Posts Tagged ‘Inflation’

Quantitative Easting 2.0 that is.  I really found Jeremy Grantham’s letter this month particularly insightful in exploring the ways that cheap money does little to advance the economy, while creating asset bubbles all over the places that must eventually be deflated.  He also makes the good point that a housing bubble is much more damaging and persistent than a stock asset bubble.  And, finally, he exposes the Federal Reserve for all of its foolishness and inability to do very much useful, other than kick the can down the road.  His bottom line:  ” In almost every respect, adhering to a policy of low rates, employing quantitative easing, deliberately stimulating asset prices, ignoring the consequences of bubbles breaking, and displaying a complete refusal to learn from experience has left Fed policy as a large net negative to the production of a healthy, stable economy with strong employment.”

Of course, the Austrians knew this a long time ago.  And, it should never be forgotten, the Federal Reserve was put in place in 1913, had much to do with the housing asset bubble of the 1920s, and in spite of its promises to prevent the business cycle, auguered the Great Depression, which, like our current depression, was made worse by various hair-brained fiscal stimulus projects under FDR.


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Banking by corporations and limited liability companies is not essential to free markets. Like bankruptcy, all of these arrangements involve shifting some of the harm caused by risk-takers onto those who did not take the risks. There may be good reasons to socialize (i.e,. disperse) risk. People may be improvident or need some paternalistic guidance. A certain amount of risk-taking perhaps should be subsidized, i.e., venture capital, homesteading. But there are other means to amass capital and spread risk–not least debt obligations and insurance respectively–without shielding decisionmakers from personal liability to creditors and others in the case of civil offenses and breached contracts. The possible value of tying corporate decisionmakers and stockholders to the downside of corporate risk-taking should be obvious, considering the heads-I-win-tales-you-lose mess we’ve gotten into under the influences of many factors that have spread risk: limited liability, financial engineering, leverage, and the ethos that on the downside these firms (and investors in the same) are simply too big to fail. I wrote something about this many years ago along these lines here and Hillaire Belloc, to his credit, long ago distinguished between the character of real property and the “paper wealth” with which it shares so little in common as far as social benefits goes. Conservatives who are found of free markets should be rethinking their attitudes towards banking, corporations, and the combination of loose money and weak regulation we’ve recently experienced.

An interesting symposium at the liberal-leaning American Prospect discussed the problems of risk, particularly risk with public consequences. It offered an interesting defense of the welfare state along the same lines as the bailouts; namely, that it frees people up to take certain risks. Of course, like FDIC insurance, bailouts, and bankruptcy, that’s part of the problem when it becomes too generous.

The polymath Richard Posner weighs in, concluding that sensible bank regulation failed, and combined with easy money this brought about the recent crisis:

Finally, let’s place the blame where it belongs. Not on the bankers, who are not responsible for assuring economic stability, but on the government officials who had that responsibility and failed to discharge it. They failed even to develop contingency plans to deal with what everyone knew could happen in a context of escalating housing prices (it had happened in Japan in the late 1980s and the 1990s). Lacking such plans, the government responded to the crisis with spasmodic improvisations, amplifying uncertainty and mistrust and thus retarding recovery.

And let’s not forget to apportion some of the blame to the influential economists who assured us that there could never be another depression. They argued that in the face of a recession the Federal Reserve had only to reduce interest rates and flood the banks with money and all would be well. If only.

Finally, in a tour de force, Allan Meltzer eviscerates the continuing inflationary practices of the unholy triumverate of Obama, Geithner, and Bernanke, viz.:

IN the 1970s, with inflation rising, I often described the Federal Reserve as knowing only two speeds: too fast and too slow. At the time, the Fed’s idea was to combat recession by promoting expansion, printing money and making it easier for businesses and households to borrow — and worry only later about the inflation that resulted. That strategy produced a sorry decade of slow productivity growth, rising unemployment and, yes, rising inflation. If President Obama and the Fed continue down their current path, we could see a repeat of those dreadful inflationary years.

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Above is an interesting chart. So is this one:

There clearly were many factors in the housing bubble, all of which aligned to create a perfect storm of sorts: higher levels of leverage among investment banks, a trade imbalance, reliance by institutional investors on misleading ratings by ratings agencies, inflationary monetary policy, conversion of housing assets into opaque financial instruments, reduced lending standards, the pressures of the Community Reinvestment Act, the mystique of home ownership, business models that invited fraud, and a pervasive mania of speculation. But one factor that seems increasingly undeniable is the Bush administration’s belief that Hispanics were “natural Republicans” and that the best way to get them into the fold was to give them a stake in the “ownership society” through various housing subsidies. Hispanics’ increasing numbers in the so-called “sand states” had a lot to do with the bubble’s disproportionate influence in those regions, and these subprime borrowers’ low levels of human capital and earnings eventually led to the music stopping as payments were unmade and new borrowers could not materialize to prop up the inflated housing prices. I mean, throughout the boom, no one said, “Does it make sense a sheetrocker from Chiapas making $11/hour can afford a $400K McMansion in Anaheim?”

This is what may be called an “overdetermined” event. In other words, without large levels of Hispanic immigration and Bush’s obsession with cultivating Hispanic political support, the bubble may still have happened. But it seems unlikely that it scale would have been quite so huge and the wave of defaults quite so numerous in the absence of the low-skill Hispanic immigration wave the U.S. has undergone since the 1986 amnesty. A million people per year is a lot of people. As the chart above shows, subprime lending tripled in the boom and the bulk of that expansion was increasing lending to blacks and Hispanics. Even more important, as shown in the second chart, blacks and Hispanics–according to the Boston Fed–have default rates nearly two times higher than white subprime borrowers. Of course, the media, the Democrats, and the Republicans don’t want to discuss such things; it’s not considered polite, and, thus, the greatest demographic and social change of the United States since the Civil Rights movement is thoroughly and deliberately under-analyzed and misunderstood by well-meaning (and not-so-well-meaning) political elites.

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There are probably a million ways to game the Geithner bailout plan, just as the TARP has already led to various unintended consequences, such as the continued provision of generous bonuses by AIG and the Merrill Lynch purchase by BofA. James Galbraith has a good article on this today.

The whole premise of the bailout is that these “toxic” assets comprised of various tranches of bonds secured by mortgages are worth a lot more than the market will presently pay for them.  Is this true?  Yes, their cash flows are in order for now, but there are impending waves of foreclosures and defaults as these loans reset in the next few years. 

The Geithner plan amounts to a bribe to investors.  Invest 7.5 cents, TARP will invest 7.5 cents, and the remaining 85 cents will come from the FDIC. Yes, that FDIC, it being the most important component of stability in our banking system that is supposed to be rock solid in all circumstances. If things go wrong, the 15 cents from the private investors and the TARP are wiped out in the manner of equity, but the FDIC has no recourse other than managing, foreclosing, and then unloading these properties. The FDIC will be in the position of foreclosing upon hapless homeowners, but it will face obvious political pressures to play ball with doomed workouts to help the unlucky. We’ll get to see how good of a landlord Obama is when his role is not “community organizin'” but salvaging value from broke people for the FDIC. My guess: not a very good one.

Under the Geithner plan, banks will sell their “toxic” assets at whatever price they want. Under this scheme, the hope is that somewhere above today’s 30 cents or less in value. The idea is that they’re “really” worth somewhere closer to 60 or 70 cents on the dollar, and that having the banks now take 70 cent (as opposed to 30 cent) losses would be an unnecessary and short-sighted exercise with systemic consequences.

But banks and investors like to make money and avoid losses. That’s in their blood. Why wouldn’t a bank take 7.5 cents of its own deposits to buy certain assets from itself at the requisite 60 or 70 cents, in spite of the fact though the assets are in fact only worth 30 cents, when 85% of the bid price is nonrecouse pain absorbed by the FDIC?  I mean, why not bid 100% if it’s just a question of minimizing losses. That way they can still reduce their collective exposure to 10% or less of what it was, because they would take no losses now and push them off into the future. At most, the gap of 70 cents from actual (i.e., 30 cents) to the $1.00 par value would only cost 7.5 cents to wipe out, and the cost of 92.5% of that shift would be borne on a nonrecouse basis by the FDIC with the remainder by the TARP? Why wouldn’t bank A and bank B do this for one another on a handshake if the self-purchase was too unseemly or prohibited?  What rules would prevent that?

Tim Geithner’s and Obama’s bullishness in general and their talk about the real value of the assets ignores all the impending defaults on the underlying mortgages.  As I already stated, they are probably worth 30 cents at most, and that generous estimate too depends on the continued vitality of home buyers on the scene who will set the market price for the various overpriced and oversupplied 2004-2006 homes. This whole plan shifts the worst banks’ risks on to the most responsible banks and ultimately the taxpayers by giving the FDIC and the Treasury the bill: specifically, at least 92.5 cents of exposure on this plan for every dollar of losses avoided by the banks. Who knew Obama would become the worst banks’ best friend?

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Steve Sailer and others have observed how the combination of changing demographics, Bush’s commitment to an “ownership society,” cheap dollars, securitized mortgages, and the emerging importance of the relatively obscure Community Reinvestment Act, were major factors that in combination render the housing crisis a “diversity recession.”

Critics have countered that a lot of other factors, including rampant speculation and “greedy executives” were far more dominant factors.  Perhaps those are important factors too, but banks don’t generally lend money to losers without some external factor.  After all, as Obama liked to tell us not too long ago, these are the evil guys that invented red-lining.

Consider this chart:


That is some big bucks, with an order of magnitude jump right before the big bubble.  Ahuge percentage of foreclosures are substandard Alt-As and Subprime loans lent in part to avoid discrimination suits by the likes of people like Obama.  The fact that the CRA funding went from a paltry sum of several billions for two decades and jumped to several trillions in CRA funding for poor, minority homeowners right before the big bubble came on the scene, it’s hard to say that this factor is being overstated by mean conservatives who don’t believe in equality.

You’re damn right we don’t believe in equality when it comes to banks lending money.  The banks were supposed to be discriminating, not on racial grounds, but rather discriminating against bad credit risks! Concerning oneself with equality of outcome when different groups have different credit-worthiness, different habits and cultures of saving, and different levels of earnings is economic suicide, as WaMu and so many others have found out. Such new progressive banks “made history” all right, just not quite as they planned.

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The absolute craziest convention on Wall Street, at the Federal Reserve, and among academic economists is simply to ignore economic history before the Great Depression. It’s particularly wacky to do so as the Federal Reserve, which was billed as a means of avoiding economic dislocation after the Panic of 1907, was established in 1913. In other words, the Great Depression happened on the Fed’s watch.

What’s happening now to the economy: the bankruptcy of overly leveraged institutions, falling prices, a general sense of uncertainty, and calls for high levels of government spending and control are hardly unprecedented. We heard such rhetoric throughout the 70s. And this shift took place once before, in Europe, in the late 19th Century in response to the “Long Depression” of the 1870s and the associated anemic recovery.

For Christmas, I received among other books Norman Rich’s The Age of Nationalism and Reform, 1850-1890. This book might seem obscure and irrelevant to all but the most die-hard history buffs. But consider the following passage, and ask yourself if you think anyone at Lehman Brothers or on Bernanke’s staff like has had much familiarity with this episode and whether it might have been useful:

The 1873 crash set off an economic depression which was to continue for another two decades in the form of a slower rate of growth, rising unemployment, and a general feeling of economic insecurity. This depression appears to have been caused primarily by overspeculation and overproduction. There was a decline in the rate of railway building, and a consequent drying up of this immense market for goods and materials. At the same time European agriculture was depressed by the competition of cheap agricultural products from the interior regions of Russia, America, and Australia, to which the railroad had given access.

During the depression years there was an actually an increase in the real wages and a rise in the standard of living of many Europeans as a result of a steady fall in the prices of agricultural and manufactured products. The fall in prices, however, which brought hardship or outright ruin to many economic enterprises, together with the increase in unemployment and the overall sense of economic insecurity, aroused a widespread feeling of dissatisfaction with existing government economic policies and anger at the threat of foreign competition. The liberal doctrine of laissez faire was discredited as industry, agriculture, and labor alike clamored for protective tariffs and state aid. And everywhere in Europe, with the notable exception of England, the state responded to these pressures. The 1873 depression thus inaugurated a new period of state intervention in economic affairs which was to increase steadily to he present day. It also contributed to the growth of an economic nationalism which was to strengthen the burgeoning forces of political and ideological nationalism.

I used to feel somewhat sorry for Obama for the crises he must now manage, a good many of which were not of his making. But then I realized: he likes this situation and this is good for his personal goals, even though obviously quite bad for the country. Crises, real and imagined, allow someone like Obama to aggrandize power, push through the most radical and spendy proposals, and–like FDR–will make a great many people worship him even more without regard to results, so long as he manages his own image carefully. Far from feeling sorry for Obama, I feel sorry for my future children and grandchildren. It’s a scary time, and we have an immature and untested demagogue at the helm, whose historical loyalties are tribal, whose background is in the cesspool of Chicago politics, and whose outlook is replete with various artifacts of 1970s cracker-barrel liberalism.

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The Federal Reserve has just lowered interest rates to, in effect, zero.  Obama promises to spend perhaps $850 billion in a very dubious infrastructure program, as if filling potholes and repairing bridges that were too expensive to repair in good times, can now be gold-plated in times of austerity, and that, by some alchemy, spending money we didn’t absolutely have to spend will lift our collective fortunes, even though those ill fortunes have been planted, as we all know, on far too much private debt.

It is hard to see how hyperinflation won’t rear its head before long.  The wealth-generating economic activity to back our fiat money is not there, and enhancements in productivity are slowing down.  Instantaneously doubling the supply of money won’t make new wealth-creating activity happen.  Nor will the dubious infrastructure projects, which have real very slim theoretical and historical support. Consider, just by way of analogy, how Bush’s spendy combination of two wars, new entitlements, low interest rates, tax cuts, tax rebates, a modest regulatory climate, and the like only succeeded in pouring money down various dead-end bubbles, particularly housing, that could not sustain themselves as soon as the money needed to be collected.

Now, the problem will get even worse, with government (instead of speculators and home-buyers) deciding how to spend the dollars under the Roosevelt-style stimulus that Obama has proposed.  Of course, government can’t easily figure out where that money should be best spent. It will always be lumberously investing in last year’s model, giving us state of the art high definition CRTs, while real entrepreneurs risking their own money, are inventing plasmas.  Consider how goofy scenes of the future look in older movies.  That’s the government’s “investment” strategy:  unimaginitive, trend-following, unmoored by profit, slowed down by bureaucracy, and laden with nonmarket considerations, such as the cronyism that infects all government contracting and hiring.

Even if it does something well, these government investments will be too costly.  Government can’t help but gold-plate.  It may make a few nice parks, arenas, and the like, but this is not the same as real wealth creation.  Real wealth creation involves a profit.  Supplying something to someone he would pay more for if necessary at less than its cost to produce. We can never easily tell if we’re spending 2X, 3X, or 10X the real economic value of the projects as measured by willingness to pay in the arena of government spending.  By way of illustration, I’m always struck by something I once saw in the former Soviet Union.  I was walking down a railroad track and noticed that all of the ties were concrete.  The ties were quite a bit sturider and more robust looking than the treated timber ties in America.  The Soviets were surely proud of these tracks.  But the Soviet Union, lest we forget, was a corrupt basketcase, characterized by an order of magnitude difference in consumer wealth than the United States.  How do we know that everything from houses to cars to Ipods are valuable in the US?  How do we know, when designing something for oneself or others, whether it should last 10, 20, or 1,000 years?  The great information sorting power of market prices.  Markets rely on the profit and loss mechanism to make these decisions.  Of course, we’ll probably get some sharp-looking projects under Obama.  But we’ll spend too much to get it, and the collective impact won’t save jobs.

In an ideal world, government should be treated like the accounting department of a large company:  unglamorous, necessary, and a cost-center that should be stripped of all that is superfluous or costly, in particular majesty, expense, or the prospect of excessive power. As in accounts payable, it’s a task that needs to be done, and it should be done honestly and well, but we shouldn’t forget that it’s the handmaiden for the real society and its real important activities.  Instead, as it’s grown in size, government has become the preferred venue for the absent spirituality of people like Obama, Hillary Clinton, John McCain, and other “dreamers.”  They see in it not as the accounting department or the meter maid, but Change We Can Believe In, Country First, and the Audacity of Hope!!!  A great many fetishists of big government can’t imagine a worthy life in business, the ministry, or even private charity.  Lacking any sense of God or the eternal, they see that government alone can do mighty and seemingly eternal things such as the Hoover Dam or the Atom Bomb.  Of couse, some people make a similar fetishization of things like science, health care, or money.   But unlike government, these spiritual substitutes do not rely on taxes and can’t, if run amuck, destroy an entire civilization within a generation.

It’s no coincidence that the Greeks equated their gods with their city-states, often “establishing new gods” and temples in their honor upon the founding of a new regime.  Without the illumination of Christian truth, civil and political life is the closest analog to philosophical and spiritual life.  But there is another lesson they can teach us:  vanity, worldliness, fascination with splendor, and loose public morality cannot last, and their biggest harbinger is a lack of physical courage (as evidenced in our time by the offensive phrase “jobs American’s won’t do”) and the devaluation of the currency, as evidenced by. . . well . . .  everything.

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