The Great Divergence

[Jester]

"The Fed did nothing to ease the tightness of money, and by November of 1930 many Banks began to fail with runs on the banks. More, and more banks failed over the subsequent months leading to more, and more people losing confidence in the banking system entirely. The Fed did not provide the reserve currency, as per its mandate, to keep banks from draining their assets due to a panicked populous."

Right. Banks are failing left right and center, being swallowed whole by the Federal Reserve. Without that action, they would simply be collapsing entirely, leaving savers up a creek. Credit is frozen enough without the intervention of the Fed - if they stopped printing money, things would be even worse.

So, why is Fed action a bad thing? Because it might cause inflation later? Fix the first problems first, and worry about inflation when we actually have inflation. As per Keynes, in the long run, we're all dead. No point in solving tomorrow's problems at the expense of today's.

But, people don't always behave rationally, which is why you see the rise of "adaptive expectations" advocates and "behavioral economics".

Sure. We can see perfectly fine how people are behaving: they're scared witless. They're retreating to a high-savings, low-risk position, and it's creating a massive drop in the velocity of money.

If you explore the details of the CPI for the past year, as I did, you'd see that for the broader basket of goods, prices are falling.

There's deflation. Deflation is bad. Therefore, the Fed should generate inflation to counteract it. Am I missing something here?

Their view of the economy tending toward deflation is what I'm seeing in the detailed CPI. Certain things are inflating, but in general, prices are decreasing. So, if you believe that the Fed will do more QE later in the year, and that it will stem the erosion of prices, then bonds may be a good deal.

I still think your intuition on this topic is precisely backwards. Bonds are a great deal during deflation. You hold money today, and you get more money tomorrow - when it's worth extra. Why would bonds be a good deal during quantitative easing? QE should yield inflation, and inflation undermines the value of tomorrow's money - which is exactly what you are buying when you buy a US government bond.

I wouldn't make that bet. I don't think we've seen the end of our financial travails yet.

Again, backwards. If you think the economy is going to continue to suck, then you'd want to buy something nice and safe - gold or bonds. Betting on continued economic woes is to bet against the stock market, and in favour of safe investments, including US government bonds. The market obviously agrees, because bond prices are high right now (that is to say, yields are low).

If you think that the US fiscal situation is going to collapse, on the other hand, then you should be shorting the hell out of bonds right now. No better time for it. Is that a bet you want to take? It's available for the taking!

I'm also with the Austrians on the nature of unintended consequences. Every positive action, raises the opportunity for an opposite negative reaction.

Yes. Which is why I find it strange you're bringing up Friedman as a hero here, because this is a place where you clearly stand with the Austrians, against the Monetarists. Except that apparently you're also for a wealth tax to decrease inequality, which is about the most un-Austrian idea on the planet. So I'm not actually sure where you're coming from.

-Jester