Why the Fed can’t lower rates

[icm63]

Re: Why the Fed can’t lower rates

Review Japans currency USDJPY with their deflationary years.
JapanDeflation.gif
usdjpy_japandeflation.jpg

I actually wrote Ed I meant EJ. Cheers !

[Andreuccio]

Re: Why the Fed can’t lower rates

Okay, I have a question.

Reading this, it seems there are two possible outcomes you are suggesting.

One possibility is the Fed gets it right by injecting enough liquidity into the system and dropping interest rates at just the right time to avoid the zero bound and the disaster that comes with it. All the liquidity causes lots of inflation, which is positive for PM's.

The other possibility is the Fed doesn't get it right and we go through the zero bound. Because we are a debtor nation at this point, going through the zero bound causes capital flight, which in turn causes huge inflation a la Argentina or Russia. This sends PM's through the roof.

Is that about right?

[icm63]

Re: Why the Fed can’t lower rates

..."The other possibility is the Fed doesn't get it right and we go through the zero bound. Because we are a debtor nation at this point, going through the zero bound causes capital flight, which in turn causes huge inflation a la Argentina or Russia. This sends PM's through the roof."...

Remember that foreign banks and others own USA debt (Treasury and Corporate bonds) and assets (Stocks, Property, etc), even though the value of this asset falls anyway (slowly) via dollar depreciation, if CPI hits zero or negative, interest rates will be ZERO and the $USD may collapse, the value of foreign banks assets fall rather bloody fast, so as a foreign holder of these assets you DUMP your assets in the mad rush to get out.

Very very low $USD causes inflation, interest rates jumps to +10%, not very nice. World depression I guess after that !

[FRED]

Re: Why the Fed can’t lower rates

So where is the chart showing what happens to a net debtor nation at the zero bound when that nation is the world's only super power and when that nation's currency is also the world's reserve currency?

A warning for the US; reassurance for China

It is often asserted (eg in Brad Setser’s blog http://www.rgemonitor.com/blog/setser) that:

(1) The growing US foreign debt is manageable because it is denominated in dollars

(2) China will sustain a loss on its reserves when the dollar inevitably depreciates

The chart below suggests that such thinking may be unwise. It shows the logged dollar return on high-quality short-term debt (ie representative of reserves investments) in the US and UK (FRBNY discount or Fed funds rate and Bank rate respectively) from 1914 to 2006. 1914 is chosen as the start date because it marks the outbreak of the First World War, which arguably began the process by which the US dollar supplanted sterling as the main global reserve currency.

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Although, as would be expected, the dollar appreciated against sterling over this period, from nearly five dollars to the pound in 1914 to about two now, the consequently higher interest rates required to retain debt capital in the UK fully compensates for this depreciation, despite the existence of exchange controls in the UK until 1979. It seems that uncovered interest parity (UIP) approximately holds in the long run. In fact, if anything, sterling debt has provided a slightly higher return, presumably reflecting the risk premium of holding a declining currency managed by a weak central bank.

Although sterling debt lost ground from 1914, the interest rate penalty was sufficiently large that sterling had caught up as early as 1925. And a similar pattern was seen after successive sterling devaluations, including those of 1931 (the suspension of gold convertibility), 1949 and 1967.

To conclude, easy money and dollar neglect can delay, but not reduce, America’s debt burden. While China may report a mark-to-market loss on its dollar reserves over the next decade or so, this is practically irrelevant, because, assuming that China will not want to actively reverse its exchange rate policy for the foreseeable future, its reserves are stuck in dollars for a while anyway. And, as evinced by Zhou Enlai’s 1972 comment when asked about the impact of the French Revolution – “it’s too early to tell” – the Chinese are famous for taking the long-term view!

[jtabeb]

Re: Why the Fed can’t lower rates

Okay, I have a question.

Reading this, it seems there are two possible outcomes you are suggesting.

One possibility is the Fed gets it right by injecting enough liquidity into the system and dropping interest rates at just the right time to avoid the zero bound and the disaster that comes with it. All the liquidity causes lots of inflation, which is positive for PM's.

The other possibility is the Fed doesn't get it right and we go through the zero bound. Because we are a debtor nation at this point, going through the zero bound causes capital flight, which in turn causes huge inflation a la Argentina or Russia. This sends PM's through the roof.

Is that about right?

Great Freaking Question! I would like to see FRED or EJ's take on this as well.

[FRED]

Re: Why the Fed can’t lower rates

A fabulous and interesting article revealing things I did not know.

And perhaps inappropriate for an ideological discussion, but I will take immediate issue with this:

The bolded section is complete nonsense EJ. If you are talking about Keynsian beliefs, then sure. But if you are talking about the truth, I believe that this is an untruth. If the government cut taxes and cut spending, that would let workers, say, keep a higher percentage of their pay. It would make American workers more competitive and outsourcing less competitive.

No end of good would come from cutting spending and certainly, unemployment would FALL. The government is the ultimate parasitic consumer, and it consumes money that otherwise would be used by productive entrepreneurs.

"That's how hyperinflations happen – the more the government prints to pay fixed expenses the more it has to print to pay fixed expenses."

The operative phrase here is "fixed expenses." Depends on your definition of "fixed" of course. We can leave the roads and bridges to fall apart, and continue to have one of the worst K-12 education systems in the world. Our 3rd world school system and infrastructure are not making US workers more competitive. A visit to any 3rd world country will disabuse Austrian ideologues of the theory that all money not spent by workers on taxes results in greater competitiveness.

Under the cover of "free-markets" national economic policy was in the early 1980s ceded to the banks and Wall Street, and they quickly figured out how to take all of the American workers' money not spent on taxes and spend it on interest on debt instead.

We'd argue for immediate cuts in tax subsidies to the non-productive FIRE Economy so that revenues can be re-deployed to fund infrastructure that allows private enterprise to operate more competitively relative to other countries.

[marvenger]

Re: Why the Fed can’t lower rates

[quote=FRED;48259
We'd argue for immediate cuts in tax subsidies to the non-productive FIRE Economy so that revenues can be re-deployed to fund infrastructure that allows private enterprise to operate more competitively relative to other countries.[/quote]

hear hear. good form

[Chris Coles]

Re: Why the Fed can’t lower rates

Under the cover of "free-markets" national economic policy was in the early 1980's ceded to the banks and Wall Street, and they quickly figured out how to take all of the American workers' money not spent on taxes and spend it on interest on debt instead.

We'd argue for immediate cuts in tax subsidies to the non-productive FIRE Economy so that revenues can be re-deployed to fund infrastructure that allows private enterprise to operate more competitively relative to other countries.

On many points I have to agree with iTulip, Fred and EJ, but on this specific I am in complete disagreement.

Tax has nothing to do with driving recovery. You do not reap any new taxation until you have completed the process of creating the engine that creates tax; private, non government business that employs citizens who pay tax from their wages and the businesses in turn pay tax from their profits.

This has been the great failure, refusing to recognise that there is a time lag between that initial investment of the equity that creates the jobs and the taxation received. It takes years for any new business to reach stability and it will take years for that stability to start to increase the tax income of the nation.

You have to get the savings of the nation back into investment into equity which in turn must return to "Arms Length" investment into new industry. That process has absolutely nothing to do with tax, or government, or any nations civil servants. It has everything to do with the recreation of a complete financial infrastructure to replace what we have now that DOES NOT WORK.

Yes, you can do a Roosevelt and spend some taxation, but as Churchill once said, you do not increase prosperity by standing in a bucket and pulling on the handles. You cannot drive out of this mess via taxation; you can only use new investment.

And that will require a complete re-vamp of our entire financial institutional structure. Nothing else will work, short term or long. Nothing.

[marvenger]

Re: Why the Fed can’t lower rates

FIRE economy is collecting rent for doing nothing, if Jp morgan's and BOA's are posting any profits, especially from taking over the ibanks, they should be taxed to the fullest extent allowable to give the taxpayer back what the FIRE has taken away, repay taxpayer debt, or use it to help re-build what FRED called in another post the US's third world infrastructure. personally I have no problem with the government owning national scale infrastructure and running it not-for profit to boost productivity, better than loaning the money to dick cheney's company to build national railways and own the equity in the name of free markets and privatisation I reckon. Think itulip disagrees with me big time on this though.

I just think these kinds of national infrastructure cannot be owned privately, it's too much power, rather accept the relative inefficency of the government running it in exhange for greedy pricks not screwing it up for everyone. Same goes for deposit taking banks.

I'm starting to think that all finance companies should be massively regulated as well. this is because all finance enterprises risk moral hazzard because of the skew of rewards, take massive risks and you can make masses of money, but you can't go beyond 0 in the negative direction other than the pain bankruptcy causes but this is not enough to offset the lopsided positive returns possible. therefore the short term view wins and excessive risk will always be taken and the crises will always be a part of life. Not the life I want personally, the prospect of massive wealth isn't that appealing to me, maybe I don't know what i'm missing.

[Chris]

Re: Why the Fed can’t lower rates

A fabulous and interesting article revealing things I did not know.

And perhaps inappropriate for an ideological discussion, but I will take immediate issue with this:



The bolded section is complete nonsense EJ. If you are talking about Keynsian beliefs, then sure. But if you are talking about the truth, I believe that this is an untruth. If the government cut taxes and cut spending, that would let workers, say, keep a higher percentage of their pay. It would make American workers more competitive and outsourcing less competitive.

No end of good would come from cutting spending and certainly, unemployment would FALL. The government is the ultimate parasitic consumer, and it consumes money that otherwise would be used by productive entrepreneurs.

I think this may imply that cutting spending means removing salaries of government workers (who constitute almost 40% of the US and UK workforce).

[orion]

Re: Why the Fed can’t lower rates

.. We can leave the roads and bridges to fall apart, and continue to have one of the worst K-12 education systems in the world. Our 3rd world school system and infrastructure are not making US workers more competitive. A visit to any 3rd world country will disabuse Austrian ideologues of the theory that all money not spent by workers on taxes results in greater competitiveness.

I don't agree with the education comment. I think the fault is as usual, Not the money you throw at something, but the quality you have to work with. Given the Ipod, MTV, bling morons we have to deal with no amount of money spent on education will motivate them to work hard and learn. Don't we already have some of the highest per capita education expesnes in the world, especially vs Asia?

Third world countries (I am working in one right now) have a problem with low wages to begin with so the tax issue to me doesn't matter too much. What is the problem then? STABILITY and using a win win attitude. As someone else mentioned in this thread the motor of free enterprise has to be running on all 8 cycliners to feed the tax machine that builds quality infrastructure that makes more competitive businesses.

[marvenger]

Re: Why the Fed can’t lower rates

america's railways and dams weren't built by free enterprise. Under supposed free enterprise america's physical and social infrastructure has crumbled. This is because it was easier to make a quick buck in the FIRE economy than to risk capital on long term significant and uncertain large infrastructure builds. Need government to provide the infrastructure, or regulate markets so they are more stable and less uncertain.

[orion]

Re: Why the Fed can’t lower rates

I'm starting to think that all finance companies should be massively regulated as well. this is because all finance enterprises risk moral hazzard because of the skew of rewards, take massive risks and you can make masses of money, but you can't go beyond 0 in the negative direction other than the pain bankruptcy causes but this is not enough to offset the lopsided positive returns possible. therefore the short term view wins and excessive risk will always be taken and the crises will always be a part of life. Not the life I want personally, the prospect of massive wealth isn't that appealing to me, maybe I don't know what i'm missing.

What a bout the regulation we already have? What about an assenine Congress that oversees all this crap, has the ability to cut off funds and write laws and then blames the administration (who also should share the blame)? The congress issue really frosts me as we have three senators in the presidencial race and they are all as guilty as any Wall Street guy.

Lots of these bozos saw this train coming but did nothing. I say give up the regualtion, drop FDIC and buyer beware. We will always fall into this trap when for the sake of good intenrtions we put in insurance (FDIC) and then fall asleep at the switch as the foxes clean out the hen house.

[marvenger]

Re: Why the Fed can’t lower rates

A steeve keen solution to the instability of financial markets is to replace the sock market with voting bonds that can only be traded at certain dates. Stock market volatity is a serious hindrance to the efficient allocation of capital if you want to look at it that way.

[marvenger]

Re: Why the Fed can’t lower rates

I think buyer beware is a very dangerous policy, will inevitably create concentration of risk excessive leverage and sytemic failure IMO.

Politicians deregulated under free market ideology and ignoring the costs of free markets, risks building up in the short term due to deregulation were ignored because it gave them an opportunity to cheer about how great things were and advance their own polital careers.