This page has been archived and commenting is disabled.
Obama, Democrats, Republicans AND Bernanke All in a Bind – What they will do and when
We
have two distinct groups in D.C. that are stuck between a very big rock
and a hard place. The first is the Federal Reserve. The second is the
Democrats and Republicans and the battle being waged over the debt
limit. I see a possible solution to these impasses. It’s so simple that I’m sure it is being considered. The prospect is scaring the crap out of me however.
The Fed is in a bind. The economy is clearly slowing down again.
Unemployment will soon follow. According to the Fed’s Dual Mandate they
should be doing something about that.
They have few options. They can’t do more Large Scale Asset Purchases
(“LSAP”). What has become referred to as “QE”, has not worked. It was
also very unpopular (both in and out of the country). LSAPs may come
back sometime, but they are on the shelf for at least a year. What could the Fed do in the near future?
I) They could increase the inflation target (core CPI) from “A little under 2%” to “A tad over 3%”.
II) They could alter the ZIRP (zero interest rates) language from: “For the foreseeable future” to: “Until such time as the Fed’s new inflation target has been achieved but not less than one year”.
These relatively minor changes would have very dramatic effects.
-Inflationary expectations would jump. Actual inflation would follow.
-The dollar would crap out. Exports would increase.
-This would result in wage pressure. Exactly what the Fed wants.
-The resulting inflation in all commodities would roll into new home
construction costs and therefore be a boost to existing values. (Soft bailout to housing/lenders)
-It is (short-term) supportive of equities. Exactly what the Fed wants.
-Debt costs can’t rise too fast as ZIRP keeps the belly of the curve cheap. This has to happen. Without LSAPs, this is the only way to achieve it.
Are you scared yet? Now consider where the politicians are on the inflation story.
Republicans have drawn a line in the sand on the debt limit with their position of “No New Taxes”. The Democrats have said pretty much the opposite with, “No spending cuts”.
Neither side appears to be giving an inch. There is no common ground.
Yet, to go to August 2 without a resolution is just a dumb move. Both
sides of this big debate know that the next presidential election is
riding on the outcome. If the US is to default; one side or the other
will shoulder the blame. The “side” that gets the blame will lose the election. And both sides understand this. So where’s the compromise?
The solution is inflation. The
government has got to get out of its inflation indexed obligations. You
don’t have to raise tax brackets to raise revenues or cut expenses. You can mess with inflation adjustments to achieve these ends. Both sides can appear to win if this is accomplished.
Consider the words last week of Brian Graff of ASPPA (Lobby for pensions and actuaries) (The conference was sponsored by the IRS!!)
"Eliminating
indexing is one of the proposals receiving serious consideration as
Congress enters “uncharted territory” with legislation to raise the debt
ceiling, If Congress were to stop indexing for a period of time, which
would affect tax brackets, individual retirement account contributions,
and contribution limits under tax code Section 415, “you could raise a lot of money, and those are the kinds of things they are talking about.”
On the expense side of the equation a great deal of fat can be cut by
eliminating/cutting COLA increases in a variety of programs. The most
important of which would be Social Security. Depending on how the cuts
in COLA are defined and how they are applied a huge amount of money
would be saved over an extended period.
If all social obligations had their COLA increases cut in half it would
(on paper) put the US on a much more solid long-term footing. It is a
very appealing “kick the can down the road” approach. No cuts in programs (just smaller increases) and no new taxes (but higher revenue as the inflation adjustments for AMT and other tax issues kick in).
If you buy into this thinking this is they way it could play out:
We DO go to the 11th hour on the debt limit. But a compromised is reached. Central to the deal is a broad restructuring of the way inflation impacts both revenue and expenses at the federal level. Both sides claim victory.
Two months later Bernanke will announce what will be called QE3. He will
make a long-term commitment (at least one year) to maintaining interest
rates at near zero levels. And he will raise the inflation target that
the Fed is hoping to achieve by 35% ('smidge' over 3% core CPI)
Should things play out along these lines it will be sea change series of
events. If anything like this were to be in our future the very worst financial position would be short gold and long bonds. Being short volatility in any market would also be a mistake. Outside of that, I’m not sure where/how to position for this.
My thoughts:
Deflation is scaring us to death. But inflation will kill us. And that is exactly what the ‘Deciders’ have in store for us.
»
- advertisements -
This is apparently how economics is done in practice. It's just a question of what various parties will accept. I guess this is why economics is called a "science" and why Nobel prizes are awarded to economists. Because, when push comes to shove, it is precisely this kind of "reasoning" that takes place. Evidently all the so-called "theory" is just window dressing and has no effect at all on how things are actually done. It's all just a question of tricking the voters and letting congress pigs line their own pockets.
Does anyone in DC ever think about what would actually help matters? (Of course not.)
Absolutely correct. Simply look at the numbers published by the federal government. Real meaningful cuts must come from DoD, SS and Medicare/Medicaid. Add interest payments on the debt (which can't be cut) and you have 80% of the yearly budget. Don't touch any of the above programs/departments and eliminate all that remains, then the federal government is still running a yearly deficit. Bruce has it right, two billion in cuts is just the circus part of bread and circuses.
Exactly.
An easier and far more practical solution would be for Euroland, the Scandinavian Countries, Switzerland, Poland, and Great Britain along with Africa, and Japan altogether to announce tomorrow that they will get rid of their countries' Fiat currencies and instead convert them to the U.S. Dollar. The U.S. Dollar would in effect be the only currency besides the Yuan in world of any consequence.
This would so fuck up the minds and economies of so many people that only one thing could possibly happen: In the ensuing chaos everyone would make so much money that all the ills of world would be cured or throw the existing establishments into a Tower of Babel trying to figger everything out that various governments would be paralyzed and the existing problems would eventually just disappear because the Central banksters would be eliminated from the equation and go back to academia where they belong.
Print, baby, print!
That's the solution.
Gold seesm to be the best hedge against both inflation and deflation according to Univeristy of Texas Employee Retirement Fund and Northwestern Mutual Life Insurance Company both of whom I understand to be very conservative.
Spot on brother. Kudos!
Bernank and the pols will have their way with you. Buy as much gold and silver and Vaseline as you can reasonably afford. It may be the only way the serfs can minimize the pain to come.
The Democrats have said pretty much the opposite with, “No spending cuts”.
What planet are you on?
YM,
and your point is that the Dems do want to make spending cuts? Can you point out the cuts and impacts?
I think this is a pretty apolitical piece Bruce has written; just is what it is. Neither side will make any hard choices to resolve the issue and instead look for the "extend / pretend" option Bruce has offered.
Tks HB.
I'm not taking sides here. Just trying to look around the corner.
e.g. http://www.washingtonpost.com/opinions/make-no-defense-cuts-or-tax-incre...
"Critics say Republicans are being unreasonable in rejecting any tax hikes. In an editorial last week,The Post called GOP leaders “childish and irresponsible” and pointed out that Democrats have agreed to accept $2 trillion in spending cuts while Republicans are refusing to accept any tax increases in exchange. “Where is the Republican flexibility?” the paper asked."
Go on a massive spending spree, increasing the deficit from $400 billion to $1.8 trillion, then demand tax increases to pay for the spending spree. Yes, that's very adult and responsible of them. The WaPo is a mouthpiece for Obama and when have they ever seen a tax hike that they didn't like? When did they ever see a new social program they didn't like?
WaPost = Jewrag. The "2 trillion over 10 yrs" cut is a) a drop in the debt bucket over that time frame and, of course, b) will never happen. The tax increase, however, happens in the here and now. And there IS a difference between the 2 parties: Dems are evil, Repubs are stupid and evil.
You are a brainless, anti-semitic dick. STFU
YM,
it's not what they say...it's what they do. For the last big tax breakthrough, go all the way back to a couple months ago when Repubs and Dems came together to create a budget for 2011...for a grand savings of a $500million or so on a budget deficit in excess of $1.5T...blame goes all around, but pleeeazzz, no more of this Dems or Repubs are serious. Neither side is serious and neither side will choose to do the "unpopular". Thus, much of Bruce's scenario (though not any of our preference) has legs.
You're all very good at criticizing the republicans and the democrats, and I have a fondness for doing that as well. I don't believe either side is serious about anything except screwing over everyone who isn't giving them money. But the simple fact is that Bruce made a claim which is made-up and false, and that's all I pointed to. He didn't say that democrats talk about willingness to cut but will only cut small amounts, or talk about being willing to cut but are lying about it. He said they've drawn a line in the sand saying no cuts at all, and that is purely made-up and false, and that's that and all I was saying.
You were clear, and right to point out the writer's emboldened mistatement. The writer was laying out a cause and effect argument for his theory but compromising himself in misstating factual elements. When one does that, even at the immaterial level, his argument suffers for overall credibility, especially when his bold text indicates that what he is presenting as fact should be considered especially important. As you've explained, this is merely a matter of accuracy.
Ah yes the ole "raise taxes" crap. How does that actually work? They can raise the tax RATES, but that doesn't equate to raising tax RECEIPTS. See the chart: http://www.google.com/imgres?imgurl=http://nationalpriorities.org/media/uploads/charts/fed_outlays_and_rev_as_perc_gdp.png&imgrefurl=http://www.cyclonefanatic.com/forum/politics-religion-global-warming/120139-krugman-fears-failure.html&usg=__yYz7zw2yjWA4oNbW3IjZG6fImcc=&h=386&w=488&sz=8&hl=en&start=0&zoom=1&tbnid=-rvEdb95iKMIFM:&tbnh=121&tbnw=153&ei=-OkITve3FYrCsAOw1N20DQ&prev=/search%3Fq%3Dtax%2Brevenues%2B45%2Byears%2Bchart%26hl%3Den%26safe%3Doff%26sa%3DX%26rlz%3D1C1DVCA_enUS327US327%26nord%3D1%26biw%3D1280%26bih%3D685%26tbm%3Disch%26prmd%3Divns&itbs=1&iact=hc&vpx=119&vpy=216&dur=7464&hovh=200&hovw=252&tx=115&ty=121&page=1&ndsp=28&ved=1t:429,r:7,s:0&biw=1280&bih=685
/yawn/
...for the gajillionth time, there are no democrats, there are no republicans. There are owners, and there are slaves. Which are you?
+1
Enemy of the State
+1
And I'm not claiming the democrats are going to get the deficit under control or even have a plan to. Just that this claim of his patently false.
Look, I'm not advocating for one of the parties either. What I'm saying is that your claim is wildly inaccurate. If you look at what democrats have said about the debt ceiling negotiations, there is not one instance of them saying such a thing. What they have said is that tax increases have to be a part of the deal. But it's understood that there will also be budget cuts, and the figure they have been hovering around in the negotiations is around $2 trillion (presumably over 10 years, but this hasn't been made explicit). I'm not making this up, it's been everywhere in all the newspapers, political news sites, their speeches. I challenge you to find me one instance of democrats drawing the line you say they do regarding these negotiations.
So cuts of $200 million per year on a $1.8 trillion annual deficit? You really think that will solve the problems? Rolling back the Bush tax cuts will bring in $100 million per year at best. Now we are left with $1.5 trillion annual deficits. Whoopee! Problem solved.
How about cutting spending back to Clinton era levels adjusted for inflation? Can anyone argue that the government was too small when Clinton was President? On top of that, roll back the Bush tax cuts and end all the wars. They don't hate us because of our supposed freedoms.
We have an instant balanced budget. Both sides get their wishes.
I find this article very interesting as I've been working on a theory that the Fed is trying to kill China and the Euro. Adjusting target inflation would go a long way towards achieving both of those goals.
My problem all along has been the same as yours I think. How do you play this? Can you go long on the dollar against the Euro? Ultimately that play will pay off, but how long will it take? What about Munis? Will they benefit from an increase in inflation? It's a really tough call, uncharted territory. But a good pick here could make you a lot of cheddar.
DRR, a Euro/dollar short ETF.
Whatever any of them do will not matter they will be doomed.
Instead of messing with the long bond, why not buy 3-year or 4-year notes and sit back as the Fed's steamroller crushes the yield....over the next 12-24 months?
Pretty much guaranteed gains.
Well, without a doubt, the show must go on. So if this is the easiest option for them keep the music playing, we're gonna get it. Right in the keester.
EDIT:
One problem here though: Oil.
Yanks don't dig $12 gas.
My young adult son just bought a new scooter to keep ahead of the gas price curve when it hits.
malikai,
We have been eating caca stew for a while now, and whatever they serve up next, we WILL like it, and we WILL eat it.
Thus sayeth the oligarchicalasswipes over xxxx that out.
They have not overseen anything, they have screwed the country into a permanent loser.The shite, just get's runnier from here.
Have another bowl of porridge.
The patient is sick and the cure will kill him.
Wait til they get a taste of what inflation can actually do!
They'll be hooked.
If a little is good, a lot must be better... right?
"If less is more, imagine how much more MORE would be!"
~ Frasier Crane
-The resulting inflation in all commodities would roll into new home construction costs and therefore be a boost to existing values. (Soft bailout to housing/lenders)
Doesn't the existing overhang negate this?
Yes, that's part of it. This is one point that I have to respectfully disagree with Bruce on. Home prices are made up of more than the construction costs. In addition to oversupply, prices also are influenced by the amount of credit available for loans. That hasn't been increasing. Indeed, Freddie and Fannie (who do 90+% of the mortgages these days) have been tightening up lately (perhaps getting a tad embarassed by their staggering losses), resulting in a higher rate of mortgage rejections lately (about 25% presently).
I don't see the posited actions driving up home prices immediately. The Administration would be lucky just to break the current 10% YOY decline, or even the acceleration. Personally, I don't think they are going to be that lucky.
Agreed. Also -- too much demand was pulled forward during the easy credit of the boom so there are few ready, willing, and able buyers now. Many potential move-up buyers are underwater and can't sell in order to purchase a new home; many are in default or foreclosure and so can't purchase due to poor credit; and many potential first-time buyers are either unemployed or are already carrying huge student loan debt. I just don't see where the demand to push prices up will come from.
Of course it does. Home builders will get squeezed and slow down construction, as they will not be able to pass increased costs along.
Bruce, nice piece! You present a very possible scenario.
I agree that nobody will make the hard decisions to put our economy on the right track. I also think that a big inflation is a greater worry than deflation, though I certainly concede that a short term deflation could happen.
Completely agree re gold.
Diversification always help protect you vs. almost any scenario.
Not going to happen. Even the Stupid Party understands that inflation is a tax.
There is always, and only, inflation.
Under a fiat currency regime, you are absolutely correct.
A fiat currency deflation is an oxymoron, never witnessed even once yet in the sad and sordid history of the fraud and abomination that is fiat currency --- nor is it likely to ever be seen.
ZH readers have repeatedly - REPEATEDLY! - tried to teach you the different definitions and understandings of what deflation means, and yet you are incapable of understanding it.
I've never seen someone so confused about such a simple word in all my life.
Thank you for demonstrating your ignorance and disingenuousness once again, RedNeckRepugnicant/WilliamtheBastard/18OtherTrollIDs.
The fact is that there is only ONE true definition of deflation: A decrease in the supply of money --- everything else is Keynesian obfuscation, misdirection or disinformation. And it is a demonstrable fact that such an event has NEVER been seen in the history of fiat money, nor has its most obvious and usual side effect, a falling general price level, even independent of changes in the money supply. So no matter how you choose to define it, deflation has NEVER been seen under a fiat currency regime. Go ahead and provide such an example, asswipe --- we all know, and so do you, that you can't.
M3 has indeed decreased.
Credit destruction is what you're missing akak.
That's not a zero sum game. Perhaps capital destruction is the point lost on many. The money is still on the books, as purchased and reported by the Fed on their balance sheet. FASB coup de gras to borrowers, the smoking gun is in the hand of BB et al.
Perhaps I do not understand the context in which you state "deflation has never been seen under a fiat currency", but bubbles deflate all the time. Tulips, housing (2007-2011), gold (1980-2000), etc. However, I agree that printers of fiat find that printing fiat is the easy solution to most of their big problems.
I would say attempted "solution". Credit makes up the vast majority of the money supply; fiat currency is a very small portion of it. So yes, you can have deflation under a fiat system, when the amount of credit out there is destructing. Which is exactly what we've had these past couple of years. Just look at Z.1.
You can also look at M3, and there you see a mixture. That was decreasing, even given the vast "printing" until just recently.
he said falling general price level. maybe a touch in early 1982, late 1990, early 2009, but never for very long.