Posts Tagged ‘Monetary Policy’

The Currency Crisis

Peter Diamond seems surprised that winning a Nobel Prize in economics for his work on unemployment and the labor market does not instantly make him qualified to serve on the board of the Federal Reserve. He wrote a fascinating article published in the New York Times discussing his thoughts and disappointment that he will not be able to fix the US economy.

He basically blames the Republicans and give this answer to why he isn’t “qualified”:

The easy answer is to point to shortcomings in our confirmation process and to partisan polarization in Washington. The more troubling answer, though, points to a fundamental misunderstanding: a failure to recognize that analysis of unemployment is crucial to conducting monetary policy.

Really? A failure to analyze unemployment is crucial to conducting monetary policy? Obviously said like a true economist with a straight face. Economists always treat economics like a science, and yet they never seem to agree and their ability to predict even short-term events are pathetic.

I don’t know anything about Diamond’s work or why he won the Nobel Prize.  Kasey Dufresne gives commentary on the topic here.  Fine. Whatever.

I just don’t like having yet another economist experimenting and tinkering with the economy. Centralized control of anything makes everyone a victim. He argues that:

But understanding the labor market — and the process by which workers and jobs come together and separate — is critical to devising an effective monetary policy. The financial crisis has led to continuing high unemployment.The Fed has to properly assess the nature of that unemployment to be able to lower it as much as possible while avoiding inflation.

Exactly my point. The new mandate for the Fed is to control monetary policy to avoid inflation and reduce unemployment.  He thinks he can control two outcomes when he won’t even be able to control one.

If much of the unemployment is related to the business cycle — caused by a lack of adequate demand — the Fed can act to reduce it without touching off inflation. If instead the unemployment is primarily structural — caused by mismatches between the skills that companies need and the skills that workers have — aggressive Fed action to reduce it could be misguided.

And what is the solution if the problem is primarily structural? I suppose government-funded training.

[He] concluded that structural unemployment and issues of mismatch were not important in the slow recovery we have been experiencing, and thus not a reason to stop an accommodative monetary policy — a policy of keeping short-term interest rates exceptionally low and buying Treasury securities to keep long-term rates down. Analysis of the labor market is in fact central to monetary policy.

He thinks the Fed should keep doing more of what it has been doing. We were told that the current policy would reduce unemployment. The economists are scratching their heads trying to figure out why it isn’t working and the grand conclusion is that we have to do more of the same for longer.

We are told not to worry about inflation.  The government claims that inflation is very low. Yet the price of everything is going up… worldwide. In the history of the World, long-term debt monetization has always led to disaster.  But they think this time it will be different because the guys holding the steering wheel really understand. Then why does gold keep rising even though economists typically say it is a short-term phase and gold has no intrinsic value? With all the terrible debt-related problems in the European Union, why does the US dollar keep dropping against the Euro? Maybe monetization has something to do with it?  And Diamond thinks we just need more of it.

I did find a bullish article published in the Wall Street Journal called “The Bullish Case for the U.S. Economy.” In the article, Robert Doll has some good news for us:

Credit markets are sound. Money growth is good.

Okay, and why is he bullish? Oh, because…

You could say we’re the best house in a bad neighborhood. We have fewer problems and more solutions than Europe or Japan.”

Now that’s a ringing endorsement. His whole positive outlook is based on the idea that the US population will continue to grow faster than Europe and Japan and, therefore, the US economy will have to grow.

Mr. Doll explains the economics: “The long-term growth rate of any economy is the product of the change in the size of the work force multiplied by the productivity of the work force.” Productivity is very hard to predict, he reports, but demographics is easy. “You count noses.” And that tally shows a very healthy America.

Now I finally understand economics. What else does he say? He thinks half of the 2009 stimulus was wasted (I think he’s being generous here) and that ObamaCare, the 2010 Dodd-Frank financial reform law, and the president’s desire for tax increases are all “retardants to growth.” He basically sums it all up like this:

We face formidable long-term structural problems that make the U.S. less attractive than it otherwise might be…. You might say we win by default, which is not a fun way to win.

Here’s the icing on the cake: When asked about long-term investments….

Mr. Doll says that if he were forced to lock up his money in one place for the next 10 or 20 years he would indeed select the developing world and specifically India over China.

Right. Definitely not Japan or Europe,…or the US. This is what passes at the Wall Street Journal for a bullish case on the US economy. Wow. This almost scares me a bit. I’m contrarian by nature. When everyone thinks things can’t get better, I’m bullish. Thankfully, my buddy Joe sent me another article which helped my confidence: Bob Rodriguez: The man who sees another crash.

Yes! Finally! This guy knows what he is talking about. How do I know? Because he says the same things that I have been saying for years about why the US economy is doomed (my words, not his.)

He predicted the last two major stock market crashes (1990 and 2008). After the 2008 financial crisis, he hoped things would be different, that people had learned a lesson.

Sobriety, it seemed, was back. Leverage was out. Frugality was hailed once again as a virtue. It appeared that the world had finally begun to understand risk.

But, only a couple of years later in 2011, he notices that…

almost nothing has changed. Risk taking is back in fashion, and the nation’s debt load, which he believes is the single greatest threat facing investors today, has soared. Now, once again, Rodriguez is sounding the alarm.

And why is the nation’s debt such a problem? Because the government isn’t honest about its balance sheet. Here’s the quote:

Rodriguez argues that the U.S. debt as a percentage of GDP ratio (currently 64%) is massively underreported because it doesn’t count off-balance-sheet entitlements such as Medicare, and debt owed by Fannie and Freddie. If you factor in those liabilities, he says, the actual ratio is greater than 500% and growing. The U.S. must reduce that before 2012, Rodriguez says, because it’s unlikely to accomplish anything during the election year. If nothing changes, he adds, investors will start to get nervous about the amount of debt on the U.S. balance sheet. As lenders balk at buying Treasuries, rates will spike, causing borrowing costs to skyrocket across the financial system. “The financial system is held together with a very thin filament called confidence,” says Rodriguez. “When you clip that, all hell breaks loose.”

Exactly true. As I see it, also inescapable. The US  government can only afford to pay the interest on the debt if interest rates are extremely low. If interest rates rise, the government will not be able to finance rolling-over the debt.  After that, it’s either a default or a massive increase in the money supply and a hopeless spiral into hyperinflation. Choose your poison.

I think things are already well underway and unavoidable. It has been reported that China has dumped 97% of its short-term US government securities. Normally, the Chinese offset decreasing holding of short-term Treasury bills by increasing holding in long-term securities, but not this time. China is also dropping its long-term holdings. It has been mainstream news for quite a while that China wants to stop using the US dollar as the world’s reserve currency. George Soros is busy trying to redesign the world’s financial and monetary system (in his own image). The party is over and the sober people are heading home. The drunks will wait until the cops arrive.

I don’t need a Nobel Prize or a degree in economics to see this.  Anyone smart enough to balance a check book should be able to see this.

And when “all hell breaks loose,” I know exactly where I don’t want to be.

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