Archive for The Fed

‘Everything we are told about deflation is a lie’

By Tim Price

[The Cobden Centre]

“The European Central Bank has given its strongest signal yet that it is prepared to embrace quantitative easing to prevent the euro zone from sliding into deflation or even a prolonged period of low inflation.”

- ‘Draghi strengthens QE signal’, Financial Times, April 4, 2014.

Yes, heaven protect Europe’s embattled citizens and savers from a prolonged period of low inflation. How could they possibly survive it ?

If history is any guide, probably quite well. As Chris Casey points out in his essay “Deflating the Deflation Myth,” the American economy during the 19th Century twice experienced deflationary periods of roughly 50 percent:

Source: McCusker, John J. “How Much Is That in Real Money?: A Historical Price Index for Use as a Deflator of Money Values in the Economy of the United States.” Proceedings of the American Antiquarian Society, Volume 101, Part 2, October 1991, pp. 297-373.

This during a period of “sustained and significant economic growth”. But just think of all those poor consumers, having to make the best of constantly falling everyday low prices.

In their research article ‘Deflation and Depression: Is There an Empirical Link?’ of January 2004, Federal Reserve economists Andrew Atkeson and Patrick Kehoe found that “..the only episode in which we find evidence of a link between deflation and depression is the Great Depression (1929-1934). We find virtually no evidence of such a link in any other period.. What is striking is that nearly 90% of the episodes with deflation did not have depression. In a broad historical context, beyond the Great Depression, the notion that deflation and depression are linked virtually disappears.”

In his 2008 essay ‘Deflation and Liberty’, Jörg Guido Hülsmann writes as follows:

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For More Jobs and Stability, Set the Economy Free

6718John Cochran writes in today’s Mises Daily:

Unfortunately Yellen’s strong compassion for the plight of the unemployed comes tied to a faulty understanding of the cause of unemployment. With Yellen’s ascendency to the Chair of the Fed, the Wall Street Journal notes the “Tobin Keynesians are back in charge at the Federal Reserve.” The last time this group’s Phillips Curve-based ideas dominated Fed policy, the Fed engineered the stagflation of the 1970s. Exhibiting a lack of historical understanding, sympathetic cheerleaders such as Justin Wolfers see Yellen’s commitment to the dual mandate as a plus.

Yellen’s appointment should be viewed as an investment in the Fed’s dual mandate, which emphasizes the central bank’s role in taming both unemployment and inflation. The unemployed should rejoice that they have a powerful advocate willing to battle the hard-money types willing to consign them to the economic scrap heap.

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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Deflating the Deflation Myth

Burst your bubbleChris Casey writes in today’s Mises Daily

If deflation does not cause recessions (or depressions as they were known prior to World War II), what does? And why was it so prominently featured during the Great Depression? According to economists of the Austrian School of economics, recessions share the same source: artificial inflation of the money supply. The ensuing “malinvestment” caused by synthetically lowered interest rates is revealed when interest rates resort to their natural level as determined by the supply and demand of savings.

In the resultant recession, if fractional-reserve-based loans are defaulted or repaid, if a central bank contracts the money supply, and/or if the demand for money rises significantly, deflation may occur. More frequently, however, as central bankers frantically expand the money supply at the onset of a recession, inflation (or at least no deflation) will be experienced. So deflation, a sometime symptom, has been unjustly maligned as a recessionary source.

Ben Bernanke Gets His Reward

6700Christopher Westley writes in today’s Mises Daily: 

“Bernanke Enjoys the ‘Fruits of the Free Market,’” or so we’re told in a Reuters headlinefrom March 4 about the former Fed chairman’s 40-minute speech in Abu Dhabi for which he received, ahem, $250,000. In the Reuters author’s defense, he was only quoting a DC lobbyist who was defending the amount, and added, Bernanke “will personally experience supply and demand.”

Well, yes, it’s just supply and demand and all that. No big deal and if you don’t like it, you must have something against markets. Still, it would be nice (and a bigger deal) if these reporters would quote someone outside of the accepted intellectual class of the Boswash corridor so compromised by being among the primary beneficiaries of all the new money Chairman Ben and his comrades created, ex nihilo, when he wasn’t shooting baskets in the Marriner Eccles building. If they did, they might hear some healthy skepticism about these events in which top officials cash in on their “public service” via contacts with the very industries they benefited while in office.

The Mythical Banking Crisis and the Failure of the New Deal

794px-Wpa1by David Stockman 

From David Stockman’s Contra Corner. Remarks to the Committee For The Republic, Washington DC, February 2014 (Part 4 in a 6-Part Series) Go to Part 1.

The Great Depression thus did not represent the failure of capitalism or some inherent suicidal tendency of the free market to plunge into cyclical depression—absent the constant ministrations of the state through monetary, fiscal, tax and regulatory interventions.  Instead, the Great Depression was a unique historical occurrence—the delayed consequence of the monumental folly of the Great War, abetted by the financial deformations spawned by modern central banking.

But ironically, the “failure of capitalism” explanation of the Great Depression is exactly what enabled the Warfare State to thrive and dominate the rest of the 20th century because it gave birth to what have become its twin handmaidens—-Keynesian economics and monetary central planning. Together, these two doctrines eroded and eventually destroyed the great policy barrier—-that is, the old-time religion of balanced budgets— that had kept America a relatively peaceful Republic until 1914.

To be sure, under Mellon’s tutelage, Harding, Coolidge and Hoover strove mightily, and on paper successfully, to restore the pre-1914 status quo ante on the fiscal front.  But it was a pyrrhic victory—since Mellon’s surpluses rested on an artificially booming, bubbling economy that was destined to hit the wall.

The Hoover Recovery of 1932

Worse still, Hoover’s bitter-end fidelity to fiscal orthodoxy, as embodied in his infamous balanced budget of June 1932, got blamed for prolonging the depression.  Yet, as I have demonstrated in the chapter of my book called “New Deal Myths of Recovery”, the Great Depression was already over by early summer 1932.

At that point, powerful natural forces of capitalist regeneration had come to the fore. Thus, during the six month leading up to the November 1932 election, freight loadings rose by 20 percent, industrial production by 21 percent, construction contract awards gained 30 percent, unemployment dropped by nearly one million, wholesale prices rebounded by 20 percent and the battered stock market was up by 40 percent.

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How the Artificial Boom of 1914-1929 Caused the Great Depression

732px-Unemployed_men_queued_outside_a_depression_soup_kitchen_opened_in_Chicago_by_Al_Capone,_02-1931_-_NARA_-_541927by David Stockman

From David Stockman’s Contra CornerRemarks to the Committee For The Republic, Washington DC, February 2014 (Part 3 in a 6-Part Series) Go to Part 1.

In this setting, Bubbles Ben 1.0  (New York Fed Governor Benjamin Strong) stormed in with a rescue plan that will sound familiar to contemporary ears. By means of his bond buying campaigns he sought to drive-down interest rates in New York relative to London, thereby encouraging British creditors to keep their money in higher yielding sterling rather than converting their claims to gold or dollars.

The British economy was thus given an option to keep rolling-over its debts and to continue living beyond its means. For a few years these proto-Keynesian “Lords of Finance” —- principally Ben Strong of the Fed and Montague Norman of the BOE—-managed to kick the can down the road.

But after the Credit Anstalt crisis in spring 1931, when creditors of shaky banks in central Europe demanded gold, England’s precarious mountain of sterling debts came into the cross-hairs.  In short order, the money printing scheme of Bubbles Ben 1.0 designed to keep the Brits in cheap interest rates and big debts came violently unwound.

In late September a weak British government defaulted on its gold exchange standard duty to convert sterling to gold, causing the French, Dutch and other central banks to absorb massive overnight losses. The global depression then to took another lurch downward.

Inventing  Bubble Finance : The Call Money Market Explosion Before 1929

But central bankers tamper with free market interest rates only at their peril—-so the domestic malinvestments and deformations which flowed from the monetary machinations of Bubbles Ben 1.0 were also monumental.

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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.

The 1914-1929 Boom Was An Artifact of War And Central Banking

390px-Flappermag001by David Stockman 

From David Stockman’s Contra Corner. Remarks to the Committee For The Republic, Washington DC, February 2014 (Part 2 in a 6-Part Series) See Part 1.

During the Great War America became the granary and arsenal to the European Allies—-triggering an eruption of domestic investment and production that transformed the nation into a massive global creditor and powerhouse exporter virtually overnight.

American farm exports quadrupled, farm income surged from $3 billion to $9 billion, land prices soared, country banks proliferated like locusts and the same was true of industry. Steel production, for example, rose from 30 million tons annually to nearly 50 million tons during the war.

Altogether, in six short years $40 billion of money GDP became $92 billion in 1920—a sizzling 15 percent annual rate of gain.

Needless to say, these fantastic figures reflected an inflationary, war-swollen economy—-a phenomena that prudent finance men of the age knew was wholly artificial and destined for a thumping post-war depression. This was especially so because America had loaned the Allies massive amounts of money to purchase grain, pork, wool, steel, munitions and ships. This transfer amounted to nearly 15 percent of GDP or $2 trillion equivalent in today’s economy, but it also amounted to a form of vendor finance that was destined to vanish at war’s end.

Carter Glass’ Bankers’ Bank: The Antithesis Of Monetary Central Planning

As it happened, the nation did experience a brief but deep recession in 1920, but this did not represent a thorough-going end-of-war “de-tox” of the historical variety.  The reason is that America’s newly erected Warfare State had hijacked Carter Glass “banker’s bank” to finance Wilson’s crusade.

Here’s the crucial background: When Congress acted on Christmas Eve 1913, just six months before Archduke Ferdinand’s assassination, it had provided no legal authority whatsoever for the Fed to buy government bonds or undertake so-called “open market operations” to finance the public debt.  In part this was due to the fact that there were precious few Federal bonds to buy. The  public debt then stood at just $1.5 billion, which is the same figure that had pertained 51 years earlier at the battle of Gettysburg, and amounted to just 4 percent of GDP or $11 per capita.

Thus, in an age of balanced budgets and bipartisan fiscal rectitude, the Fed’s legislative architects had not even considered the possibility of central bank monetization of the public debt, and, in any event, had a totally different mission in mind.

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How Inflation Destroys the Wealth of Nations

6682Joseph Salerno writes in today’s Mises Daily: 

Brown explains that such monetary disequilibrium is not necessarily manifested in consumer price inflation in the short run. In fact, it is generally the case that the symptoms first appear as rising temperatures on assets markets. Indeed some episodes of severe monetary disequilibrium, such as those that occurred in the U.S. during the 1920s, the 1990s, and the years leading up to the financial crisis of 2007-2008, may well transpire without any discernible perturbations in goods and services markets. Yet overheated asset markets are completely ignored in the Friedmanite view of monetary equilibrium that underlies the Bernanke-Draghi policy of inflation targeting. Brown perceptively argues that one reason for the wholesale neglect of asset price inflation is the positivist approach that is still dominant in academic economics. Speculative fever in asset markets is nearly impossible to quantify or measure and thus does not neatly fit into the kinds of hypotheses that are required for empirical testing.