Archive for category Fed
Jeb Bush and Newt Gingrich Back State Bankruptcy Option
Posted by Tom in Bankruptcy, Fed, Federalism, State Finances on January 27, 2011
In an L.A. Times op-ed today, Better off Bankrupt, Jeb Bush former Florida governor and Newt Gingrich former speaker of the house, call on congress for legislation to allow for the states to seek voluntary bankruptcy under the federal system. They recite all the economic necessities for such a law and they add a couple of interesting points.
- Just as with municipal bankruptcies, the federa judge would not have power to mandate tax hikes or any other governmental functions. He could only approve or reject the reorganization plan which may include a reformation of union contracts and benefits.
- Triggering mechanisms, respecting the sovereignty of the states, should allow for a majority vote of the legislature or an initiative of the people to put the state into bankruptcy. I would include action by the governor as well.
Hugh Hewitt hosted an interesting discussion on the subject during his radio broadcast yesterday. The callers were worried about the ”contracts clause” of the Constitution (Article I, Section 10) precluding reformation of union contracts and specifically reformation of unfunded pension obligations. The clause basically prohibits states from “passing any law impairing the obligations of contract.” My cursory research today indicates that this will not be a problem as the clause does not prohibit court action. And it certainly will not prohibit federal court action.
As usual, I would add to the bankruptcy option a statutory provision precluding the Fed from buying or guaranteeing any state obligations. And I also think a “belt and suspenders” constitutional amendment prohibiting a federal bailout of states would be advisable.
In any case it is heartening to see the calls for congressional action becoming more frequent and being made by a former governor and former speaker. This adds gravitas to the effort.
Our Inflation “Export” Will Almost Certainly Boomerang!
Posted by Tom in Economics, Fed, Financial Policy, Foreign Policy, Monetary Policy on January 18, 2011
Ron McKinnon, a Stanford professor and senior fellow at the Stanford Institution for Economic Policy Research, pens a brilliant history lesson in today’s WSJ, The Latest American Export: Inflation. In it he reviews three recent periods of “hot”money dollar outflows causing world-wide inflation.
“The hot money was caused by the Fed’s low rate easy money policy and consequent dollar depreciation. It flows out of the U.S. seeking higher returns. Foreign central banks intervene buying dollars to prevent their local currencies from appreciating. When central banks issue base money to buy dollars, domestic interest rates are forced down and domestic inflationary pressure is generated. Primary commodity prices go up quickly because speculators can easily bid for long positions in organized commodity futures markets when interest rates are low.”
McKinnon’s three periods:
- The Nixon shock when the U.S. abandoned the gold standard resulted in the surge of dollar prices of primary commodities.
- The Greenspan-Bernanke shock of 2003-2004 when the fed funds rate was reduced to 1% and followed by a falling dollar.
- And, the Bernanke shock starting in 2008 with short term rates at zero and quantitative easing (money printing) resulting in commodity price inflation in 2010 alone of over 30%!
Historically the remedies for this U.S. monetary folly, were not fun. Remember the “stagflation” of the 1970s, with inflation, unemployment, volatile exchange rates and little productivity? Well the cure came with Volcker at the Fed raising the fed funds rates drastically, touching 22% in 1981! And the Greenspan-Bernanke interest rate shock of 2003-2004 sowed the seeds of the weak dollar bubble economy in 2008. The biggest bubble was real estate with 50% increases in average home prices from 2003-2006!
Two lessons according to McKinnon: 1. Sharp price increases in auction-market goods like primary commodities is a warning sign that the Fed’s monetary policy is too easy. In 2010 CPI indexes shot up more than 5% in major emerging markets while only 1.2% in the U.S. 2. General price inflation in the U.S. “only comes with long and variable lags.” After the Nixon shock of 1971 inflation exploded in Japan in the 1972-1973 period but by December 1979 the U.S. CPI and PPI were higher than 13%!
In short, the inflation we ship abroad comes back to bite us where the sun doesn’t shine, and really bad!
In concluding commentary McKinnon points out that the U.S. can basically do what it wants, and since Bretton Woods has had the luxury of managing the world’s exchange and reserve currency. “But by ignoring inflationary early warning signs on the dollar standard’s periphery, which in turn lead to rising domestic prices and asset bubbles, the Fed has made both the world and American economies much less stable.”
Let’s hope Bernanke heeds the obvious. If not, we’re due for a repeat of the Carter years.
O’Driscoll Comments on Inflation
Posted by Tom in Economics, Fed, Financial Policy, Monetary Policy on January 13, 2011
Inflation is Here
January 13, 2011
by Jerry O’Driscoll
“Prices Soar on Crop Woes” reads the headline in today’s Wall Street Journal.
Global output of key crops such as corn, soybeans and wheat is down, and their prices are up, respectively, 94%, 51% and 80% from June lows. Today’s PPI report has wholesale prices up 1.1% in December after rising 0.8% in November. The Journal reminds us that in 2008 high food prices sparked riots around the world.
Meanwhile Fed officials tell us they don’t expect inflation. It is not an issue of expecting inflation, but of observing it here and now. The Fed prefers, of course, to look at “core” inflation rates, which are much lower. A former Fed colleague explained to me the central bank does so on the theory that people do not need to drive to work and can stop eating.
In our global economy, easy US monetary policy has thus far mainly affected commodity prices (including now food), real-estate in Asia and now broader price measures in Asia. It is implausible that the US would remain unaffected. Food, energy and clothing prices are all rising. I don’t think many households are presently gripped with a fear of deflation.
In the Mises/Hayek theory of economic fluctuations, the transmission of monetary shocks works through producer prices and incomes, and only later consumer prices. No measure of consumer prices, and certainly not a subset of consumer prices, is an adequate gauge of inflation.
Thanks to Jerry for republication of this ThinkMarkets post.
They Never Learn: Leftists Won’t Cut As Long As They Can Tax and Borrow
Posted by Tom in Deficit, Fed, Federalism, State Finances, Taxation on January 8, 2011
Illinois legislators, facing a $15 Billion deficit, $54 Billion unfunded pension liability and the highest state borrowing costs in the nation, are considering, what else, 75% income tax increase, from 3% to 5.74%, according to an IBD editorial, Illinois Taxes: How Blue Can You Get? And this, despite the preponderance of evidence showing that businesses, jobs and people flee high-tax states.
A chart illustrates the great migration and resulting great reapportionment:
But Illinois pols don’t have the same long view perspective that muni bond investors have, so the borrowing spigot is now in jeopardy. Michael Corkery picks up the story in his WSJ article, Bond Buyers’ Eyes Are on Illinois. The smart investors like Bill Gross of Pacific Investment Management are avoiding Illinois bonds. The state has been paying its vendors in IOUs. And “Illinois has struck fear in bond buyers’ hearts because, they say, more than many other financially troubled governments the state has increasingly relied on debt to pay bills, rather than making deep spending cuts or raising income taxes to increase revenue.”
So Illinois debt costs are the highest of the spendthrift states, including CA and NV.
People and businesses vote with their feet as the great migration from the high tax states to the business friendly low tax states well illustrates. As the IBD editorial exhorts: “Stop worrying about the distribution of the golden eggs and start worrying about the health of the goose!”
The only ray of hope here is Ben Bernanke’s statement Friday: “We have no expectation or intention to get involved in state and local finance,” Mr. Bernanke said in testimony before the Senate Budget Committee. The states, he said later, “should not expect loans from the Fed.” For the full discussion see, Bernanke Rejects Bailouts in today’s WSJ.
I would argue for a statutory prohibition against such Fed loans, a statutory provision for voluntary state bankruptcy, and a constitutional amendment precluding federal bailout of the states.
History Lesson in State Defaults
Posted by Tom in Bankruptcy, California, Constitution, Fed, Federalism, State Finances on January 4, 2011
Dennis Berman pens an excellent history lesson in today’s WSJ, When States Default: 2011, Meet 1841. Illinois one of today’s default candidates along with its neighbor Indiana and six others defaulted on their bonds. The consequences were severe and long lasting, bond yields skyrocketed and lending dried up. Taxes also skyrocketed.
Berman quotes Randall Kroszner a former Fed Governor and University of Chicago who in discussing today’s state default possibilities advocates “a clear legal framework, and a clear way in which people would be treated.” Of course, that is now lacking since there is no bankruptcy provision covering states.
I reiterate my calls: 1 For a voluntary bankruptcy provision allowing states access to the federal bankruptcy courts on a voluntary basis. This is politically appealing for governors and legislators alike as it gives them the leverage to negotiate with both public unions and bondholders. 2. For a statute precluding the Fed from making loans to or guaranteeing obligations of a sovereign state. And, 3. for a constitutional amendment prohibiting federal bailouts of any of the sovereign states either by way of grant, loan or guarantee. This latter bootstrap point, even though as Berman points out: “Congress, meanwhile, helped set a precedent that still holds: In 1843, it rejected an elaborate plan for a bailout, with one critic later observing it would “cause recklessness and extravagance” among the states. Surely, someone will dust off those ideas in 2011.” In my opinion, the reason it still holds, if it still holds, is that no one has tested it!
Repeal Humphrey-Hawkins. It’s a recipe for failure!
Posted by Tom in Economics, Fed, Monetary Policy on November 22, 2010
The Fed has an impossible mandate: keep price stability and promote full employment. Emphasizing one detracts from the other and visa versa. This weekend’s WSJ editorial, The Fed’s Bipolar Mandate, quotes the 1978 Full Employment and Balanced Growth Act (Humphrey-Hawkins) mandate: “promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.”
A product of the Carter years of high inflation, high unemployment, price controls and gas lines, the Humphrey-Hawkins act is a stupendous testimonial to big government meddling, a shrine to John Maynard Keymes. It lists various duties of the government, briefly according to Wikipedia, it:
- Explicitly states that the federal government will rely primarily on private enterprise to achieve the four goals.
- Instructs the government to take reasonable means to balance the budget.
- Instructs the government to establish a balance of trade, i.e. to avoid trade surpluses or deficits.
- Mandates the Board of Governors of the Federal Reserve to establish a monetary policy that maintains long-run growth, minimizes inflation, and promotes price stability.
- Instructs the Board of Governors of the Federal Reserve to transmit an Monetary Policy Report to the Congress twice a year outlining its monetary policy.
- Requires the President to set numerical goals for the economy of the next fiscal year in the Economic Report of the President and to suggest policies that will achieve these goals.
- Requires the Chairman of the Federal Reserve to connect the monetary policy with the Presidential economic policy.
The Act set specific numerical goals for the President to attain. By 1983, unemployment rates should be not more than 3% for persons aged 20 or over and not more than 4% for persons aged 16 or over, and inflation rates should not be over 4%. By 1988, inflation rates should be 0%. The Act allows Congress to revise these goals over time.
Think of that power of the ruling class! The Act is a statement of progressive, Keynesian, Democratic, liberal, leftist hubris. The only thing it did not attempt to do is repeal the law of gravity!
Forbes publisher Rich Karlguaard said it well last year: “The Humphrey-Hawkins bill was an act of stupendous government meddling in markets and monetary policy. By the Fed’s own language, it had to serve two masters: “The Fed then has two main legislated goals for monetary policy: promoting full employment and promoting stable prices.”
As the WSJ editorial points out, the bipolar mandate inevitably makes the Fed a political actor instead of an independent agency charged with monetary stability. The current brouhaha over QE2 is a perfect example of Bernanke trying to save Obama’s failed fiscal policies over the international outcries of our trading partners.
Friedrich Hayek had a simple theory that the massess of economic actors acting independently will produce better results than the elitist planners can ever hope to achieve. Adam Smith had much the same thinking with his invisible hand producing the best outcomes.
Let’s dump the Keynesian albatross called Humphrey-Hawkins and give the Fed one independent job, price stability.
QE2 Made Simple
Posted by Tom in Economics, Fed, Monetary Policy on November 14, 2010
Jerry O’Driscoll alerted me to this economic piece.
Are Low Rates Counterproductive?
Posted by Tom in Centrally Managed Economy, Deficit, Fed, Financial Policy, Monetary Policy, National Debt on August 12, 2010
John Michaelson’s WSJ post, “The High Costs of Very Low Interest Rates,” presents the dark side of the Fed’s current policy. In it he makes the following points:
- low rates mean low earnings on savings giving consumers less to spend,
- folks close to retirement need to save more to get expected earnings,
- corporate pension plans need to fund more to make up for low earnings, which reduces money available for investment, and
- banks can borrow at zero and buy US bonds at a risk free return, so they do not lend to businesses for investment and job creation.
What’s sad is that the Fed has not learned from Japan’s lost decade experience. In 1990 following the burst of the credit bubble, Japan dropped it rate to an unprecedented .25% It’s government then borrowed to create massive “stimulus.” This froze out private borrowing, investment and consumption creating the lost decade.
Does any of this sound familiar?
I recommend the full article linked above.
Deflation, A Self Fulfilling Prophesy?
Posted by Tom in Business, Centrally Managed Economy, Deficit, Fed, Financial Policy, Monetary Policy, National Debt, Nationalized Health Care, Taxation on August 3, 2010
When Bill Gross, the bond guru manager of Pimco Total Return Fund, says “it’s happening,” he brings credibility to the deflation first scenario, that is deflation before inflation. According to yesterday’s WSJ article many fund managers are loading up on US Government bonds and hedging stocks. Others expect the Fed to come to the rescue. The Fed has limited options since it has interest rates near zero. According to another WSJ report these options are “unorthodox!” As the Fed mulls these, it may spook investors and highlight the weakness in the economy. So when the Fed is playing offense in trying to reflate the economy, savvy investors might conclude as Gross did that it’s time to play defense. Typically these “unorthodox” measures mean increasing the money supply by buying bank assets good and bad, bonds and mortgage backed securities. Problem is that there are not too many bullets left in the Fed’s arsenal.
To cap matters off, vis a vis the “self fulfilling prophesy,” today’s WSJ leads the front page with “Fed Mulls Symbolic Shift” that is using cash from maturities to buy additional assets instead of letting its portfolio shrink to a stable economy level. The Fed’s $2.3 Trillion portfolio has nearly tripled in size since 2007!
So, what to do? If prices are going to be lower tomorrow, why buy today? And this, ad infinitum! Couple this with Hussein Obama’s proposed tax increases, the pile on of entitlement deficits from Obamacare, and the great uncertainty posed by the regulatory bureaucracy, and you get a bleak picture.
Hope I’m wrong!