Bogeyman Economics

I'm just a buffoon, and I love a little laughter. We all need a little comic relief from time to time, so I like to make light of the economic mess we're in. However, when surly individuals with Ph.D.s and/or lots of government power start making spooky declarations and rattling their chains, I get a little nervous. After all, they could hurt somebody.


[Thanks to Zoogstercostumes.com for the image.]

Take Ben Bernanke, Timothy Geithner, and Alan Blinder, for example.

A few months ago, Dr. Bernanke looked Steve Croft straight in the eye and declared his absolute faith that the Federal Reserve can keep our economy stable and, at the same time withdraw the Fed's monetary support as soon as prices rise too much in the U.S.

I guess he thinks prices outside the country can rise as much as they want and it's not our problem. Yet credible researchers argue that U.S. monetary looseness is directly behind the current international rise in dollar-priced commodities. (See this Steve H. Hanke article for a breath of fresh common sense.) And rising food and raw material prices around the world cause misery, poverty, and death. (See this report by the World Bank.)

Then almost in the same sentence Bernanke went on to tell Steve about controlling "market expectations." Now, which is it, Sir? Does withdrawal of monetary support really stop incipient price inflation, or is price inflation merely the result of "market expectations"? Because in the latter case, you must believe that the Fed's words are more important that its actions.

But even Bernanke seems to admit that, sooner or later, the Fed will have to correct the situation; yet I don't see how the Fed can withdraw liquidity without causing a rise in interest rates and a second serious economic dip. So I suspect Bernanke and his colleagues are hoping against hope they can keep liquidity high, convince the markets that price inflation isn't going to happen, and then -- Voila, no price inflation, i.e. an economic miracle. Good luck to you, Doc. When it goes awry, either with price inflation or a second dip, don't say I didn't tell you so.

Then there's our Secretary of the Treasury, Mr. Timothy Geithner, warning us that the debt ceiling must be raised or America could default. Now, you and I know this is nonsense. (If you're not sure, read this common sense piece from Michael D. Tanner.) But no matter to the all-powerful Mr. Geithner. Recently his main purpose in life has been to scare debt-wary Republicans into believing they're driving the country into default. But, Mr. Geithner, what happens when Congress does raise the ceiling? Obviously, it condones the debt spending. But wait a minute, don't you get it, Sir? We don't want any more debt. How much of "No more!" don't you understand? You may not care if the U.S. retains its credibility, but we do.

Professor Alan Blinder, a Keynesian voodoo-economics professor at Princeton, declares that "if we crash into the debt ceiling ... it's not likely to be pretty. [WSJ commentary.] ... "At some point," says Blinder, "Mr. Geithner could wind up brooding over horrible questions like these: Do we stop issuing checks for Social Security benefits, or for soldiers' pay, or for interest payments to the Chinese government? Such agonizing choices are what make default imaginable."

Sounds like plain old scaremongering to me. This guy is the kind of academic soothsayer who furnishes politicians like Geithner with serious-sounding, credentialed ammunition. Shame on you, Professor. You're lucky you won't have to pay for the mess when U.S. debt explodes off the charts and we can't even pay the interest anymore.

Blinder goes on: "[S]uppose the federal government actually does reduce its expenditures by 40% overnight. That translates to roughly $1.5 trillion at annual rates, or about 10% of GDP. That's an enormous fiscal contraction for any economy to withstand, never mind one in a sluggish recovery with 9% unemployment. Even contemplating such a possibility is evidence of a dark, self-destructive impulse."

So Professor, which is the more self-destructive party: the academics like yourself, along with the politicians and their voters, who have gotten the U.S. into the worst pickle of its history, or those who would try to save us from people like you? No, you can't scare me -- well, wait; actually, you DO scare me. But not for the reasons you think.

American jurisprudence is missing one important element: Political Accountability. American citizens should be able to hold individuals in positions of power accountable for their recommendations and actions, other than just voting them out of office. If people want the power, they should get the liability.

There should be a law that anyone in a position of power who makes policy decisions that later turn out to be wrong should be held responsible and should give up everything they own or will ever earn, in order to pay back a fraction of what is owed to all those who have been harmed.

Drunk bus drivers who cause accidents are fired and penalized, even put in jail. Politicians inebriated by the headiness of power, and academics swollen with their sense of self-importance, can cause billions of losses to defenseless citizens with no fear of reprisal. What do they get when they screw up? A comfortable pension, full retirement benefits, and a book deal.

That's Bogeyman Economics for you.

The Biggest Show On Earth Is Coming to Town

Got your agenda marked? The Federal Reserve Board meets this week, and for the first time Chairman Ben Bernanke has decided to face the public immediately afterward in an effort to increase transparency.


[Thanks to Circus Contraption, at SeattleTwist.com for the photo.]

Bernanke will be giving his first real press conference on Wednesday, April 27, 2011, at 2:15 p.m. EDT.

This particular Fed meeting is crucial, because on June 30, 2011, the Fed is planning to end its second round of quantitative easing (Fed purchases of treasury bonds). Through this program they are currently purchasing up to 85 percent of the bonds issued by the U.S. Treasury since November 2010. What will the Fed do next, stop altogether or phase the program out? Future Fed actions are based on current statistics, and the Board might do either, or they might just decide to continue easing a bit longer if the numbers so indicate.

The consensus seems to be that the Fed will stop their purchases but continue trying to hold down interest rates in other ways. However, a consensus does not a crystal ball make.

Bernanke is probably hoping he doesn't gaff and send the world's markets into fits of dyspepsia. The slightest misplaced word, sudden bead of sweat, or uncontrolled twitch of Ben's brow could add an unknown dimension of insecurity to his studied words. Will the end of QE2 cause bonds to fall into a tail spin? Will it turn the recent stock market recovery into a bursting bubble? Will it cause a flight from the dollar? Will a misplaced comma or tremble of the voice start World Recession III?

The other possibility is that the markets see the end of QE2 as they did QE1, i.e. as business as usual. The slight retraction of liquidity could simply displace a sum of money from the stock market to the assumed security of the bond market, without necessarily causing significant disruption in either. Two very prominent U.S. bond dealers are debating this very issue as I write. (See Gross versus Rieder at this Wall Street Journal article.)

My slow-motion movie on "The Economic Crisis of 2008" is unfolding even slower than I thought it would. We've had to wait three years for the denouement even to approach the horizon, but I think it's finally coming.

The next months will be fascinating. Not only do we have the QE2 situation, but we also have much to learn about the upcoming federal budget and debt ceiling, about the candidates for the 2012 election, about the future of the U.S. dollar's hegemony over other fiat currencies, and about the world's opinion of the safety of U.S. treasury instruments as a secure store of value. Any unexpected disruptions in the latter could throw a hard ball to all the Modern Portfolio Theorists, as real life tends to do.

Some even think there's the possibility that America's heyday is coming to an end, just as England's did at the turn of the last century. (See the article at Marketwatch.) I don't believe this quite yet, and I refuse to until I see the results of the latest silent-majority push towards smaller government. If it fails in 2012, i.e. if Obama passes again and both Congress and the Senate weaken in resolve and/or shift towards the left (whether it be Republicans or Democrats), then maybe we should start to worry.

While all this is going on, what can one do with one's money? I'm not an investment advisor, and I'm just as frustrated as the next person with 0.05 percent interest. When people remark that I have been right about gold until now and then ask whether they should get into it at this point, I still must respond that I just can't predict what gold will do in the next year. I do permit myself to say that it looks like we're headed for one of two scenarios:

1. 1970s-style price inflation with a significant rise in gold, and then the subsequent obligatory tightening a-la-Volcker with its healthy contractionary forces (not so much a recession as a readjustment of the previous misalignments of money flows), accompanied by a subsiding of the gold price to a more stable level; or

2. A Japanese-style twenty years or more of stagnation, with prices and GDP remaining relatively tame, held in check by the squeezing of the ordinary wage earner through a bad employment market, caused in turn by political dithering of the kind we saw in the 1990s when Gingrich and the Republicans lost their mojo.

I'll be heating up the popcorn come Wednesday.

The Climax is Coming

I have said in the past that this Great Recession is playing out like a slow-motion movie. Every scene takes forever--months even--to occur. Ben Bernanke is our hero/anti-hero, and he has implemented his last tactic: QE2 (a second round of Quantitative Easing, another enormous expansion of the Federal Reserve balance sheet), just as he announced he would.

At least he doesn't mess around. He has put his--oops, our--money where his mouth is.



For Jon Stewart's take on all of this, watch this hilarious clip.

So if everything goes as Bernanke expects (or hopes), inflation, i.e. the general price level, will rise a bit, to around two percent. The banks will remain solvent in spite of the fact that they are still carrying billions of bad loans and that real estate will continue to fall in value. Freddie and Fannie will survive. The unemployed will begin to find jobs. U.S. Bonds will continue to sell at low interest rates and the Treasury will be able to finance the biggest budget in history. The U.S. dollar will retain its reserve status because the Chinese and other U.S. financiers will continue to play the game, in spite of the fact that the dollar will continue to lose purchasing power relative to other store-of-value items (e.g., gold and perhaps other currencies). And all will go well in the world.

On the other hand, if things don't go as he expects, commodities will blow off the charts. Retailers will find themselves forced to pass along costs, and general prices will start to rise even though real estate will continue to tank. U.S. bonds will take a big hit and reveal themselves to have been in bubble territory up until two months ago. Banks will find themselves in the interest-rate squeeze. Foreign trading partners will continue the currency race to the bottom and impose more restrictions. The American workforce will profit from the additional year of benefits the government might hand out, and the unemployment figures will not budge or may get worse. General unrest will rise in parts of the world that depend upon commodity prices remaining stable.

Whatever happens to us, all of Europe is, and will continue to be, in a wrestling match with their unions. Usually this is good for the dollar. However, it is not Europe's troubles that will save the U.S. when Moody's downgrades our bonds. Up to now, whenever Europe trembled, the markets fled to the safety of U.S. bonds. But with this new federal spending bill, the current and upcoming battles between the two parties in Congress, and the insecurity of the next two years, we are in for some mind-bending, rule-bending times.

The big question is: Will the world markets accept U.S. profligacy for another round, or will they demand correction? The answer depends upon factors that are unforeseeable at the moment. Even Bernanke couldn't suppress a tremble of the upper lip during his interview on 60 Minutes. I cringed when he declared "100 percent certainty" of his capacity to reverse gears whenever he chose. I imagined I could feel his fear.

I have grave doubts about any such human capacity, and even about Bernanke's sincerity. He has fallen into the Great Hubris Trap. When Japan was on the hot seat, he was full of bravado and advice. Now he is on the hot seat, and he has to make good on his theory. I suppose he might get lucky; but he also might get what he deserves, i.e. a collapse of the U.S. dollar and pandemonium. The problem is, we don't deserve it.

The Chinese are waiting patiently in the wings. They have taken steps to liberate their yuan on the currency markets, and the results have surprised everyone. Hong Kong is scrambling to handle all the business. It seems doubtful that China's currency will become the next world reserve unit, given their efforts to control everything; but what will the markets decide? That is the real question. The Chinese, as the French say, have forgotten to be dumb ("ils ont oublie d'etre cons").

We may have to be patient as this movie plays itself out, but play itself out it will. And the speed can change unexpectedly.