/Iranian "supernotes" plale in comparison.

BTW, it looks like QE3 is being floated. Zimbabwe, here we come....   

[G M]

**Oy-fracking-vey!

http://www.cnbc.com//id/44963251

QE3 'Certainly a Possibility': Boston Fed President
Published: Wednesday, 19 Oct 2011 | 3:16 PM ET

By: Margo D. Beller
Special to CNBC.com
 
Another round of quantitative easing by the Federal Reserve  is "certainly a possibility" if there is a "bad economic shock," Boston Fed President Eric Rosengren told CNBC Wednesday.

"It depends on what you think is the likelihood of what a bad economic shock is," he said. "So if you think there’s a shock from Europe, or you think that some of the fiscal discussion is gonna break down, those might be the types of incidents…[that] might affect how likely you think it is that we’ll have additional quantitative easing  ."

Deflation would be another condition "under which it would make sense to have additional quantitative easing," he added.

Rosengren was interviewed after speaking at the Boston Fed's annual conference. He said it is "critical that we focus on strengthening the financial architecture" of U.S. banks "so that the struggles of one institution or group of them no longer poses risks to the broader global economy."

To CNBC he said most U.S. banks don't have huge direct exposure to the troubles in Europe. But "if a serious problem erupted in Europe, we would not be immune," he said, and that might be something the Fed would "have to react to."

[TB]

"Oy-fracking-vey!"

I like that!

By the way, miss.org has many, many free books in pdf and epub formats (see their literature tab). I have my iPad filled with just about every significant Austrian School book with very few exceptions. On the subject of hyper inflation there are several worth looking at. Fiat Money Inflation in France is one: http://mises.org/resources/3041/Fiat-Money-Inflation-in-France. Another book is When Money Dies -- not available from miss.org, but an interesting history of hyperinflation in Weimar Germany.

IMO, it's too easy to see many of the inflationary disease symptoms right her in the USA. Rapidly rising consumer prices didn't necessarily happen early in these historic hyper-inflations. Governments everywhere seem to be applying the same belief system to money management, so it's difficult to imagine where we are going with all this. Oy-fracking-vey! -- may become my favorite expression over the coming months!

Tom

[Crafty_Dog]

http://www.businessinsider.com/the-hottest-idea-in-monetary-policy-2011-10

Over the weekend, Goldman came out with a report calling on the Fed to embrace Nominal GDP targeting: In other words, set as a goal for the economy that nominal GDP that we saw back in 2007, and then produce enough inflation so that we got there.
Now Bernanke is out with a new speech about monetary policy in the post-Great Recession era, and though he doesn't say that much substantive, he does talk more about trying to more clearly express monetary policy goals.
According to PIMCO's Bill Gross, that's code for... targeting Nominal GDP.
Meanwhile, Chicago Fed President Charles Evans has been making similar comments, about weighting the Fed's mandate much more towards the full employment/growth end of the spectrum, even if it means high inflation.
All of which means you should really be reading the work of Bentley Economist Scott Sumner, who has been writing forever about the benefits of Nominal GDP targeting, and who is sure to be the hottest economist in the world, as this takes off.
You can start by watching his lecture below.
Please follow Money Game on Twitter and Facebook.


Read more: http://www.businessinsider.com/the-hottest-idea-in-monetary-policy-2011-10#ixzz1bWRKLZcr

[TB]

"Now we really are fuct"

Yes indeed. In the 1920s, the charge was "price stability." Professor Irving Fisher was the initiator of that failed doctrine. With sound money in the 1920s, prices would have fallen slowly due to rapidly rising productivity, but the Fed used the stable price indices as a license to step on the monetary accelerator. Price stabilization policies were very popular during times of falling prices, not so popular during times of rising prices -- the objective is always to increase monetary inflation, not to tame it.

It will be the same with nominal GDP targeting. It'll be very popular when GDP is falling short, meaning that more monetary inflation is called for. When nominal GDP is exceeding the target ... well, heck, what's wrong with that?

And the problem with both of these ideas, as I have said in earlier posts, is that monetary inflation does its serious damage by distorting prices and interest rates. When interest rates are artificially lowered, people spend too much on capital goods and durable goods. Since 1980, the Fed has not allowed a recession to run its course, so we must have quite an impressive total of malinvestments by now. Anyone doubting that needs to take another look at the aggregate trillions of dollars poured into Fannie Mae, Freddie Mac, GM, AIG, and all the other Wall Street institutions and banks that have been sucking the country dry.

Doug Noland has been commenting upon credit expansion bubbles for a long time now (http://www.prudentbear.com/index.php/creditbubblebulletinview?art_id=10586). He worries more and more that we will eventually reach the point where, suddenly, US debt obligations will fail to find a bid. That would change everything.

<I fear global market dynamics and Fed policymaking are propagating the worst-case scenario for the U.S. government finance Bubble.  As was the case in Greece, Ireland, Portugal, Spain, Italy and elsewhere, a distorted market is content to accommodate profligate borrowing until it’s way too late.  Is another round of Fed MBS QE going to help?  A dysfunctional marketplace has, almost without exception, been incapable of imposing any degree of market discipline until the point when only exceptionally harsh and destabilizing “austerity” suffices.>

It's reached the point now where the US desperately needs a deflationary correction. Left to run its course, such a correction would soon put this once great nation into to shape to grow and prosper again. But our rulers will never allow that to happen. It appears that they will take us all down "fighting" battles that not only don't need to be fought -- but guarantee our destruction.

Tom

[G M]

http://www.minyanville.com/businessmarkets/articles/central-bank-hyperinflation-debt-money-supply/10/17/2011/id/37410?page=full

**I think so. 

[DougMacG]

Seems to me that a prolonged period of deflation following a bubble means that the asset prices are not freely correcting.  In the case of housing today, we made this bubble by artificially inflating a market, now we prevent correction with more of the same policies on steroids, forcing re-writes, blocking foreclosures and delaying properties to market.  Fixing an error by exacerbating it, what could possibly go wrong?  The deflationary period it seems to me is a result of the correction not fully occurring.  The downward expectation becomes a force of its own, just like the inflating bubble did.  An asset price correction should not require a prolonged economic downturn to occur, IMO.

That we try to cover up other policy problems by injecting more and more dollars means yes, hyper inflation is very likely if/when we ever snap out of this. 

[Crafty_Dog]

Spurred on by Tom's presence here I think we are having a good conversation.  I now repost something from the Economics forum that I originally had brought to my attention by Tom.

The point of particular interest here is the explanation of low interest rates.  Then I will follow with a separate post concerning a different explanation of interest rates-- which will plant the question of whether both analyses are correct, one is, or neither is.

============

I am trying to understand your reasoning in the discussion about inflation vs. deflation.  One of the things I don't understand is the role of "credit". You write that "the market value of credit is collapsing at an amazing rate".  But isn't "credit" the same as "debt"?  When the market value of debt falls, then I wouldn't I need less "real estate" to get rid of my debt? Please, can you spend a minute to clarify this contradiction.
---------------
No Contradiction

Hello Josef,

An accepted offer for credit is a loan, resulting in debt for the borrower, and an asset (the loan) on the balance sheet of the lender (typically a bank or finance company). So yes debt = credit extended (plus agreed upon interest).

When the value of assets (loans) drop significantly, banks become capital impaired and cannot lend. This is happening now even though banks are hiding losses by not marking assets to market prices.

We have heard absurd statements from the Central bank of France that there are no toxic assets on French bank balance sheets. The market price of Greek debt says otherwise.

Plunge in Mark-to-Market Prices of Bank Assets

We can infer marked-to market plunges in value of bank assets by the enormous drops in financial stocks this year. We know the value of debt on the balance sheets of banks has collapsed, even if banks deny it.

Inability to pay back debt also shows up in credit default swaps, sovereign debt ratings, and soaring bond yields of Greece, Portugal, Spain, and Italy vs. Germany.

These credit actions show a demand for safe hiding places such as US and German government bonds and cash. We can see that in record low US treasury yields and German government bond yields.

Debt Not Marked-to-Market

The second question is where your error is "wouldn't I need less real estate to get rid of my debt?"

The debt remains until it is written off. In the US, people still owe more on their houses than they can pay back. The money is owed but will not be paid back. The same applied to may types of loans including auto loans, credit card debt, home equity lines, etc.

Enormous Foreclosure Backlog

US Banks have the value of their assets (mortgage loans, commercial real estate loans, consumer credit loans), at prices that do not reflect likelihood of default and thus that debt is not marked-to-market.

Writedowns are deflation in action, and they are coming.

In many instances, people walk away from mortgage debt. In those cases banks eventually foreclose. The key word is "eventually" as the list of pending foreclosures is measured in decades at the current rate.

Please see First Time Foreclosure Starts Near 3-Year Lows, However Bad News Overwhelms; Foreclosure Pipeline in NY is 693 months and 621 Months in NJ for details.

US Writedowns Coming on REOs

When homeowners walk away or go bankrupt, generally they are relieved of debt. However the problem for banks does not go away.

After foreclosure, banks have a different asset on the books. It is no longer a loan, but rather REO (Real Estate Owned).

What do you think those houses on the balance sheets of banks are worth vs. the value banks hypothesize they are worth?

Once again, this capital impairment shows up in banks inability and unwillingness to lend. When banks don't lend, businesses don't expand, and when businesses don't expand unemployment stays high.

This deflationary cycle feeds on itself until home prices fall to the point where there is genuine demand for them and banks are recapitalized.

European Writedowns

The biggest debt problem in Europe is in regards to loans made by French and German banks to Greece, Spain, Portugal, and Italy.

The ECB, EU, and IMF compounded the problem by throwing more money at Greece, on terms and timelines Greece cannot possibly pay back.

Europe has other huge structural issues regarding productivity in Spain and Greece vs. Germany, and in currency union that cannot possibly work given the lack of a fiscal union.

Poor Policies by IMF, EU, ECB, Fed

EU, IMF, ECB, and Fed policies in the US and Europe were designed to hide losses on real estate loans, to hide losses on sovereign debt loans to Greece, Spain, Portugal etc, and to prevent losses to banks and bondholders.

Barry Ritholtz had an excellent column on that yesterday called Banking’s Self Inflicted Wounds.

Policies of governments and central banks that bail out private banks are wrong because they place more burden on already over-extended and deep in debt taxpayers who are not equipped to take on more debt.

The deflationary backdrop will persist until debt is written off, consumer deleveraging peaks, home prices fall to affordable values, and global structural imbalances fixed. The situation is not encouraging because of five critical problems.

Five Critical Problems


Keynesian clowns everywhere refuse to accept the fact that debt is the problem and one cannot possibly spend one's way out of debt crisis.
Europe has structural problems related to the currency union, productivity, union work rules, pensions, retirement, and country-specific fiscal problems.
The US has structural problems related to prevailing wages, collective bargaining of public unions, corporate tax policies, etc.
Stimulus and bailouts are bad enough in and of themselves, but stimulus and bailouts without fixing structural problems is insanity.
Politicians on both continents refuse to address structural issues

Process is Important, Not the Term

It's important to not get hung up on the term "deflation" but rather to understand the process I am describing, the implications of that process, and why the policy actions taken have not worked (and cannot possibly work), all called well in advance.

For more on the process of deflation (regardless of what one wants to call it), please see Bizarro World Inflation; About that 2011 Hyperinflation Call ...

Yes Virginia, U.S. Back in Deflation; Inflation Scare Ends; Hyperinflationists Wrong Twice Over

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

[Crafty_Dog]

A repost from the Economics thread on SCH:  Second post of the evening, to be read in conjunction with the various posts from today.  If I summarize the relevant point correctly, it is that the absence of increase in interest rates despite truly wild irresponsiblity on the part of the Fed and the US govt is that there has been a qualitative increase in the demand of central banks for dollars-- created by the Fed's policies!-- and that this increase in demand has qualitatively diminished the role of private capital in determining interest rates. 

Question presented:  Is this analysis correct?  Is Shedlocks' analysis correct?  Are the two analyses consistent with each other or not?

By RONALD MCKINNON
In past decades, tense political disputes over actual or projected fiscal deficits induced sharp increases in interest rates—particularly on long-term bonds. The threat of economic disruption by the so-called bond market vigilantes demanding higher interest rates served to focus both Democratic and Republican protagonists so they could more easily agree on some deficit-closing measures.

For example, in 1993 when the Clinton administration introduced new legislation to greatly expand health care without properly funding it ("HillaryCare"), long-term interest rates began to rise. The 10-year rate on U.S. Treasury bonds touched 8% in 1994. The consequent threat of a credit crunch in the business sector, and higher mortgage rates for prospective home buyers, generated enough political opposition so that the Clinton administration stopped trying to get HillaryCare through the Congress.

In the mid-1990s, Democrats and Republican cooperated to cap another open-ended federal welfare program—Aid to Families with Dependent Children—by giving block grants to the states and letting the states administer the program. Interest rates came down, and the Clinton boom was underway.

Enlarge Image

CloseChad Crowe
 .In contrast, after the passage of ObamaCare in March 2010, long-term bond rates remained virtually unchanged at around 3%. This was despite great doubt about the law's revenue-raising provisions, and the financial press bemoaning open-ended Medicare deficits and the mandated huge expansion in the number of unfunded Medicaid recipients. Even with great financial disorder in the stock and commodity markets since late July 2011, today's 10-year Treasury bond rate has plunged below 2%. The bond market vigilantes have disappeared.

Without the vigilantes in 2011, the federal government faces no immediate market discipline for balancing its runaway fiscal deficits. Indeed, after President Obama finally received congressional approval to raise the debt ceiling on Aug. 2, followed by Standard & Poor's downgrade of Treasury bonds from AAA to AA+ on Aug. 5, the interest rate on 10-year Treasurys declined even further.

Since Alexander Hamilton established the market for U.S. Treasury bonds in 1790, they have been the fulcrum for the bond market as a whole. Risk premia on other classes of bonds are all measured as so many basis points above Treasurys at all terms to maturity. If their yields are artificially depressed, so too are those on private bonds. The more interest rates are compressed toward zero, the less useful the market becomes in reflecting risk and allocating private capital, as well as in disciplining the government.

To know how to restore market discipline, first consider what caused the vigilantes to disappear. Two conditions are necessary for the vigilantes to thrive:

(1) Treasury bonds should be mainly held within the private sector by individuals or financial institutions that are yield-sensitive—i.e., they worry about possible future inflation and a possible credit crunch should the government's fiscal deficits get too large. Because private investors can choose other assets, both physical and financial, they will switch out of Treasurys if U.S. public finances deteriorate and the probability of future inflation increases.

(2) Private holders of Treasurys must also be persuaded that any fall in short-term interest rates is temporary—i.e., that the Fed has not committed itself to keeping short-term interest rates near zero indefinitely. Long rates today are the mean of expected short rates into the future plus a liquidity premium.

The outstanding stock of U.S. Treasury bonds held outside American intergovernment agencies (such as the Social Security Administration but excluding the Federal Reserve) is about $10 trillion. The proportion of outstanding Treasury debt held by foreigners—mainly central banks—has been increasing and now seems well over 50% of that amount. Since 2001, emerging markets alone have accumulated more than $5 trillion in official exchange reserves. And in the last two years the Fed itself, under QE1 and QE2, has been a major buyer of longer-term Treasury bonds to the tune of about $1.6 trillion—and that's before the recently announced "Operation Twist," whereby the Fed will finance the purchase of still more longer-term bonds by selling shorter-term bonds. So the vigilantes have been crowded out by central banks the world over.

Central banks generally are not yield-sensitive. Instead, under the world dollar standard, central banks in emerging markets are very sensitive to movements in their dollar exchange rates. The Fed's near-zero short-term interest rates since late 2008 have induced massive inflows of hot money into emerging markets through July 2011. This induced central banks in emerging markets to intervene heavily to buy dollars to prevent their currencies from appreciating versus the dollar. They unwillingly accept the very low yield on Treasurys as a necessary consequence of these interventions.


True, in the last two months, this "bubble" of hot money into emerging markets and into primary commodities has suddenly burst with falls in their exchange rates and metal prices. But this bubble-like behavior can be traced to the Fed's zero interest rates.

Beyond just undermining political discipline and creating bubbles, what further economic damage does the Fed's policy of ultra-low interest rates portend for the American economy?

First, the counter-cyclical effect of reducing interest rates in recessions is dampened. When interest rates dipped in the past, at least part of their immediate expansionary impact came from the belief that interest rates would bounce back to normal levels in the future. Firms would rush to avail themselves of cheap credit before it disappeared. However, if interest rates are expected to stay low indefinitely, this short-term expansionary effect is weakened.

Second, financial intermediation within the banking system is disrupted. Since early 2008, bank credit to firms and households has declined despite the Fed's huge expansion of the monetary base—almost all going into excess bank reserves. The causes are complex, but an important part of this credit constraint is that banks with surplus reserves are unwilling to put them out in the interbank market for a derisory low yield. This bank credit constraint, particularly on small- and medium-size firms, is a prime cause of the continued stagnation in U.S. output and employment.

Third, a prolonged period of very low interest rates will decapitalize defined-benefit pension funds—both private and public—throughout the country. In California, for example, pension actuaries presume a yield on their asset portfolios of about 7.5% just to break even in meeting their annuity obligations, even if they were fully funded.

Perhaps Fed Chairman Ben Bernanke should think more about how the Fed's near-zero interest rate policy has undermined fiscal discipline while corrupting the operation of the nation's financial markets.

Mr. McKinnon is a professor at Stanford University and a senior fellow at the Stanford Institution for Economic Policy Research.

[DougMacG]

Interesting stuff Crafty. I also look forward to the comments of others The Shedlock explanation of the difference between credit and debt is excellent.  His deflation thoughts in housing need to be considered in the context of 'all other things held constant', which of course is not true.  We are throwing trillions of fictional dollars at it all, so for the net effect, all bets are off.  We do keep the cycle alive by slowing and preventing correction and the downward cycle feeds on itself killing off jobs andl income putting even more home loans upside down or into default, more homes to sell, less income, lower prices and lower expectations, more businesses close or layoff, keeping us from ever getting fully corrected - until something bold breaks the cycle.  

Tom makes a great point that money supply and general price level are among most things economic that are impossible to measure accurately.  You can see trends in standardized measures, but you never get a complete, accurate measure.

I'm no Keynesian, but poor Keynes gets his name besmirched by these hacks. He never said run up all this debt during good times which makes a a hundred billion of two of attempted stimulus when Keynes would call for a stimulus a meaningless drop in the ocean, with no economic or psychological boost, just more monetary dilution and more poisonous debt.

The MacKinnon piece (IMO) gives an excellent explanation of why a Fed operating with no ground rules (a huge portion of the deficits is not even borrowed), markets of buyers and sellers no longer set and adjust interest rates with such a farce for a market.  Like a hang glider defying gravity for a time, isn't there always eventually a settlement of account with real market forces?

To make sense of both pieces at once I might offer this.  Since we can't measure price levels accurately because of substitution of goods and complexity of goods and services offered, we could instead instantly devalue the dollar for each new fictional dollar put into circulation.  If prices and wages were measured this way I think you would instantly see what a period of prolonged economic decline we are experiencing and how this self-perpetuating cycle is keeping itself from ever getting fully corrected.

The fix requires bold action on the 'all other things held constant' side of the equation.  Shift the economy into forward with a comprehensive, all of the above, pro-growth agenda.  The boost in jobs and income brings up the demand and affordability of the homes, and helps to close the deficits.  Then, by congressional action, tell the Fed to work on one task only, safeguard and rightsize the dollar.  No funny business.

[G M]

I think the heart of the matter is the massive debt at the federal, state and local levels. As pointed out in the Steyn piece Doug posted earlier, we are the brokest nation in human history and I think we are past the tipping point where we can avoid default. We can try to string this out a bit longer, but we will see this house of financial cards come crashing down, sooner rather than later.

Everything else is just attempts at Feng Shui-ing the deck chairs on the Titanic.

[G M]

http://www.usdebtclock.org/

Terminal.

[DougMacG]

GM: "As pointed out in the Steyn piece Doug posted earlier, we are the brokest nation in human history and I think we are past the tipping point where we can avoid default."
Debt Clock approaching $15 trillion: Terminal.
-----

On the other side of the coin, total assets of the economy are impossible to measure, but one estimate is $188 trillion. http://rutledgecapital.com/2009/05/24/total-assets-of-the-us-economy-188-trillion-134xgdp/

A 15% tax on a trillion barrels of new $100 oil alone is 15 trillion.  Another flawed measure but there are plenty of sources of wealth and revenues in a healthy growth economy.

Unlike 3rd world countries, our debt (so far) was iussued in our currency and devaluing rapidly as we speak.  If we were to quit borrowing now, accumulated debt gets smaller over time through both real growth and inflation even if never paid off.  Of course these devaluation policies are form of default.

What is terminal is the attitude of class envy, class warfare where we choose economic decline and anti-growth policies for 'fairness' instead of trusting people to succeed with economic freedom, limited government and the amazing innovation and growth powers of a private entrepreneurial economy.  It isn't that we can't fix this, it is that we aren't fixing it.  Instead, after another year of these clowns we will owe $16 trillion and be one year deeper into an anti-innovation, anti-freedom, anti-production mindset.

[G M]

Doug,

I hope you are correct. One of the problem with these low interest rates and the devaluation of the dollar is the impact on the retired. If a republican were in office, the MSM would be filled with images of struggling retirees. My wife and I have our retirements sunk into a state retirement fund that by most estimates will be defunct in 5 years or so. We haven't even begun to see the waves of new American poverty waiting on the horizon. Most pension funds, public and privates are in similar situations.

[Crafty_Dog]

Agreed that the consequences of low interest rates on pension funds is devastating.

"It isn't that we can't fix this, it is that we aren't fixing it."

This is exactly right.  

A big part of the problem is that we lie to ourselves with baseline budgeting.  Until we stop using baseline budgeting for our thinking we continue down the road to destruction.

If we were simply to make some genuine cuts to entitlements (e.g. block grants to states for Medicaid and Medicare, set in place gradual increases in the age for social security) truly freeze overall spending from there and set off growth by putting in a genuine massive tax reform (e.g. 9-9-9) would could turn this around in short order.

[G M]

http://legalinsurrection.com/2011/10/rhode-island-a-public-sector-pension-plan-which-doesnt-make-anything/

Rhode Island – A public sector pension plan which doesn’t make anything

 



Posted by William A. Jacobson   Sunday, October 23, 2011 at 9:51am

You know about the RI pension mess, because I’ve been pounding that issue pretty much since the founding of this blog three years ago.
 
The New York Times takes a devastating look at Rhode Island, The Little State With a Big Mess (h/t @amandacarpenter):
 

ON the night of Sept. 8, Gina M. Raimondo, a financier by trade, rolled up here with news no one wanted to hear: Rhode Island, she declared, was going broke.
 
Maybe not today, and maybe not tomorrow. But if current trends held, Ms. Raimondo warned, the Ocean State would soon look like Athens on the Narragansett: undersized and overextended. Its economy would wither. Jobs would vanish. The state would be hollowed out.
 
It is not the sort of message you might expect from Ms. Raimondo, a proud daughter of Providence, a successful venture capitalist and, not least, the current general treasurer of Rhode Island. But it is a message worth hearing. The smallest state in the union, it turns out, has a very big debt problem.
 
After decades of drift, denial and inaction, Rhode Island’s $14.8 billion pension system is in crisis. Ten cents of every state tax dollar now goes to retired public workers. Before long, Ms. Raimondo has been cautioning in whistle-stops here and across the state, that figure will climb perilously toward 20 cents….
 
In some ways, the central question is not only what the government owes to pensioners but what citizens owe to one another.
 
That last sentence hits the nail on the head.  In Rhode Island, the citizenry is being asked to spend increasing percentages of its income and assets not for the general welfare, but for the welfare of a relatively small percentage of the population who have state and municipal pensions.
 
It’s often joked that General Motors is a pension plan which makes automobiles.  Rhode Island is in worse shape.  Rhode Island is becoming a public sector pension plan which doesn’t make anything.

[G M]

http://www.cbsnews.com/stories/2011/02/20/sunday/main20034120.shtml

At 66, Alfred Arnold considers himself lucky, in a way. In September 2009, when the city of Prichard, Alabama, suddenly stopped paying pension checks to its retirees, at least he was able to work, as a security guard at a mall in Mobile.


And this past Christmas, instead of exchanging gifts, mall employees gave all the money they would have spent on each other to Alfred and his wife Jackie.


"They knew we didn't have a pension, we wasn't getting paid," said Alfred.


"How did you feel?" Teichner asked about the gift.


"Oh, man, that was devastating. I almost cried."


Alfred Arnold was Prichard's first black firefighter. He retired after 35 years, as a captain.


"If I didn't retire, I might not make it to the next day, going in the fire. You know, it gets too strenuous, you know? So I had to retire because I had heart problems."


Jackie worked for the Prichard Police Department for 40 years, and was the city's first female officer.


"I retired in June 2009," Jackie said. "I received two pension checks, and nothing after that. I said, 'Well, they'll come up with something.' But nothing ever happened."


"Had it not been for my job at the mall as a security officer, we probably couldn't even eat," Alfred said.


After 17 months, it's come to this: The Arnolds and Prichard's other retirees want to know what's wrong with this picture. Why handouts? Why not the pensions they contributed to? The pensions state law says Prichard has to pay?


"You can't draw blood from a turnip," said attorney Scott Williams, who represents the city of Prichard. "All the colloquialisms you want to come up with, if the money's not there, we can't pay it.


"If we took all the city's money and paid it to the pensioners, we won't have money to pay for the fire department or to keep the street lights on."


Prichard is small: 144 retirees, 27,000 residents. But what happens in Prichard is being watched by much larger cities - Chicago . . . Philadelphia . . . San Diego, to name a few - and by many states.


They all would like nothing better than to dump their staggeringly underfunded pension plans.


"Across the United States there is a difference of $3 trillion between the amount of money that we have promised public employees and the amount that has been set aside," said Joshua Rauh, who teaches finance at Northwestern University's Kellogg School of Management.


He's tracked the pension crisis: "Politicians are often trying to make it look like we can have our cake and eat it, too. And that's created a situation where we just push the problem down the road. And now we or our kids are going to have to pay for it."


Prichard has reached the end of that road. During the 1960s and '70s it was thriving - the fastest growing city in Alabama. Its population: 45,000 at its peak. Then, businesses began to leave, and hard times set in for good.


In 1999, its finances in shambles, the city declared bankruptcy. The pension fund was in trouble then. The city ignored a court order to replenish it.


A letter dated 2008 was sent to members of the city council and the mayor saying, essentially, that the pension fund would run out of money in July 2009.

.

"The math was pretty simple," said city councilman Troy Ephriam, chairman of the pension board. "I think the letter was basically saying something needs to be done. And it needs to be done immediately. Unfortunately, there were no real efforts.


"I don't feel we've done everything in our power to prevent the inevitable from happening."


Woulda, coulda, shoulda. Famous last words being heard all over the country these days. When its pension fund did run out of money - right on schedule - what did Prichard do? It filed for bankruptcy, again, this time hoping to be rid of its pension.


"Was the attempt to file for bankruptcy a deliberate attempt to stall, to not solve that problem?" asked Teichner.


"Yes, yes, absolutely," said Ephriam.


The petition was eventually thrown out of court.


The city now owes its pensioners more than $2.5 million in back payments.


Robert Hedge represents retirees in a class action suit against the city of Prichard. He tells of their sad stories, such as Nettie Banks, a former police dispatcher who ended up having to file for bankruptcy.


"This breaks my heart," he said of another case. "Hugh Dawsett has some serious arthritis issues, unable to work. His 73-year-old wife had to go back to work.


"We're talking about, on average, $1,000 a month per person," said Hedge. "That's the difference between buying your medications and buying food."


And then there are current employees, like Police Captain Charles Kennedy. He's 67, has had a serious heart attack and open heart surgery, but can't afford to retire.


"Because if I was to leave now, I'd be like the rest of the retirees - I'd have nothing," he said.


Kennedy is the most decorated officer on the Prichard police force.


"I dedicated myself to the city. I did my part," he said.


And that's what gets him about how the city has acted.


"I did an honorable job for them," Kennedy said. "I think they owe me the same kind of respect."


Retired Fire Captain Alfred Arnold agrees.


"It's one thing to lose one check, but to lose two? That's devastating, you know what I mean?" he said. "You're not giving us something that we didn't earn. You're not giving us no welfare. You're giving us our money that we put in, see? Where's it? How we supposed to live?"


On Thursday nights at city council meetings, local reporters ambush Prichard Mayor Ron Davis: "These people haven't been paid in 17 months. What can you say?"


"I'm concerned about them not getting paid," Davis replied. "I would like to see them get some payment."

[G M]

http://www.theatlantic.com/business/archive/2011/10/the-limits-of-stimulus/247178/

The Limits of Stimulus
By Megan McArdle

Oct 21 2011, 2:37 PM ET192

Kevin Drum ponders an interesting factoid: rising gas prices have pretty much wiped out the whole cash value of the stimulus to families:


Stimulus is hard in an energy-constrained world. I confess that the more I think about this, the more I wonder if conventional fiscal/monetary policy has as much traction as we believe. I'm not an energy fundamentalist by any stretch, but the constraints are real. Ordinary stimulus measures still work, and we should be pursuing them more aggressively, but I can't help but suspect that we're entering an era where they're getting less effective all the time.
My macro professor at the University of Chicago argued that the stagflation of the 1970s looks pretty good as an oil-led phenomenon; when supply constraints are real, stepping up the fiscal and monetary policy gives you inflation plus economic doldrums.



But how relevant is that to the current recession?  Well, James Hamilton has made a prettly compelling case that oil prices are responsible for more of the current setback than we might think.  And even if you dispute that, I think it's easy to agree that they're making a bad downturn worse.




While I was at Chicago last weekend I sat down with Raghu Rajan, formerly Chief Economist of the IMF.  And one of the things he pointed out is that the Great Moderation bred this assumption that policy can always do something.  That may not be the case.

[Crafty_Dog]

GM:  Those public sector pension funds articles are very interesting, but I'm thinking this is not quite the thread for them.  How about the Government Programs thread?

[TB]

On the subject of Lord Maynard Keynes.

"poor Keynes gets his name besmirched by these hacks"

It's true that contemporary economists and others may sometimes incorrectly attribute ideas to Keynes, but on the other hand it's pretty darn difficult to even find out what ideas Keynes actually believed by reading The General Theory (http://www.amazon.com/General-Theory-Employment-Interest-Money/dp/1169831990/ref=sr_1_1?s=books&ie=UTF8&qid=1319468352&sr=1-1).

If you haven't read the book, you are in for a treat. Here is a reference that takes Keynes' book apart chapter by chapter (http://mises.org/resources/3655/Failure-of-the-New-Economics). As Hazlitt says, "What is original in the book is not true; what is true is not original." and "...I have found in Keynes General Theory an incredible number of fallacies, inconsistencies, vaguenesses, shifting definitions and usages of words, and plain errors of fact."

I have read other critiques of Keynes (http://mises.org/resources/3683/The-Critics-of-Keynesian-Economics) written by mainstream economists who were his contemporaries, and sometimes they were nearly left speechless by the confusion and errors sowed by this man. As an aside, by the way, Keynes had very little formal training in the economics of the time -- and no university degree in the discipline. He said that his only training was in Marshallian economics, and that was only a few courses. He admitted to knowing nothing about what we now know as "Austrian" economic thought because he could read in German "only ideas which I already understand."

Macro economics was not founded by Keynes, but macroeconomic constructs such as he used are among the grievous errors committed by what we now identify as mainstream economists. When these clowns start writing equations to describe  the relationship between economic aggregates, they might as well stop right there. It absolutely is not true that these aggregates are in "functional" relationships of any kind. The mathematics implies a precise relationship. Y is a function of X implies that for every X there is a precisely defined result for Y (let's leave other complexities aside). This type of relationship NEVER exists in economics. Humans have volition, they are not bowling balls or subatomic particles.

Keynes was a very smart man, but his genius IMO lay strictly in his ability to cozy up to politically powerful people and tell them what they wanted to hear. Keynes was fundamentally a totalitarian and an elitist who wanted to manage the world. In the German edition of The General Theory Keynes even said, in his preface, that the ideas described within his book would be more easily implemented in a totalitarian state.

Keynes "besmirched"? It really takes some doing to besmirch this miserable S.O.B. Done properly, the besmirching looks something like this: http://mises.org/resources/5223/Keynes-the-Man

Tom

[DougMacG]

Tom, Thank you for that.  Yes I've read Keynes' works and my inability to follow him was a very positive step forward in my quest to understand economics. 

[Crafty_Dog]

Doug:

A similar epiphany for me too.

In the late 60s I strongly disliked the idea of being drafted off to Vietnam.  I had no idea why we should be there and the Vietnamese Army had a desertion rate three times the American casualty rate.  This certainly fit in with the gestalt of my peers and I like them I fancied myself a leftist.  Then in 1976 I returned to college by going to the U. of PA where in my first semester I took Micro-Econ.  I was the star of the class  (about 50 people) and Professor Mansfield's favorite.  The second semester was Macro Economics and the text was a Keynesian manifesto written by Prof. Mansfield himself.

I found the fallacies glaring and in fairly short order asked of Professor Mansfiedl in front of the class if the ideas there in could actually work because they would require sustained intelligence of the part of the government.  People chuckled behind their hands but Prof. Mansfield was NOT amused.  I went from an "A" to a "C".

This is when I realized I really was not a leftist at all- that I had been a free minds and free markets person all along. 

[Crafty_Dog]

STRATFOR
---------------------------
I love Stratfor, but frequently I find its economic analysis to be glib, Keynesian blather.  I'm not saying the following piece is that, but I'm saying read its econ stuff with care.
======================================

November 30, 2011


FED ACTION IN EUROPE UNDERSCORES DOLLAR PRIMACY

The U.S. Federal Reserve on Wednesday adjusted its "dollar liquidity swap
arrangements" with Europe's central banks, as well as with Japan and Canada. This
means that for now, European banks will not require a massive bailout that Europe is
ill-equipped to provide. It also demonstrates the true nature of the U.S.-dominated
global financial order.

"Even though the Fed is merely providing liquidity as opposed to long-term
structural support, its action will do much to abate Europe's crisis."

 
The Fed's action effectively gives these central banks access to a massive pool of
new U.S. dollars that they can borrow at low costs. Central banks will then provide
funding to their banking sectors. The loans must be repaid to the Fed within three
months and are structured so that the risks are borne by the foreign central banks,
not the Fed. Similar arrangements have been used since the days following the 9/11
attacks and were deployed in the early stages of the U.S. subprime crisis, but
Wednesday's deal offers the best terms yet to borrowers. And loans like this are
regularly refinanced as they expire.
 
The move generates relief amid rapid deterioration in the European financial markets
as banks' holdings of distressed sovereign bonds decline in value. European banks
cannot withstand serious declines in the value of their assets compounded by
unwieldy amounts of leverage -- borrowing money to purchase these bonds and other
assets. In some cases even two-percent fluctuations in asset values could lead these
banks into bankruptcy. In this environment, banks stop lending to each other,
fearful that the borrower will go bankrupt and therefore be unable to pay back the
loans.
 
Europe's intertwined banking and sovereign debt crises create a complex and unwieldy
situation. The banks need governments to service what are basically unserviceable
debt burdens or the banks will become insolvent.  Governments, meanwhile, need banks
to refinance their countries' growing debts or they will default. And on top of this
sits a relatively constrained European Central Bank (ECB) that does not have the
wide latitude for action its counterparts in other economies have. There is a strong
argument to be made that limitations on the ECB will ease as the crisis continues --
they already have to a significant degree -- but the stress in Europe's banking
sector has reached a critical stage.
 
The proposed solutions are, for the most part, not clearly conceived -- and all are
improbable as long-term fixes. Sovereign wealth funds based in nations whose per
capita incomes are a fifth of Europe's balked at providing funds. Investors who had
already shunned European bond markets despite full sovereign guarantees could not be
lured back with complex schemes involving only partial guarantees. The overall sense
of futility has been growing.
 
Even though the Fed is merely providing liquidity, as opposed to long-term
structural support, its action will do much to abate Europe's crisis. Nominally
designed to support markets with short-term dollar loans, the funds provided by the
currency swaps will find their way through numerous channels into the broader
European financial markets. Thus, in addition to helping banks, the funds could
relieve pressure on Europe's sovereign debt markets. For example, banks can purchase
government bonds -- even  those, such as Greek bonds, that are very poorly rated --
and use them as collateral to secure this unlimited funding. But even though the
risk of a fundamental breakup in the banking sector or currency union will abate
somewhat, none of the underlying problems that have created the crisis will have
been solved.
 
In fact it is STRATFOR's standing forecast that nothing will solve the underlying
problems that have created Europe's crisis. The European Union is an inherently
desynchronized entity, and packing disparate economies like Germany and Greece into
a free trade zone, let alone a currency union, is naturally problematic. Peripheral
European countries cannot forever absorb unchecked German exports with no recourse
to the traditional methods they have used to protect themselves-- such as trade
barriers, controls on capital flows and independent monetary policies.
 
Still, forceful backing from the United States is a significant geopolitical event
in that it reinforces the established global financial and monetary order.  The
United States provided this type of liquidity to Europe in the past, in order to
counter the effects of the U.S. subprime crisis. Now, as countries watch Europe's
crisis grow to threaten the eurozone's very existence, the United States is
ultimately the only economy large enough and with enough political credibility to
prop up the global system. This was a given for most of the postwar era, but was
seemingly forgotten over the past decade as proponents of the euro touted the
currency as a counterbalance to the dollar. But the facade of the euro's stability
has begun eroding, and dollar primacy has begun reasserting itself.

Copyright 2011 STRATFOR.

[Crafty_Dog]

Email Print Save ↓ More .
.smaller Larger  By GERALD P. O'DRISCOLL JR.
America's central bank, the Federal Reserve, is engaged in a bailout of European banks. Surprisingly, its operation is largely unnoticed here.

The Fed is using what is termed a "temporary U.S. dollar liquidity swap arrangement" with the European Central Bank (ECB). There are similar arrangements with the central banks of Canada, England, Switzerland and Japan. Simply put, the Fed trades or "swaps" dollars for euros. The Fed is compensated by payment of an interest rate (currently 50 basis points, or one-half of 1%) above the overnight index swap rate. The ECB, which guarantees to return the dollars at an exchange rate fixed at the time the original swap is made, then lends the dollars to European banks of its choosing.

Why are the Fed and the ECB doing this? The Fed could, after all, lend directly to U.S. branches of foreign banks. It did a great deal of lending to foreign banks under various special credit facilities in the aftermath of Lehman's collapse in the fall of 2008. Or, the ECB could lend euros to banks and they could purchase dollars in foreign-exchange markets. The world is, after all, awash in dollars.

The two central banks are engaging in this roundabout procedure because each needs a fig leaf. The Fed was embarrassed by the revelations of its prior largess with foreign banks. It does not want the debt of foreign banks on its books. A currency swap with the ECB is not technically a loan.

The ECB is entangled in an even bigger legal and political mess. What the heads of many European governments want is for the ECB to bail them out. The central bank and some European governments say that it cannot constitutionally do that. The ECB would also prefer not to create boatloads of new euros, since it wants to keep its reputation as an inflation-fighter intact. To mitigate its euro lending, it borrows dollars to lend them to its banks. That keeps the supply of new euros down. This lending replaces dollar funding from U.S. banks and money-market institutions that are curtailing their lending to European banks—which need the dollars to finance trade, among other activities. Meanwhile, European governments pressure the banks to purchase still more sovereign debt.

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 .The Fed's support is in addition to the ECB's €489 billion ($638 billion) low-interest loans to 523 euro-zone banks last week. And if 2008 is any guide, the dollar swaps will again balloon to supplement the ECB's euro lending.

This Byzantine financial arrangement could hardly be better designed to confuse observers, and it has largely succeeded on this side of the Atlantic, where press coverage has been light. Reporting in Europe is on the mark. On Dec. 21 the Frankfurter Allgemeine Zeitung noted on its website that European banks took three-month credits worth $33 billion, which was financed by a swap between the ECB and the Fed. When it first came out in 2009 that the Greek government was much more heavily indebted than previously known, currency swaps reportedly arranged by Goldman Sachs were one subterfuge employed to hide its debts.

The Fed had more than $600 billion of currency swaps on its books in the fall of 2008. Those draws were largely paid down by January 2010. As recently as a few weeks ago, the amount under the swap renewal agreement announced last summer was $2.4 billion. For the week ending Dec. 14, however, the amount jumped to $54 billion. For the week ending Dec. 21, the total went up by a little more than $8 billion. The aforementioned $33 billion three-month loan was not picked up because it was only booked by the ECB on Dec. 22, falling outside the Fed's reporting week. Notably, the Bank of Japan drew almost $5 billion in the most recent week. Could a bailout of Japanese banks be afoot? (All data come from the Federal Reserve Board H.4.1. release, the New York Fed's Swap Operations report, and the ECB website.)

No matter the legalistic interpretation, the Fed is, working through the ECB, bailing out European banks and, indirectly, spendthrift European governments. It is difficult to count the number of things wrong with this arrangement.

First, the Fed has no authority for a bailout of Europe. My source for that judgment? Fed Chairman Ben Bernanke met with Republican senators on Dec. 14 to brief them on the European situation. After the meeting, Sen. Lindsey Graham told reporters that Mr. Bernanke himself said the Fed did not have "the intention or the authority" to bail out Europe. The week Mr. Bernanke promised no bailout, however, the size of the swap lines to the ECB ballooned by around $52 billion.

Second, these Federal Reserve swap arrangements foster the moral hazards and distortions that government credit allocation entails. Allowing the ECB to do the initial credit allocation—to favored banks and then, some hope, through further lending to spendthrift EU governments—does not make the problem better.

Third, the nontransparency of the swap arrangements is troublesome in a democracy. To his credit, Mr. Bernanke has promised more openness and better communication of the Fed's monetary policy goals. The swap arrangements are at odds with his promise. It is time for the Fed chairman to provide an honest accounting to Congress of what is going on.

Mr. O'Driscoll, a senior fellow at the Cato Institute, was vice president at the Federal Reserve Bank of Dallas and later at Citigroup.

[Crafty_Dog]

Scott was kind enough to respond to my concerns about this:

The ECB is essentially doing the same thing today that the Fed did in 2008: massive balance sheet expansion, which by and large consists of swapping bank reserves for sovereign debt. Neither central bank has engaged in "money printing" in the sense that most people understand it (i.e., the kind of monetary expansion which fuels a big rise in inflation), because the vast majority of the newly created reserves are "excess" reserves sitting idle on deposit at the ECB and the Fed. Monetary aggregates like M2 are reasonably well-behaved. That's not to say things won't deteriorate in the future, of course, but for the moment a reasonable person can conclude that we are not on the cusp of hyperinflation.

Scott Grannis
http://scottgrannis.blogspot.com

and this:

Question for the Austrians: if the Fed and the ECB expand their balance sheets by hundreds of billions of dollars in a short period, but the value of the euro and the dollar relative to gold rises, and inflation remains very low, and commodity prices are flat to declining, have they in fact expanded the money supply by more than the demand for money? I think the answer is obviously "no."  I think it's clear that, to date, both the ECB and the Fed have expanded their balance sheet in line with the public's demand for more risk-free assets (e.g., bank reserves) and more money in general.

I think it is also obvious that banks have not used their excess reserves to create more money than the system has wanted to hold. Furthermore, there is no evidence of any unusual expansion in the amount of money that people and corporations like to hold as "cash."

As a partial rebuttal to Hussman, who writes that "even the slightest exogenous interest rate pressure will imply the need for massive reversals in the monetary base in order to avoid steep inflationary pressures," and implies therefore that a reversal of the reserve injections would either be politically impossible, or economically disastrous, I note that the Fed has several times in the past executed "massive injections" base money in order to avoid deflationary pressures, and nothing much happened. If they can instantly expand base money, why can't they instantly contract it when the times call for such action?

I think all the alarmists are making the mistake of assuming that central banks will over-supply reserves ad infinitum regardless of what happens. If that were to occur, of course, then the result would be hyper-inflationary. But it hasn't happened yet.

Scott Grannis
http://scottgrannis.blogspot.com

[Crafty_Dog]

Federal Reserve Chairman Ben Bernanke and most of his colleagues showed little concern when house prices started to decline in 2006, predicting “a soft landing” in the then-strong U.S. economy, transcripts from the central bank released Thursday show.


Bloomberg News
Fed Chairman Ben S. BernankeBernanke, who took over from Alan Greenspan as Fed chairman in February 2006, is cautious in making forecasts about housing and the wider economy. But, together with then New York Fed chief Timothy Geither, he believes the slowdown in housing is healthy and likely to end well.

Few central bank officials look overly worried just a few months before the storm hit, leading to the worst recession since the Great Depression. There are expectations, however. At the May 2006 meeting, for example, Fed Governor Susan Bies brings the discussion back to housing and her growing worries about mortgages. At the following meeting in June, Janet Yellen, the Fed vice chairwoman who headed the San Francisco Fed in 2006, appears to be the most concerned about housing.

The transcripts, available on the Fed’s website, provide full details of Fed officials’ individual views during the eight Federal Open Market Committee Meetings, with the traditional five-year lag (the minutes, released three weeks after FOMC meetings, only give a summary.)

Highlights of the transcripts include:

JAN. 31: Alan Greenspan, who took over as Fed chairman in 1987, is chief for the last time during the meeting of the Fed’s decision-making body. Fed officials spend much of their time praising him. “I’d like the record to show that I think you’re pretty terrific, too,” says Timothy Geithner. “And thinking in terms of probabilities, I think the risk that we decide in the future that you’re even better than we think is higher than the alternative.”

MAR. 27-28: In Bernanke’s first meeting as Fed chairman, housing looms as a risk, but officials haven’t grasped the severity of the threat. The Fed’s chief economist, David Stockton, offers some ominous warnings. “Right now, it feels a bit like riding a roller coaster with one’s eyes shut,” when discussing his forecast for a modest slowdown in housing. “We sense that we’re going over the top, but we just don’t know what lies below.” Later, he notes that housing is “the most salient risk” to the economy. “I just don’t know how to forecast those prices,” he says of housing prices.

“Again, I think we are unlikely to see growth being derailed by the housing market, but I do want us to be prepared for some quarter-to-quarter fluctuations,” Bernanke says. He identifies housing as a crucial issue, but adds that he agrees “with most of the commentary that the strong fundamentals support a relatively soft landing in housing.

Timothy Geithner, who is now Treasury Secretary and was then president of the Federal Reserve Bank of New York, doesn’t see the parallel risks building in the financial system. “Equity prices and credit spreads suggest considerable confidence in the prospect for growth,” he says. “Overall financial conditions seem pretty supportive of the expansion.”

In terms of policy, Bernanke picks up where predecessor Greenspan left off: with another quarter-point boost in interest rates, and a hint of more to come.

But he puts a modest stamp of his own on the Fed’s closely watched post-meeting statement, by including a more explicit view of where the nation’s economy is headed. The statement’s forecast that economic growth appears likely “to moderate to a more sustainable pace” may be an early, though small, sign of his efforts to make the central bank’s thinking more transparent.

MAY 10: Fed officials spend a lot of time discussing rising energy prices and risks to inflation and agree to raise short-term interest rates by 0.25%. Susan Bies, a Fed governor, tries to bring the discussion back to housing and her growing worries about mortgages. She looks enlightened in retrospect in a discussion about the risks that increasingly exotic mortgages pose to consumers and banks.

Bies points in particular to negative amortization loans, in which household loan balances get bigger and not smaller over time. “I just wonder about the consumer’s ability to absorb shocks,” she warns. “The buildup of home equity and the ability to borrow against it have helped individual homeowners when they have had layoffs, medical problems, divorces-all the things in life that create month-to-month problems for cash flow. With the growth of negative amortization, home equity is not being built up anymore.” She sums up with a ominous warning: “The growing ingenuity in the mortgage sector is making me more nervous as we go forward in this cycle, rather than comforted that we have learned a lesson. Some of the models the banks are using clearly were built in times of falling interest rates and rising housing prices. It is not clear what may happen when either of those trends turns around.”

Bernanke acknowledges the risks, but doesn’t sound overly worried: “So far we are seeing, at worst, an orderly decline in the housing market; but there is still, I think, a lot to be seen as to whether the housing market will decline slowly or more quickly. As I noted last time, some correction in this market is a healthy thing, and our goal should not be to try to prevent that correction but rather to ensure that the correction does not overly influence growth in the rest of the economy.”

JUNE 28-29: In summarizing Fed officials’ views, Bernanke notes how it’s getting more and more difficult to make forecasts, describing the economic situation as “exceptionally complicated.” Since housing is particularly hard to project, Bernanke calls it “an important risk and one that should lead us to be cautious in our policy decisions.”

The Fed raises interest rates to 5.25% from 5% at this meeting, the 17th increase in a row. But for the first time since it began raising rates from a low of 1% in June 2004, the Fed doesn’t explicitly say another rate increase was under consideration.

AUG. 8: Bernanke reminds his colleagues that the Fed has not been “terribly successful with soft landings” in the economy. Then he adds: “We have a chance to get one.” Janet Yellen, the Fed vice chairwoman who headed the San Francisco Fed in 2006, appears to be the most concerned about housing, warning that the housing slowdown could become an “unwelcome housing slump.” The central bank leaves rates unchanged at this meeting after two years of steady increases. Geithner wants to cite housing weakness as a factor, but the majority is against that.

SEP. 20: The Fed cites housing and energy declines in holding interest rates steady. However, chief economist Stockton says that the economy “bends but doesn’t break” under one Fed forecasting scenario of a housing slump. “So far the collateral damage from the downturn in housing has been limited, and for the most part, we expect it to remain that way, at least for a time,” he says. Bernanke notes there’s a split on how housing is viewed at the Fed, with some expecting a deep correction while others believe incomes and rates will support housing. Here’s how he sums it up: “the economy except for housing and autos is still pretty strong, and we do not yet see any significant spillover from housing.”

OCT. 24-25: Fed officials spend most of the meeting talking about how to improve their communication with the public, a topic still obsessing them that will be the focus of the upcoming FOMC meeting this month. Officials are mired in an extensive debate about the words employed in the policy statement. They also devote significant time to airing views on whether the central bank should adopt an inflation target, a matter still unresolved to this very day.

The market’s long struggle to divine meaning from certain words is mirrored inside the Fed. Officials struggle to choose the right words to associate with their economic views. Geithner flags the “dictionary” issues before them, amid a conversation about what a word like “moderate” might mean when applied to the FOMC’s expectations of growth. He asks, “have we used that phrase in the recent past in a way that would allow the reasonably informed outside person to interpret it that way?” That leads to Vincent Reinhart, who was then an FOMC monetary policy advisor, to say “I don’t know.”

DEC. 12: The meeting that closes out the year sees policymakers showing little rising awareness of the storm coming their way. Indeed, much of the conversation officials have was about employment and inflation. Some of the evidence of rising weakness in housing was seen largely as a correction for past excess, rather than the genesis of the worst financial crisis since the Great Depression.

Boston Fed boss Cathy Minehan then observes her district was seeing a slowdown in housing, but she saw no great concern in this development. The Richmond Fed President Jeffrey Lacker notes a mixed housing picture: he doesn’t see any great catastrophe coming the sector’s way. Cleveland Fed leader Sandra Pianalto flags some borrowers’ increased difficulty in getting mortgages in her region. Then Fed Vice Chairman Donald Kohn says rising inventories in manufacturing was “a bit more troubling” than the cooling in housing activity he’d seen.

Fed Governor Bies once again looks ahead of the curve. She says “the amount of leverage in each housing deal may still need some correction going forward, and so we may see some slowdown in the volume of dollars that are funded through mortgage lending.” She also says that in markets there is a realization “that a lot of the private mortgages that have been securitized during the past few years really do have much more risk than the investors have been focusing on.”

Bernanke fails to see any major problem brewing in housing based on his comments in the transcripts, once again predicting a “soft landing” for the economy.

[Crafty_Dog]

The Producer Price Index (PPI) declined 0.1% in December To view this article, Click
Here

Brian S. Wesbury - Chief Economist
 Robert Stein - Senior Economist


Date: 1/18/2012






The Producer Price Index (PPI) declined 0.1% in December, coming in below the
consensus expected gain of 0.1%.  Producer prices are up 4.5% versus a year ago.
The decline in the PPI in December was due to food and energy, each dropping 0.8%.
The &ldquo;core&rdquo; PPI, which excludes food and energy, increased 0.3%.
 
Consumer goods prices dipped 0.2% in December but are up 5.4% versus last year.
Capital equipment prices rose 0.2% in December and are up 2.3% in the past year.
 
Core intermediate goods prices fell 0.5% in December but are up 4.2% versus a year
ago.  Core crude prices were unchanged in December but are up 3.3% in the past
twelve months.
 
Implications: Due to falling commodities, producer prices took a breather in
December, dipping 0.1% overall.  However, the Federal Reserve can hardly use this
data to justify another round of quantitative easing. &ldquo;Core&rdquo; prices,
which exclude food and energy and which the Fed says it follows more closely than
the overall figures, increased 0.3% and are now up 3.1% versus a year ago. With the
exception of a temporary surge in 2008-09, this is the largest 12-month increase for
core producer prices since the early 1990s. The increase in core prices in December
was largely due to light trucks and construction machinery, which suggests some
firms are preparing for an increase in activity. There has been a recent lull in
producer price inflation. Prices for overall finished goods increased 4.5% in the
past twelve months, but are down at a 0.6% annual rate in the past three months.
There has been a similar slowdown in producer price inflation at the intermediate
and crude levels of production, for both overall prices and for prices excluding
food and energy. Although monetary policy is loose, the reaction of inflation to
that policy is variable, not a straight line. We do not expect the lull in producer
price inflation to be long-lived. In other recent news, chain-store sales continue
to grow, up 3% versus a year ago according to the International Council of Shopping
Centers and up 2.8% according to Rebook Research. And remember, these data are only
for stores open for more than a year.