Inflation for Goods Prices, Attempted Inflation for Housing-Related Assets, but Sorry, No Inflation for Wages
In the midst of a loosening cycle, the Fed keeps the monetary base flat. This is not normal. Instead, they use their high-quality balance sheet to bail out the liquidity problems of banks, broker-dealers, and maybe others, all while not expanding high powered money. This is not normal, either. After all, the Fed wants to heal the providers of badly underwritten credit (and increased their efforts last week, also here, here, and here), but they don’t want any liquidity to spill over into the general economy, because it might spark a wage-price spiral.
Consider the efforts of the Treasury toward Fannie, Freddie, the banks, and the housing market generally. Yes, they are trying to avoid systemic risk, and that’s important. But where is the support from the Fed and Treasury over unemployment, which is beginning to grow currently. I’m not just talking about more unemployment, but about less compensation growth for labor in total. Their focus is away from that, and looking at stabilizing a financial structure. That’s good for all of us, but a disproportionate amount of the benefits goes to enterprises that made bad loans. My rules of bailouts say that you must make bailouts painful to management teams and shareholders, while protecting senior debt, and thus preventing systemics risk. That is not what is going on here.
I’m no great fan of central banking; I believe it makes our economy more stable in the short run, but intensifies crises when they take place (In my opinion, we never would have had the Great Depression if we had not created the Federal Reserve). Life under a true gold standard has real panics, but they are sharp and short.
At present, we are setting the stage for an increase in unionization. I am no fan of unions, but who can blame workers from seeking more bargaining power when they have had it rough for a long while?
My summary is that the policies of the Bernanke Fed are too clever. Restrain wage/price inflation while bailing out banks and broker-dealers, Fannie, Freddie, etc. But goods inflation keeps running ahead, and the oversupply of houses keeps forcing prices lower. The actions of the Fed and Treasury protect the financial system for now, but at what eventual cost? It might have been better for the Bernanke Fed to have been more traditional, and have stimulated the general economy, while letting the Treasury protect individual financial institutions in trouble.
I don’t think this will end well, but perhaps a recession like 1973-74 will clear the decks. The Fed has to see that its main roles are price inflation and unemployment, with systemic risk third. Any other way of prioritizing Fed action will lead to greater controversy in the long run.
August 3rd, 20088:30 am at
Gee David, I didn’t know you held these views. It’s more what I tend to encounter from the Ron Paul guys (many of whom are very good analysts and traders), but I haven’t ever heard any professional finance people take the no Fed + gold standard position before. Interesting.
Not that anything you usually write about inherently conflicts with what you’ve expressed in this post. It’s notable though in that this sounds more…personal, like you’re reacting with an disconsolate edge to something poignant in the news.
Given that it seems like you’ve opened a door to discussing a broader set of considerations than your usual hunting grounds, I’m going to take the liberty to try formulating a convoluted question that’s been nagging me for several months now as I read you and (Big Picture) Barry, Macro Man, Yves, Mich, Waldman and quite a few others. I apologize in advance for how long winding this has turned out.
The base question itself is misleadingly short and simple: Where do you stand (and why) on the inflation/deflation debate? While there are instances in which the advocates or each view are being selective about the data their reasoning is based on, in most (of the interesting) cases I think people are talking past each other, by either not meaning the same thing by the word ‘inflation,’ or not considering the same time frame. As a result, I sometimes end up trying to make sense of compelling arguments which agree on many of the facts yet claim to reach opposite conclusions (and definitely with opposite defensive strategy implications), or which get uselessly sidetracked into arguing about definitions.
In the present and very near term we have price inflation in commodities and deflation in real estate (and a number of other) assets. No controversy there. As worldwide demand slows, and hot money seeks shelter trend-chasing elsewhere (where?), and credit defaults deplete bank capital, thus reversing credit expansion, demand is disrupted and inflated commodity prices come down (at least in relative terms) and the mixed inflation/deflation becomes all deflation…at least for a while. That’s the Fed’s bet anyway.
Presumably, as global growth resumes (however far down the line) commodity prices resume trending up, although perhaps by then some of the longer term capacity expansion projects put in the pipeline before the recession will be coming on-line for some items. I would expect that most deflationists believe that much as well. If the US recovery lags rather than leads the rest of the world, maybe we get abrupt and significant stagflation here, at least in terms of globally sourced or priced inputs.
Also, long run, my understanding is that the US current account deficit is unsustainable, inevitably resulting in a further repricing of the dollar downward from even current levels, and a significant drop in living standards for Americans unless we have a big innovation/productivity breakthrough (gasoline making bacteria, for instance). From the viewpoint of Americans, the other currencies of the world effectively inflate relative to us.
Perhaps using the EUR/USD cross becomes somewhat irrelevant in understanding “value” at some point, given Europe’s own unsustainable government obligations together with their negative demographics. Both currencies might be on a path to sink drastically in relation to BRIC currencies and/or gold. Or am I getting carried away here?
Roubini says that Breton Woods II breaks down either overtly by dollar-pegged countries floating (or at least re-valuing) together with multi-pricing commodities in other currencies, or stealthily, by allowing internal inflation to reprice their economic activity nominally higher within their still-pegged currencies, accomplishing the same thing in terms of relative buying power to the dollar.
However one parses differing views about scale and detail, I think there’s general agreement about directionality over the long run. The argument really seems to be about the tradeable macro narrative for the next 6-36 months. So what I suppose I’m really seeking your own version of this time frame, together with a view or how you see the moving parts fit together:
Dollar up or down in relation to other currencies and gold? As Europe follows us into recession or slowdown (or at least, if and when the ECB capitulates on rates), and some smaller export-driven economies in other regions implode, will the dollar rise as a safe haven (and for FDI money returning home), and result in a bull treasury market? Or do you think reduced levels of recycled trade deficit dollars (or concern over bailout-driven deficit increases) overwhelms what there may be of the safe haven effect, with the resulting lack of treasury/agency demand driving long rates (thus mortgages) higher, deepening asset deflation further?
If our cumulative trade deficits cannot grow to the sky, what is (and what triggers) the devaluation end game (absent a miracle tech breakthrough in energy and/or a revolution in medical costs)? Does it happen during the unfolding credit drama, or does it happen somewhere further down the road? Is it a slow grind or an abrupt crash?
Tangentially to all of the above, while I am already abusing your attention` I’ve got one more: Given the current dress rehearsal we’ve been living through this year, how do you see peak oil playing out when it comes? (I have my own answer to this one)
August 3rd, 200811:17 am at
David, forgive my ignorance, but I have two questions I hope you can help with. 1) can you elaborate on what the fed /could/ be doing to help goose wages and employment, through policy? (you seem to be lamenting that they’re not.) 2) isn’t globalization the real culprit here? short of erecting trade barriers, won’t we have restrained wage growth for the vast middle class as it competes with the cheaper, striving nations?
August 3rd, 20089:12 pm at
David, one of Andrew Mellon’s famous quote was, “Liquidate labor, liquidate stocks, liquidate farmers.”
For that kind of thinking he nearly went to jail after being hounded by the vindictive New Dealers in the 30’s.
Americans have long lost the nerve to deal with _real_ economic hardships.
I’m afraid Ben Bernenke will get to fulfill his lifetime dream: see whether hyperinflation will get America out of a New Depression. We will all suffer through it.
Monetization is coming — but the dollar has to strengthen first — Note I did not say from what kind of base will it start rising. The dollar will stengthen when the international economies start faltering one by one.
August 4th, 20081:12 pm at
The main issue regarding the fed and its inability to fight inflation has to do with its agrrement with the Treasury and the SEC about the sustainability of Fannie Mae. My point is one to be strogly considered, as of Sept. 2007 10q of Fannie the spread between its debt paper and asset portfolio was a mere spread of .23%, this all after the feds cutiing of the fed funds rate by 1.5% in the preceeding 6 weeks to the end of Fannie’s quarter. During this time Fannie reported that roughly 21% short term debt was at a rate of 5.63% and roughly 79% long term debt was at a rate of 5.22%. As of the March 2008 10q Fannie reported roughly an overall saving of .72% on the total cost of funds, while during this same time period the portfolio yield decreased from 5.54% to 5.25% a loss of .29% making a total savings of only .43%. This all occurred while the fed fund rates were cut from 5.25% to 2%. The situation is now one where the fed cannot raise rates to combat inflation without the destruction of Fannie.