Author Archive for Hunter Lewis

Leading Keynesian Economist Uses The “D” Word

 

Most Keynesian economists do not want to admit that we are in another depression.  They find the word painful.

They find it painful because it contradicts the idea that Keynesian economic ideas have ended depressions forever. It also contradicts the idea that the massive and continuing Keynesian stimulus applied by world governments since 2008 has worked. For this and other reasons, euphemisms such as the Great Recession have been embraced not only by Keynesian economists, but by their allies in government and in the mainstream press.

I argued that we were in a depression in a January article and again in April. Now Brad DeLong, one of the most prestigious Keynesians, a professor at Berkeley and former deputy assistant secretary of the Treasury under Clinton, says that he agrees. It really is a depression (http://www.project-syndicate.org/commentary/j–bradford-delong-argues-that-it-is-time-to-call-what-is-happening-in-europe-and-the-us-by-its-true-name).

DeLong doesn’t blame Keynesianism; that would be too much to expect. But he does call the thing by its right name, which is a major departure from the usual Keynesian style.

These are after all the people who call the government creating money out of thin air “ quantitative easing,” “ bond buying,” and the like, all of which are parroted by the press. When Keynes did this, he was often being impish, as when he called newly created money ““green cheese,” echoing the old nursery nonsense that  “the moon is made of green cheese.” His acolytes have adopted the style of dissimulation, but without the slightest trace of a sense of humor.

Although we are in a depression, it is not a depression for everyone, as is by now well known. Even so, the full hit on the middle class and the poor relative to the affluent is not adequately understood. Consider these figures from Larry Lindsey, who served Bush 2 as chief economist at the beginning of the first term, only to be booted from the White House for too much truth telling:

US Household Net Worth 2007- 2013

Top 1%         Up       1.9%

Next 9 %       Up       3.4%

Next 15%      Down   0.5%

Next 25%      Down  16.7%

Bottom 50%  Down   44.2%

None of the economic statistics we get from the government are reliable. Inflation is understated. Economic growth is overstated. Unemployment is understated.  But this chart of net worth is about as reliable as we can expect to get.

It tells the story of a middle class in the process of  being destroyed and of poor people who will never be able to get into it. It is also noteworthy that the nine percent below the top one percent have done best of all. Although a great many government employee households are in the top one percent, a larger number are in the next nine percent.

Sometimes the economic statistics are intentionally manipulated. It cannot be a coincidence that the method of calculating inflation changed so much under Bill Clinton. But keep in mind that the statistics also reflect Keynesian assumptions that do not make  sense.

In Keynesian theory, it doesn’t matter whether money is spent or invested or what it is spent on or invested in. In this cockeyed view, spending more money to put people into Medicaid, paid for by borrowing from overseas or printing new money, is just as good as Apple investing in new jobs.

We saw an example of this in the recent Gross Domestic Product numbers released by the government. Most of the new spending in the first quarter of this year was for health care and most of that for Medicaid expansion. But it wasn’t even actual, documented spending. It was just a wild, finger-in-the-wind guess by the government.

As a result, the first quarter was initially reported with a minus 1% economic growth, then revised to minus 2.9%. One idea floating around is that the Commerce Department’s revision reflected a decision to make the first quarter look worse in order to move healthcare spending to the second quarter and thus make it look better. If so, why would the second quarter have been deemed more important? Because it is leading up to the fall elections. The second quarter is currently reported at 4.2%.

The destruction of common sense economics by Keynesianism is a major reason for what has happened to the American middle class and poor. But our governing elites and special interests do not just love Keynesianism for its own sake. They especially  love the opportunity for crony capitalism that it affords. Keynes himself was not financially corrupt, and would have been appalled to see the corruption he unleashed.

Nor did our present problems arrive in 2007-08. They can be dated at least to the beginning of bubbles and busts during the Clinton administration and arguably even further back.

For example, if we look at what has happened to poor people since the War on Poverty began in the 1960’s, we see them earning less and less on their own and sinking even further into poverty, if we exclude growing welfare payments. Analyst John Goodman  (http://healthblog.ncpa.org/why-we-lost-the-war-on-poverty/) has calculated that economic growth cut the rate of poverty in half between the end of World War Two and 1964, when the War on Poverty was launched. Since then the percent of people poor would have increased, but for the extraordinary $15 trillion spent by the government, much of it with borrowed funds.

There are those among the top one and top ten percent of households who are working on this problem every day. They help the middle class and poor by working hard, saving, making wise investments, and hiring, or even by not investing or hiring until conditions are right. There are many others who make it steadily worse by feeding off a corrupt and swollen government and wasting trillions of borrowed of manufactured dollars.

 

 

 

 

Senator Elizabeth Warren (D-Ma) Defines Today’s Progressivism

Nomination_of_Richard_CordrayWarren reviewed eleven tenets of contemporary progressivism in a July 18 speech before Netroots Nation . She should be commended. Very often progressive politicians prefer to talk about “hope and change” rather than what they really stand for. Her list is not free of exaggerated rhetoric, such as claiming the mantle of “science” for herself. When she talks about supporting fast food workers on picket lines, she doesn’t mention the millions she is collecting from labor unions. But, even so, her account contains some honest and useful information.

1. “We believe that Wall Street needs stronger rules and tougher enforcement, and we’re willing to fight for it.”

2. “We believe in science, and that means that we have a responsibility to protect this Earth.”

3. “We believe that the Internet shouldn’t be rigged to benefit big corporations, and that means real net neutrality.”

4. “We believe that no one should work full-time and still live in poverty, and that means raising the minimum wage.”

5. “We believe that fast-food workers deserve a livable wage, and that means that when they take to the picket line, we are proud to fight alongside them.”

6. “We believe that students are entitled to get an education without being crushed by debt.”

7. “We believe that after a lifetime of work, people are entitled to retire with dignity, and that means protecting Social Security, Medicare, and pensions.”

8. “We believe—I can’t believe I have to say this in 2014—we believe in equal pay for equal work.”

9. “We believe that equal means equal, and that’s true in marriage, it’s true in the workplace, it’s true in all of America.”

10. “We believe that immigration has made this country strong and vibrant, and that means reform.”

11. “And we believe that corporations are not people, that women have a right to their bodies. We will overturn Hobby Lobby and we will fight for it. We will fight for it!”

Here are a few questions for Warren.

1.  Since you are willing to fight for stronger rules and tougher enforcement for Wall Street, are you willing to fight for an end to government bail-outs? How will you end them if Wall Street is operated as a subsidiary of Washington? How will you end them if Washington needs big Wall Street firms to buy its bonds with money created by Washington, since Washington is barred from buying its own bonds directly but can do so indirectly through Wall Street? In general, how will you keep government control from wrecking the internal disciplines of the market, which include loss and bankruptcy as well as profit?

2. How will an increase in the minimum wage help those who can’t get any job because of the minimum wage? How will this help teenagers or other young people get their first job?

One of your favorite presidents, Franklin Roosevelt, intervened to keep wages high during the Great Depression. The result was that those who succeeded in keeping their jobs were even better off than before while millions of others were thrown out of work and had nothing.

3. Hasn’t the federal student loan program driven up the cost of a college education, leaving many students worse off than before it existed?

And why is the federal government borrowing at a low interest rate and then charging the students a much higher rate? How can it be right to make a profit off the students and then apply it to the federal budget under a line called “ deficit reduction.”

4. Since you hold that “equal means equal… in all of America,” why do federal programs discriminate in favor of one group over another? Why, to choose just one of many examples, are non-unionized companies barred from federal construction contracts?

5. If corporations are not people, does that mean the government can not only tell them what to do, but even gag them or tell them what to say?

Having reviewed what Warren believes to be the eleven tenets of contemporary progressivism, what does she think that conservatives and libertarians believe? Here it is: “I got mine. The rest of you are on your own.”

Is this what either conservatives or libertarians teach? Is this what markets teach? They teach us to be selfish? Or do they teach us that we had better put our selfishness aside and tend to the needs of customers and employees first if we want to be successful?

People who run businesses are serving the needs of others. And people who work for the government may be just as selfish as anybody else.

Did Senator Warren describe all the tenets of contemporary progressivism? No, she described the ones she wanted to describe. But it’s helpful to have her eleven.

Atlanta Fed Paper: We Reduced Unemployment By 0.13%!

Lincoln_Memorial_July_4th_1A paper written by two staff members of the Federal Reserve Bank of Atlanta tried to quantify what all the Fed’s new money creation and related measures have accomplished. They conclude that unemployment today would be 0.13% higher without the radical measures and 1.0% higher if nothing at all had been done.

For some time, the Fed has been trying to demonstrate what its massive interventions  have accomplished. This has not been easy. In the first place, the results have been poor, far below what the Fed hoped for. In the second place, the Fed does not even have a theory about it that can be modeled.

After many false starts, a few papers have emerged arguing that the Fed’s actions helped. But even these papers don’t argue that they helped much. And the story isn’t yet over.

Economist John Hussman has likened the Fed’s current financial policies to a Roach Motel, easy to get into, impossible to get out of. It will be interesting to see how the Fed tries to get out.

The Atlanta Journal-Constitution wrote about the new Fed paper: “Without the Fed and its low interest rates, the jobless rate would have been higher these past few years—pretty much all economists agree on that.” This will be news not only to Austrian economists, but to others as well.

If the Fed and federal government had not intervened in 2008 to arrest the crash which their own policies had created, unemployment would no doubt have been higher in 2008 or 2009. But by now, almost six years later, our economy might have long since recovered. 

This is the difference between short term and long term thinking. Environmentalists are always reminding us that we need to consider long term results of how we treat our planet. We also try to teach our children to consider the long term, not just the short term, but the government always seems oblivious to anything but the next election.

The Fed’s chairman, Janet Yellen, will be testifying today in Congress. Perhaps some senator or representative will ask her how she plans to conduct monetary policy in the future, since the Fed Funds rate, the key tool of past Fed policy, has been rendered increasingly irrelevant by recent Fed policy excesses.

We know that the Fed plans to lean heavily on the interest it pays on bank reserves, a new tool that was slipped into the TARP bill in 2008 without most members of Congress knowing. It might also be useful to ask how much of this interest is now being paid to foreign banks, which we are in effect subsidizing.

Another, related issue is whether the federal home-loan banks, which are not supposed to be eligible to “earn” this money, are evading the rule by lending to foreign banks who then “earn” it for them.

What all this illustrates is that the Fed operates in secrecy, and not even Congress has much of a clue what is going on.

Less Fed Financial Repression Irrational?

220px-Marriner_S._Eccles_Federal_Reserve_Board_BuildingIn a recent Bloomberg Views piece, mainstream economist Noah Smith accused his Austrian  critics of having “brain worms” and even “anti-semitic overtones.” He then mischaracterized what his critics were saying so that he could ridicule it.

This wasn’t very conducive to a dialogue. His last Bloomberg piece, out on July 10, is better. It offers a specific proposal: don’t raise today’s ultra low interest rates.  Unfortunately it doesn’t say whether this advice is forever, or for now. But it is a specific proposal.

This is all the more helpful because it is difficult to tease specific proposals out of mainstream ( usually Keynesian) economists. For example, during and after the Crash the best known Keynesian economists ( Krugman, Shiller, Romer, Yellen etc.) kept saying we needed more government stimulus of the economy, but refused to give us the exact prescription.

This was very convenient when the stimulus failed; they could just claim that there hadn’t been enough. Never mind that they had refused to tell us in the first place how much was needed or for how long.

In his latest piece, Noah Smith not only says that short term interest rates should stay where they are, close to zero, and well below even reported inflation. He further argues that these giveaway interest rates ( made available to Wall Street, not to Main Street) are not creating a stock market or other asset bubble like the dot com or housing bubbles.

Smith then gives us what he calls Finance 101. Here is what he says: “The value of a financial asset is the discounted present value of its future payoffs, and when the discount rate — of which the Fed interest rate is a component — goes down, the true fundamental value of risky assets goes up mechanically and automatically. That’s rational price appreciation, not a bubble.”

Let’s see. The Fed artificially represses interest rates for now, with no guarantee that they won’t go bounding back up anytime in the future, even the near future, but stocks should be valued as if the artificially repressed rates are permanent. Sorry, this isn’t “rational” and it certainly isn’t Finance 101.

Smith further notes that “bubbles form when people think they can find some greater fool to sell to.” Hm. Why do people expect to find “greater fools” at some times and not other times?

George W. Bush famously said that “Wall Street got drunk” before the 2008 crash. But where did the cheap alcohol come from, if not from the rivers of new cash created by the Fed and delivered to the bars in Manhattan and around the world?

Even Smith admits that “there’s laboratory evidence for bubbles, too — it’s by far the most-researched phenomenon in experimental finance. And it’s true that when you give traders in the lab more cash, you get more and bigger bubbles.” Exactly. More cash, cheap cash, and the promise of bail-outs. It’s a deadly combination.

Smith even argues against his position when he thinks he is arguing for it. He says that “the Fed has been regulating the monetary base for many decades, and for a lot of that time there were no big bubbles.” Right again. The Fed isn’t operating as it did in the pre-Greenspan era. Far from following a “cautious, middle-of-the-road policy, It has embraced radical and recklessly untested new methods of money creation and interest rate repression that would have horrified earlier Fed boards and chairmen.

The main thrust of Smith’s piece is that interest rates should not be raised. For reasons he does not give, repressing interest rates and driving up stock prices are entirely rational while increasing rates is “irrational.” Rate reductions are wise policy; rate increases are a “blunt hammer.“

This echoes Keynes’s argument in the General Theory that the way to create a boom is to lower interest rates and the way to keep it going is to lower them further. Unfortunately history reveals that this doesn’t work; it just feeds bubbles. And even Keynes did not argue for forcing interest rates below inflation.

Smith has at least a glimpse of what his critics find troubling. He asks: “ what good is a crash to prevent a crash?,” but acknowledges that the critics have a “mental model …[of]… a little pain now to prevent a lot of pain later.” That’s it. They don’t want a crash at all; but they certainly don’t want an even bigger crash than the last one in 2008.

Smith rejoinder is curious: “If the rise in prices has been a rational response to Fed easing, then there’s no need for such medicine; causing a crash today will just cause a crash today, period.” But, as we have already noted, this only makes sense if the Fed will hold rates down forever and never bring them back up.

If the Fed will at some point bring them back up or perhaps even lose control of them, there will have to an adjustment. The only question is whether it would be healthier to have it now, or later, after even more new money has flooded the economy and created even more mal-investment and unrepayable debts.

Solving these problems for the long run requires abolishing the Fed  and restoring honest money and banking practices. But, for now, maintaining giveaway rates for favored special interests just makes everything worse.

http://www.bloombergview.com/articles/2014-07-10/what-good-is-a-crash-to-prevent-a-crash

Mainstream Economist Freaks Out

The_Scream What does it suggest when Noah Smith, writing in Bloomberg, calls his critics “9/11 truthers
…enslaved by… brain worms?”

It suggests that he is very worried. He not only thinks the barbarians are at the gate. He thinks  that his cozy citadel might actually fall.

And what does it tell us when he accuses his target, Austrian economics, of having  “anti-Semitic overtones?”–and then documents this outlandish charge by linking to someone’s video on U-tube?   Smith may not be just worried. He may be terrified if he has to resort to such nonsense.

Behind all this is a fierce contest of ideas which the economics and other establishments want to go away, and go away now! Fortunately we are not a totalitarian society, and a free society has a market in ideas as well as in products. Many people have a vested interest in defending old ideas. In the case of economists, their very livelihood may depend on it. So change comes slowly, and is always hard fought.

When new people challenge the old orthodox ideas, the establishment first ridicules them. What a joke! If the new ideas gain some traction, the establishment resorts to a stony silence. Shh! Don’t say a word about it; we don’t want anyone else to hear about it! If the silent treatment doesn’t work, the establishment comes out swinging, attacking the new ideas with a blood lust. War to the death!  If finally, in a fourth stage, the new ideas win out and become the new orthodoxy, the old opponents just shrug and say “ Oh, I knew that all along.”

Looking at it this way, Noah Smith’s savage attack on Austrian economics is a good sign. Much of the establishment media is still giving Austrian economics the silent treatment. An article like this in the establishment bastion Bloomberg News suggests that we may be entering stage three, where the final battle will be fought.

We could leave it there, and dismiss Smith’s overblown rhetoric as simply a sign of panic, but it is also worth noting that Smith doesn’t really offer an argument. Apart from the name calling, his main technique is to set up straw men and then knock them down. So, for example, he says that Austrian economists are discredited because all the new money created by the Fed and other central banks hasn’t yet led to runaway consumer price inflation.

This just shows that Smith hasn’t actually read the Austrians. If he bothered to do so, he would read  that both the timing and the direction of new money flowing out into the economy are unpredictable. If it flows into consumer goods, it won’t flow into all of them evenly or at the same time. It may also flow more into assets ( stocks, homes etc.) rather than into consumer goods, so that the inflation shows up in asset bubbles. This happened in the 1920’s and again in recent decades, and it leads to a bubble/ bust cycle that by now is all too drearily familiar.

Smith says in this context that “Austrians writhe and contort under the pure, burning light of extant reality.” But it was Austrian economists who warned that the Fed and other central banks were leading us into a horrendous cycle of bubble/bust. And, importantly, they are still warning us that these cycles are not yet played out.

Just recently Janet Yellen, the current Fed chair, once again denied that her policies had anything to do with creating the housing bubble or crash. This would seem to be a prime example of what Smith tries to tar the Austrians with: being completely “out of touch with reality.” It is, however, convenient for Yellen, since it means that she can persist with the same mistakes, without having to worry that she might be creating yet another, even bigger bubble and bust.

Smith’s ignorance of Austrianism or blithe disregard for what it says is illustrated by another post from February of this year, written in his characteristically insouciant style. At that time, he said: “It seems to me that the Austrian School’s demise came not because its ideas were rejected and marginalized, but because most of them were co-opted by mainstream macroeconomics.”

So which is it? Are Austrian ideas “brain worms” or are they part of mainstream economics now?

One can only wish that Austrian ideas had been “co-opted” by mainstream economics, but this too is a fantasy. Austrianism is still an insurrection. It remains a mortal threat to the conventional economics that has caused so much needless unemployment and suffering around the world. And, so long as it does, Smith and other defenders of the old order will lash out at it.

Negative Interest Rates– Only The Start?

5856811567_c7ef991796_bAs Ryan McMaken noted on June 5,  the European Central Bank has instituted negative interest rates for member banks. This could soon spread to the US and also to consumer accounts. If so, you would find money taken out of your bank account each quarter unless you spend it. Some observers think that in the US at least it will start with higher account fees, which will be stealth negative interest rates, and then move to overtly negative rates.

The idea is that if low rates are not yet persuading you to spend, then why not punish you even more for saving. To make this more effective, there would also be a push for all electronic money, to keep you from stashing any away from the confiscation agents. Ken Rogoff, leading Harvard (and Republican) economist has just recommended this to facilitate negative interest rates and in general to increase government control over cash.

This is far from the only “innovation” that could be coming our way. In a speech on June 4, San Francisco Fed Chairman John Williams suggested that the Fed should at least take a look at “nominal income targeting.” He said this could be “a creative way to bend the curve in terms of macroeconomic and financial stability trade-offs.” What this gobbledegook means is that the Fed would simply create money and then distribute it to parties in danger of bankruptcy and foreclosure.

Isn’t that a great idea? Why stop with the bail-out of big banks when you can bail out anyone who gets in financial trouble? That would guarantee the zombification of the economy that is already well underway. Bad business ideas and badly managed companies would live forever at the expense of good ideas and well managed companies.

Here are some other daft ideas being discussed in central banking and other circles:

1. Take a leaf from Japan by forcing banks to lend in return for Fed support.

2. Hold interest rates down but simultaneously drive inflation up to as much as 5-6%. With real interest rates at negative 5%, borrowing will soar. What isn’t clear in this scenario is why lenders will want to lend, but they can always be forced to do so.

3. Create even more money and use it to buy corporate bonds, stocks, real estate, anything that can be bought, which will flood the economy with money.

Some of the ideas waiting in the wings are not monetary. They include:

4. The government should set an annual borrowing target for the economy. If it isn’t being met by the private sector, government will itself step in and borrow to achieve the target. Who cares how the borrowed money is spent, so long as it is spent?

5. The government should issue bonds that will never be repaid. Not simply replaced with new bonds as at present—never repaid.

6. Employers should have to seek government permission to lay off or fire a worker. This idea of Paul Krugman’s is already true to a large degree in France, with the result that employers are very reluctant to hire anyone.

These days government economic managers are like mad tinkerers. Aldo Leopold said that the first rule of tinkering is that you don’t throw away the parts. But the Keynesian PhDs in charge of our economy are disassembling the economy at too fast a pace to listen.

Hillary and Ben Bernanke on the Economy

400px-Msc2011_dett-clinton_0298Hillary Clinton’s speech yesterday revealed some of her thoughts about reviving the economy.

She said she was trying to “encourage more companies to come off the sidelines and, frankly, for some to use some of that cash that is sitting there waiting to deploy.”

This echoes the naïve idea embraced by the Obama administration that economies are fueled by ever more borrowing and spending. But this is not how jobs are created.

Jobs are created when businesses deploy their cash savings wisely. It is always the quality of investment that counts, not the quantity. If high quality investment opportunities are lacking, often because of government interference with the economy, businesses actually help us all by refusing to waste their cash on projects that will blow up in short order and just create even more unemployment in the long run.

When this false recovery, fueled by all the wasteful spending, blows up, as it will eventually, what will pull us out of the next crash? It will be those businesses and individuals who have refused to play at the casino, who have saved and put money away, who will be able to step in, invest, and start a genuine, not a phony, recovery process.

Hillary’s viewpoint is as crony capitalist as President Obama’s. They both complain that government has done favors for business and business in turn must do favors for government. Favors start with campaign contributions, but extend to more hiring, especially before an election. Who cares about quality of investment, or long run results? “In the long run we are all dead,” as Lord Keynes, the godfather of crony capitalism, helpfully reminded us.

Hillary further stated that “as secretary of state I saw the way extreme inequality corrupted other societies.” This is a clever reversal of the truth . It is corruption, in particular crony capitalist corruption, that creates the worst kind of inequality, in which the poor, the young, and the middle class fall further and further behind while rich government cronies thrive.

There was more nonsense in Hillary’s speech. She boasted about how 23mm new jobs had been created during her husband’s administration and the government’s budget balanced, without mentioning the role of the dot-com bubble in making it all look good until the mini-crash of 2000. In truth, today’s rotten economy had its origin under the Clinton administration, but who will believe this when the 2016 election rolls around?

This speech has been called “populist” by the press, and much of it purported to be. Hillary said that “some are calling [today’s economy] a throwback to the gilded age of the robber barons.” This is ironic coming from Mrs. Clinton, who is the master manipulator of the crony system, and of late has been busily giving speeches on Wall Street and elsewhere for as much as $450,000, and often for $200-250,000, usually with a private jet thrown in for transportation.

Mrs. Clinton has been doing this since leaving the secretary of state job. Ben Bernanke waited for two months after leaving the chairmanship of the Fed, but is now cashing in the same way. He has spoken at an Abu Dhabi conference, on a private telechat to Japan, and at select Wall Street dinners hosted by the likes of JP Morgan Chase at posh restaurants such as Le Bernardin. His speech fee is also reported to be around $250,000 with private transportation extra.

According to participants in the dinners, Bernanke suggests that the Fed a) wants reported inflation of at least 2% and b) will hold interest rates down for a long time. In effect, then, the present policy of virtually giving away money to favored institutions may go on and on into the indefinite future.

Meanwhile another report today reveals that savers lost $750 billion in interest they could have earned since 2008 if the Fed had not repressed rates. This estimate is very much on the low side, and much of this money came right out of the pocket of the endlessly abused middle class.

It is a shame to see Ben Bernanke enriching himself among the people he enriched as chairman of the Federal Reserve. Prior to this, as much as he contributed to the corruption rampant in this economy, he had not personally benefited from it.

Daily Kos Gets it Right

89803558_b2ee934690_zHere is an April 29, 2014 headline from Daily Kos:

Inflation-adjusted median household income down $4,309 since high point in 2008.

Left and right should at least be able to agree about this. For the average American, there has been no recovery. Median household income rises in a recovery, even if there is a lag.

It gets worse. Today’s median household income, adjusted for inflation, is no higher than in 1988, at the end of the Reagan presidency. The middle class has in effect stood still for more than a quarter century.

It gets worse still. The government keeps moving the goalposts on inflation. Especially under Clinton, the method of calculating it changed, and of course changed in such a way that less inflation was reported. Today the Fed complains that it wants more inflation. But if inflation were calculated the old way, it would already be running at 5% a year.

This is important. Median household income adjusted for the cost of living is not just the same as in 1988. In actuality, it is much lower. We have fallen backward for a generation.

Former Fed chair Ben Bernanke  said that the Fed would start increasing interest rates when unemployment hit 6.5%. Now that reported unemployment is 6.3%,  former Fed vice chair Alan Blinder  congratulates current Fed chair Janet Yellen for so nimbly sidestepping this pledge.

The government’s highest rate of unemployment, the one that includes part time workers who would rather be full time and other “discouraged” workers, now registers 12.3%. This is still an understatement.  If unemployment were calculated as it was during the Great Depression, it would be more like 23%. (An excellent source on past versus current methods of calculating inflation and unemployment is John Williams’s shadowstats.com. Mark Thornton also cited figures from Williams in his May 7 post about the recovery-less recovery.)

And who, by the way, has lost the most inflation-adjusted household income since the current depression began? Left and right can agree about this too: blacks, those with a high school education or less, southerners, those under 25, and those between 55 and 65. Everyone knows how hard it is in this economy for anyone, but especially anyone  under 25 or over 55, to get a job.

In response to this, President Obama proposed legislation that would grant disappointed job seekers the right to sue a firm that did not employ them. Imagine how many firms would be interviewing if that passed. Paul Krugman also offered a complementary  proposal: require that companies seek government approval before laying off or firing. Something like that has already been tried in France and of course it just means that no one hires in the first place.

Sites like the Daily Kos stamp their feet about the rampant inequality of today’s economy. Why should the rich keep getting richer while the middle class, the young, and the poor slip further behind? We  agree. Something is wrong, terribly wrong.

To see what is wrong, you need only ask: who is getting so rich in the midst of this non-recovery? A moment’s inspection reveals that it is people with close connections to the government money fount at the Fed ( eg. Wall Street) or people with close connections to government officials ( think big companies such as Pharma and Farma, not just little green energy firms started by major Obama campaign finance donors).

This isn’t a failure of capitalism. It is instead crony capitalism run riot, and it is destroying America’s capital and economic base.

We could yet recover. To do so, we would need a consumer led economy, one with honest prices not nudged, manipulated, or controlled by Washington. We would need honest savings and thoughtful investment, the kind of investment that will create jobs for decades, not pay off cronies.

Real populists seek to help the middle class, the young, and the poor by beating back the corruption of crony capitalism. One would think that left and right could unite on that point too.

Further to Julian Adorney on the Maximum Wage

It is worth recalling that Congress during the first Clinton administration passed legislation limiting cash compensation for CEO’s of public companies to $1 million. The result was that compensation swung to stock options. This in turn encouraged CEO’s to borrow in order to buy in company stock, which helped stoke the subsequent stock market bubble.

When the accounting profession then sought to rein in the use of options, which at the time did not have to be treated as corporate expenses, several congressmen and senators, Joe Liberman in particular, publicly threatened them with legislation that would take away their authority over options.

The actions of the Fed were far more important in creating the stock market bubble that subsequently popped in 2000, but Congress certainly made it worse with its unwise legislative interference with executive compensation. This was just one more example of government fixing, manipulating, or nudging prices that should be set by the market, that is, by consumers.

Thomas Piketty’s Sensational New Book

piketty_0This 42 year economist from French academe has written a hot new book: Capital in the Twenty-First Century. The US edition has been published by Harvard University Press and, remarkably, is leading the best seller list, the first time that a Harvard book has done so. A recent review describes Piketty as the man “who exposed capitalism’s fatal flaw.”

So what is this flaw? Supposedly under capitalism the rich get steadily richer in relation to everyone else; inequality gets worse and worse. It is all baked into the cake, unavoidable.

To support this, Piketty offers some dubious and unsupported financial logic, but also what he calls “a spectacular graph” of historical data. What does the graph actually show?

The amount of U.S. income controlled by the top 10% of earners starts at about 40% in 1910, rises to about 50% before the Crash of 1929, falls thereafter, returns to about 40% in 1995, and thereafter again rises to about 50% before falling somewhat after the Crash of 2008.

Let’s think about what this really means. Relative income of the top 10% did not rise inexorably over this period. Instead it peaked at two times: just before the great crashes of 1929 and 2008. In other words, inequality rose during the great economic bubble eras and fell thereafter.

And what caused and characterized these bubble eras? They were principally caused by the U.S. Federal Reserve and other central banks creating far too much new money and debt. They were characterized by an explosion of crony capitalism as some rich people exploited all the new money, both on Wall Street and through connections with the government in Washington.

We can learn a great deal about crony capitalism by studying the period between the end of WWI and the Great Depression and also the last twenty years, but we won’t learn much about capitalism. Crony capitalism is the opposite of capitalism. It is a perversion of markets, not the result of free prices and free markets.

One can see why the White House likes Piketty. He supports their narrative that government is the cure for inequality when in reality government has been the principal cause of growing inequality.

The White House and IMF also love Piketty’s proposal, not only for high income taxes, but also for substantial wealth taxes. The IMF in particular has been beating a drum for wealth taxes as a way to restore government finances around the world and also reduce economic inequality.

Expect to hear more and more about wealth taxes. Expect to hear that they will be a “one time” event that won’t be repeated, but that will actually help economic growth by reducing economic inequality.

This is all complete nonsense. Economic growth is produced when a society saves money and invests the savings wisely. It is not quantity of investment that matters most, but quality. Government is capable neither of saving nor investing, much less investing wisely.

Nor should anyone imagine that a wealth tax program would be a “one time” event. No tax is ever a one time event. Once established, it would not only persist; it would steadily grow over the years.

Piketty should also ask himself a question. What will happen when investors have to liquidate their stocks, bonds, real estate, or other assets in order to pay the wealth tax? How will markets absorb all the selling? Who will be the buyers? And how will it help economic growth for markets and asset values to collapse under the selling pressure?

In 1936, a dense, difficult-to-read academic book appeared that seemed to tell politicians they could do exactly what they wanted to do. This was Keynes’s General Theory. Piketty’s book serves the same purpose in 2014, and serves the same short-sighted, destructive policies.

If the Obama White House, the IMF, and people like Piketty would just let the economy alone, it could recover. As it is, they keep inventing new ways to destroy it.

The Hidden Motive Behind Quantitative Easing

220px-Marriner_S._Eccles_Federal_Reserve_Board_Building Foreign individuals and businesses long ago cut back on their purchases of U.S. bonds. Their place was taken by foreign central banks. The central banks simply created money in their own currency and used it to buy our bonds.

The Federal Reserve always knew that we couldn’t rely on foreign central banks to buy our bonds forever. This may be the main reason it began the program called quantitative easing, in which the Fed created money out of thin air specifically to buy back U.S. debt.

Quantitative easing may have been intended to be a kind of insurance policy. If foreign central bank buying of U.S. bonds collapsed, the Fed would already have a program in place to buy them back itself.

The Fed  said that quantitative easing was meant to create U.S. jobs, but this never made much sense. Even a hard core proponent of QE, Fed official William Dudley ( formerly of Goldman Sachs), admitted that the Fed’s own economic models could not explain how creating money out of thin air and using it to buy U.S. bonds would increase employment. Some link to rising stock prices could be demonstrated, if only through the cheap financing of corporate stock buy-backs, but then rising stock prices could not be shown to create jobs either.

One inference from this was that chairman Ben Bernanke, and now new chairman Janet Yellen, were just taking wild stabs in the dark. A more reasonable inference is that they had another reason for QE, one which they did not want to acknowledge.

Viewed in this way, the 2008 bail-out should be viewed not as a bail-out of Wall Street, but rather  as a bail-out of Washington. The Federal Reserve feared that the market for government bonds was about to collapse, which would lead to soaring interest rates, and a complete collapse of our bubble financed government.

The Fed did not have the option of creating money and buying debt directly from the Treasury. That would be illegal. The Treasury must first sell its bonds to Wall Street, after which the Fed can then use its newly created money to buy them back. Hence, in order to rescue the Treasury, the Fed felt it had to rescue Wall Street.

This is a simplification of what happened, and only part of the story, but it is the untold part of the story, and in all likelihood the most important part. The Fed was in a panic in 2008, but not primarily about what might happen to Wall Street, and certainly not about what might happen to Main Street. It was in a panic over what might happen to government finance.

This interpretation is strengthened by new information contained in former Treasury secretary Hank Paulson’s recent book. He revealed that Russia tried in 2008 to persuade China to join in a collaborative effort to dump U.S. bonds in order to bring down the U.S. financial system. Although China refused to do so at the time, its government would clearly like to end dollar dominance, and has  been paring U.S. bond purchases.

At the moment,  Janet Yellen’s worries about finding buyers of government bonds can only be getting worse. For much of last year, foreign central bank purchases of U.S. bonds in aggregate fell. As of October of 2013, they had been negative for three and six months. Then they turned up a smidge, only to fall again, so that the last three months show a decrease of just over 12%.

It is known that Russia withdrew its U.S. bonds from custody of the Fed after the Crimea invasion, and has either been selling or could sell at any time. It will no doubt try again to persuade other countries to join in undermining the U.S. bond market and replacing the dollar as the mainstay of world trade.

Under these circumstances, it should not be surprising that the Fed is today taking only baby steps to reduce its program of creating new money to buy U.S. bonds. This program is probably not just meant to revive the economy, which it has not done and cannot do. It is more likely designed as a desperate and in the long run counterproductive effort to finance the U.S. government and save today’s dollar dominated financial system.

The Fed Is Not Following The Law

799px-Handcuffs01_2003-06-02Some of the games being played behind closed doors by the Fed are not only troubling. They are not even legal.

It was a clear violation of Section 14 (B) of the Federal Reserve Act for the Fed to respond to the Crash of 2008 by buying $1.5 trillion of mortgages not guaranteed by the federal government. The agency hid behind Section 13.3 language allowing a broad scope of action under “unusual and exigent circumstances,” but the statute states clearly that Section 13.3 loans can only be short term and backed by high quality collateral, a requirement that was blatantly ignored.

It was also a violation of both the Fed statute and the Constitution to offload potential Fed losses from its hedge fund-like operations onto the Treasury, as was done stealthily via a note to the Fed’s Statistical Release H 4.1 dated January 6, 2011. The notion of the Treasury (i.e. The taxpayers) having to bail out the Fed is not just a theoretical possibility. The Fed’s annual report just released shows a $53 billion unrealized loss.

It would also appear to be a violation of the Constitution to locate the new Consumer Financial Protection Bureau created by the Dodd-Frank Act inside the agency. The Constitution requires that all government expenditures be authorized and funded by Congress. The Fed has always been treated as an exception. It uses income on securities it has bought with newly created money to pay its bills and has not even been subject to Congressional oversight.

Having a secretive, self-funded, extra-constitutional agency inside government was bad enough when the Fed consisted of seven governors and a few staff members. The new Consumer Bureau already employs an estimated 1,359 people and keeps growing. Many of these employees were transferred from other government agencies where they formerly had been counted as part of the federal budget, but are now suddenly off-budget. If this is allowed to stand, what other federal agencies will be slipped inside the Fed in future in order to reduce the reported Federal deficit?

Some of the Fed’s actions since the Crash have been perfectly legal, but also designed to escape detection by the press and public. For example, in the dark days of the 2008 crash, a provision was buried deep in the TARP bill passed by Congress authorizing the Fed to pay interest to banks on their lending reserves. This made it legal for the Fed to print money and hand it over to the banks in unlimited amounts. One wonders how many members of Congress were aware they were passing this?

Today the Fed pays ¼ of 1 percent interest on trillions of dollars of unused bank reserves. An estimated 37% of that is paid to foreign banks. This is a grey area legally. One wonders how many members of Congress know about it.

During the Crash itself, as much as 70% of Fed discount window loans seem to have gone to foreign banks at rates as low as 0.01%. In other words, we made huge gifts to foreign banks.

If the economy gets overheated, the Fed says that it will simply increase the interest it is paying on bank reserves to ensure that those reserves aren’t turned into loans to business and consumers. But the more money that is created to pay interest on unused reserves, the bigger the unused reserves become. In typical government style, a problem will be alleviated short term only at the cost of making it worse in the future.

After reading this post, you might conclude that someone should sue the Fed over its illegal actions. Unfortunately taking the Fed to court is easier said than done. Under federal law, you must have “standing” to sue. Ordinary citizens are deemed not to have standing. Under recent court decisions, even banks do not seem to have standing, despite their being regulated by the Fed.

Fed illegality can best be addressed by Congressional action. Congress created the Fed and can reform it or even shut it down. There are critics of the Fed in Congress, but not nearly enough of them. And there are reasons why Congress mostly leaves the Fed alone.

It is the Fed that backstops federal deficit spending. Without the Fed, government could not continue indefinitely spending more than its tax revenue. So long as politicians think they benefit from the expansion of government and runaway spending, they will not want to reform the Fed.

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What David Hume ( 1711-76) Has To Teach Us Today

Painting_of_David_HumeReading David Hume on economics, one has the feeling that he is rebutting current Keynesian policies. How could that be, since Keynes lived hundreds of years later? The explanation is simple: Keynesianism is not new. It is just a revival of the  old mercantilist ideas that Hume was targeting.

Keynes even admits at the end of the General Theory that he is reviving mercantilism, apparently having forgotten his claim at the beginning of the same book to be staking out new ground in economics. Whatever the reason, much of Hume seems highly relevant to today’s debates:

1. On deficit spending

“…Our modern expedient, which has become very general, is to mortgage the public revenues, and to trust that posterity will pay off the encumbrances contracted by their ancestors:  …[This is] …a…ruinous… practice….

“It is very tempting to a minister to employ such an expedient, as it enables him to make a great figure during his administration, without overburdening the people with taxes, or exciting any immediate clamors against himself. The practice, therefore, of contracting debt, will almost infallibly be abused in every government. It would scarcely be more imprudent to give a prodigal son a credit in every banker’s shop in London, than to empower a statesman to draw bills, in this manner, upon posterity.

“What, then, shall we say to the new paradox, that public encumbrances are, of themselves, advantageous, independent of the necessity of contracting them. . . .  [These]… absurd maxims [ are] patronized by great ministers, and by a whole party among us. . . .

“It must, indeed, be one of these two events; either the nation must destroy public credit, or public credit will destroy the nation. It is impossible that they can both subsist. . . .” [ Of Public Credit]

2.  On money and banking

“… A government has great reason to preserve with care its people and its manufactures. Its money, it may safely trust to the course of human affairs….

“ We fancy, because an individual would be much richer, were his stock of money doubled, that the same good effect would follow, were the money of every one increased; not considering that this would raise as much the price of every commodity, and reduce every man in time to the same condition as before. . . .” [Of the Balance of Trade]

“It is also evident, that the prices do not so much depend on the absolute quantity of commodities and that of money, which are in a nation, as on that of the commodities, which come or may come to market, and of the money which circulates….

“Though the high price of commodities be a necessary consequence of the increase of gold and silver, yet it follows not immediately upon that increase; but some time is required before the money circulates through the whole state, and makes its effect be felt on all ranks of people. At first, no alteration is perceived; by degrees the price rises, first of one commodity, then of another till the whole at last reaches a just proportion with the new quantity of specie which is in the kingdom.

“Institutions of banks, funds, and paper credit, with which we in the Kingdom are so much infatuated,…render paper equivalent to money,  [and] circulate it through the whole state…. What can be more short -sighted than our reasoning on this head… .

“It must be allowed that no bank would be more advantageous, than such alone as … never augmented the circulating coin.” [ Of Money].  (Hume pointed with admiration to the Bank of Amsterdam that was run at the time on 100% reserve lines.)

3. On trade

“Nothing is more usual, among states which have made some advances in commerce, than to look on the progress of their neighbors with a suspicious eye, to consider all trading states as their rivals, and to suppose that it is impossible for any of them to flourish, but at their expense. In opposition to this narrow and malignant opinion, I will venture to assert, that the increase of riches and commerce in any one nation, instead of hurting, commonly promotes the riches and commerce of all its neighbors; and that a state can scarcely carry its trade and industry very far, where all the surrounding states are buried in ignorance, sloth, and barbarism. . . .” [ Of the Balance of Trade]

4. On the theory of Value

When Hume received a copy of Adam Smith’s Wealth of Nations during his final illness, he immediately saw the error of Smith’s labor theory of value:

“If you were at my fireside, I should dispute some of your principles. I cannot think…but that… price is determined altogether by the quantity and the demand.” [ Letter to Adam Smith, April 1, 1776, Hume’s Correspondence, Writings on Economics, E. Rotwein, 1955. P. 217]

5. On the need for better economic reasoning

“Mankind are, in all ages, caught by the same baits: the same tricks played over and over again, still trepan them.” [ Of Public Credit]

“. . . It must be owned, that nothing can be of more use than to improve, by practice, the method of reasoning on these subjects, which of all others are the most important, though they are commonly treated in the loosest and most careless manner.” [ Of Interest]

 

 

Obama’s Latest Fed Appointments

387px-Marriner_S._Eccles_Federal_Reserve_Board_BuildingPresident Obama has named three more nominees to the Fed and the Senate has had a chance to interview them. The first and most important is Stanley Fischer, aged 70, nominee for vice chairman as well as a regular member.

The most curious thing about Fischer’s resume is that, having been born in Zambia, and naturalized as an American in 1976, he accepted Israeli citizenship in 2005 in order to become head of Israel’s central bank. Today he holds dual citizenship. Prior to living in Israel, he worked as a vice chairman of Citigroup from 2002-5, the years leading to the bank’s bail-out, and prior to that was deputy director of the International Monetary Fund, chief economist of the World Bank, and professor at MIT, where he taught Ben Bernanke among others. Somewhere along the way, he acquired a personal fortune of between $14 and $56mm.

We are thus to understand that President Obama, having searched the entire length and breadth of our land, could find nobody better than a 70 year old with Wall St. and International Monetary Fund baggage who had most recently worked for a foreign government.

The second nominee after Fischer is Lael Brainard, who has recently worked at the Treasury as an undersecretary. Ms. Brainard told senators that the Fed should protect “the savings of retirees.” She did not bother to explain how refusing to allow interest to be paid on savings, or seeking to foster inflation higher than interest would do so.

The final nominee, Jerome Powell, would be a reappointment. Although not a Phd economist and nominally a Republican from the George H. W. Bush administration, he fits the Obama mold in other ways, notably by being from Wall Street, and by being willing to keep quiet and go along. His most daring moment came when he called the Fed’s money creation machine under Bernanke and now under Janet Yellen “innovative and unconventional” and added that “likely benefits may be accompanied by costs and risks.” He has been a reliable vote for Bernanke and likely will be for the Yellen/Fischer regime as well.

Senator Corker ( R-Tenn.) waxed enthusiastic about this group of three, saying “I’m impressed,” and leading bond manager Mohamed El-Erian describes them as a “dream team” together with Yellen.

This does indeed seem to be a “dream team” for Wall Street, for corporations boosting profits to record levels with the help of government deficits, for other special interests feeding off the stimulus trough, and for government employees. For everyone else, it just promises more and eventually even worse economic misery.

US Government Will Continue Interfering With Apple Pricing Decisions

220px-Red_AppleA federal court has ruled that a US Department of Justice “monitor” will remain inside Apple Computer to supervise all the company’s pricing decisions.

The “monitor,” Michael Bromwich, was appointed when Apple lost an anti-trust case involving E-books. He bills for his time at $1,100 an hour and charged $138,432 for his first two weeks of “work.”

Apple has filed an appeal which labels Bromwich’s appointment “unprecedented and unconstitutional.” This “monitor” is a particularly dangerous precedent because court appointed. But by now “monitors” established through “settlements” are common.

Joseph Covington, who headed the Justice Department’s Foreign Corrupt Practices Act Division in the 1980’s, told Forbes, in reference to monitors appointed to enforce settlements under that act: “This is good business for Justice Department lawyers who create the marketplace [for monitors] and then get…a job there [after they leave government].”

Nor is it limited to the Justice department. If a company gets into the sights of the Federal Trade Commission (FTC) or even the Food and Drug Administration (FDA), the terms of settlement increasingly include “monitoring” by highly paid lawyers, who are typically former FTC or FDA employees.

This is not just the small time corruption it might seem. The collapse of the Soviet Union should have demonstrated once and for all how important free and unimpeded prices are for an economy. Can Apple really be expected to continue its past success if it cannot even control its own pricing?

How did Apple get into this mess? Didn’t Apple give enough money to the Obama administration? Apple employees gave 93 percent of their contributions to Obama in 2012 and only 7% to Romney. Wasn’t that good enough? Perhaps not. Google employees gave 98 percent of their money to Obama and it was a whole lot more money ($727,702 versus $338,752). Apple CEO Tim Cook failed to max out (give to the legal limit) in his own contribution.

Politico mocked Apple during the election year for being “naive” in failing to hire enough Washington lobbyists to protect its interests. And, importantly, Jeff Bezos, owner of Amazon and de facto”winner” of  the anti-trust case against Apple, bought the Washington Post. Owning the Post makes him a key Washington player and provides his company a great deal of political protection.

Lack of campaign contributions may not be the only factor driving the politicized Justice Department in its pursuit of Apple. There is also the Patriot Act. Apple announced that it would both reveal any government request to gain access to people’s private information and oppose it. That would not have been well received by the administration.

Henry Waxman: “Legislative Genius” or Corrupt Crony Capitalist?

George_Bush_signs_the_Federal_Funding_Accountability_and_Transparency_Act_of_2006President Obama described his fellow Democrat, who just announced his retirement after four decades in Congress, as “one of the most accomplished legislators of his or any era.” The Washington Post’s Harold Meyerson calls him a ” legislative genius” who “decisively consigned the Republican right’s favored ideology—libertarianism—to history’s dustbin.” He did so, Meyerson went on, by proposing “common sense” laws. “Who could be against “ Waxman?

In order to answer this question, one must look at what he actually did. One of the reasons that Waxman was so powerful was that he operated behind the scenes. Few people outside of his district ever heard about him. He was the acknowledged master of underhanded legislative tricks, and was especially skilled at writing amendments that not even a lawyer could understand and then slipping them into unrelated bills when nobody was watching.

For example, he drafted a bill written in no known human language that was intended to restrict the sale of dietary supplements, a longtime crusade of his. He then waited until House and Senate were about to reconcile their massive Wall Street reform bills and at the last moment dropped in his supplement bill posing as an amendment to the finance bill. Fortunately the totally unrelated amendment was discovered just before one of Waxman’s famous all night conference committee meetings, and after heated discussion was rejected by the other conferees.

The odd part of this story is that Waxman’s district, which included part of Hollywood, must have teemed with health food stores selling dietary supplements. It is doubtful that many of the voters supporting him even knew about this and similar behind-the-scenes gambits.

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Does Barack Obama Realize How Indebted He is to Herbert Hoover?

HDid you notice this line in the president’s recent State of the Union address: “ I ask… America’s business leaders to…raise your employees’s wages.”

This is not the first time a president has made this “request” of employers.

After the stock market crash of 1929, President Hoover began talking about wages. They needed to be protected from cuts, he said, and preferably increased, so that consumer demand would increase. More consumer demand would supposedly get the economy through the storm.

As the economy sputtered and prices began to fall, Hoover acted on his pet theory. He began lobbying businesses not to reduce wages. He did more than lobby. He sent a clear signal that if his directive was ignored, the government might step in and legislate wages.

Businesses listened. But they also had their backs against a wall. With consumer prices falling, wage reductions were needed to protect profits. Without profits, a business fails and everyone loses their job.

Faced with this reality, but afraid to make any reduction in wages, businesses did the only thing they could do to try to stay afloat: they cut jobs. Millions were thrown out of work who might have kept their jobs at reduced pay but for Hoover’s intervention. All of this is described fully in Murray Rothbard’s masterful account of the Great Depression.

When the new Roosevelt administration came in, it embraced the same bogus economic theory. Both prices and wages were tightly controlled by the National Recovery Act. In a famous incident, a New Jersey immigrant worker, Jacob Maged, was sentenced to jail for three months on a charge of pressing a suit for 35 cents instead of the legislatively required 40 cents.

These policies had the paradoxical effect of making some Americans newly affluent even while throwing millions out of work. Since prices had fallen sharply, those who kept their jobs at the old wages could in many cases buy twice as much with the same money.

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Where Is The Inflation Today?

4161629227_6a52154cf3People often ask today: if the Fed has created so much new money, why hasn’t it produced more inflation?

When the Fed creates masses of new money, it initially flows to Wall Street, which profits from  it in a variety of imaginative ways, but from there its path is unpredictable.

The Fed inserted into the TARP bill in 2008 the authority to pay interest on bank reserves. Of course this interest is paid by creating even more new money, but it provides an incentive for banks to leave reserves idle.

On the other hand, the reserves are not as idle as they look. For example, they support derivatives activity. The total amount of derivatives held by the top four US banks is estimated at the moment to be $217 trillion. And keep in mind that it was derivatives exposure that brought Lehman Brothers down in 2008.

To the degree that the new money does get out into the economy, it will flow in different directions and have different effects. If it reaches the average consumer, it will produce consumer price inflation. This does seem to be happening. Consumer price inflation calculated as it was in the past would be much higher than today’s reported 1%.

If the new money  reaches rich people, it will drive up the prices of what rich people buy. We see this today when a single townhouse in Manhattan is listed for over $100 million. If it flows into the stock market, it will raise stock prices. If enough flows in this direction, it will create an asset bubble, which seems to be happening once again today. Asset bubbles are followed by crashes, which in turn bring recession and unemployment.

Wherever the new money flows, it may increase demand in the short run, only to reduce it in the long run. This is because the new money created by the Fed is not just given away. It is made available to banks to lend, which means that it enters the economy as debt. A little debt, especially if spent or invested wisely, may help an economy. But too much will strangle it.

As consumers, businesses, and governments become weighed down with more and more debt from the past, especially debt that was spent unwisely, the interest and principal payments become increasingly burdensome. Dollars that might have been spent on new investments with the potential to create new jobs and new income are instead siphoned off to pay for past mistakes. We end up with a zombie economy, still breathing, but just barely.

Historically we can measure how many dollars of economic growth we get from each new dollar of debt. At the moment, it seems to be negative. In other words, more new debt makes it worse, not better.

Despite this plain evidence, the Fed continues to try to persuade consumers and businesses to increase their borrowing and spending and also underwrites government borrowing and spending. It holds interest rates very low, which for now keeps the debt house of cards from tumbling down.

Will the Fed’s feckless money creation end in inflation or depression? It could go either way, which is potentially confusing. Insofar as it stokes demand, it could lead to inflation. Insofar as it increases an already too heavy debt burden, it could lead instead to recession, joblessness, and depression. Or it could lead first to the one and then to the other.

It could also lead to a third possibility: stagflation. In this scenario, consumer prices advance even while unemployment increases. We had this in the 1970’s. If we measured inflation as we did in the 1970’s, it would be apparent that this already exists today.

( Photo credit: Gage Skidmore)

 

Can The Fed Reverse The “Monetary Morphine?”

800px-MorphineRxDuring Senate confirmation hearings on the nomination of new Fed chairman Janet Yellen,  Mike Johanns ( R-Neb) expressed the opinion that Fed stimulus is putting the economy on an unsustainable “sugar high.”  Pat Toomey (R-PA) described it as a monetary “morphine drip.”

The Fed insists that it can quickly reverse all the new money it has conjured up to create this  “sugar high” or “monetary morphine.” Retiring chairman Ben Bernanke said on 60 Minutes that he had 100% confidence about this. But the facts suggest otherwise.

Respected economist John Hussman has called present Fed policies a roach motel, easy to get into but hard to get out of. He calculates that lifting short term interest rates back to 2%, a very low rate by historical standards, would require the Fed to sell at least $1.5 trillion of securities on the open market. Who would buy these securities?

In recent years, the US government has counted on foreign central banks to buy US treasuries not purchased by the Fed. These foreign central banks, like the Fed, are using newly created money. And their willingness to hold more US debt has sharply waned over the past year. There are indications that China in particular has decided not to add to its US treasury holdings.

For now, it is likely that the Fed will at least appear to “taper” its “stimulus.” It will report less “quantitative easing,” but this shift does not mean it won’t create new money in a slightly different way, using a different term for it. This is already under consideration within the Fed building.

Here is Janet Yellen’s explanation for the paradoxical policy of creating more new money and debt to cure a problem caused by creating too much new money and debt in the first place:  “You know, if we want to get back to business as usual and a normal monetary policy and normal interest rates, I would say we need to do that by getting the economy back to normal.”

 

New Fed Chair Starts With– What Else?–A Forecast

Janet_yellen_swearing_in_2010Janet Yellen celebrated her confirmation as Fed Chairman on January 6 by immediately issuing a carefully hedged prediction: “I am hopeful that the first digit [ of GDP growth] could be 3 rather than 2… and  [that] inflation will move back toward our longer-run goal of 2%.”

Let’s hope she has better luck with her predictions than the retiring Ben Bernanke, who almost always got his wrong.

In 2006, at the zenith of the housing bubble, he told Congress that house prices would continue to rise. In 2007, he testified that failing subprime mortgages would not threaten the economy.

In January 2008, at a luncheon, he told his audience there was no recession on the horizon. As late as July 2008, he insisted that mortgage giants Fannie Mae and Freddie Mac, already teetering on the verge of collapse, were “ adequately capitalized [and] in no danger of failing.”

Following the Crash of 2008, Bernanke’s prognostications did not much improve. Nor did Yellen’s, who had also misjudged the housing bubble, and who became Fed vice chairman in 2010.

The two of them got the “recovery” they predicted, but the weakest “recovery” in history. Real income for the average American fell during the recession, but then fell even more after its supposed end, and now hovers at a level last seen in 1989.