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The Road To Stagflation
From The Daily Capitalist
This is an article I wrote for a newspaper that is a reprise of my reasoning why I think we are headed for stagflation. The article will appear next week, but it will be familiar stuff for Daily Capitalist readers.
*****
The Fed voted two weeks ago to print money as much money as they think is necessary to fight deflation, economic decline, and rising unemployment. It is a major policy change little noticed by the media.
There has been a lot of noise in the media lately about deflation. While a few of us have been forecasting deflation and a decline in the economy for some time (your truly since December, 2009), it is as if most economists had just discovered it.
The reason for all this concern is the weak economic data coming in:
- Jobless claims jumped to a 9-month high which forecasts rising unemployment.
- Consumer spending is softening.
- Disposable income is flattening.
- New manufacturing orders are declining and inventories are rising.
- Durable goods orders are falling.
- Credit continues to shrink, both for consumers and businesses.
- GDP was revised downward for Q2.
- The Consumer Confidence Index took a big slide.
- Commercial and industrial real estate is still declining.
- Home sales continue to decline.
- Some of the leading indicator indices are falling, such as the ECRI and the Consumer Metrics institute.
There are two more data points that really have the Fed concerned. One is that the Consumer Price Index is very low. While you would think that low rates of inflation are good, the Fed wants inflation.
The other thing that bothers the Fed is that money supply is declining and has been doing so since last December. They think that we may be heading for deflation.
What does all this mean? It means that everything the Fed and the federal government have done to revive the economy has failed. From massive fiscal stimulus (spending $787 trillion on mostly wasteful projects), to the TARP bailouts of Big Money, to zero interest rate policy (“ZIRP”), to gimmicks such as Cash for [your industry here], they have failed to stimulate the economy.
With all the bad data coming in, it is no wonder that the Fed, as reported in the minutes of its June, 2010 meeting, was so pessimistic:
Participants generally anticipated that, in light of the severity of the economic downturn, it would take some time for the economy to converge fully to its longer-run path as characterized by sustainable rates of output growth, unemployment, and inflation consistent with participants’ interpretation of the Federal Reserve’s dual objectives; most expected the convergence process to take no more than five to six years.
They are saying that they think it could take 5 or 6 years from 2008 for things to turn around.
What they overlook is that it is the Fed’s manipulation of the money supply that is the cause of our boom-bust cycles: they are the problem, not the solution. And that is why their policies are failing.
Which gets us back to the inflation-deflation issue. It is an axiom of faith with the economists who control Fed and government policy that the economy needs a little bit of inflation to grow. They think that all the Fed has to do is step on the money pedal and the new money stimulates the economy, money supply grows evidencing healthy business lending, prices rise modestly, employment rises, and the economy grows.
The only problem with that idea is that it isn’t working.
Why have they failed?
It all has to do with the banks, mostly the regional and local banks that finance about one-half of our economy. These banks have two problems. First, as a result of the crash, their balance sheets are clogged up with (mostly) bad commercial real estate loans. Bad loans tie up a lot of capital that banks would otherwise lend out. Second, because of the economic decline, business customers aren’t borrowing. And it’s not just because banks have tightened lending standards; businesses see weak demand plus, with all the new laws passed, they are very uncertain about the future.
The Fed saw the plight of banks and they lowered the interest rate (the Fed Funds rate) to zero on money banks borrow from the Fed to make loans. They have also massively increased the pool of money available to banks to tap into (money base).
But, if banks aren’t lending and borrowers are reluctant to borrow, the new money never gets lent out, and the giant pool of new money just sits at the Fed as banks’ reserves.
Since the money is not being lent out, which is their main tool to increase money supply, money supply is now declining, and that is deflation. This is why the Fed is very concerned with a potential “deflationary spiral,” a phenomenon that occurred during the Great Depression.
What can the Fed do? They can’t lower the Federal Funds rate because it is already as low as it can go. And this hasn’t worked anyway.
This is what the big change in Fed policy was all about.
There was a huge internal fight at the Fed between the anti-deflationists and the anti-inflationists, and the anti-deflationists won. The Fed decided they would fight deflation through “quantitative easing” or “QE.”
With QE, another tool the Fed has to increase money supply, the Fed buys Treasury debt (bills, notes, and bonds) from its primary dealers and prints money to pay for it. This puts money directly into the economy.
It’s not as if this is something new. From last year through April of this year, the Fed bought $1.25 trillion of debt issued by Fannie Mae and Freddie Mac. They also bought about $700 million of Treasury debt. This put $2 trillion of new money into the economy. This apparently wasn’t enough.
The second important thing they announced is that they will replace their Fannie/Freddie paper with Treasury debt. This seems harmless at first because the Fed is not increasing its total debt holdings—yet.
They announced this with a seemingly innocuous statement: that they would keep their current level of debt at about $2 trillion. In Fed-speak this means they are clearly worried about the sinking economy, and that they will print as much fiat money as they think is necessary to increase the money supply to induce inflation.
In economic terms, buying Treasury debt is called “monetizing” debt. In plain English it means that the government prints money to pay for its debts. This policy has been the downfall of many governments who destroy their currency through hyperinflation.
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covert
Jesusland dude.
The amount of discounting that I see every day in the retail market is absolutely staggering, and I doubt that most of these 25-50% off deals are being picked up in the CPI. Only the regulated/govt sectors, where we don't have a choice, are showing any real inflation around here. I suspect that it is going to take a lot of money dumping to reverse this trend.
One cannot create a false non-sustainable economy as a solution....This just adds more expense to someone else at a later date.....
The economy has to be "real"....
"Real' means a true supporting base of ongoing innovative and opportunistic small businesses....
The best that the government can do is to recuse itself....and change tax structure such that small businesses can most easily develop....
The government needs to downsize to not greater than 10% of the economy....special consideration should be the immediate cutting of the military economic drain....Taxes are just a part of all prices and should be minimized in order to allow for recovery....
......................................
Tax structure change has to be broad based....
Both the individual and corporate income taxes need to be eliminated....
The most broad based tax structure possible would be a small basis point monthly charge on all cash balances....including cash deposits of loans....
ie 40 basis per month....thus allowing the government to downsize until it reaches 10% of the economy....
......................................
Common stock is the number one lever of capital....
All banks need more and higher valuations to abound...and common stock is the answer....
The exchanges need to be reconstructed favoring RETAIL....
There would be nothing better than a defragmented electronic direct access exchange with more than 2 billion personal accounts worldwide pressing their own computer buttons....This would make for a "real" marketplace....and better distribution of wealth....
.......................
As for the simple explanation of inflation versus deflation ...this is incredibly simple....
2006/7 100/100 (All credit and asset valuations......)
Today 60/100
Tomorrow 30/100
Even Bernanke will not print 70/100.....
The government moving to 10% of the economy and tax structure change would change this course....
MF,
BINGO!..........
But, there's the issue, that eludes the sheeple.
The Fed, and this administration in reality, DO NOT WANT A RECOVERY.
If they did, they would already have done what you wrote.
Why the vast majority of sheeple have not figured this out yet, is beyond me.
Perhaps a few million have, and like us, lack the power, and resolve to remove a bad tree, that cannot / will not produce good fruit.
Read this:
www.prudentbear.com/index.php/creditbubblebulletinview?art_id=10425
Thanks. I read Noland's pieces every Friday night when they are published and the guy is sooo spot on. It would be great if TD could take his "comments" section and publish it as a "Guest Post" every week. I am confident the ZH readers would really enjoy it.
Like Peter Schiff, these smart guys at Prudent Bear have been calling the credit bubble for about a decade...they are hardly the johnny -come-lately bears
Good luck with that. The fed doesn't even realize the bottom of the economy exists. They only think in terms of the TBTFs. And the TBTFs are taking all that free cash and dumping it into the shadow economy to pump the T-bond rocket ride we currently see. If it keeps the treasury borrowing cost less than 5%, the fed thinks they are performing a public service.
Here is the way bureaucrats think: One of my salesmen dealt with an S&L around 1989 who had been seized by FDIC. The on-site conservator was dollar rolling a big lot of FHLMC pass throughs at lower than current coupons. These were fairly obscure bonds to borrow and had a lot of severely paid-down balances. She did not like the accounting aggravation of 3 pool/mm delivery and asked specifically for 3 pools/trade. We accommodated her request at a cost that resulted in the bank being liquidated within 9 months. I wish I could remember her name, but I don't think it was Sheila.
The Fed wants to think they are 'helping' by directing their attention to the TBTFs. Its really a matter of convenience. Who wants to address a problem with 2000 banks? Especially when its now so much more profitable to kill them and pay your friends to take the remains?
I learned along time ago that direct access is a powerful source of influence. You always want your office to be on the same floor as your boss and as close to his/her office as possible.
Geithner, Obama, Frank and the rest of the political class are influenced by the legions of TBTF lobbyists and CEOs who are in touch with them daily. They think they are taking the correct actions because they are insulated from the other 99% of the population who are getting a raw deal.
Obama disappoints me the most. He is completely out of touch with the needs of workers and the poor. He likens himself as one of the East Coast elites and pursues abstract concepts generated out of the academic community.
I understand the minority community's pride in having the first African American president. However in my opinion they are getting a raw deal.
"The Fed wants to think they are 'helping' by directing their attention to the TBTFs. Its really a matter of convenience."
SO TRUE! More than we realize. It's also a matter of personal association... No kidding!
Oligarchies don't need conspiracies... They just need to go to the same clubs.
Ayn Rand & Alan Greenspan: The Altruism Fly in the Objectivist Ointment
http://culturalengineer.blogspot.com/2009/10/ayn-rand-alan-greenspan-alt...
Compensation and the Social Network
http://culturalengineer.blogspot.com/2009/10/compensation-social-network...
I don't suppose this will be a very popular opinion. But I believe the only solutions will require some sort of 'social disontinuity' at best.
There are all the ugly versions... you know... collapse, riots, purges and guillotines.
But the less drastic versions will require abandoning some shibboleths.
Two possible radical solutions (but less radical than the guillotines)...
Direct cash infusions to the bottom of the economy but with heavy biases for spending on domestic goods and services... (even if it takes tariffs, boycotts or specialized taxes)...
Or a massive re-distribution of wealth downwards via a one-time wealth levy (a la 'monopoly) and high progressivity going forward at least for some period of time.
Neither of these seems too likely. Maybe I'm wrong. It's an attempt to look solutions that might derive from a social energy* perspective.
*social energy: a civilization or any social organism is quite literally is a product of countless Decisions (Decision = an Idea + an Action) by individuals and groups operating within limits of physical reality. We then can see culture as an expression of net social energy. But unlike the other forms of energy we're familiar with social energy requires agreement on a whole collection of underlying values and assumptions to operate efficiently for the benefit of the organism as a whole.
Credit Creation and the Building of Sustainable Economic Ecologies
http://culturalengineer.blogspot.com/2010/02/credit-creation-and-buildin...
Whether these ideas have any merit or not (even theoretically)... we don't have a chance if we don't do something about our political and economic decision systems.
Political Fundraising: Act Blue, Facebook and the Missing Network Imperative
http://culturalengineer.blogspot.com/2010/08/political-fundraising-act-b...
"Direct cash infusions to the bottom of the economy"
That sounds like some kind of suppository.
Uncle Ben- "Now bend over and spread your cheeks. I've got the cure for what ails you!".
Don't take that cure.
I think the problem is more fundamental, and shifting things around as you suggest would not fix anything, as it deals with moving perceived wealth, and does not focus on the real issue of wealth creation, which is sorely lacking today. Health of small businesses is the key.
I think it is inevitable that we must all face a good deal of pain. The average lifestyle will need to change dramatically. We will go back to the days where children will need to care for their own aging parents. Neighbors will need to care for those in need in the community.
I grew up in the 60's. The house I grew up in was a small 2 bedroom home. It was heated by open flame propane heaters, and cooled by a single evaporative window unit, clothes were dried outside on a clothes line. We had one car. No granite counter tops, no cable TV, no gym membership, no maid, no yard guy, no dish washer, no color TV, no stereo system, no digital camera, no IPOD, no wood floors, no ice maker, no garbage disposal, no trash service, no sprinkler system in yard, no riding mower, no speedboat, no jet ski, no fancy vacations, no fitness coach, no eating out, no DVD's, no junk food, no diet soda, no designer clothes, and NO DEBT.
While I was never cold, and never hungry, and felt like I had all I needed, the conditions I grew up in, today, would be considered abject poverty. I think that we will be forced to return to a more moderate existence. The path from here to there, though, might prove to be interesting.
Yup, I grew up the same way at the same time. Very nicely worded Rebel.
The FED doesn't give a shit about the "bottom of the economy", they are there to serve the best interests of the money cabal.
The money cabal has been bailed out, the average J6P not so much.
Any actions the FED takes in the future will continue to be in the best interest of the money elite and to try and continue the busted ponzi scheme called "debt based monetary system". They don't give a fuck about you. Your President, Administration and Congress don't give a fuck about you. They have been captured by the money cabal and have become their enablers. The sooner America wakes up to this fact, the sooner we can have a social uprising that can lead to real change, not the kind a hologram president reads off a teleprompter.
(rant over)
Depreflation, bitchez!!
You want a rant? I'll show you a rant.......
But on second thought your comments covered it quite well. It used to be that one Party represented business interests and the other Party represented workers and the downtrodden. Today the Republican Party only represents CEO interests and the Democratic Party only represents wealthy elites. This is not going to turn out well for the middle class or the working poor. They can only keep folks pacified with food stamps and UC checks for so long until the entire process breaks down.
Social unrest will come. From where, what will be the catalyst, how will it play out, I have no clue.
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