It’s the Fed, Stupid!

A Messaging Tip For The Donald: It’s The Fed, Stupid!

The Fed’s core policies of 2% inflation and 0% interest rates are kicking the economic stuffings out of Flyover AmericaThey are based on the specious academic theory that financial gambling fuels economic growth and that all economic classes prosper from inflation and march in lockstep together as prices and wages ascend on the Fed’s appointed path.

Read more

Book Review: Makers and Takers

Makers and Takers: The Rise of Finance and the Fall of American Business by Rana Foroohar

Crown Business; 1st edition (May 17, 2016)

Ms. Foroohar does a fine job of journalistic reporting here. She identifies many of the failures of the current economic policy regime that has led to the dominance of the financial industry. She follows the logical progression of central bank credit policy to inflate the banking system, that in turn captures democratic politics and policymaking in a vicious cycle of anti-democratic cronyism.

However, her ability to follow the money and power is not matched by an ability to analyze the true cause and effect and thus misguides her proposed solutions. Typical of a journalistic narrative, she identifies certain “culprits” in this story: the bankers and policymakers who favor them. But the true cause of this failed paradigm of easy credit and debt is found in the central bank and monetary policy.

Since 1971 the Western democracies have operated under a global fiat currency regime, where the value of the currencies are based solely on the full faith and credit of the various governments. In the case of the US$, that represents the taxing power of our Federal government in D.C.

The unfortunate reality, based on polling the American people (and Europeans) on trust in government, is that trust in our governmental institutions has plunged from almost 80% in 1964 to less than 20% today. Our 2016 POTUS campaign reflects this deep mistrust in the status quo and the political direction of the country. For good reason. So, what is the value of a dollar if nobody trusts the government to defend it? How does one invest under that uncertainty? You don’t.

One would hope Ms. Foroohar would ask, how did we get here? The essential cause is cheap excess credit, as has been experienced in financial crises all through history. The collapse of Bretton Woods in 1971, when the US repudiated the dollar gold conversion, called the gold peg, has allowed central banks to fund excessive government spending on cheap credit – exploding our debt obligations to the tune of $19 trillion. There seems to be no end in sight as the Federal Reserve promises to write checks without end.

Why has this caused the complete financialization of the economy? Because real economic growth depends on technology and demographics and cannot keep up with 4-6% per year. So the excess credit goes into asset speculation, mostly currency, commodity, and securities trading. This explosion of trading has amped incentives to develop new financial technologies and instruments to trade. Thus, we have the explosion of derivatives trading, which essentially is trading on trading, ad infinitum. Thus, Wall Street finance has come to be dominated by trading and socialized risk-taking rather than investing and private risk management.

After 2001 the central bank decided housing as an asset class was ripe for a boom, and that’s what we got: a debt-fueled bubble that we’ve merely re-inflated since 2008. There is a fundamental value to a house, and in most regions we have far departed from it.

So much money floating through so few hands naturally ends up in the political arena to influence policy going forward. Thus, not only is democratic politics corrupted, but so are any legal regulatory restraints on banking and finance. The simplistic cure of “More regulation!” is belied by the ease with which the bureaucratic regulatory system is captured by powerful interests.

The true problem is the policy paradigm pushed by the consortium of central banks in Europe, Japan, China, and the US. (The Swiss have resisted, but not out of altruism for the poor savers of the world.) Until monetary/credit policy in the free world becomes tethered and disciplined by something more than the promises of politicians and central bankers, we will continue full-speed off the eventual cliff. But our financial masters see this eventuality as a great buying opportunity.

The Guardian view on central bankers: growing power and limited success

I am now somewhat sceptical of the success of a merely monetary policy directed towards influencing the rate of interest. I expect to see the State, which is in a position to calculate the marginal efficiency of capital-goods on long views and on the basis of the general social advantage, taking an ever greater responsibility for directly organising investment.

– John Maynard Keynes

This editorial by The Guardian points out the futilities of current central banking policy around the world. Unfortunately, they only get it half right: the prescience of Keynes’s first sentence is only matched by the absurdity of his second sentence. Calculate the marginal efficiency of capital? Directing investment? Solyndra anyone? The captured State is the primary problem of politicized credit…

Reprinted from The Guardian, Thursday 25 August 2016

To find the true centre of power in today’s politics, ignore the sweaty press releases from select committees, look past the upcoming party conferences – and, for all our sakes, pay no mind to the seat allocations on the 11am Virgin train to Newcastle. Look instead to the mountains of Wyoming, and the fly-fishers’ paradise of Jackson Hole.

Over the next couple of days, the people who set interest rates for the world’s major economies will meet here to discuss the global outlook – but it’s no mere talking shop. What’s said here matters: when the head of the US Federal Reserve, Janet Yellen, speaks on Friday, the folk who manage our pension funds will take a break from the beach reads to check their smartphones for instant takes.

This year the scrutiny will be more widespread and particularly intense. Since the 2008 crash, what central bankers say and do has moved from the City pages to the front page. That is logical, given that the Bank of England created £375bn of new money through quantitative easing in the four years after 2009 and has just begun buying £70bn of IOUs from the government and big business. But the power and prominence of central banks today is also deeply worrying. For one, their multibillion-pound interventions have had only limited success – and it is doubtful that throwing more billions around will work much better. For another, politicians are compelling them to play a central role in our politics, even though they are far less accountable to voters. This is politics in the garb of technocracy.

Next month is the eighth anniversary of the collapse of Lehman Brothers. Since then the US central bank has bought $3.7tn (£2.8tn) of bonds. [Note: We’re going on $4 trillion of free money pumped into the financial sector, folks] All the major central banks have cut rates; according to the Bank of England’s chief economist, Andy Haldane, global interest rates are at their lowest in 5,000 years. Despite this, the world economy is, in his description, “stuck”. This government boasts of the UK’s recovery, but workers have seen a 10% drop in real wages since the end of 2007 – matched among developed economies only by Greece. Fuelling the popularity of Donald Trump and Bernie Sanders is the fact that the US is suffering one of the slowest and weakest recoveries in recent history. In April, the IMF described the state of the global economy as “Too Slow for Too Long”.

Having thrown everything they had at the world economy, all central bankers have to show is the most mediocre of score sheets. When it comes to monetary policy, the old cliche almost fits: you can lead a horse to water, but you cannot make it avail itself of super-low interest rates to kickstart a sustainable recovery. Two forces appear to be at work. First, monetary policy has been used by politicians as a replacement for fiscal policy on spending and taxes, when it should really be complementary. Second, major economies – such as Britain after Thatcher’s revolution – have become so unequal and lopsided that vast wealth is concentrated in the hands of a few who use it for speculation rather than productive investment. QE has pushed up the price of Mayfair flats and art by Damien Hirst. It has done next to nothing for graphene in Manchester. [Does it take a rocket scientist to figure this out?]

All this was foreseen by Keynes in his General Theory: “I am now somewhat sceptical of the success of a merely monetary policy directed towards influencing the rate of interest. I expect to see the State, which is in a position to calculate the marginal efficiency of capital-goods on long views and on the basis of the general social advantage, taking an ever greater responsibility for directly organising investment.”

Eighty years on, it is time those words were heeded by policymakers. In Britain, that means using state-owned banks such as RBS and Lloyds to direct loans to those industries and parts of the country that elected and accountable politicians see as being in need. Couple that with a tax system that rewards companies on how much value they add to the British economy, and the UK might finally be back in business.

The State, run by the political class and their technocrats? Yikes!!! Will we ever learn?

Economic Policy Report Card: C-

Today’s headlines:

Still anemic: U.S. growth picks up to only 0.8%

U.S. economic growth between January and March was 0.8% compared to the same time frame a year ago. That’s better than the initial estimate of 0.5%, which came in April, but still pretty sluggish.

unemployment-grads-cartoon1

US created 38,000 jobs in May vs. 162,000 expected

Job creation tumbled in May, with the economy adding just 38,000 positions, casting doubt on hopes for a stronger economic recovery as well as a Fed rate hike this summer.

The Labor Department also reported Friday that the headline unemployment fell to 4.7 percent. That rate does not include those who did not actively look for employment during the month or the underemployed who were working part time for economic reasons. A more encompassing rate that includes those groups held steady at 9.7 percent.

The drop in the unemployment rate was primarily due to a decline in the labor force participation rate, which fell to a 2016 low of 62.6 percent, a level near a four-decade low. The number of Americans not in the labor force surged to a record 94.7 million, an increase of 664,000.

growth chart

We’ve been predicting such disappointing results of ineffectual monetary and fiscal policies since this blog began back in August of 2011. And providing corroborating evidence along the way. Yet our policy experts continue to double-down on failed policies.

The problem is that when a nation inflates asset bubbles like we did with commodities, houses, stocks, and bonds over the past 20 years, there is no silver-lining policy correction that does not involve some  economic pain for the body politic. We had that awakening in 2008, but since then we have merely jumped on the same train by pumping out cheap credit for 8+ years.

Perhaps a medical metaphor works here. When prescribing antibiotics to combat an infection one can use small doses to avoid side-effects or one large overkill dose to knock-out the offending bacteria. The first treatment is the conservative, prudent approach that seeks a gradual recovery. The second risks a sudden shock to the system that kills off the infection so the patient can begin healing.

In medicine we’ve discovered that the gradual treatment can enable the bacteria to evolve and resist the antibiotics, making them ineffectual. In a nutshell, this is what we have done with economic policy, especially monetary policy that has distorted interest rates for more than 15 years.

The conservative approach marked by bailouts and government bail-ins has kept the patient flat on his back for 8 years. The more disciplined approach would have shocked the economy severely but gotten the patient out of the recovery room much quicker. We’ve seen that with other countries, like Iceland, that were forced to swallow their medicine in one quick dose.

But, of course, that would have meant a lot of politicians would have lost their cozy jobs. That may happen anyway after the next election.

Statistical Fixations

Martin Feldstein is nowhere near as excitable as David Stockman on Fed manipulations (link to D.S.’s commentary), but they both end up at the same place: the enormous risks we are sowing with abnormal monetary policies. The economy is not nearly as healthy as the Fed would like, but pockets of the economy are bubbling up while other pockets are still deflating. There is a correlation relationship, probably causal.

The problem with “inflation targeting” is that bubble economics warps relative prices and so the correction must drive some prices down and others up. In other words, massive relative price corrections are called for. But inflation targeting targets the general price level as measured by biased sample statistics – so if the Fed is trying to prop up prices that previously bubbled up and need to decline, such as housing and stocks, they are pushing against a correction. The obvious problem has been these debt-driven asset prices, like stocks, government bonds, and real estate. In the meantime, we get no new investment that would increase labor demand.

The global economy needs to absorb the negative in order to spread the positive consequences of these easy central bank policies. The time is now because who knows what happens after the turmoil of the US POTUS election?

Ending the Fed’s Inflation Fixation

The focus is misplaced—and because it delays an overdue interest-rate rise, it is also dangerous.

By MARTIN FELDSTEIN
The Wall Street Journal, May 17, 2016 7:02 p.m. ET

The primary role of the Federal Reserve and other central banks should be to prevent high rates of inflation. The double-digit inflation rates of the late 1970s and early ’80s were a destructive and frightening experience that could have been avoided by better monetary policy in the previous decade. Fortunately, the Fed’s tighter monetary policy under Paul Volcker brought the inflation rate down and set the stage for a strong economic recovery during the Reagan years.

The Federal Reserve has two congressionally mandated policy goals: “full employment” and “price stability.” The current unemployment rate of 5% means that the economy is essentially at full employment, very close to the 4.8% unemployment rate that the members of the Fed’s Open Market Committee say is the lowest sustainable rate of unemployment.

For price stability, the Fed since 2012 has interpreted its mandate as a long-term inflation rate of 2%. Although it has achieved full employment, the Fed continues to maintain excessively low interest rates in order to move toward its inflation target. This has created substantial risks that could lead to another financial crisis and economic downturn.

The Fed did raise the federal-funds rate by 0.25 percentage points in December, but interest rates remain excessively low and are still driving investors and lenders to take unsound risks to reach for yield, leading to a serious mispricing of assets. The S&P 500 price-earnings ratio is more than 50% above its historic average. Commercial real estate is priced as if low bond yields will last forever. Banks and other lenders are lending to lower quality borrowers and making loans with fewer conditions.

When interest rates return to normal there will be substantial losses to investors, lenders and borrowers. The adverse impact on the overall economy could be very serious.
A fundamental problem with an explicit inflation target is the difficulty of knowing if it has been hit. The index of consumer prices that the Fed targets should in principle measure how much more it costs to buy goods and services that create the same value for consumers as the goods and services that they bought the year before. Estimating that cost would be an easy task for the national income statisticians if consumers bought the same things year after year. But the things that we buy are continually evolving, with improvements in quality and with the introduction of new goods and services. These changes imply that our dollars buy goods and services with greater value year after year.

Adjusting the price index for these changes is an impossibly difficult task. The methods used by the Bureau of Labor Statistics fail to capture the extent of quality improvements and don’t even try to capture the value created by new goods and services.

The true value of the national income is therefore rising faster than the official estimates of real gross domestic product and real incomes imply. For the same reason, the official measure of inflation overstates the increase in the true cost of the goods and services that consumers buy. If the official measure of inflation were 1%, the true cost of buying goods and services that create the same value to consumers may have actually declined. The true rate of inflation could be minus 1% or minus 3% or minus 5%. There is simply no way to know.

With a margin of error that large, it makes no sense to focus monetary policy on trying to hit a precise inflation target. The problem that consumers care about and that should be the subject of Fed policy is avoiding a return to the rapidly rising inflation that took measured inflation from less than 2% in 1965 to 5% in 1970 and to more than 12% in 1980.

Although we cannot know the true rate of inflation at any time, we can see if the measured inflation rate starts rising rapidly. If that happens, it would be a sign that true inflation is also rising because of excess demand in product and labor markets. That would be an indication that the Fed should be tightening monetary policy.

The situation today in which the official inflation rate is close to zero implies that the true inflation rate is now less than zero. Fortunately this doesn’t create the kind of deflation problem that would occur if households’ money incomes were falling. If that occurred, households would cut back on spending, leading to declines in overall demand and a possible downward spiral in prices and economic activity.

Not only are nominal wages and incomes not falling in the U.S. now, they are rising at about 2% a year. The negative true inflation rate means that true real incomes are rising more rapidly than the official statistics imply. [Sounds good, huh? Not quite. Read Stockman’s analysis.]

The Federal Reserve should now eliminate the explicit inflation target policy that it adopted less than five years ago. The Fed should instead emphasize its commitment to avoiding both high inflation and declining nominal wages. That would permit it to raise interest rates more rapidly today and to pursue a sounder monetary policy in the years ahead.

inflation-vs-employment

The Debt Driven Economy

mtdebt

The problem is that like all Keynesians they do not know the difference between fiat credit, which is manufactured out of thin air by fractional reserve commercial banks or money-printing central banks, and honest debt that is funded out of genuine savings from current income by households and business.

Krugman’s Dopey Diatribe Deifying The Public Debt

Actually, dopey does not even begin to describe Paul Krugman’s latest spot of tommyrot. So here are his own words—–least it appear that the good professor is being unfairly caricaturized. In a world drowning in government debt what we desperately need, by golly, is more of  the same:

That is, there’s a reasonable argument to be made that part of what ails the world economy right now is that governments aren’t deep enough in debt.

Yes, indeed. There is currently about $60 trillion of public debt outstanding on a worldwide basis compared to less than $20 trillion at the turn of the century. But somehow this isn’t enough, even though the gain in public debt——-from the US to Europe, Japan, China, Brazil and the rest of the debt-saturated EM world—–actually exceeds the $35 billion growth of global GDP during the last 15 years.

But rather than explain why economic growth in most of the world is slowing to a crawl despite this unprecedented eruption of public debt, Krugman chose to smack down one of his patented strawmen. Noting that Rand Paul had lamented that 1835 was the last time the US was “debt free”, the Nobel prize winner offered up a big fat non sequitir:

Wags quickly noted that the U.S. economy has, on the whole, done pretty well these past 180 years, suggesting that having the government owe the private sector money might not be all that bad a thing. The British government, by the way, has been in debt for more than three centuries, an era spanning the Industrial Revolution, victory over Napoleon, and more.

Neither Rand Paul nor any other fiscal conservative ever said that public debt per se would freeze economic growth or technological progress hard in the horse and buggy age. The question is one of degree and of whether at today’s unprecedented public debt levels we get economic growth—–even at a tepid rate—–in spite of rather than because of soaring government debt.

A brief recounting of US fiscal history leaves little doubt about Krugman’s strawman argument.  During the eighty years after President Andrew Jackson paid off the public debt through the eve of WWI, the US economy grew like gangbusters. Yet the nation essentially had no debt, as shown in the chart below, except for temporary modest amounts owing to wars that were quickly paid down.

In fact, between 1870 and 1914, the US economy grew at an average rate of 4% per year——the highest and longest sustained growth of real output and living standards ever achieved in America either before or since. But during that entire 45 year golden age of prosperity, the ratio of US public debt relative to national income was falling like a stone.

In fact, on the eve of World War I, the US had only $1.4 billion of debt. That is the same figure that had been reached before the Battle of Gettysburg in 1863.

That’s right. During the course of four decades, the nominal level of peak Civil War debt was steadily whittled down; the Federal  budget was in balance or surplus most of the time; and at the end of the period a booming US economy had debt of less than 5% of GDP or about $11 per capita!

In short, nearly a century of robust economic growth after 1835 was accompanied by hardly any public debt at all. The facts are nearly the opposite of Krugman’s smart-alecky insinuation that today’s giant, technologically advanced economy would not have happed without all of today’s massive public debt.

Indeed, on a net basis every dime that was added to the national debt between Jackson’s mortgage burning ceremony in 1835 and 1914 was 100% war debt that never contributed to domestic economic growth and was mostly repaid during peacetime. In effect, Rand Paul was right: In a modern Keynesian sense, the US was “debt free” during the 80 years when it emerged as a great industrial powerhouse with the highest living standard in the world.

Thereafter, there were two huge surges of wartime debt, but those eruptions had nothing to do with peacetime domestic prosperity;  and they were quickly rolled back after the war-time emergencies ended. Its plain to see in the graph below.

During WWI, for example, the national debt soared from  $1.4 billion to $27 billion, but the great Andrew Mellon, as Secretary of the Treasury during three Republican administrations, paid that down to less than $17 billion, even as the national income nearly doubled during the Roaring Twenties. That meant the public debt was back under 20% by the end of the 1920s.

To be sure, for the last 70 years the Keynesian professoriate has been falsely blaming the severity and duration of the Great Depression on Herbert Hoover’s balanced budget policies during 1930-1932. But none has ever charged that paying down the WWI debt had actually caused the Great Depression. Nor have the Keynesian economic doctors ever claimed that had Mellon not paid down the peak WWI debt ratio of about 45% of GDP that the Roaring Twenties would have roared even more mightily!

Likewise, the national debt did soar from less than 50% of GDP in 1939, notwithstanding the chronic New Deal deficits, to nearly 120% at the 1945 WWII peak. But this was not your Krugman’s beneficent debt ratio, either. Nor is it proof, as per his current diatribe, that the recent surge to $18 trillion of national debt has been done before and has proven helpful to economic growth.

Instead, the 1945 ratio was a temporary and complete artifact of a command and control war economy. Indeed, the total mobilization of economic life by agencies of the state during WWII was so complete that Washington had essentially banished civilian goods including new cars, houses and most consumer durables, and had also tightly rationed everything else including sugar, butter, meat, tires, shoes, shirts, bicycles, peanut brittle and candied yams.

With retail shelves empty the household savings rate soared from 4% of disposable income in 1938-1939 to an astounding 35% by the end of the war.

Consequently, the Keynesians have never acknowledged the single most salient statistic about the war debt: namely, that the debt burden actually fell during the war, with the ratio of total credit market debt to GDP declining from 210 percent in 1938 to 190 percent at the 1945 peak!

This obviously happened because household and business debt was virtually eliminated by the wartime savings spree, dropping from 150 percent of GDP in 1938 to barely 60 percent by 1945, and thereby making vast headroom for the temporary surge of public debt.

In short, the nation did not borrow its way to victory via a Keynesian miracle.  Measured GDP did rise smartly because half of it was non-recurring war expenditure. But even then, the truth is that the American economy “regimented” and “saved” its way through the war.

Once the war mobilization was over Washington quickly reduced it massive wartime borrowing, and set upon a 35 year path of drastically reducing the government debt burden relative to national output. Looking at the chart’s veritable ski-slope from 120% of GDP in 1945 to barely 30% of GDP when Reagan took office in 1980 you would think that the US economy should have been buried in depression during that period if Professor Krugman silly syllogisms are to be given any credit.

Of course, just the opposite is true.  The greatest sustained period of post-war real GDP growth occurred between 1955 and 1973, with real output growth averaging nearly 3.8% per annum. But after that, as shown by the relative growth rates of real final sales in the chart below, the trend rate of growth steadily eroded. Thus, economic prosperity actually reached its highest level precisely when the national debt ratio was speeding down that ski-slope.

Capture5-480x305

Indeed, during the very period when the fiscal deficit got out of control during the early 1980’s owing to the Reagan Administration’s impossible budget equation of soaring defense, deep tax cuts and tepid restraint on domestic spending, young professor Krugman was toiling away in the White House as a staff member of the Council of Economic Advisors.

During the dark days of the 1981-1982 recession when the economy was collapsing and the deficit was soaring I heard some pretty whacky ideas from the White House economists on how to reverse the tide. But never once did I hear professor Krugman argue that with the GDP at about $3.5 trillion while the public debt stood at less than $1.5 trillion or about 40% of GDP that it was time to turn on the deficit spending after-burners and get the national debt up to 100% of GDP forthwith.

No, this whole case for mega-public debt has emerged since 2008. For crying out loud,  before the great financial crisis Krugman was one of the noisiest voices in the chorus denouncing George Bush’s massive tax cuts on the grounds that they would add to the national debt, which was then $6 trillion, not $18 trillion.

The fact is, the financial crisis was caused by the massive money printing campaigns of the Fed in the years after Greenspan assumed the helm in 1987. The resulting falsification of money market interest rates and distortion of prices and yields in the capital markets gave rise to serial booms and busts on Wall Street. But these financial market deformations had virtually nothing to do with fiscal policy and most certainly did not reflect an insufficiency of public debt.

These destructive busts——the dotcom crash, the 2008 mortgage bust and Wall Street meltdown and the stock market plunge just now getting underway——-are owing to the fact that Wall Street has been turned into a gambling casino by the Federal Reserve and the other major central banks.

But rather than acknowledge that obvious reality, Krugman actually manages to turn it upside-down. To wit, he argues that repairing the nation’s busted financial markets after September 2008 required the creation of  “safe assets” in the form of government debt so that investors would presumably have a place to hide from Wall Street’s toxic waste:

Beyond that, those very low interest rates are telling us something about what markets want. I’ve already mentioned that having at least some government debt outstanding helps the economy function better. How so? The answer, according to M.I.T.’s Ricardo Caballero and others, is that the debt of stable, reliable governments provides “safe assets” that help investors manage risks, make transactions easier and avoid a destructive scramble for cash.

Now that puts you squarely in mind of the young boy who killed his parents and then threw himself on the mercy of the courts on the grounds that he was an orphan. That is, having experienced a runaway financial bubble owing to excessive monetization of the public debt during the Greenspan era, the nation’s economy now needed even more public debt in order to subdue the very Wall Street gamblers that the Fed’s printing presses had unleashed.

Every phrase in the above quoted passage is nuts, even if it is attributable to an MIT rocket scientist, who is apparently handsomely paid for publishing pure drivel. After all, investors on the free market have known how to manage genuine financial risk from time immemorial; they didn’t need today’s vast emissions of public debt to help them.

In fact, treasury notes and bonds have no logical relationship to honest hedging in the first place. The most salient case of treasury based hedging was the spectacular blow-up of Long Term Capital in 1998. In that particular instance, the gamblers who ran a trillion dollar book of speculative assets including tens of billions of high yield Russian debt blew themselves up shorting the treasuring market to hedge their interest rate risk. Then, during the panicked investor flight to safety in August 1998, their giant losses on risky assets were compounded by even larger losses on their short treasury hedge.

In fact, the real point about the government debt market in today’s central bank rigged financial system is that it has become a venue for state sponsored thievery. That is to say, when the Fed pegs the front end of the curve at zero for 80 months running and then pours $3.5 trillion of fiat purchasing power into buying the rest of the treasury curve, including mortgage-backed agency securities, in order to boost bond prices and lower yields, it is creating a  virtually risk free arbitrage for Wall Street gamblers. And that serves no public purpose whatsoever, except to transfer massive windfall profits to the most adept gamblers among the 1%.

Professors Krugman and Caballero  actually think this helps?

The problem is that like all Keynesians they do not know the difference between fiat credit, which is manufactured out of thin air by fractional reserve commercial banks or money-printing central banks, and honest debt that is funded out of genuine savings from current income by households and business.

Allocating genuine savings to public versus private capital investment almost always results in a diminution of productivity and efficiency, thereby reducing society’s wealth and living standards, not raising them. That’s because governments are invariably controlled by squeaky wheel special interest groups and lobbies which succeed in gaining in the halls of Congress what they cannot justify in the private market. Amtrak, subsidized mass transit and bus services, corps of engineers water projects and export subsidies to Boeing and GE are obvious cases in point.

But our Keynesian professors have no sense of allocative efficiency. They think that any spending—-including having the unemployed dig holes with tablespoons and fill them up with teaspoons—– adds to GDP:

One answer is that issuing debt is a way to pay for useful things, and we should do more of that when the price is right. The United States suffers from obvious deficiencies in roads, rails, water systems and more; meanwhile, the federal government can borrow at historically low interest rates. So this is a very good time to be borrowing and investing in the future……..

You can’t make this stuff up. And here’s the rest of it for the purpose of any remaining doubt.

Beyond Piketty’s Capital

Income-USA-1910-2010

What Ben Franklin and Billie Holiday Could Tell Us About Capitalism’s Inequalities

It has now been two years since French economist Thomas Piketty published his tome, Capital in the Twenty-First Century, and one year since it was published in English, raising a fanfare of praise and criticism. It has deserved both, most notably for “putting the distributional question back at the heart of economic analysis.”[1] I would imagine Professor Piketty is also pleased by the attention his work has garnered: What economist doesn’t secretly desire to be labeled a “rock-star” without having to sing or pick up a guitar to demonstrate otherwise?

Piketty’s study (a collaborative effort, to be sure) is an important and timely contribution to economic research. His datasets across time and space on wealth, income, and inheritances provide a wealth of empirical evidence for future testing and analysis. The presentation is long, as it is all-encompassing, tackling an ambitious, if not impossible, task. But for empirics alone, the work is commendable.

Many critics have focused on methodology and the occasional data error, but I will dispense with that by accepting the general contour of history Piketty presents as accurate of real trends in economic inequality over time. And that it matters. Inequality is not only a social and political problem, it is an economic challenge because extreme disparities break down the basis of free exchange, leading to excess investment lacking productive opportunities.[2] (Piketty ignores the natural equilibrium correctives of business/trade cycles, presumably because he perceives them as interim reversals on an inevitable long term trend.) I have followed Edward Wolff’s research long enough to know there is an intimate causal relationship between capitalist markets and material outcomes. I believe the meatier controversy is found in Piketty’s interpretations of the data and his inductive theorizing because that tells us what we can and should do, if anything, about it. Sufficient time has passed for us to digest the criticisms and perhaps offer new insights.

Read the full essay, formatted and downloadable as a pdf…

———————–

[1] Distributional issues are really at the heart of our most intractable policy challenges. Not only are wealth and income inequalities distributional puzzles, so are hunger, poverty, pollution, the effects of climate change, etc. Unfortunately, the profession tends to ignore distributional puzzles because the necessary assumptions of high-order mathematical models that drive theory rule out dynamic network interactions that characterize markets. Due to these limitations, economics is left with the default explanations of initial conditions, hence the focus on natural inequality, access to education, inheritance, etc. General equilibrium theory (GE) also assumes distributional effects away: over time prices and quantities will adjust to correct any maldistributions caused by misallocated resources. For someone mired in poverty or hunger, it’s not a very inspiring assumption.

[2] As opposed to distributional problems, modern economics is very comfortable studying and prescribing economic growth. Its mathematical models provide powerful tools to study and explain the determinants of growth. This is why growth is often touted as the solution to every economic problem. (When you’re a hammer, everything looks like a nail.) But sustainable growth relies on the feedback cycle within a dynamic market network model, so stable growth is highly dependent on sustainable distributional networks.

The Bull Market Bull

bullx-large

From David Stockman’s blog:

Never has there been a more artificial—-indeed, phony—–gain in the stock market than the 215% eruption orchestrated by the Fed since the post-crisis bottom six years ago today. And the operative word is “orchestrated” because there is nothing fundamental, sustainable, logical or warranted about today’s S&P 500 index at 2080.

In fact, the fundamental financial and economic rot which gave rise to the 672 index bottom on March 9, 2009 has not been ameliorated at all. The US economy remains mired in even more debt, less real productive investment, fewer breadwinner jobs and vastly more destructive financialization and asset price speculation than had been prevalent at the time of the Lehman event in September 2008.

Indeed, embedded in Friday’s allegedly “strong” jobs report is striking proof that the main street economy is the very opposite of bullish. In January 2015 there were still 2 million fewer full-time, full-pay “breadwinner” jobs in the US economy than there were before the crisis in December 2007.

breadwinner

Read more

 

Recovery?

QE

We have enough data and David Stockman nails it on the head here…

Q4 Obliterates The Case For QE And ZIRP

by  • February 27, 2015

The most important number in today’s Q4 GDP update was 2.3%. That’s the year/year change in real final sales from Q4 2013. As an analytical matter it means that the Great Slog continues with no sign of acceleration whatsoever.

Indeed, the statistical truth of the matter is that this year’s result amounted to a slight deceleration—–since the Y/Y gain in real final sales for Q4 2013 was 2.6%.  But beyond the decimal point variation the larger point is this: Take out the somewhat jerky quarterly impacts of inventory stocking and destocking, and view things on a year/year basis to eliminate seasonal maladjustments and data collection and timing quirks, such as the double digit gain in defense spending during Q3 and the negative rate for Q4, and what you get is a straight line slog since the recession ended in 2009.

read more

Somebody Loan Me a Dime…

Loan me a dime

…as Boz Scaggs sang (as Duane Allman burned on guitar).

Debt as a Share of GDP

This graph (compiled by McKinsey) shows the levels of debt by sector across several significant countries as a percentage of their GDP. This is the relevant measure because it tells us how much bang countries are getting for their borrowed ‘buck’  (in their home currency).

An analogy would be if you were borrowing money on your household account that did not increase your income over time, but instead increased the burden of interest you had to pay on the debt, which would reduce the share of your income for other purchases, like vacations or retirement savings. It makes sense to borrow to earn a degree that will increase your earning potential; it makes less sense to borrow money to take a vacation or buy a car you can’t afford.

A rising debt to GDP ratio means the excessive borrowing is not paying off with increased income (national GDP). We can compare countries on the chart below and see that the US has greatly increased government debt, which according to the effects of our monetary policies, has been used to retire private debt. In other words, we’ve shifted private debt, much of it from the financial sector, to taxpayers. Japan is not included, but would show that just government debt as a share of GDP is well over 200%. All this debt has not bought Japanese citizens much in terms of real wealth. One could argue it has just prevented the Japanese economy from imploding.

Another risk factor not displayed here is the effect of financial repression on the service of this debt. US debt is being financed at historically low interest rates that do not reflect the time value of money or the risk premium of lending. When interest rates rise, as they must eventually, all this debt will need to be rolled over at higher rates, meaning the service on the debt will explode, driving out other spending priorities while driving balance sheets toward insolvency. (If we can’t pay, we won’t pay.)

All in all, this is not a pretty picture. Be afraid.

World debt