Archive for category Monetary Policy
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.
Yuan As a Mini Reserve Currency?
Posted by Tom in Business, China, Economics, Foreign Trade, Monetary Policy on December 14, 2010
We read in today’s WSJ that Yuan trading is booming just months after Beijing allowed the currency to be traded outside the country for the first time. Trading has grown from nothing to $400 million in just a few months. Just a small part of the $4 trillion world wide currency trading in convertible currencies, the Yuan is still important.
This for the simple reason that China is the world’s second biggest economy. It’s the exporter to the west and a major holder of US dollars to which its value is pegged.
Who would buy and hold Yuan? Who would import anything from China, that’s who. In fact those who import may also export. How happy they should be to avoid messy currency conversions.
Is the Yuan a good proxy reserve currency? Almost to the extent the dollar is a reserve currency.
So, some of the speculation in the Oster, McMahon, Lauricella article, Offshore Trading in Yuan Takes Off, makes abundant sense.
“Already, banks such as Citigroup Inc. and HSBC are offering investors yuan-priced options and interest-rate derivatives. Mutual funds dedicated to yuan-priced investments have already been created.”
“The move has opened the doors to wider issuance of yuan-denominated bonds and other investments. McDonald’s Corp. and Caterpillar Inc. recently became the first U.S. non-financial corporations to sell debt priced in yuan, in what is being nicknamed the “Dim Sum” bond market.”
“A big driver of the increase in yuan holdings offshore is emerging economies, major trading destinations for China. HSBC forecasts that at least half, or nearly $2 trillion worth, of China’s cross-border trade with emerging markets could be settled in yuan annually within three to five years.”
“For example, countries rich in natural resources that export commodities to China could get paid in yuan and then use the yuan to buy finished goods and services from China—cutting out the cost and hassle of converting to dollars.The moves come against a broader background of growing Chinese concern over the country’s reliance on the dollar.”
“Long term, the offshore yuan market could decrease demand for the dollar and lower its value. That’s in part because Chinese companies doing business with counterparts in other countries wouldn’t need U.S. dollars to conduct that business as they do today.”
![[YUAN_NS]](http://sg.wsj.net/public/resources/images/OB-LI421_YUAN_N_NS_20101214092904.gif)
China is on the move. The international Yuan trading is a positive step in making global trade more efficient. It may soon be convertible and compete with the US dollar as a reserve currency. In that eventuality, the US fiscal house had better be in balance, because our reserve currency pinnacle will no longer provide a safe haven for our spendthrift ways.
Debt Problem? Solution: More Debt! And You’re A Lender!
Posted by Tom in Bankruptcy, Banks, Business, Deficit, Europe, Financial Policy, Foreign Policy, Monetary Policy, National Debt, State Finances on December 3, 2010
Makes absolutely no sense at all. Greece has a debt problem, can’t pay its debts when due; so the EU together with the IMF bail it out. How by lending it more money! Ireland has a problem, can’t pay its obligations when due, so the EU together with the IMF lend Ireland more money. Spain and Portugal see this and demand a larger bailout pool while the financial markets worry about “contagion.”
John Cochrane, a finance professor at the University of Chicago Booth School of Business, calls a spade a spade in yesterday’s WSJ op-ed, ‘Contagion’ and Other Euro Myths. The EU/IMF bail out facility promises that no sovereign bond holder will lose a cent at least for now. Basically what that says is that those lenders holding EU country debt now have a super guarantee. This is a guarantee to which they are not entitled. They did not bargain for this when they made the loans by buying the bonds. Their credit underwriting said that Spain, Greece, Ireland, and Portugal (the PIGS) were creditworthy at the interest rates charged. In short those lenders made underwriting mistakes.
So what happens when borrowers can’t pay? Normally, they restructure their obligations, sometimes extending maturities, and other times by having the principal balance reduced. In other words the lenders take a haircut. Why can’t this be done in Europe?
Now who are those dumb lenders, the sovereign bond holders, that the EU is so anxious to bail out? Well, they are the European and UK banks, principally those in France and Germany. To bail out dumb lenders or to guarantee them is bad policy. It denies the market discipline necessary for a functioning economy. It promotes moral hazard which simply means that those same lenders will not change their sloppy underwriting, will make more bad loans, and will expect future bailouts. Failure is just as essential to the marketplace as success.
As Cochrane points out the “contagion” boogyman is a myth: “The bailout is being justified on grounds of containing “contagion.” This is nonsense. The notion is that news of an Irish restructuring would scare investors in Spanish bonds, who would start looking at Spain’s ability to repay its debts and then demand higher interest rates.”
“But haven’t investors in Spanish bonds already noticed that there’s a bit of a problem? And wouldn’t news of a giant bailout make these investors question Spanish finances as much as would news of debt restructuring?”
“Any contagion is entirely self-inflicted. The only way Ireland’s fate affects Spanish investors is by changing the odds that the European Union (EU) will bail out Spain. And Spanish interest rates are rising, suggesting investors now think a Spanish bailout is less, not more, likely.”
On top of that all, U.S. taxpayers are putting money in to the unnecessary bailout facility. Yep, that’s right, the U.S. is the largest national contributor to the International Monetary Fund. So with our current weak economy, continuing deficits, and generation choking debt, we via the IMF are digging our hole deeper. The sad thing is that we have the ability to block the IMF action. But we don’t.
Question, will the United States face the same issues with our spendthrift sovereign states like CA, IL, and NY? Or will we get smart and (1) enact a state bankruptcy provision and (2) pass a constitutional amendment precluding bailouts? Something to ponder!
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.
There is No Spoonful of Sugar – The Case for Higher Taxes
Posted by Tom in Deficit, Financial Crisis, Monetary Policy, Taxation on November 18, 2010
This post is abbreviated from a more extensive essay by Stephen Benavides, a CPA and tax attorney.
If I were asked to give a professional opinion on the income statement of the United States I would be forced to qualify it or include a statement that without drastic and material changes of fortune the United States would cease to exist as a going concern. The three largest items in the budget for 2009 (the last year for which we have complete records) are Social Security, Medicare, and interest on the national debt. None of these three are discretionary. In addition, the defense budget for that year is about the same as the interest on the national debt, but can defense spending be thought of as discretionary? ……
That same $2.4 trillion in tax revenue, representing the sum total of all taxes collected in the United States by the federal government, is sufficient only to pay for three of these four items. Unfortunately, we are now spending $4 trillion a year and one way of looking at our situation is that everything other than Medicare, Social Security, and interest on the national debt is being paid for with borrowed money. That is a 40% structural revenue shortfall!….
The United States is insolvent. From an accounting standpoint, from a business standpoint, for the sake of our sanity and the welfare of our children, this is unsustainable and borders on madness. A day of reckoning is here for our nation and its people. The longer we wait, the worse it will be, not only for ourselves but for the rest of the world since it is pretty obvious that when the United States start sneezing the rest of the world will soon have our cold.
Like all good tax guys I hate income taxes as much or more as any of you but I’m also a businessman. There is no magical way to get us out of this mess. The medicine is going to be bitter and there is no spoonful of sugar to help the medicine go down. The medicine that no one wishes to talk about is a material tax increase. By material, I don’t just mean an increase in tax on the wealthiest 1% of the country. I happen to believe that all citizens should be paying taxes yet our progressive system allows almost 50% of our citizenry to pay no federal income tax at all. I happen to feel strongly that everybody should be paying taxes and find arguments to the contrary revolting……
I hope this rant raises your attention level all the way to outrage! If you are not there yet, consider this: The Federal Reserve just raised your “taxes” again and took as much as 7-10% of your net worth by printing up billions and debasing the currency. This was a planned, considered move to monetize the debt and pay off our obligations with cheaper dollars. They have almost certainly set an inflationary spiral into motion as holders of our debt will want to be paid off or get substantially more interest to continue to finance our madness. Inflation is the most insidious of all taxes. An increase in marginal income tax rates only affects new and future income. Inflation taxes not only our future income but taxes our previously taxed income and all the wealth we have previously amassed in after-tax dollars. It is already too late to stop this from hurting you and your families.
My thanks to Steve Benavides for this post.
QE2 Made Simple
Posted by Tom in Economics, Fed, Monetary Policy on November 14, 2010
Jerry O’Driscoll alerted me to this economic piece.
Stratfor Dispatch: Currency War and the G-20
Posted by Tom in China, Europe, Financial Policy, Foreign Policy, Monetary Policy on November 10, 2010
Today’s Stratfor summary of the currency brouhaha is the best and most succinct I’ve seen in a while. I heartily recommend subscribing, http://www.stratfor.com
Here is the link: http://www.stratfor.com/analysis/20101110_dispatch_currency_war_and_g_20
Trade War With Major Supplier & Lender?
Posted by Tom in Deficit, Democrats, Economics, Entitlements, Financial Policy, Fiscal Policy, Foreign Trade, Monetary Policy, National Debt on October 11, 2010
Dee Woo, an economics professor in Beijing, suggests the futility of a trade war with China in his WSJ article, The U.S. Will Lose a China Trade War. He argues:
- Even if the Yuan appreciates the U.S. trade deficit will not reduce until we reduce our “chronically low”savings rate and diffuse the disincentive to manufacture.
- Washington can’t afford a weak dollar policy because the only thing standing between the U.S. and a Greek style sovereign debt crisis is the dollars status as a reserve currency. (CBO projects debt at 140% of GDP in 20 years!) Reserve currency status in not guaranteed!
- A strong Yuan would reduce Americans’ real income because it would kill U.S. jobs that depend on Chinese exports. The stronger Yuan will reduce China trade, thereby reducing Chinese trade surplus in turn reducing in recycled dollars reinvested in the U.S. promoting economic growth and lower interest rates.
- A strong Yuan would slow China’s rapid growth which is facilitating its transition from export dependency into a more balanced consuming nation.
- Finally, a strong Yuan would hurt and force out some export oriented businesses thus eliminating demand for excess low wage labor and disrupting China’s goal of attaining a “harmonious society.”
Monday’s paper details the planned continued pressure on China, U.S. to Step Up Pressure on China.” Direct pressure and international pressure on China will indeed continue. It has in the past led to small increases in the Yuan and no doubt will continue to do so. China may in fact revalue to a much greater extent, compelled to do so to control internal inflation.
But will this help a nation of spendthrift dependency brought about by the so called progressive leftists? And, how long will the dollar last as a reserve currency? The international confidence which made the dollar the reserve currency is evaporating. “As sound as a dollar” is sounding laughable.
Obama continues to borrow, tax and spend at an unsustainable pace. He and the Democrats added the unsustainable entitlement of Obamacare upon the unsustainable entitlements of Medicare, Medicaid and Social Security all growing out of control. The Fed’s continuing monetization of debt, devaluation of the dollar, reduces confidence, the confidence necessary to maintain the reserve currency status. This fiscal and monetary combination is a catastrophe.
Sad that Dee Woo’s arguments are probably correct!
Chilling Comparison-Will History Repeat?
Posted by Tom in Business, Economics, Education Facts & Policies, Entitlements, Financial Policy, Monetary Policy, National Character, National Debt, Taxation, Welfare on October 4, 2010
Donald Luskin, chief investment officer of Trend Macrolytics, LLC posted an interesting chart in his WSJ op-ed, The Trade and Tax Doomsday Clocks. It charts the Dow Jones Industrial Average in the 1930s against the same average from mid 2009 to today with the depression forward, 1932 to 1936, as a scary warning. Here’s the chart:
The article points out that Obama’s upcoming tax increase, allowing the Bush cuts to expire on those most able to invest productively, is dangerously close to the Roosevelt tax increases of the 30s. FDR tipped the economy into a “depression within a depression.” Obama is close to the same thing.
Luskin then shifts to trade noting that the House passed the “Currency Reform for Fair Trade Act” which adds dangerous new powers to the infamous Smoot-Hawley Tariff Act, the proximate cause of the Great Depression. This bipartisan vote is a shame. 99 Republicans participated in this homage to Herbert Hoover; they should know that his name “lives in infamy” for erecting those tariff barriers. Hopefully the Senate Republicans will hold out. If not, another source of economic growth will wither.
These observations alone are frightening enough, but when coupled with the WSJ front page article, Americans Sour on Trade, portend something akin to an upcoming depression. In essence a majority of Americans tend to favor protectionism or, at least, are against the economies of outsourcing. Understandably economic ignorance is prevalent, fostered by our leftist institutions of higher education. But, in fairness, conservatives have not convincingly explained the compelling economic benefits of free trade.
Finally and in nail-in-the-coffin fashion, we have the growing international trend of beggar thy neighbor competitive currency devaluations. Japan is the most recent example. The Fed with its impending QE2 threatened is another. What is the dollar worth, the pound, the Euro? If world trade stops or dramatically slows, depression or worse is assured.
I say that as a layman with no credentials. But it is becoming obvious that the socialized world cannot sustain itself in its current level of consumption without productive investment and growth. The U.S. is trending away from that growth regimen. Obama is penalizing productive investment and limiting growth by increasing the size of government.
So, we must economically educate the ignorant products of our universities, vote for leaders who have the guts to reform our unsustainable entitlements, and decrease the size and take of our government.
Meanwhile, one of my Irish friends sums it up nicely, “…guns and gold, Tom, guns and gold!”