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Cowboy Keynesianism
Friday, September 28, 2007
According to this Financial Times report, U.K. economics professor Jeff Frank sees the same motivation for last week's Fed rate cut as noted here last month and last week.
Sir, Martin Wolf makes a good point about how “the Fed must weigh inflation against the risk of recession” (September 26).
Now that's one rather sharp, yet still dismal, scientist (and the graphic is even more relevant now than just ten days ago.)
The test may come very soon. It is likely that the Fed cut rates by 50 basis points precisely because the window for cutting is short. Prices fell sharply between August and September last year. Next month’s change in the base for year-on-year CPI inflation to September leads to some ugly arithmetic. Even if prices didn’t rise at all in September 2007, headline CPI will rise from 1.97 per cent to 2.47 per cent. But we know that energy prices rose sharply in September, so the headline will rise to nearly 3 per cent. The baseline shift effect is even worse for October! Further, the moderation in core inflation may be due to lagged effects from the fall in energy input costs in the second half of 2006. If so, this is likely to be reversed as well. Inflation may well be over 4 per cent by the end of the year.
The big US inflation of the 1970s was set in motion in 1968. In June 1968, headline CPI crossed over 4 per cent. In September 1968, perhaps under political pressure, the Fed lowered the Fed funds rate by 25 basis points to 5.75 per cent. It reversed this by December and then started raising rates sharply, peaking the next year over 9 per cent. In hindsight, that was viewed as an irresponsibly accommodative Fed. In comparison, the 50bps cut by the Bernanke Fed is “cowboy Keynesianism”.
US public and private debt is hugely out of equilibrium. There are four ways equilibrium can be restored. US consumers and the US government can cut their expenditure to repay the debt. They can default on some of the debt. They can renegotiate some of the debt. Or the Fed can inflate away the real value of the debt.
Mr Wolf recognises that inflation is the easiest course. Realistically, it may be the only option open to a country that finds it difficult to live within its means. The US will have traded toxic debt to China for lead-painted toys.
Jeff Frank,
Professor of Economics,
Royal Holloway,
University of London,
Egham, Surrey TW20 0EX, UK
12 comments:
Tim,
My understanding is that even the monetiziation path is fruitless.
If Bernanke lowers the fed funds and discount rates and floods the markets with dollar liquidity the interest rates that really matter to people would still rise as market-determined long term rates soar in response. So we wouldn't just have inflation, but stagflation, and high unemployment would certainly follow.
Add to this the likely collapse of the US dollar with such a Fed policy and we are talking $150/barrel for oil (though probably still a comfortable price in the Euros oil would then be traded in). I don't see how basketing and regression could protect the CPI from THAT! Even if the books could continue to be cooked, there would be no avoiding the obvious unemployment and contraction of economic activity.
If I had a dime for every time somemone told me about the "export surge" we would get from a lower dollar I'd be a rich man. Does anyone really think the rest of the world would be in the mood for a flood of "cheap American products"? I mean, at least in the face of a rapid reduction in dollar value, I don't think Europe or Japan will be as accomodating to high imports as we have been. They saw what that did to us.
So, sure, we could monetize the debt, but at the cost of stagflationary depression.
Am I wrong? Please correct me if I am.
-Vespucian
Here's a thought - we're playing a game of "chicken" with China and the other export-led growers. We know that they have to keep funding us if they want us to keep buying their goods and keep their populations employed. They are also forced to keep their currency competitive vs the $US. Meanwhile, the real value of the dollar falls as its buying less and less with the rest of the world.
As these Asian exporters accumulate dollar based securities, we devalue the dollar and see at what point they will give in and stop keeping their currencies pegged. Also, their dollar holdings become worth less and less.
Not only is inflation the easiest route, it is the route that hurts foreigners more and us less. So it makes sense - we are maximizing our utility and foreigners don't enter the equation.... suckers!!!
I have come to suspect that economics, in the form it is first presented and taught in schools, is confusing and dismal by design. That way, it primarily attracts only truly dull yes persons (ex. any Fed governor ever, including Volcker) to the profession. Very occasionally, it does suck in the odd 200 IQ genius willing to dedicate a life to fighting the system (von Mises). But most importantly, it keeps the bulk of the general public from ever divining that economic policy is clearly designed to steal from them.
By inflation, ‘we’ attempt to monetize the debt at the expense of creditors. By creditors, this means everyone that holds the currency as savings, not just the Chinese and including a lot of vulnerable people in the US. The risk is that creditors refuse to grant ‘us’ further credit. Inflation is just a sneaky way of disguising a default. It even has whole grand academic theorems devoted to championing it - so did alchemy and phlebotomy. Central banks do not manage inflation. They create inflation and manage inflation expectations, which is your confidence the fiat currency will hold value. Think about that … for a while.
In a way, the gold standard never went away. It is always still with us as long as gold remains an option. The market can enforce it any time by exchanging paper for gold. A gold standard as public policy is no more than an attempt to manage free market enforcement of gold as currency. It would encourage one to place confidence where it is least deserved. As it has many times before, gold will be used as a tool to solve a very, very old problem: elitism run amok.
Notice once again, UK wants US to raise rates.
They want a stronger US currency so they can exchange back into pounds. The weakness of the dollar is a major cause in the financial mess in UK.
There is no real economic logic behind what he says, except British Propaganda.
To grow an economy, money supply has to increase. If the economy is producing nothing of real value, the value of the money declines.
AMerica produces next to nothing of real value anymore, so our dollar declines as we grow the money supply. We get inflation AND lower dollar value. It's pretty simple.
The way out is to start producing what people will buy again, instead of educating and valuing only financial wizards and lawyers.
We could have jump-started the green economy and done very well. Instead, we're chasing "cheap" oil.
We lose. Like every empire that has chased cheap resources rather than producing value.
"To grow an economy, money supply has to increase."
Why? This is not true. In fact, if the money supply is growing, how do you tell the difference between that and real economic growth? With inflation metrics? We know where that leads.
If you all haven't seen this from Pimco, it's pretty good:
Renegade Economics: The Bretton Woods II Fiction
They conclude by recommending a Zero Interest Rate Policy (ZIRP) for the U.S. in combination with fiscal tightening - it looks like Bernanke will do his part.
of course pimco wants the government to lower rates to zero - think of how much all their bonds will be worth. still i'll read the piece.
and a point to mr chubbray - yes inflation will hurt savers who are in the US as well as abroad, but on net foreign savers are becoming more and more exposed as they become bigger holders of our debt.
Some interesting research in the Pimco article though I'd disagree with the argument that export competitiveness has been achieved through currency arbitrage. The reason China has become competitive is simply supply of productive and skilled labor. It has become possible for roughly 20% of the world's population, formerly isolated from the modern global economy, to reintegrate. This is all the magic behind the success. The effects of currency arbitrage are insignificant by comparison and so will the result of any policy based upon it.
"yes inflation will hurt savers who are in the US as well as abroad, but on net foreign savers are becoming more and more exposed as they become bigger holders of our debt."
Hmmm ... what about swindling creditors whether domestic or foreign is beneficial? Do you aspire to thievery as a profession? Well, I suppose that is central to the elitist manifesto ... or something like all is fair in class warfare. I suppose also then, that you wouldn't mind and could easily understand if people come to your house and help themselves should times get tough or if they felt what's yours should be theirs.
chubbray,
i'm not saying it is the right thing to do (swindle foreign investors, as Wall Street has just done), but would you put that past Wall Street to swindle foreign investors and take a short term windfall vs a long term view?
Anonymous 819am,
Don't understand your point. I fully expect a swindle. It would just help if we all called a spade a spade. Inflation only benefits very select special interests and, I suppose to a lesser extent, those who can see it coming and get out of the way. The main result is that everyone sees their real wages driven down. Those who receive the loot first benefit with no risk. Those who possess enough assets to shuffle and know how to do it can also partake. But ultimately, an entire economy of asset shufflers would die of starvation or exposure. So by the time enough people catch on, this avenue of escape or 'prosperity' will be cut off. Best regards, Chubster.
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