Dale Franks’ QandO posts
In the Financial Times today, Martin Wolf comes out swinging (free registration required) against those who are afraid the Fed’s Quantitative Easing programs carry a danger of sparking serious inflation.
The essence of the contemporary monetary system is creation of money, out of nothing, by private banks’ often foolish lending. Why is such privatisation of a public function right and proper, but action by the central bank, to meet pressing public need, a road to catastrophe? When banks will not lend and the broad money supply is barely growing, that is just what it should be doing (see chart).
The hysterics then add that it is impossible to shrink the Fed’s balance sheet fast enough to prevent excessive monetary expansion. That is also nonsense. If the economy took off, nothing would be easier. Indeed, the Fed explained precisely what it would do in its monetary report to Congress last July. If the worst came to the worst, it could just raise reserve requirements. Since many of its critics believe in 100 per cent reserve banking, why should they object to a move in that direction?
Now turn to the argument that the Fed is deliberately weakening the dollar. Any moderately aware person knows that the Fed’s mandate does not include the external value of the dollar. Those governments that have piled up an extra $6,800bn in foreign reserves since January 2000, much of it in dollars, are consenting adults. Not only did no one ask China, the foremost example, to add the huge sum of $2,400bn to its reserves, but many strongly asked it not to do so.
Everything he says is correct, but that’s not really any help, because the implications are pretty severe, even if he’s completely right.
First, let’s assume the Fed can, via repos or changes in reserve requirements, sterilize the increase in the money supply. The problem then becomes when does the Fed do this sterilization. let’s go back to 1981-1982. When the Fed was looking at monetary aggregates in the wake of the 1981 recession, they saw the money supply growing far faster than their target. At the time, the Fed’s primary tool was securities sales and purchases to control the rate of growth in the money supply directly, while letting the markets set interest rates. (Today, the fed primarily uses changes in the Discount Rate and Federal Funds target rate to run monetary policy.)
When the Fed saw those big increases in money supply, they immediately moved to sterilize the increases, to keep inflation in check. Sadly, the lack of velocity in the money supply, i.e., its actual rate of use in transactions, was near zero. as a result, the Fed’s tightening threw the economy into another recession, with unemployment rising to 11%. The policy may have been correct, but the timing was wrong.
So, what guarantee do we have that the Fed will perform sterilization at precisely the right time? If they move too early, the economy shuts down, a la 1982. Too late, and inflation takes off. Then the Fed would really have to tighten, which would probably result in another recession to wring out the extra inflation.
The trouble with the Fed is that monetary policy moves take 6-18 months to fully percolate through the economy. And they make these decisions based on economic data gathered in previous months. It’s like driving down the street by looking only at the rear-view mirror.
That makes proper timing by the Fed…hard.
Perhaps the Fed will operate as if run by infinitely wise solons, who know precisely when to sterilize their quantitative easing, either through repo operations, or raising the banks’ reserve requirements appropriately.
If it doesn’t, however, we’re looking at either another steep recession, or a bout of serious inflation, follwed by another serious recession to tame the inflation.
Oh, and even if the Fed is that good, it doesn’t address the problem of how the Chinese will react to any increased currency risk they face by holding dollar-denominated securities if the value of the dollar falls in the FOREX. As Mr. Wolf admits, the Fed’s mandate has nothing to do with the foreign exchange value of the dollar. So, maybe, the Chinese will decide to sell as much of their holdings in Treasuries as they can. That implies a serious decline in treasury prices, and a concommittant rise in bond yields, i.e., interest rates. Aaaand, we’re back to a possibility of a steep recession again Especially if they do it while the Fed is already in the middle of money supply sterilization operations.
So, I guess the question is, “How much to you trust in the ability of the Federal Reserve to do exactly the right thing, at exactly the right time?” And, “How much do you trust the Chinese to go along with all this?”
I suppose I should be surprised at this, but I’m not. Mitch McConnell seems now to believe that earmarks are a hallowed legislative prerogative, and Rep. Jerry Lewis is keen to retake the gavel of the Appropriations Committee.
Basically, the deal is this: After talking a good game about fiscal conservatism for months, the GOP is going to take its cues in the Senate from a guy who basically doesn’t give that much of a crap, and very likely empower a guy in the House whose top priorities have previously included money pit swimming pools into which he likes to dump massive, great, heaping piles of your hard-earned cash because, hey, he’s in charge here, dammit.
I don’t like it; you don’t like it. Let’s hope that by some miracle, folks calling the shots up on the Hill might possibly be paying attention to what everyone from the Tea Partiers to me, your local candy-ass RINO, thinks: Quit with the earmarks, and let’s not just empower the people who pursued them with zeal last time the GOP was in charge, because well screw it, we won… kind of…
So, is that the deal? Head fake to the right on spending for the Tea Party during the election, but back to business as usual after winning? Are the 2006 Republicans back?
If so, it’s gonna be a long two years, and 2012 is gonna be a nightmare.
It has become an article of faith in modern economics that the gold standard just isn’t suitable for modern economies. Since the Great Depression started the movement away from the gold standard, we have moved towards a system of freely convertible fiat currencies whose values are, in the main determined by the ability of central banks to maintain control of inflation. Any talk of returning to the gold standard, therefore, is derided as some sort of fanatical return to a failed past.
Now, to be sure, there are problems with gold as money. Some of them are perceived problems, others are real.
Ultimately, gold, as a currency, tends to be deflationary. A country’s money supply is limited by the amount of gold on hand. Absent an increase in the amount of gold, any increase in real output must cause prices to decline.
Also, any balance of payments deficit reduces the country’s gold supply. For instance, during the Depression, England had a horrific balance of payments problem. The country was paying out so much money in foreign payments, that it was literally draining all the gold out of Britain. The only real remedy to this was to massively deflate British prices…in the midst of an already deflationary recession.
Monetary shocks are easily transmitted from one country to another via gold. Since countries who participate in the gold standard have fixed links, inflation or depression in one country can be quickly transmitted to another. For instance, the discovery of a large gold mine increases the supply of gold, without affecting real output. That inflationary effect is quickly felt throughout all the countries who share the standard.
But–and this is a big “but”–the change from a gold standard to freely convertible fiat currencies has solved those old problems by introducing entirely new ones. Governments and central banks have embarked on massive programs of public indebtedness, the inflationary–and sometimes hyperinflationary–printing of fiat currencies, and the wholesale selling of sovereign debt to foreign countries who may not have, as their primary interest, recouping the money on their investments, but rather the manipulation of an enemy’s economy, should it become necessary.
These problems bring us to Robert Zoellick, the head of the World Bank. In an Op/Ed in the Financial Times addressing our current economic woes, he suggests something that will no doubt be much discussed. In a discussion of how to create a monetary regime to succeed the clearly dying Bretton Woods II paradigm in which we’ve operated since 1971, he suggests, among other things:
This new system is likely to need to involve the dollar, the euro, the yen, the pound and a renminbi that moves towards internationalisation and then an open capital account.
The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values. Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today.
If I’m not mistaken, the head of the World bank just called for the creation of a new gold standard for international trade.
This should be interesting.
In this podcast, Bruce and Dale discuss Tuesday’s midterm elections, and Friday’s unemployment report.
The direct link to the podcast can be found here.
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The reactions to the Federal Reserve’s announcement that they would embark on a new, $600 billion round of quantitative easing is raising reactions from all around the world.
Unbridled printing of dollars is the biggest risk to the global economy, an adviser to the Chinese central bank said in comments published on Thursday, a day after the Federal Reserve unveiled a new round of monetary easing.
German Economy Minister Rainer Bruederle said on Thursday he was concerned at U.S. efforts to stimulate growth by injecting liquidity into its struggling economy.
“I view that not without concern,” Bruederle said, adding that a variety of measures were needed to solve the problem and it was not enough to pump in liquidity alone…
Bruederle also said there was some truth to the criticism that the United States was influencing the dollar’s exchange rate with monetary policy and voiced concern about increased protectionism in different forms around the world.
Brazilian officials from the president down have slammed the Federal Reserve’s decision to depress US interest rates by buying billions of dollars of government bonds, warning that it could lead to retaliatory measures.
“It’s no use throwing dollars out of a helicopter,” Guido Mantega, the finance minister, said on Thursday. “The only result is to devalue the dollar to achieve greater competitiveness on international markets.”
Brazil, especially, seems to be treating this as a currency devaluation war, and, according to the Financial Times, really doesn’t like that.
But the worries go far beyond trade and protectionism issues brought about by fears of devaluation. It’s the domestic inflationary effects which have many–including me–worried:
Federal Reserve policies have put the US dollar the risk of crashing, which will hammer consumers through higher prices, strategist Axel Merk told CNBC…
“So we will have a cost-push inflation. We’re going to get inflation but not where Bernanke wants to have it. We’re not going to get wages to go up. We’ll get the price at the gas pump to go up instead.”
We’re right on a path towards high inflation and slow economic growth, otherwise known as “stagflation”. Except that there’s a lot more monetary expansion this time than we experienced in the 1970s. Maybe we’ll have to coin a new term, like “hyperstagflation”.
Oh, and in case you were wondering, it begins like this.
This is one of those cases where the headline numbers and claims of new jobs are so totally out of step with reality, that it’s hard to believe how badly the banner numbers reverse the actual employment situation. In fact, I’d argue that this month highlights perfectly why the Bureau of Labor Statistics needs to thoroughly revise the way the Employment Situation is reported.
To understand why, let’s look at the “A” Tables of the Employment Situation report. Take a careful look at the “Employed” line in the table. Last month, there were (in thousands) 139,391 persons employed. This month, there were (in thousands) 139,061 employed. So, non-farm payrolls may have increased by 151,000 jobs, but there are 330,000 fewer employed Americans than there were last month.
The total civilian, non-institutional adult population, in thousands, was 238,530 this month. With the historical long-term trend rate of labor force participation of 66.2%, that means the actual size of the labor force should be 157,907. With only 139,061 persons actually employed, the real unemployment rate is actually 13.6%, up from 13.2% last month, and from 12.8% in May.
The current labor force participation rate of 64.5 is the lowest since November of 1984.
Essentially, the employment situation worsened last month, rather than getting better. The only reason it looks better is because so many people are just dropping out of the labor force. When they do so, they magically disappear from the official banner statistics.
What is actually happening is that job growth is not keeping up with population growth, so every month, real employment is declining. It’s nice to see that employers have added 151,000 payroll jobs, but that simply isn’t a rate that keeps pace with job force growth. To give you an idea of how this is working, since Oct 09, the civilian non-institutional adult population has increased by 1,980 thousand people, while at the same time, the number of employed has risen by 819 thousand. That means that there is a deficit of 1,161 thousand jobs that has built up over the last year.
The banner statistics of payroll jobs and unemployment rate are increasingly out of step with the true employment situation.
Would you like to get a crystal clear insight into the “progressive” mindset. An informative look into the hard Left’s reaction to this week’s election. Well, go no further than this diary by Tim Wise at Daily Kos. Mr. Wise is not only miffed at the election, he’s already laying out a picture of the future in which the tables are turned.
You really should read the whole thing. I’d be interested in your responses.
What made me laugh out loud was wondering who Mr. Wise is planning to tax to pay for his socialist utopia, after all the rich white people are dead.
The Federal Reserve announced today that it would embark on a second round of “quantitative easing”, to the tune of $600 billion. This will join the previous round of $1.3 trillion over the last 18 months. For those of you who don’t know, Quantitative Easing is a monetary policy transaction, whereby the Federal Reserve buys securities from banks–usually US Treasury Notes and Bonds–with cash. This infuses fresh cash into the monetary system. After this second round of Quantitative Easing, the Fed will have injected $1.9 TRILLION in cash into the monetary system.
Now, sadly, the Fed did not, and does not, just have $1.9 trillion in cash lying around in big vaults to take Scrooge McDuck money swims in when the mood takes them. But that’s not particularly a problem, since the Federal Reserve simply prints up the required amount of cash (or creates it electronically for funds transfers). In any event, the Fed buys the securities with money that is newly made for that purpose.
With that in mind, my advice to you is to collect all of the printed currency you can. You will then need to package it in extremely tightly-wrapped bundles. Yes, it is a bit troublesome to do, but you’ll find that it burns much longer and hotter that way, which works far better for either cooking or heating purposes.
I have a few random thoughts about the midterm election results.
You never run the table. You always lose a race or two where you th ought you were strong. But what was odd about last night is how the Republican wave simply crashed against the Pacific time zone. After turning over the Senate seats in Pennsylvania, and especially in the blue states of Wisconsin and Michigan, it’s hard to believe that the Democrats kept Colorado, Washington, and Nevada intact. There was every indication that two of those states were going to go Republican. That they didn’t is just puzzling.
There hasn’t been a mid-term House turnover this sweeping since 1938, when a Republican tide essentially ended the New Deal. The 65-seat gain for Republicans means that the Democrats lost more house seats than the Republicans did in 2006 and 2008 combined.
CNN is projecting the final Republican House seat tally will be 243. I predicted 247 (+/-3). So, I missed it by one seat. This means that, of the 43 toss-up seats, more than half broke for the Democrats. This is the reverse of historical trend, which is that about 55% of toss-up seats break for the majority party. Again, you never run the table.
The less-reported results from last night is that Republicans really swept up at the state level. As Erick Erickson wraps it up:
There will be 18 states subject to reapportionment. The Republicans will control a majority of those — at least ten and maybe a dozen or more. More significantly, a minimum of seventeen state legislative houses have flipped to the Republican Party.
The North Carolina Legislature is Republican for the first time since 1870. Yes, that is Eighteen Seventy.
The Alabama Legislature is Republican for the first time since 1876.
For those saying this is nothing because it is the South, consider these:
The entire Wisconsin and New Hampshire legislatures have flipped to the GOP by wide margins.
The State Houses in Indiana, Pennsylvania, Michigan, Ohio, Iowa, Montana, and Colorado flipped to the GOP.
The Maine and Minnesota Senates flipped to the GOP.
The Texas and Tennessee Houses went from virtually tied to massive Republican gains. The gains in Texas were so big that the Republicans no longer need the Democrats to get state constitutional amendments out of the state legislature.
These gains go all the way down to the municipal level across the nation. That did not happen even in 1994.
That really is a massive change at the state level, and even traditionally blue states were swept up in it. Since the next legislative session in many of these states will address reapportionment, that has further implications for the next election cycle, when House seats get shuffled.
Lots of new Republican governors in what have been blue states means that the 2012 Republican nominee now has access to pre-existing ground organizations in those states, which did not exist for the last three presidential election cycles. That means that the nominee will have to spend less in those states to create a ground game from scratch. That’s not necessarily an election-winning advantage, but it’s and advantage that hasn’t existed in those states for quite a while.
Democrats, including the president, are just impervious to any suggestion that their policies contributed to these losses. They are saying is was all about jobs and the economy, as if their policies had nothing to do with either. It’s really a willful blindness.
The California electorate is just…wacky. Take a look at the proposition results. They voted to refuse an $18 vehicle registration surcharge. They refused to allow the state to take local transportation and other funds, and voted to require a 2/3 majority for “fee” increases by reclassifying them–properly–as taxes. They then elected to allow the legislature to pass a budget by simple majority vote, which will, in many cases, effectively invalidate the other propositions through the budget process. Republican senators and assemblymen now have essentially no reason to attend the legislative sessions in Sacramento.
Jerry Brown will now teach another generation of Californians what the term “Governor Moonbeam” means. In his victory speech, he sounded quite mad. Now that he has a majority budget vote in the legislature, I have no confidence that the result will be anything other than a financial meltdown in California. The Democrats in California are addicted to spending–mainly in the form of generous benefits to teachers, firefighters, cops, and other government workers. with a $19 billion deficit, such spending can only be financed by either massive borrowing or massive taxation. Neither choice can possibly end in a positive economic outcome for the state. It will, however, teach the country an instructive lesson about what happens when you turn the government over to aging hippies.
California has greatly increased the chance that it will require a massive rescue from the Federal government, at the very same time that the general electorate has chosen a Congress that will be much less likely to approve such a rescue. So, aging hippies will now be taught an instructive lesson about the nature of reality versus ideology.