The Great Divergence

[kandrathe]

"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.

I'm not convinced they needed to do everything they did. TARP wasn't a bad idea, and it was effectively a loan. The stimulus was mostly a 44 year pent up Reid Pelosi progressive regulatory wet dream labeled as "Stimulus" backed by the Keynesian manta of spend, spend, spend. I feel part of the stimulus helped a little, but about 2/3rds of it was a matter of pushing future spending into the present, robbing the future of economic activity. Much like the cash for clunkers, cash for caulkers, or cash for home buyers, it mostly accelerated purchasing that would have already occurred, leaving a dearth of spending once it ended. And, due to the heavy regulatory changes, it was left structurally struggling to spend itself since most of the ready shovels, weren't.

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.

Keynes advocated doing something, rather than standing still. I'm not opposed to doing something, as long as its the right thing. The Hoover administrations regulatory changes, coupled with the Feds terrible policies are what helped cause the Great Depression, and when FDR instituted the Hoover program as the New Deal, it probably resulted in the recession of 1938-39. Friedman's objections to Keynes were in that doing anything was better than doing nothing, and this is not true. You can make it worse.

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.

And, in the face of that, the administration passed an massive health care regulatory change affecting every employer, employee, and insurance company. This creates profit uncertainty, which makes it hard for businesses to predict their cash flow. Then, they worked on Cap-Trade, (it thankfully got shelved) which threatened to add a whole new slew of carbon taxes throughout the production stream. Then, regulatory reform, and a whole new regulatory agency writing a vast array of new regulations overseeing consumer credit. Adding lending regulatory uncertainty to a frozen credit market doesn't seem very smart. Then, the worst of two possible scenarios, either letting the tax cuts expire, or making most of them permanent. They should just extend them for two years, or one year and be done with it quickly. Add to that, a looming debt crisis as soon as we need to raise interest rates to curb inflation ( inflation that is built into the economy due to the vast increase of fiat money). Worrisome as well is the recent beggar-your-neighbor currency interventions which mirror a modern day Smoot-Hawley tariff. Rather than the side show that has happened, the idiots in Washington needed to redesign social security, medicare, medicaid, and draw down the costs of military operations. In the near future we need to come up with a 12% positive change in the budget by cutting spending, and increasing tax revenues.

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?

I agree, runaway deflation is as bad as runaway inflation. But, there are other ways to encourage inflation, such as giving corporations a tax break for two years.

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 think my intuition is ok. I'm not denying that if all were as if appeared at face value, the Fed would spend another Trillion in QE, and bond yields would rise. But, we're not alone in this economy. Other large economies can take actions to suck the wind out of the Feds moves, and protect their own economies. As Albert Edwards writes, “once unfunded liabilities are included, it is obvious that most governments are already insolvent, with debt to GDP ratios closer to 500% of GDP than the official estimates for most G7 countries. It is simply too late. We’re stuffed either way and cannot escape the consequences of years of private and public sector debt debauchery, much as we might pretend otherwise.” Add to that the growing unease of China, and other nations to continue to hold US debt.

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 thinking that it is reality that has unbalanced the worlds economy. Too many investors are keen to "get things back to where they were in 2008", when that was a fiction. As consumers here in the US, we are out of ways to squeeze any more blood from the stones. That "progressive" article I linked above mentioned a few things that were spot on. In the 1970's productivity increased as millions of women entered the job market, allowing prices to rise and families needed two incomes to remain above the poverty line. In the 80's and 90's easy credit allowed us to build up huge amounts of debt, and automation / computerization allowed companies to do more with less. Now, with globalization, all this is portable, and capitalists can take the work to whomever will do it cheapest, but Americans are losing their ability to afford to buy the products anymore. I believe there is something more fundamentally wrong with our economic situation than a lack of confidence. Precious metals are probably the last refuge of $ that are dropping through the floor in value. In reference to Shadow's original post, the income gap will be larger after this latest 20 year economic fiasco.

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.

Are you familiar with George Akerlof? I find in various economic theories, some things that ring true, and some things that are baseless, unproven, incomplete, or off track. I try to look for the best in all of it.

I admire in;

Marx -- his understanding of the plight of workers, and his identification of the source of capital stemming from the transaction between worker and owner. Where he is mistaken is in understanding the mobility, and the duality in that a person can move from one to the other, or be both at the same time.

Keynes -- his understanding of aggregate employment, and his work on income determination and national macroeconomic theory. I think he was mistaken on his over confidence in being able to control the system, just as the worlds money manipulators are now.

Austrians -- understanding business cycles, and the unforeseen consequences of market manipulations. They are mistaken, as you pointed out, in insisting that market equilibrium should be systemic, and not at all coerced.

Friedman (Monetarists) -- for understanding ways in which a government can tweak the economy without making a mess. However, as in what happened in 1930, or to Greenspan, or perhaps Bernancke, there is a seduction in believing in your own power to fix it. Friedman even cautioned against this arrogance.

I think the system is complex, and we've broken it. Pushing and pulling on the gears of liquidity, and interest rates may not fix it, and may break it further. The government's regulatory meddling only makes the situation more complex, and solution more dubious.