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Keynesians Are Wrong: We CAN (And Very Well May) Have Disinflation With Rising Real Interest Rates, Which Could Hasten the Decline of American Power
One of the world's leading economic historians - Niall Ferguson - has previously pointed out that too much debt can drive countries into default:
There
are economic professors in American universities who think they are
masters of the universe, but they don't have any historical knowledge.
I have never believed that markets are self correcting. No historian
could...
"The
idea that countries don't go bust is a joke... The debt trap may be
about to spring ... for countries that have created large stimulus
packages in order to stimulate their economies."
(Keen, Roubini, Morgan Stanley and many others are warning about a debt crisis as well).
Ferguson now points out
in a must-read article he wrote for Newsweek that we might get falling
inflation (disinflation or deflation) and rising real interest rates:
So
here's another scenario—which in many ways is worse than the inflation
scenario. What happens is that we get a rise in the real interest rate,
which is the actual interest rate minus inflation. According to a
substantial amount of empirical research by economists, including Peter
Orszag (now at the Office of Management and Budget), significant
increases in the debt-to-GDP ratio tend to increase the real interest
rate. One recent study concluded that "a 20 percentage point increase
in the U.S. government-debt-to-GDP ratio should lead to a 20–120 basis
points [0.2–1.2 percent] increase in real interest rates." This can
happen in one of three ways: the nominal interest rate rises and
inflation stays the same; the nominal rate stays the same and inflation
falls; or—the nightmare case—the nominal interest rate rises and
inflation falls.Today's
Keynesians deny that this can happen. But the historical evidence is
against them. There are a number of past cases (e.g., France in the
1930s) when nominal rates have risen even at a time of deflation.
What's more, it seems to be happening in Japan right now. Just last
week Hirohisa Fujii, Japan's new finance minister, admitted that he was
"highly concerned" about the recent rise in Japanese government bond
yields. In the very same week, the government admitted that Japan was
back in deflation after three years of modest price increases.
It's
not inconceivable that something similar could happen to the United
States. Foreign investors might ask for a higher nominal return on U.S.
Treasuries to compensate them for the weakening dollar. And inflation
might continue to surprise us on the downside. After all, consumer
price inflation is in negative territory right now.
Why should we
fear rising real interest rates ahead of inflation? The answer is that
for a heavily indebted government and an even more heavily indebted
public, they mean an increasingly heavy debt-service burden. The
relatively short duration (maturity) of most of these debts means that
a large share has to be rolled over each year. That means any rise in
rates would feed through the system scarily fast.
Already, the
federal government's interest payments are forecast by the CBO to rise
from 8 percent of revenues in 2009 to 17 percent by 2019, even if rates
stay low and growth resumes. If rates rise even slightly and the
economy flatlines, we'll get to 20 percent much sooner. And history
suggests that once you are spending as much as a fifth of your revenues
on debt service, you have a problem. It's all too easy to find yourself
in a vicious circle of diminishing credibility. The investors don't
believe you can afford your debts, so they charge higher interest,
which makes your position even worse....
The precedents are
certainly there. Habsburg Spain defaulted on all or part of its debt 14
times between 1557 and 1696 and also succumbed to inflation due to a
surfeit of New World silver. Prerevolutionary France was spending 62
percent of royal revenue on debt service by 1788. The Ottoman Empire
went the same way: interest payments and amortization rose from 15
percent of the budget in 1860 to 50 percent in 1875. And don't forget
the last great English-speaking empire. By the interwar years, interest
payments were consuming 44 percent of the British budget, making it
intensely difficult to rearm in the face of a new German threat.
Call it the fatal arithmetic of imperial decline. Without radical fiscal reform, it could apply to America next.
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Excellent points made GW !! By far my favorite piece of yours in a while, simply bc disinflationary push is an important issue that the US/ Europe have each enjoyed for about twenty years now, thanks to SE-Asia ... and however ya wanna dance around definitions, ever since either the top of 2000 (where the inflation-adjusted REAL DOW is down c. 80% in the interim) or more recently, we have enjoyed/ suffered disinflation (to be just mildly generous with a very hard tongue-in-cheek) with RRIR.
Our current deflationary depression is a very ripe 9 years young and has at least half as long if not the same amount of time left in its tanks. FWIW, which I certainly hope is next to nothing since biased personal opinions during off-peak w/o charts, facts, figures or good link are exceptionally worthless ... this baby ain't anywhere close to being finished and we would strongly recommend getting up to stretch one's legs because this game is only in the 5th inning and the next 4 are gonna be VERY long and very arduous with a LOT of pitching changes, tv timeouts and unnecessary announcement/ fake pomp/ extremely depressing circumstance while there will be NO way for anyone to get out of their seats since ALL of the exits will be jam-packed.
Thanks for sharing this with everyone GW ! And beware the Full Moon at 02:28, gold bugs are on the loose!!
Can it be that we can have inflation/deflation on two levels? Namely,, deflation of imported manufactured products that are vulnerable to competiton and global overproduction in emerging markets and on the other hand inflation of domestic services including taxes,plumbers,distribution, transportation, (especially energy related where declining US$ results in higher prices) Problem is that jobs under this scenario can not grow or even be maintained Bottom line is that the Global Economic Model is no longer benefiting the US because we are no longer creating wealth---just decapitalizing as have other empires
"Can it be that we can have inflation/deflation on two levels?"
Yes.
Still... the end game isn't the balancing act itself, but where one ends up at the end of the year. In short, I measure inflation via living standard and when gas/oil/electricity/food prices are going up then I'm taking those hits daily/weekly/monthly and this all adds up to cumulatively to a hit on my overall standard of living.
"Bottom line is that the Global Economic Model is no longer benefiting the US because we are no longer creating wealth---just decapitalizing as have other empires."
Agreed. I don't give my allegiance to "free" trade. Heck, I don't even give my allegiance to "fair" trade. I favor whatever pragmatic policies best serve my country and the majority of my fellow citizens year in and year out and if that means changing tactics and strategies decade by decade or even year to year, so be it.
I want Americans gainfully employed in useful endeavors which add to the hard national security strength of this nation. The policies identified with deindustrialization certainly don't make the grade - not if I'm doing the grading.
BILL
Anonymous #148326 is dead on.
I see stagflation erupting full bore by spring of next year.
Present inflation at the grocery store is being masked to an extent by a proliferation of loss leader sales and (as previously mentioned) simple downsizing of product itself. Beyond noting the present reality, allow me to add that to those of us who pay attention, we can already see doubling of prices coming in the not too distant future via present pricing indicating "half price" on sale pricing that is at best indicative of pre-oil price surge (pre-Katrina) era pricing.
Oh, and speaking of oil pricing... raise you hand if you doubt that come spring (and perhaps in spurts prior to spring!) we'll see world oil prices back up above $100/bl., perhaps way above $100/bl.
Between ethanol, anti-irrigation insanity in California, trade policies and tax policies which tend to work against "excessive" American agricultural production, and the health nazis, who in their right mind expects food prices not to continue to rise?
Fuel and food inflation... those two alone set the stage for middle class inflation directly taking a huge chunk out of the average American's "disposable" income and add to that our government doing everything within its power to reinflate for a "new" housing/commercial real estate bubble on top of the "new" stock bubble...
(*SHRUG*)
Anyway... long story short... inflation, not deflation, is coming our way.
BILL
what the fuck is disinflation??? i am sure it is orwell speak for something....could it be deflation? no....could it be near zero inflation....maybe....could it be acadmenic bullshit? peekaboo!!....
Really? So busts in the economic cycle are just random then... right.
I do not defend Keynesianism but I believe you have the effects of what is happening confused. Something I think no one has pointed out so far is that it is not the amount of money in existence that is causing deflationary preasure, it is the number of people with money that is causing deflation.
Think of it this way, price is determined by supply and demand on two differnt levels. Money supply is one factor, and the number of participants within a market is another. So what happens when you have a 1 trillion dollar money supply with a few billion market particpants, or a 2 trillion dollar money supply with half of the number of market participants.
... or a few CB's that control the SUPPLY.
When you say "you" are you addressing that to Niall Ferguson or George Washington?
Liquidity is a multiplication. Quantity of money times speed of circulation. After Ben's 'quantitative easing" quantity of money is NOT a problem...There are so much pieces of paper..
But the money went to the banksters, that are hoarding them in irreparably broken balance sheets, Main Street was alraedy oveindebted, so the banksters are NOT lending out to Joe Public, and Joe is jobless, can't afford his mortgage anymore, will walk away and throw the keys more and more, cut his credit cards etc.
So, simply put..an infinite quantity of money multiplied for zero speed of circulation = 0 liquidity= a Big Depressionary Deflation.
That is what scares them shitless, no matter how much they print, the only inflated things are asset prices...with less and less people who cab buy and exchange them. The system will go over the edge, sooner or later.
"Daddy, I'm scared. Too scared to even wet my pants."
"Just relax and it'll come, son."
I don't disagree with just about anything you wrote here. I just have a comment on one part.
When you wrote, "so the banksters are NOT lending out to Joe Public", I have to say that while this is true to an extent, I don't think they should be loaning to 'Joe Public', for the reason you mentioned right after the comma, namely "and Joe is jobless, can't afford his mortgage anymore, will walk away and throw the keys more and more". If i was a bank, i wouldn't be seeing many reasons to loan to anyone--and that's not even discussing the clear evidence that despite many banks doing nothing to make it harder to get loans, the demand for new debt is absent.
I know that this ends in inflation though for the reasons you pointed out. People are over indebted which means they will have less and less reason to "believe" that paper has value. The reason that most people still believe the money they have has value is because they have it. They have to believe in it when it benefits them to do so, on the other hand when it is unbeneficial, like it is becoming through various means of out right fraud and manipulation, most people will simply stop using because they are pushed out anyway.
Secondly deflation causes lower productivity levels because producers lose money during deflation. So what happens when you have a bloated money supply, few market participants, and even few products because it is unbeneficial on so many levels to even produce something (i.e. taxes, deflation, regulatory fees etc).
Inflation in dollar valuations is what will ultimately happen.
This person does not shop at a grocery store.
"After all, consumer price inflation is in negative territory right now"
Try going to the grocery store and buying food! Then come back and say the same thing with a straight face.
Bull shit! Prices are the same to slightly higher, PACKAGES are fucking HALF SIZED!
That's 100% inflation in like six months.
If you don't actually buy food from a supermarket for a family of four, you might miss this. If you DO BUY food at the supermarket, it stares you in the face every day.
You have to buy 2x the "new package size" to get the same as you used to and spend 2x as much money to do so.
Consumer prices negative! MY FUCKING ASS! Go shopping asshole!!!!!!!!!!!!!
Anonymous #148326 is dead on.
I see stagflation erupting full bore by spring of next year.
Present inflation at the grocery store is being masked to an extent by a proliferation of loss leader sales and (as previously mentioned) simple downsizing of product itself. Beyond noting the present reality, allow me to add that to those of us who pay attention, we can already see doubling of prices coming in the not too distant future via present pricing indicating "half price" on sale pricing that is at best indicative of pre-oil price surge (pre-Katrina) era pricing.
Oh, and speaking of oil pricing... raise you hand if you doubt that come spring (and perhaps in spurts prior to spring!) we'll see world oil prices back up above $100/bl., perhaps way above $100/bl.
Between ethanol, anti-irrigation insanity in California, trade policies and tax policies which tend to work against "excessive" American agricultural production, and the health nazis, who in their right mind expects food prices not to continue to rise?
Fuel and food inflation... those two alone set the stage for middle class inflation directly taking a huge chunk out of the average American's "disposable" income and add to that our government doing everything within its power to reinflate for a "new" housing/commercial real estate bubble on top of the "new" stock bubble...
(*SHRUG*)
Anyway... long story short... inflation, not deflation, is coming our way.
BILL
But the system needs deflation, that's the point. Wages aren't inflating. Not with unemployment at upwards of 22%!
You can have 95% unemployment with 1000% daily inflation, just look at the NUMEROUS historical examples (Zimbabwe today is a good on).
What do you folks NOT GET. A Decline in economic activity DOES NOT EQUAL DEFLATION. (And if you care to argue, please explain to me how Zimbabwe gets 95% unemployment with SIMULTANEOUS 1000%+ daily inflation rates.)
One counter-example disproves a theory, and you just got served one my friend.
Awaiting your response....
I just said that the system needs deflation. Such as in the housing market and other goods. Have wages kept up with the rate of inflation in this country? Maybe for the finance industry, health care, and government.
Is it really going to matter when no one can buy or afford anything since we let capital flow overseas to enrich other emerging markets middle class to spawn "growth" for the bottom line when really it is just labor savings, benefit, and expense cuts?
The rate of inflation is fudged by own government. And you wonder why people used the credit cards, HELOC's, etc. to get by?
So, WTF does warrant deflation then? What is a deflationary depression? What is your definition of economic activity?
I'm here to learn. Educate me.
Possibly, but I'm not so sure. Where is the demand? In fact, this timely bit of commentary comes just today:
That's from an article titled EIA: U.S. Oil Consumption Much Lower Than Previously Thought, right next to an article titled IEA: Chinese Oil Demand Will Not Bring Price Spike in 2010. I don't doubt the possibility that it could higher. But the extent is the question. With global demand destruction underway in every major economy but Brazil, who is going to fuel a spike?
Dude, take a blue pill, and start shopping at Costco. I buy a bushel of hash browns for less than 6 bucks.
Dude, get a clue.
It's called inflation, not disinflation or defaltion, inflation.
And thanks for the costco tip, definately gonna do my shopping there as much as I can.
You can get large amounts of pretty food at Costco for good prices.
Unfortunately, most of it lacks good nutrition.
It will fill your tum-tum though, and thus keep your groinfruit from crying a lot in the lean times. Just don't be surprised when little Timmy often gets colds and gets asthma when he's excited.
costco reference +1
fuck keynesians and krugman
While I do believe that any rise in prices we see will manifest most in foods and energy, I do also believe that said commenter is not employing economies of scale when shopping at the food market.
I say this for two reasons: I am seeing both increases and decreases in price in food lately. Since I shop for a lot of my freshest organic produce in small frequent purchases--and those prices are generally increasing from what I can tell--I see it impacting my budget. On the other hand, for those items I buy in bulk (literally bulk such as flax, lentil, and barley) I see price decreases and this is also true for prepared foods such as pasta and soy milk.
The net is I think a wash, as the fairly steep savings in the large purchases are getting crowded out by the ramp in small very fresh organic produce.
I lament that organic investment is what it is. A simple doubling from 1% to 2% of the total food industry would go a long way to lower prices for healthier food.
Great article. I like bashing Keynesians. We used
to kick them around over the Phillips curve back
in the day. I bet they still teach that in macro.
I'm sure they wouldn't like to talk about it now,
among other things. Expose them.
But they do mean well.
Irrelevant.
But what if the Federal Reserve becomes the primary holder of our debt over time, and we the people say we are not going to pay you back. Then what? I see that as the end game. We internalize our debt, create trade barriers and default our debt to the Federal Reserve.