“Sell? To whom?”

Via:  The Fed's Anti-Inflation Exit Strategy Will Fail – Allan Meltzer in the WSJ

Prof. Meltzer demeans himself by even addressing the Fed’s ridiculous proposition that by paying interest on reserves the Fed can control excess reserves.  Where is the reserves interest going to come from?  This is just another underhanded way to try to recapitalize the bad banks (not all banks are insolvent).

Meltzer instead suggests the Fed use the traditional method of selling securities to suck in high-powered money.  But what are they going to sell, and to whom (the “Wall Street question”)?  The Fed has taken in untold and literally unknown amounts of garbage as if it were worth being reserves—they won’t even tell us what it is or how much of it has already charged off!

If and when inflation becomes a problem (when the next Big War gets going) the Fed won’t have the balls to reign in anything, would be my guess.  And we know the Whole Sick Crew of neoclassical economic advisors to the President are on record as welcoming an inflation to “lower the debt load.”

In the meantime the only thing that will restore a healthy middle class to America is an explicitly redistributionist rebalancing of aggregate demand.  Let the ruling class that has engineered the economy and the tax system to its own benefit for the past generation start to pay its own bills—especially the gigantic Wall Street bailouts, the largest transfer of wealth from ordinary Americans to the wealthy in history. 

[I hate to admit it, but a rebalancing of aggregate demand that put more money in the hands of the middle class would also increase the odds of a “benign” mild wage-price inflation getting going.  Combine this with a concerted effort to get big American corporations to knock their preening executives off their pedestals—who strut through the halls wearing expressions that say, “We are gods, oh ye puny cube-dwellers!  Do not think that you are even the same species as we!  You will never join our club!”—and get pay ratios in America back toward something that doesn’t cause gagging, and the economy might just pick up steam….]

Raise marginal tax rates on the super-rich to where they were in the 1950s (see this), the last time the federal debt load was this high.

I called my Senators today and told them to dump Bernanke.

P.S.  The Fed always has reserve requirements to reign in excess reserves.

P.P.S.  If the Fed had not bailed out the banks, and instead had provided unlimited deposit protection, what would have happened?  There would be a large amount of high-powered money in the hands of the public rather than in the banks.  The public could have made runs on as many banks as they liked, and the banks that lost their deposit base failed, and there would have been no massive wealth transfer to the investors in the failed banks—but the executives of the banks that levered up irresponsibly would be out of work, instead of cracking jokes to Congress about financial crises being something that come around every seven years, and paying themselves record bonuses.  Would this have been inflationary?  No.  People are reducing their marginal propensity to consumer, and increasing precautionary demand for money.  When things calmed down, they just would have put the money back in a bank.

The next bubble?

Cf.:  The Total Debt Relative to GDP Trumps Everything Else – Comstock Funds

Comstock has published Ned Davis’s charts on total debt/GDP for years.  They wonder why no one among the financial pundit (i.e., dunce) class can see the elephant in the room.

Barron's magazine printed the first part of its annual Roundtable discussion of 2010 this past week.  We noticed that many of the participants were very concerned about the debt (mostly government debt while we think total debt is a much more useful metric).  Marc Faber, in fact, talked about a 7,000 word New York Times article by Professor Paul Krugman.  He stated that the article "How Did Economists Get It So Wrong?" never mentioned that excessive credit growth or leverage was the cause of monetary instability and brought about the financial crisis.  Bill Gross stated that by lowering interest rates we promote consumption instead of manufacturing.  Central bankers were forced to respond with liquidity to a problem that developed over the past 25 years.  There was more discussion of credit growth (another way to say debt growth) in the macro analysis that is always presented in the first part of the three Barron's articles of the Roundtable.  The amazing thing to us is that most of the roundtable participants understand the same problems we talk about almost every single week, yet are mostly very positive on the market for 2010. 

It seems that most of the roundtable participants understand the debt problem we have been talking about for the past 14 years. The worst period of the debt explosion started with the outrageous internet bubble in the late 1990s, continuing through the correction in the internet bubble, then the housing bubble which should have been obvious to everyone (even the Fed) and then the financial crisis of 2008.  We are astounded that we have the potential for another bubble in the stock market now.  We expected the rebound from a much oversold market in March of 2009, but not a 70% rebound from the lows.  We don't believe it is possible to fool the investors in the US stock market one more time. Especially this close to the 2003-2007 and 1996-2000 bubbles. 

They expect competitive devaluation as I do in what I call the “supernova of Bretton Woods.”  See the pdf on “The Cycle of Deflation.”  However, I am more concerned that desperate governments will resort to war, a tried and true inflation-starter, to counter currency appreciation due to deflation.  You’ve got to have inflation to devalue your currency under floating rates.

Anyway, their bearish view of the US stock market matches mine, and raises the question:  What will Ben’s (or whoever’s) next [asset] bubble be, the chances for wage-price spiral being about nil as the jackboot comes down on the labor market Big Time?

I am going to guess it’s Oil.  Goes hand-in-hand with geopolitical instability.  But as I wrote in the last “animal spirits” update, we’re likely to experience a period of eerie calm (and further deflationary real estate wreckage as the next wave of resets hits) before any wage-price inflation happens.

This is not to say that there is no inflation.  Anyone who buys gas or goes to a grocery store can see it in their monthly budget.

Total Debt (Public & Private) Relative to GDP
The Cycle of Deflation

Dr. Paul’s diagnosis

So long as we practice triage along the way, radical change is okay.  Actually, radical change is upon us whether we practice triage or not.  The mystery to me is how we can get representatives in Congress who aren’t merely pimps for the moneyed interests that got them in.  At a time when the federal budget is hemorrhaging, income (and wealth) inequality is at century-level highs, and marginal income tax rates on super-high incomes are at multi-generational lows, why isn’t the government asking those who can afford it to do a little more?  The share of income going to the top 10 percent is 50 percent!  The share going to the top 1 percent is more than a fifth!  The share going to the top 0.01 percent is 6 percent! Why can’t these people pull their oar?  (See this paper by Emmanual Saez.) 

Shouldn’t this be a no-brainer?  And we don’t even hear it being discussed.  Disgusting.

I will just note in passing that I don’t believe these people have done anything fundamentally to deserve these incomes.  The heads of major corporations thirty years or forty ago, when America was growing far faster than it is now, were content with much smaller multiples of average incomes—as are heads of corporations in other developed nations.  Almost as if they recognized that they alone were not responsible for the company’s creation of jobs and wealth!  Our ruling class has done this because we let them do it.  They have manipulated incomes before tax to their advantage, and then gutted the progressivity of the federal income tax to ensure maximum possible personal benefit.  And the charming Pied Piper who sold this bill of goods to the American people was Ronald Reagan.

US Crosses the Bernholz Line -- Hyperinflation Early Warning Signal

Via:  US Crosses the Bernholz Line -- Hyperinflation Early Warning Signal – EconomicPolicyJournal.com

The basic point:

Economic historian Peter Bernholz has identified that inflation starts to take on hyperinflationary characteristics some time after the deficits of a country as a share of government expenditure rise above a third and stay there for several years.

According to Bernholz, the great hyperinflations of France, Germany, Poland, Brazil, and Bolivia all occurred after deficits reached that magic percentage or higher (In Bolivia, it reached 91%). The United States crossed over the Bernholz line last year.

The time lags for onset of the disease vary following the indication.

A word about the definition of inflation:  Monetarists and Keynesians alike (neoclassical economists) generally follow Friedman in saying “inflation is always and everywhere a monetary phenomenon.”  Some Austrians say inflation is money supply growing faster than real product.

For practical purposes, let’s define inflation as a general and sustained rise in prices, all prices, including consumer and producer prices.  This is very different from a localized asset inflation such as America has recently experienced in stocks and real estate and commodities.  Let’s call these “asset inflations.”  Asset inflations are not so good at reducing real debt loads, as most people’s incomes (and wealth) don’t follow asset price bubbles upward—and they are definitely left behind when the bubble bursts.

For a general inflation to get going there must be a “wage-price spiral,” so that incomes rise to meet or at least follow the general rise in price level.  Hence, I define a general price inflation as “a labor market phenomenon accommodated by monetary policy.”  The money supply does indeed grow faster than real product in such a case.

I go through all this merely to point out the unlikelihood of a general inflation in the current environment, in which labor unions are nearly extinct, employment-at-will is the law of the land, fascistic Storm Troopers routinely terrorize citizens for trivial infractions, basic Constitutional rights to due process have been destroyed (the Government can “disappear” you legally if they designate you a “terrorist”—hold you forever without any due process, torture you, do whatever they like with you), and for the most part citizens respond by cowering in their homes, afraid they will be next to run afoul of the dystopian corporate police state, to drop into poverty and a life of internal exile or worse.

Now, the monetary authorities, in their wisdom, would actually like to see a general inflation, as this is their deus ex machina for dealing with excessive federal debt loads (debts of all varieties, really).  Hence, I expect the national governments, goaded by their monetary wizards, to try to “enfranchise” the working populations of the world somehow, in a desperate last stand of Bretton Woods (II).  If successful, they will accomplish nothing less than the the supernova of Bretton Woods II, a global hyperinflation. 

And hyperinflations generally end up permitting those with money and access to leverage, the Big Money, to expropriate the working folks of whatever they had left, and if historical precedent applies, to set the stage for full-bodied Fascism to arise.

The solution:  raise taxes on the rich in America who have twisted the income distribution so much in their favor, and provide workfare and health benefits to the people.  There is enough to go around.  We don’t need to run huge deficits, we don’t need to cut taxes on the rich, we don’t need more war.

Shame upon the ruling class of America!  You sit and watch as this happens without the slightest pangs of conscience?  As if you don’t know what is happening?  Shame upon you!

Shalom.

See also: 

U.S. Income Inequality Is Frightening--And Much Worse Than We Thought – businessInsider.com

Social contract broken

Scott Brown’s victory in Massachusetts was a cruel irony from the point of view of anyone wishing that barbaric America might actually provide its citizens with universal health care.  The irony is that Massachusetts already did it, and didn’t want a Washington plan that would have cost them more money.  Ted Kennedy must be rolling over in his grave.

That, and according to Democratic pollsters, a pervading dissatisfaction with the President’s lack of backbone in standing up to the oligarchs of Wall Street.  The memory of Franklin Delano Roosevelt may run strong in Massachusetts.  The health insurance stocks rallied.  Given the fiscal woes of the states now it is unlikely that any will be in a position to emulate Massachusetts’ plan.

Dysfunction at a national government level is just what the top 1 percent of the income and wealth distribution want.  They’d be happy to see an independent candidate run for president in 2012.   The more the merrier!  Nothing will get done!  Marginal tax rates on super-high incomes will remain at multi-generational lows!  The rich can continue to hollow out America, to create serfs where there once was a middle class.

It is important to see the big picture.  Follow the money.

Can you say, “banana republic”?

Interfluidity post on inequality

Steve Waldman on interfluidity.com, linked to at nakedcapitalism.com, has referenced some of my reference rants on inequality in a nice list of references on inequality.  Before starting The Animal Spirits Page I contributed frequently to interfluidity.com.  Today I was happy to thank Steve.

Benign writes:

Steve,

We discussed this back in June 2008 (oh so long ago!) on Interfluidity, and at the time I did a Google search on inequality and productivity and came up with this:

http://www.interfluidity.com/v2/125.html#comment-790

Richard B. Freeman, Alexander M. Gelber

NBER Working Paper No. 12588

Issued in October 2006

NBER Program(s): LS POL

—- Abstract —–

This paper examines performance in a tournament setting with different levels of inequality in rewards and different provision of information about individual's skill at the task prior to the tournament. We find that that total tournament output depends on inequality according to an inverse U shaped function: We reward subjects based on the number of mazes they can solve, and the number of solved mazes is lowest when payments are independent of the participants' performance; rises to a maximum at a medium level of inequality; then falls at the highest level of inequality. These results are strongest when participants know the number of mazes they solved relative to others in a pre-tournament round and thus can judge their likely success in the tournament. Finally, we find that cheating/fudging on the experiment responds to the level of inequality and information about relative positions. Our results support a model of optimal allocation of prizes in tournaments that postulate convex cost of effort functions.

This seems plausible to me. The question for Americans going forward is whether we descend into neo-feudalism–which implies long-term economic decline if the above is true–or whether our income and wealth distributions can be returned to something that most Americans find to be fair. Simon Johnson is correct in saying that the country is currently being run like a banana republic ("with nukes"). But the inequality has been long in the making and extends across virtually all occupations.

Most Americans today believe in some way or another that the social contract is broken. The most compelling historical theory of this that I've found is Strauss and Howe's The Fourth Turning, which suggests that we're heading into a crisis over the next decade or more that will require a rewrite of the American social contract. It's going to be interesting.

Thanks.

January 13th, 2010 at 2:47 pm

Princeton economics department merits an “F”

Keep these idiots in the ivory tower. Here is an entertaining and damning video featuring Bernanke and Krugman trumpeting their total ignorance of the real world in the mid 2000’s. And the Fed is going to be our “systemic risk regulator”? It’s our systemic risk creator! h/t patrick.net

Keynsians vs. Austrians video from eclipptov