Free Markets, Free People


Cracks in the Edifice

For the most part, both the Fed and the Obama Administration have been publicly confident of a number of things. They’ve assured us that the bailouts and stimulus spending, along with the great monetary expansion we’ve had since last October, were necessary to stave off economic collapse.  They’ve also assured us that they have an end game for unwinding these policies when necessary.

But, Federal Reserve Bank of St. Louis President James Bullard is now warning that the negative results of the monetary expansion imposes more risk of inflation than generally believed.

I am concerned about a popular narrative in use today … that the output gap must be large since the recession is so severe … [and] any medium-term inflation threat is negligible, even in the face of extraordinarily accommodative monetary policy. I think this narrative overplays the output-gap story.

Take away Pres. Bullard’s Fed-speak, and what you have is a Federal Reserve bank president warning that the Fed’s accomodative policy runs a very real risk inflation when the economy picks up.  Naturally, to fight this ionflation, the Fed will need to raise interest rates.  With a doubling of the monetary base in the past year, that implies the possibility for raising rates quite substantially, which could strangle any nascent economic recovery in the cradle.

So, while Pres. Bullard also says that moderate economic growth for the end of the year is possible, we probably shouldn’t get our hopes up for a while.

Meanwhile, all of the extra dollars floating out there, combined with extremely large federal budget deficits for the next several years, is having an effect on the dollar.  Not only has the number of dollars vastly expanded, the deficits require greatly increased bond sales, which encumber the federal government with a long-term debt obligation that will be harder and harder to meet.  This is making the dollar…unattractive to heathen foreigners.  Not only in terms of dollar-denominated investments, but also in making the dollar fundamentally unattractive as  the world’s reserve currency. The rumblings about dumping dollar continue.

[T]he United Nations itself last week called for a new global reserve currency to end dollar supremacy, which had allowed the United States the “privilege” of building up a huge trade deficit.

UN undersecretary-general for economic and social affairs, Sha Zukang, said “important progress in managing imbalances can be made by reducing the (dollar) reserve currency country’s ‘privilege’ to run external deficits in order to provide international liquidity.”

Zukang was speaking at the annual meetings of the International Monetary Fund and World Bank, whose President Robert Zoellick recently warned that the United States should not “take for granted” the dollar’s role as preeminent global reserve currency.

You cannot simultaneously have your currency act as the global reserve currency while deflating the currency to uselessness by using foreign investment in dollars to maintain huge current account deficits.  The foreigners may talk funny, and have quaint ways, but they’re not big enough hayseeds to recognize who ultimately gets the short end of that deal if it continues.

Still, our government’s response has been heartening.

Following the summit, US Treasury Secretary Timothy Geithner repeated Washington’s commitment to a strong dollar.

At this point, I suspect that the international financial community takes this commitment as seriously as the attendees of the local junior college take my commitment to have sex with barely legal teen girls.  Actually, my commitment probably has a better chance of coming to fruition, since the international financial community doesn’t have “daddy issues”.

Meanwhile,  all of the teachers, cops, firemen, DMV workers, etc., who thought taking a relatively low-paying government job now in return for really good retirement benefits, may need to rethink that strategy.

The upheaval on Wall Street has deluged public pension systems with losses that government officials and consultants increasingly say are insurmountable unless pension managers fundamentally rethink how they pay out benefits or make money or both.

Within 15 years, public systems on average will have less half the money they need to pay pension benefits, according to an analysis by Pricewaterhouse Coopers. Other analysts say funding levels could hit that low within a decade.

After losing about $1 trillion in the markets, state and local governments are facing a devil’s choice: Either slash retirement benefits or pursue high-return investments that come with high risk.

In other words, start stocking up on Alpo for those hearty retirement meals, or hope that the pension fund’s investment in fur-bearing trout farms come through big-time.

But it’s not just government workers who may be looking at a bleak future.  The government’s actions since last October are also having unintended consequences on the domestic economy that affects all of us–although I should point out that these unintended consequences were entirely predictable.

The Fed’s policy of essentially free money means that household savers get no return at all on CD’s, T-bills, Money Markets, etc., while speculators can borrow money at no cost, and toss them at any speculative investment that promises any return at all.  So traditional savings are being gutted.

Excessive government borrowing is sucking the air out of the private credit markets.  While goverment borrowing is proceeding at a $1.9 trillion annual rate, private credit is collapsing.

Last year, banks provided new credit at the annual pace of $472.4 billion in the first quarter and $86.7 billion in the second. This year, on a net basis, they’re not providing any credit whatsoever. In fact, they’re actually liquidating loans at the rate of $857.2 billion in the first quarter and $931.3 billion in the second.

Ditto for mortgages. Last year, mortgages were being created at the annual clip of $522.5 billion and $124 billion in the first and second quarters, respectively. This year, they’ve been liquidated at an annual pace of $39.3 billion in the first quarter and $239.5 billion in the second.

This lack of credit means that businesses have been unable to expand or hire–or even maintain their workforce.  As a result, 7.2 million jobs have been lost in the last 21 months, compared to the 2.7 million jobs lost in the 30 months of the last recession.  The official unemployment rate of 9.8% hides the effect of discouraged job seekers, or the under-employed, which means the actual unemployment rate, as it was calculated prior to 1973 is 17%.  Shadow Government Statistics places the actual unemployment rate at an even worse 21%.

And now, after all the unintended consequences of our past actions, some in Congress are now calling for Stimulus II.  Apparently, Stimulus I did such a bang-up job, that they want to double down on two sixes.

Hop.  Hop.  Hop.

the United Nations itself last week called for a new global reserve currency to end dollar supremacy, which had allowed the United States the “privilege” of building up a huge trade deficit.

UN undersecretary-general for economic and social affairs, Sha Zukang, said “important progress in managing imbalances can be made by reducing the (dollar) reserve currency country’s ‘privilege’ to run external deficits in order to provide international liquidity.”

Zukang was speaking at the annual meetings of the International Monetary Fund and World Bank, whose President Robert Zoellick recently warned that the United States should not “take for granted” the dollar’s role as preeminent global reserve currency.

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5 Responses to Cracks in the Edifice

  • Actually, my commitment probably has a better chance of coming to fruition, since the international financial community doesn’t have “daddy issues”.

    Though it also doesn’t have a wife that would see to it that we never found all of your body…

    So there are trade-offs…

  • I believe that since the early eighties, when debt started to massively expand, the the current account went from surplus to deficit, we’ve been on a path to economic disaster. It was made worse by the expansion of debt during the Bush Administration (not just government: credit card debt went from about $250 billion to now around a trillion, home equity has declined dramatically — total debt may be around $50 trillion now for all sectors), and Obama’s policies are exceedingly dangerous. When the baby boomers start retiring they’ll stop buying stocks and bonds, and start selling them. Then comes the expansion of retirement costs. Everything looks on course to a major economic meltdown.

  • Gold at record highs.
    Silver on an express elevator upward.
    Lead, attached to a brass casing, unobtainable in some cases.
    Buy precious metals.

  • Well, I’m not sure precious metals are going to ultimately be the best bet. The dollar is going to weaken dramatically, but that will start a re-balancing of the US and world economy. The US will buy fewer cheap Asian goods and switch to home production, the current account deficit will contract considerably, and the center of economic power will move away from the US and become more diffuse. That process is underway, as the US starts to learn that it no longer is the dominant world power. Precious metals is the best bet if you strongly believe some of the worst theories of global warming — if they are true, then we could face total global economic crisis.