Thursday, January 15, 2009

Chinks in the FED’s Armor, and the Reducto ad Keynsianism

Two items. First, not everyone at the FED agrees with the current “stimulus” tack taken by Bernanke. In a Market Watch article, “Fault Lines Emerge at the FED,” Philadelphia FED President Charles Plosser and former St. Louis FED President William Poole publicly took issue with Bernanke’s policies.

Plosser urged the Fed to "proceed with caution" with the new policy. Others outside the Fed are much more strident and want plans in place immediately to reverse it. They believe an inflation storm is already in train…

Fed officials who pay attention to the money supply believe that the Fed's current policy of printing money never ends well and the danger of inflation is very high. They believe the Fed must withdraw the stimulus before there is any sign of inflation or it is too late….

William Poole, who recently left his post as president of the St. Louis Fed, says it is crucial that the Fed set a target for cutting its balance sheet.

Poole said the expansion of the Fed's balance sheet is unprecedented and research suggests that a surge of inflation is sure to follow.

"I would say if the policy is not reversed, there is a high probability that the unpleasant risk (of inflation) materializes," Poole said in an interview.

I chuckle when I see the empiricist phrase “there is a high probability that…” as though we are simply relying on some unexplained correlation in the data to suggest that inflation is on it’s way. We know what causes inflation. It occurs when the government cranks up the printing presses. If the FED President knows that such policies are occurring, he could be a little bit more certain of what it portends. As in 100%.

I am preparing a letter to my congressmen specifically advocating them to deny additional TARP funds and also vote down the Obama stimulus. I urge my readers to do the same. Maybe we’ve become too used to seeing the large bills from the IRAQ war, but the fact remains that these stimulus packages are tremendously large. Our Congress is mortgaging our future to accomplish very little, and ultimately damage us greatly.

My next item is an analysis discussed by Yves over at naked capitalism. Martin Wolf has an analysis over at the Financial Times (free RSS feeds there!) looking at the stimulus package. He attempts to understand the cost imposed on the US private sector of all this government “stimulus.” The answer? The stimulus won’t work.

The stimulus required is significantly larger than anyone has estimated, and since public money comes from the private sector, the damage that paying down this stimulus debt will inflict on the private sector is significant.

The argument still seems to take a Keynesian perspective on the whole issue, but at least he is attempting to account for where this stimulus money is going to come from, and the damage that obtaining it will do.

This is the logical conclusion of Keynsianist policies. The government doesn’t create anything of value. It is simply mortgaging the private sector’s productivity in order to supposedly fix the private sector. On the surface this makes no sense, and I marvel at how seemingly rational people can hold the idea. If the problem was over-leverage the solution cannot be more of the same.

Yves comes back with some rational analysis in her critique. Banks were not restructured using the TARP funds, and this is what must occur. True asset values must be discovered and write downs must be taken. Treasury is simply providing banks with operating cash and ignoring the toxic balance sheets. This is like throwing money down a bottomless pit. It does nothing.

We are avoiding the bitter pill, spending like there is no tomorrow, hoping that we won’t have to deal with the problems. I’ve not seen a situation like this in my lifetime.

2 comments:

Doug Reich said...

Hi Kendall,

I liked your comment related to the empiricist thinking of these economists.

Part of the confusion rests in not defining "inflation" properly. In other words, these economists define inflation as rising prices. To define inflation this way is to equate the concept with its effect. Inflation, properly defined, is the increase in the quantity of money (caused by the government) above the increase in the quantity of precious metals. A consequence of this increase in the quantity of money can be rising prices but it does not have to be.

In other words, all that has to happen is that prices are higher than they would otherwise be. For example, in the 1920's, prices actually declined somewhat despite inflation of the money supply. This was due to massive increases in productivity. In this case, prices did not rise in absolute terms - they just failed to decline as rapidly as they would have. However, even though prices did not rise dramatically or possibly even declined, the effects of the inflation were still experienced. In other words, this increase in the quantity of money had the effect of destroying capital in all the ways that inflation destroys capital in particular in causing malinvestment, i.e., investment in businesses that appear profitable due to the expansion of credit. (This is what led to the stock market crash).

This is vital in understanding inflation and its consequences. Inflation has the same devastating effects even if absolute prices mask its influence. The increase in the quantity of money above the increase in precious metals is the primary.

Kendall J said...

Thanks Doug,

Of course the definition of inflation and its converse, deflation are equally important. It seems we're all fretting due to deflation these days and once again it is confusing the concept with its effect.

Thanks for your comment!