Monday, June 28, 2010

Is This The Climax Yet?

I particularly enjoyed this non sequitur today in my inbox, from one of my favorite news providers,

"The G20 has agreed to pursue programs of austerity while also preserving and enhancing the recovery."

When I clicked on the link, I got the real headline:

"G20 Officially Reveals Its Total Pointlessness."

Yes, the politicians are stymied. The only good thing going for them is that they are finding lots of occasions to practice their talent for talking out of both sides of their mouth. But the straight-talking intellectual academics aren't faring much better.

A few blogs ago, I described this slow-motion movie we're all watching as this recession unfolds. The movie's climax will approach when the Federal Reserve finds itself in front of a dilemma: They must withdraw central bank assistance to maintain credibility in the U.S. bond and dollar, but when is the right time to begin?

[Thanks to for the image.]

Their problem is that no one seems to know. Bernanke and his colleagues are reportedly hunkered down as I write, trying to figure out how to handle what is looking increasingly like another slowdown, or to be precise the second V in the W. But this is not what they expected to happen. This is not AT ALL what they expected to happen.

Modern macroeconomic theory tells us that during crises the Fed's role is to maintain super-affordable interest rates (for the debtors, including the big banks) and to stabilize prices (keeping them high for the creditors and producers, which, by the way, is seriously detrimental to consumers). The idea is to keep panic in abeyance, to make the great middle-class savers pay through the nose without feeling any pain, and to give us all the impression that things are relatively normal compared to, say, the Great Depression with a D.

If the Great Recession were acting according to the textbooks, the various stimuli and bail-outs would have had their salutary effect and the economy would be reviving about now, allowing the Fed to start gradually pulling out its support as things normalized. But the economy is not cooperating (surprise, surprise) and the Fed Governors are stumped.

What the Fed and the politicians don't seem to realize is that you cannot push a string ... good heavens, do we have to bring out that old cliché again? Well, yes, apparently we do. You cannot force consumption or production. All you can do is borrow or create money and then either play with it or burn it until the real action characters in our movie, the consumers and producers, decide the climate is right to go back to normal. (That is what the Stimulus Package does: borrow or create, and then burn, money.)

But how can consumers and producers go back to normal when (1) the consumers are paying the bill through artificially maintained prices, artificially low interest rates on their savings, and old and new taxes; and when (2) the producers don't know what the Fed and government are going to do tomorrow, never mind next year? It's a vicious circle. One group is waiting for the other, at least until November of 2010 when the producers will have a better idea where the politicians will be heading.

So stay in your seats. The moment of truth is arriving, albeit at a snail's pace. (Meanwhile, hold onto your gold.)

See this good article for another person's expression of the same idea. Enjoy the cartoon halfway down, too.