Free Markets, Free People

inflation

Quantitative Easing, Round II, Approved

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.

QE2 is unlikely to save the day

In fact, it may set in motion inflationary pressures that will blow up in the Fed’s face.

Randall Wray has put together one of the best summaries I’ve seen on the subject, and it doesn’t give me a warm fuzzy at all.  Essentially QE2 (“quantitative easing”) has the Fed buying up toxic bank assets to push up their excess reserves.  The thinking is that pushing those reserves into excess will stimulate loans.  But it will also stimulate inflation. 

Bernake’s claim is the reserve creation will be “temporary”.  But – and this is the crux of the problem – it will have difficulty buying back those reserves because of the quality of the assets the Fed is sucking up to create them:

Bernanke carefully tries to navigate these waters by agreeing with the hawks that in the long run, Fed creation of too many reserves would be inflationary, but argues that in current circumstances the greater danger is deflation. Still, he reassures markets that reserves creation is temporary, and that the Fed will “exit its accommodative policies at the appropriate time”. Yet, if the Fed buys junk assets that will never have any value, it will not be able to sell these back to markets later — so there is no way to remove the reserves it created when it buys trash.

Indeed.  So without the ability to sell back marketable assets, the reserves remain out there and inflation does too.  You might think “deflation” is the biggest threat until you see run-away inflation reduce your retirement funds to zip and push your wages to poverty level.

This is a mess.  And as we discussed in this week’s podcast, screwing with the economy at the central bank level is very delicate thing and could go wrong quickly and dramatically. 

And what I’m hearing and reading – to include this article – says the possibility of that happening is high.

~McQ

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Observations: The Qando Podcast for 17 Oct 10

In this podcast, Bruce, Michael, and Dale discuss the Economy, and the government’s effect on it.

The direct link to the podcast can be found here.

Observations

As a reminder, if you are an iTunes user, don’t forget to subscribe to the QandO podcast, Observations, through iTunes. For those of you who don’t have iTunes, you can subscribe at Podcast Alley. And, of course, for you newsreader subscriber types, our podcast RSS Feed is here. For podcasts from 2005 to 2009, they can be accessed through the RSS Archive Feed.

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Looking at the PPI

Today’s release of the Producer Price Index raises some interesting and scary questions. The core PPI was up only 0.1%, but a 1.2% increase in good prices and a 0.5% increase in energy prices brought the overall PPI up by 0.4%.

Now, the reason that food and energy are excluded from the core PPI and CPI is that they often show a lot of monthly volatility. Those prices simply rise and fall quickly, so, on a month-to-month basis, they may not mean much. Ultimately, however, a trend of price increases in, say, energy will trend to raise prices across the board, as that increases the cost of production.

The traditional Keynesian argument about inflation is that it tends to decrease when the economy is struggling, as aggregate demand is stifled. Sadly, in the 1970′s we learned that simply wasn’t true, and the existence of stagflation sent the Keynesians back to the drawing board for about 15 years to reformulate a Neo-Keynesian economic model. Essentially what happened in the late 60′s and early 70′s was that the Fed pursued a very accomodative monetary policy. Ultimately, even a slow economy couldn’t prevent that monetary expansion from showing up as inflation.

Sound familiar?

It should, because the housing boom was kicked off by a similar policy, and since the collapse, the Fed has pursued a policy of “quantitative easing”, i.e., buying $1.2 trillion of securities with hastily printed money. Overall, the monetary base has more than doubled over the past two years, also, as the Fed has kept short-term interest rates at 0%.

So, I guess the question is whether today’s PPI is just a monthly outlier due to the volatile sectors, or whether it’s a sign that monetary expansion is beginning to kick off an inflationary spike that will soon begin to show up in the CPI as real, noticeable inflation.

The Kangaroo is Still Hopping

Bruce mentioned yesterday that the 5-year note auction drew thin demand, with a low bid-to-cover ratio, and a steep drop in indirect buyers.  This led to a jump in interest rates for both the Fives and the Tens also went up by 13 basis points.  meanwhile, investors began moving into corporate paper, instead of treasuries.

I also note that this week saw weaker than expected durable goods orders, atrocious new home sales, and initial unemployment claims still at 442k–which is better than it was last week, but not great.

The “recovery”, apparently is still on pretty shaky ground.

Meanwhile, the new health care reform law attempts to shift a bunch of spending via Medicaid to the states, who are not really in a position to cover those costs, as state tax revenues have sharply declined from 2007.

In short, with a weak economy, we are planning on adding what may be as much as $2 trillion to the deficit over the next 10 years–deficits that are already at $1 trillion per year as far as the eye can see.  How neatly that coincides with the announcement that Social Security will run into the red this fiscal year, paying more in benefits than it receives in payroll taxes, six years earlier than previously expected.

So, we got that going for us.

The United States is supposed to be the richest country in the world.  But, on our present fiscal course, that cognomen will not attain in a very few years.  We simply will not have enough money to service the debt load we will be carrying.  In a very real sense, it doesn’t matter whether the Republicans can win in November and repeal the HCR law just passed.  Or Cap & Trade.  Or Medicare Part D.  Or whatever.

We are directly on course to having to run massive inflation by monetizing the debt, or to simply defaulting on it, both of which will result in massively high interest rates, and economic stagnation. With the added bonus of runaway inflation, for good measure.

That this will happen cannot be in serious doubt if we continue our present course. Our fiscal and monetary policies are self-evidently unsustainable.

I can only presume that the Democrats believe that, at the appropriate time, fairies will appear out of thin air to sprinkle magical pixie dust on the economy, and all will be well.  The current raft of policies they are proposing to enact will crush the economy.  We’ve seen it happen time and again in South America, and now even in the EU, in which the Greeks are headed for a default in the very near future.

What is coming out of Washington is not policy.  it is full-scale flight from reality.

Podcast for 21 Feb 10

In this podcast, Bruce, Michael and Dale discuss the economy in the US and Europe, as well as gun rights.  The direct link to the podcast can be found here.

Observations

The intro and outro music is Vena Cava by 50 Foot Wave, and is available for free download here.

As a reminder, if you are an iTunes user, don’t forget to subscribe to the QandO podcast, Observations, through iTunes. For those of you who don’t have iTunes, you can subscribe at Podcast Alley. And, of course, for you newsreader subscriber types, our podcast RSS Feed is here. For podcasts from 2005 to 2009, they can be accessed through the RSS Archive Feed.

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Inflation: The Lurking Beast

Despite all the happy talk from the Fed about its ability to manage the money supply and wring the excess out of the economy at the proper time, avoiding inflation, when and if the economy ever takes off, is going to be a lot tougher than advertised. And we’re beginning to see rumblings that inflation is trying to find it’s footing:

Inflation at the wholesale level surged in November, reflecting price jumps in energy and other products.

The bigger-than-expected increase is certain to get the attention of Federal Reserve policymakers beginning a two-day meeting on interest rates.

The Fed has been able to keep interest rates at record-lows to bolster the shaky recovery, but if inflation pressures begin to mount, the central bank could be forced to start raising rates sooner than expected to cool the economy and keep prices in check.

That’s the trade-off: raise interest rates to hold off inflation. The tricky part is knowing how much to raise them to do that without killing the recovery. And, with the massive amounts of cash pumped into the system, I’m not sure that’s possible. Which means it is probable, at some point, that the Fed is simply going to have to make a choice – inflation or high recovery killing interest rates. My guess is they’ll choose the latter (while the politicians holler foul and try to spend more money). That’s why many don’t see economic recovery in the cards any time soon despite the “green shoots” so many politicians continue to spot among the economic ruin of the present economy.

~McQ

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Venezuela – Hugo’s New Shower Rules

Hugo Chavez and his socialist government have handled everything so well that they’ve decided to go green and show the world how it is done:

Turn out the lights, shorten the shower to three minutes, buy a portable generator.

That is President Hugo Chávez’s message to the citizens of energy-rich Venezuela, where the “socialist revolution” has brought power cuts, water shortages and collapsing public services.

Heh … Chavez actually did try to push the green theme in his radio address discussing showering and turning off the lights. But it was a facade designed to hide the fact that the infrastructure is collapsing. As you might imagine, that’s sparking more than a little unrest:

“We’re accused of wasting electricity, but the fact is the government didn’t plan, didn’t invest and didn’t carry out maintenance,” Aixa Lopez, president of the Committee of Blackout Victims, told the TV news channel Globovisión.

In fact, as with all marginal leaders, Chavez blames all of his problems on others:

In early 2007, after winning re-election, Chávez decreed the nationalization of those parts of the electricity industry still in private hands — notably the Caracas power company EDC. Since then, there have been seven national power outages. In most parts of the country, weary consumers have grown used to frequent, unscheduled blackouts lasting hours.

This month, the president admitted there was a crisis in both the power and water industries. This came on the heels of a similar admission regarding healthcare. He put the blame mainly on the El Niño phenomenon for producing drought — Venezuela is 70 percent dependent on hydro power for its electricity — and on consumers for their wasteful habits.

Much of his ire was aimed at shopping malls because, he said, they foment capitalist values. “They’re going to have to buy their own generators,” he threatened, “or I’ll cut off their electricity.”

Ordinary Venezuelans have been urged to use less water and turn off the lights. “Some people sing in the bath for half an hour,” Chávez told a recent cabinet session, broadcast live. “What kind of communism is that? Three minutes is more than enough!”

Formal water rationing has now been introduced, government departments have been told to reduce their electricity consumption by a fifth, and the president has created a new Electricity Ministry in a tacit admission that the state has failed to manage the power industry correctly.

In fact, both the Water and Electricity Ministry are in a shambles:

According to Víctor Poleo, who was deputy minister for electricity at the beginning of the Chávez era, despite huge sums of money allocated, little has actually been done.

“My guess is that of every $100 pumped into [electricity] generation and transmission since 2003, $75 has been stolen by the politicians,” Poleo said.

Venezuela is a oil rich state from which 90% of its foreign earning are garnered. Chavez called his socialist economy “bulletproof”. However, it is now deep in recession:

Worse still, its shrinking economy has done little to blunt inflation, which is running at close to 30 percent a year — around three times the regional average. And the economic downturn is having a predictable effect on the government’s popularity, just as it gears up to fight crucial legislative elections next year.

The latest data from polling company Datanálisis shows voters evenly split, for the first time since mid-2004, over whether the president has been good or bad for “national wellbeing.” Only 17.2 percent say they would vote for him if the presidential election were imminent — down from over 31 percent in September.

Of course, as the article points out, the opposition is “incoherent” and unable to provide unified opposition at this point. But those sorts of things have a way of rectifying themselves if the economic and infrastructure problems continue. Chavez may have figured out how to position himself to be president for life on paper, but remaining president for life with the problems Venezuela is now beginning to face (and may see compounding) may be tougher then he thought.

~McQ

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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.