Posted on 10/10/2005 7:22:10 AM PDT by thinking4me
Why the Fed has no other alternative but to print money!
Next time the Fed embarks on its usual money printing exercise, consumer price inflation accompanied by renewed dollar weakness is likely to both exceed asset inflation - especially in the housing sector - and income gains. This should ensure that the forthcoming recession will be characterized by consumer price inflation and simultaneous economic weakness.
In the past, I have demonstrated that economic growth and deflation is entirely compatible. The entire economic expansion of the US in the 19th century was a deflationary boom. Declining prices led to strong real income gains. As time went by, workers could buy with their incomes a larger and larger basket of goods because prices for consumer goods and commodities declined.
In other words, whereas inflation is the equivalent of a loss of purchasing power of money, in deflationary times the purchasing power of money increases. In deflation my 100 dollars today are worth more in a year's time since they will buy a larger basket of goods and assets, whose prices are declining. In my opinion, there is, therefore, nothing wrong about deflation. So why is the US Fed so concerned about deflation that Mr. Bernanke even suggested dropping US dollar bills from a helicopter in order to combat it?
There is one condition under which deflation is a disaster and this is when total credit market debt is high as a percentage of the economy. When debts are as large as there are now, deflating prices and especially deflating asset prices would wreck havoc in the economic system and lead to massive defaults and bankruptcies.
I may add that between 1950 and 1980 the debt to GDP remained largely constant. But after 1980, and in particular after Mr. Greenspan became Fed chairman in 1987, debt to GDP exploded. Therefore, it is not deflation that is the problem, but the preceding debt inflation for which the Fed's expansionary monetary policies are fully responsible. So, having created a monetary and debt monster, the Fed embarked starting 2001 in a huge money printing operation in order to avoid deflation.
Money supply tightening Now, it is true, as my friends at Gavekal pointed out, that in recent times money supply growth has been decelerating. According to Gavekal, over the last six months, the US monetary base had been contracting, which is normally a sign that monetary conditions are actually tight. Usually such periods of a declining monetary base are followed by stocks not performing as well as cash, and frequently also by some kind of financial accident.
Now, I have no doubt that money has become tighter, which is also reflected by the US dollar strength since the beginning of the year. However, we should not overlook the fact that despite tighter money - the Fed fund rate has been increased from 1% one year ago to currently 3.75% - compared to nominal GDP growth and inflation, short term interest rates are still too low. In fact, at 3.75% the Fed fund rate is below the unofficial US inflation rate of about 5% and significantly below nominal GDP growth.
Moreover, observers of monetary conditions may do well not only to look at money supply growth but also at credit growth, which has in recent times gone through the roof! According to Doug Noland of www.PrudentBear.com, year-to-date, US bank credit has expanded by $544.7 billion, or 13.5% annualized. Among this total, security credit gained $145.6 billion, up 12.7% annualized. Commercial and industrial loans have surged at an annualized rate of 18.8%.
Real estate loans are up at an annualized rate of 16.7%. Year-to-date, asset backed securities issuance is up $ 451 billion, i.e., 21% ahead of the comparable period of 2004. Home equity loan ABS issuance of $286 billion is 24% above its growth in 2004's same period.
I may add that the 13.5% annualized credit growth generated only a 3.6% GDP growth. In other words, US credit is growing about four times faster than GDP growth - not exactly a sign of a sound and well balanced economy. Still, the monetary overhang the Fed created post 2000 and the rapid credit expansion lifted US home prices significantly in recent years.
As a side, I may mention that the same way housing inflation decelerated in the UK and in Australia, in the US this will sooner or later surely also be the case (in my opinion rather sooner than later). Moreover, in the case of both Australia and the UK, once housing inflation diminished consumption also slowed down considerably. I would, therefore, expect consumption to slow down shortly in the US as well.
But the critical point here is that the asset inflation, which replaced consumer price inflation starting 1980, led the American public to believe that rising asset prices - first equities and since 2000 home prices would be permanent features of the economic environment. Therefore, US households began to save less and less and to rely increasingly on rising asset prices to take care of their future retirement needs.
I am not surprised that US economists and strategists continuously find a new 'angle' to justify their overpriced stock and property market, and their currency, but what really baffles me is how the world, and also Mr. Greenspan still believe that the US economic expansion is 'sound'.
Lesson of the prudent household Consider the following: Your household spends all or even more than you earn every month while your next door neighbor puts aside 20% of his income and invests his savings into the shares of a company whose business prospects are favorable or into property investments or bonds. After 10 years, which family will be richer - the one that spends all its income and even borrows money to maintain its standard of living or the family that puts aside month by month money for the purpose of savings and investments?
I do concede that not all investments will work out but - if well diversified - the household that saves should end up far richer than the household that not only spends all its income but also borrows money. This is the situation in the world today. The US prints money and spends its 'illusionary wealth', which is created through asset inflation, while Asia has a high savings rate - a relationship which is evident from the growing US current account deficit, and the growing current account surpluses and the accumulation of foreign exchange reserves in Asia.
But there is another angle to the declining US savings rate. Over the last six years US households have been selling financial assets and borrowed money in order to support their consumption. Along with the decline in the savings rate, which began already 20 years ago, this has boosted US GDP growth above what it would have been if the savings rate had remain constant.
According to Bridgewater Associates, if US households ever returned to just a normal savings rate, US GDP would collapse by about 7%! Now why would the US savings rate ever move back up? Once the housing inflation comes to an end, and households can no longer refinance their homes at lower interest rates, consumer confidence will tumble and lead to a rising savings rate, and along with it, to a recession.
This could happen sooner than expected, given the fact that the shares of the largest lender to the housing industry, Fannie Mae, just hit an eight years' low and that the shares of homebuilders now appear to have topped out! However, not to worry too much! The Fed, once it notices that the asset inflation, which supported consumption, has come to an end will once again turn on the money printing press. But will it help? I doubt it since further money printing is likely to result in consumer price inflation exceeding personal income gains. Already now hourly earnings are declining in real terms.
US inflation, weak economy So, the next time, the Fed embarks on its usual money printing exercise, consumer price inflation accompanied by renewed dollar weakness is likely to both exceed asset inflation - especially in the housing sector - and income gains.
This should ensure that the forthcoming recession will be characterized by consumer price inflation and simultaneous economic weakness. Maybe the rise in the gold price, which admittedly could be interrupted temporarily by profit taking, does begin to discount this unpleasant scenario.
Needless to say that under this scenario long term bonds would be about the worst possible investment! I may add that when long term interest rates are below the rate on nominal GDP growth, which was the case in the 1960s and 1970s, consumer price inflation accelerates whereas when interest rates are above the rate of nominal GDP growth (1980-2000) consumer price inflation decelerates (disinflation).
For investments the following should be clear: when consumer price inflation accelerates it leads to poorly performing financial assets - especially bonds. However, a whiff of inflation would be good for Japanese equities as it would move institutional and private money parked in bonds and deposits into equities and real estate.
A FEW QUOTE TO CHEW ON:
"By a continuous process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method, they not only confiscate, but they confiscate arbitrarily; and while the process impoverishes many, it actually enriches some....The process engages all of the hidden forces of economic law on the side of destruction, and does it in a manner that not one man in a million can diagnose." - John Maynard Keynes Economic Consequences of the Peace, 1920
"The central bank is an institution of the most deadly hostility existing against the Principles and form of our Constitution. I am an Enemy to all banks discounting bills or notes for anything but Coin. If the American People allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the People of all their Property until their Children will wake up homeless on the continent their Fathers conquered. "... - Thomas Jefferson
"Whenever destroyers appear among men, they start by destroying money, for money is men's protection and the base of a moral existence. Destroyers seize gold and leave to its owners a counterfeit pile of paper. This kills all objective standards and delivers men into the arbitrary power of an arbitrary setter of values. Gold was an objective value, an equivalent of wealth produced. Paper is a mortgage on wealth that does not exist, backed by a gun aimed at those who are expected to produce it. Paper is a check drawn by legal looters upon an account which is not theirs: upon the virtue of the victims. Watch for the day when it bounces, marked, 'Account overdrawn.'" - Ayn Rand - Atlas Shrugged
I've heard stories that during some of the periods of high inflation in South America, it got to the point that the stamp to pay a mortgage payment cost more than the mortgage payment itself.
" In my opinion, there is, therefore, nothing wrong about deflation."
Ask Japan how well it's worked out for them.
"So why is the US Fed so concerned about deflation that Mr. Bernanke even suggested dropping US dollar bills from a helicopter in order to combat it?"
Now we're in tin foil hat territory...
Now we're in tin foil hat territory...
I'm sorry, I do not understand your remark here. Are you claiming that he never said this, or that it is a ridiculous notion, even though Bernanke did actually suggest it as a possible deflation fighter? http://www.federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm
Economics is so very hard to understand, but it is clear that being a rich country is a blessing. One in which we must be thankful to he who blesses, and vigilante to keep our economic books in order.
I'm saying its a ridiculous notion. No matter what somebody "said", do you really think it was a serious consideration? If not, then citing it as evidence of the level of Fed consideration regarding deflation is disingenuous.
So then it is your contention that the Fed SERIOUSLY considered throwing money out of a chopper to fight deflation?
If the hat fits...
I read a blessing to be a rich country... rich country??? A country: with $72TN debt??? Banking interests are gobbling wealth at the speed of light. Bear in mind that America needs 80% of the world savings to stay afloat right now.
The only optimistics are those who believe we can print ourselves into oblivion...
LUCKILY SEE WHAT IS GOING TO HAPPEN CLEARLY, THANK GOD
CBS MARKET WATCH: How the boom of 2006 ended (We should have seen it coming)
Each of the policy options I have discussed so far involves the Fed's acting on its own. In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman's famous "helicopter drop" of money.18
It was not a literal flying of helicopters with cash falling behind, but in effect giving money away, just the same.
Just more troubles at the bend ahead being off-loaded to future Presidents.
By the way, does the term "irony" mean anything to you? The fact that he didn't mean his statement literally doesn't mean it isn't a window into his attitude, and most likely, that of a great many of his associates.
"By the way, does the term "irony" mean anything to you? The fact that he didn't mean his statement literally doesn't mean it isn't a window into his attitude, and most likely, that of a great many of his associates."
Look up irony. I believe you're really thinking of satire.
Actually, I did go to your link. I see " Milton Friedman's famous "helicopter drop" of money.18"
But note 18 does not mention Friedman making that comment nor the context it was made in. Does it?
Debased currencies are fatal to great powers.
We will be no exception.
The only thing difficult about economics is trying to make things that are happening agree with what we believe should be happening. I like to save my time and energy and I just accept what is. I sometimes make educated guesses as to how it happened. Not difficult at all.
This Gloom, Boom, and Doom report is a waste of time --pure delusion. If anyone's interested, reality is the fact that the Fed doesn't print money, the most it can do is fudge interest rates. Inflation is nil. Real wages have been rising for years. Unemployment is low. Total Family Wealth is higher than ever and have been increasing faster than both public and private debt.
My apologies to anyone who had his heart set on being miserable, but there's a point where sooner or later we simply have to face reality.
I agree that we are headed for another bout of "stagflation", akin to the Jimmy Carter years.
What is the best investment strategy to cope with stagflation.
If it's worth your time to comment on it, it's worth your time to refute something it said. All you've done is issue bare denials. Not terribly convincing.
Well said.
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