Fed Credibility

[Finster]

Let's see, inflation figures continue to rise, the economy (at least according to official stats) is doing fine, and the Fed expresses its concern about its credibility by standing pat at 5.25% Fed funds. Oh, maybe it will hike more later, say the pundits.

Uhm ... when? When oil prices break $100? When gasoline breaks $5? When a loaf of ordinary bread costs $10? I suppose it will get easier if it continues to wait? Is 5.25% Fed funds really tight? Or does it just seem like it given that we had rates all the way down to the "emergency" level of 1%, and only added back in 25 bp baby steps?

Despite the hawkish noises the Bernanke Fed was making just scant weeks ago, it's clear that pressure from politicians in Washington and on Wall Street alike is at work here. You couldn't go a day without one of them wringing his hands about whether the Fed might go "too far" and risk the harrowing perils of a garden variety recession. Perish the thought! A recession would definitely mean the Fed went "too far", right? Yet when it comes to cutting rates and printing money, you won't hear these voices fretting about the Fed going "too far".

Short sighted. For anyone here who remembers the 1970's, we are on the fast track to repeat the same here - perhaps even worse. Greenspan tried to rescue his maestrohood after the collapse of the stock market bubble he created but couldn't see by creating a historic liquidity gusher and igniting a housing market bubble. The housing market bubble is now past its peak. The only bubble left to create is the one in consumer prices we are well on our way into now. Ordinary middle class Americans will pay.

[blazespinnaker]

Re: Fed Credibility

Well, there is theory that pimco is spouting that wages are going to increase significantly and corporate profit is going to slow significantly.

An interesting theory.

[Finster]

Re: Fed Credibility

Well, there is theory that pimco is spouting that wages are going to increase significantly and corporate profit is going to slow significantly.

An interesting theory.

If only "interesting" could make it true. In this "global economy" US workers just won't get that much pricing power. They have to compete with foreigners getting a fraction of their pay. So well, maybe if they're talking about foreign wages rising I could buy it.

[jk]

Re: Fed Credibility

Short sighted. For anyone here who remembers the 1970's, we are on the fast track to repeat the same here - perhaps even worse.

sssshhhhhhhhhhhhhh. [we are going to let inflation go up as slowly as possible, but we are going to let inflation go up to try to get around all this debt and the possiblity that debt revulsion will produce a deflationary depression.] sssshhhhhhhh.

[Finster]

Re: Fed Credibility

sssshhhhhhhhhhhhhh. we are going to let inflation go up as slowly as possible, but we are going to let inflation go up to try to get around all this debt and the possiblity that debt revulsion will produce a deflationary depression.] sssshhhhhhhh.

It gets worse:

sssshhhhhhhhhhhhhh. We are going to let inflation go up as slowly as possible, and we are going to lie about it so that people won't notice what we're doing. We long ago quietly dumbed down the CPI with statistical ledgerdemain like "homeowner's equivalent rent". Now we got the media almost totally ignoring that and talking about the perennially lower "core" inflation instead. And now that "homeowner's equivalent rent" is starting to backfire on us, we've got them making a big to-do about how the CPI is being "artifically" goosed by rising rents. It's just like PT Barnum said ... sssshhhhhhhh.

[jk]

Re: Fed Credibility

unfortunately, i actually think as-slow-as-possible-without-risking-deflation inflation is the best choice the maestro has left us. that's what we'll get if we're lucky!

[Finster]

Re: Fed Credibility

unfortunately, i actually think as-slow-as-possible-without-risking-deflation inflation is the best choice the maestro has left us. that's what we'll get if we're lucky!

There is a way out, but it seems unlikely our policy makers would consider it. First, you'd have to make gold and silver transactions free of tax so that people could use them as a store of value without giving up a chunk of imaginary gains each transaction. Then you could increase inflation so that dollars owed to foreign creditors would become cheaper without killing off domestic saving for good. Finally, the question of higher import taxes would have to be revisited. We've had three administrations worth of free trade pacts, getting China into the WTO, tariff cutting, NAFTA and WTO, and things have gotten progressively worse. What's that definition of insanity? If what you're doing isn't working, do more of the same? Meanwhile, we have the income tax, FICA, HITS, and numerous other taxes and regulations burdening domestic production. Maybe instead of focusing exclusively on free trade across internation borders, we ought to be taking a look at having more free trade right here at home?

[jk]

Re: Fed Credibility

There is a way out, but it seems unlikely our policy makers would consider it. First, you'd have to make gold and silver transactions free of tax so that people could use them as a store of value without giving up a chunk of imaginary gains each transaction. Then you could increase inflation so that dollars owed to foreign creditors would become cheaper without killing off domestic saving for good. Finally, the question of higher import taxes would have to be revisited. We've had three administrations worth of free trade pacts, getting China into the WTO, tariff cutting, NAFTA and WTO, and things have gotten progressively worse. What's that definition of insanity? If what you're doing isn't working, do more of the same? Meanwhile, we have the income tax, FICA, HITS, and numerous other taxes and regulations burdening domestic production. Maybe instead of focusing exclusively on free trade across internation borders, we ought to be taking a look at having more free trade right here at home?

i disagree about import taxes, and think we'd be better off with vat than our current taxes. but what you or i think would be better is irrelevant to the decisions we actually DO face. i prefer to avoid the theoretical debates about a "better" but non-existant world. i'd rather ask: how do we understand the economic system AS IT IS and AS IT IS UNFOLDING, and how do we protect or even benefit ourselves and those we love?

i prefer to avoid the theoretical analysis of a "better" but non-existant world.

[Finster]

Re: Fed Credibility

i disagree about import taxes, and think we'd be better off with vat than our current taxes. but what you or i think would be better is irrelevant to the decisions we actually DO face. i prefer to avoid the theoretical debates about a "better" but non-existant world. i'd rather ask: how do we understand the economic system AS IT IS and AS IT IS UNFOLDING, and how do we protect or even benefit ourselves and those we love?

i prefer to avoid the theoretical analysis of a "better" but non-existant world.

You don't need to resort to theoretical analyses. Just ask yourself if we are better off for all tariff cutting we've been doing the past fifteen years. Has our trade balance improved? Has our national wealth increased? Our global stature?

Have we increased our credit with the rest of the world, or gone from being a creditor nation to most indebted in all of history?

Meanwhile, compare that with a period in which the Federal government was primarily financed - as our founders envisioned - with duties and tariffs. Basically, from 1776 to 1914, when the income tax was introduced. During this period, the United States of America went from being a rag-tag group of colonies to preeminent global economic power, developing most of the technology that is responsible for modern standards of living.

So before you attempt to instruct me or anyone else on the benefits of shifting the tax burden from cross-border trade to domestic production, please first enlighten those idiots - Washington, Jefferson, Madison, et al - as to why they should have taken the advice of 1990's economists. That way our country could have much sooner enjoyed the many benefits of all-time record trade deficits, inflation, faltering standards of living, and loss of economic sovereignty.

[jk]

Re: Fed Credibility

You don't need to resort to theoretical analyses. Just ask yourself if we are better off for all tariff cutting we've been doing the past fifteen years. Has our trade balance improved? Has our national wealth increased? Our global stature?

Have we increased our credit with the rest of the world, or gone from being a creditor nation to most indebted in all of history?

Meanwhile, compare that with a period in which the Federal government was primarily financed - as our founders envisioned - with duties and tariffs. Basically, from 1776 to 1914, when the income tax was introduced. During this period, the United States of America went from being a rag-tag group of colonies to preeminent global economic power, developing most of the technology that is responsible for modern standards of living.

So before you attempt to instruct me or anyone else on the benefits of shifting the tax burden from cross-border trade to domestic production, please first enlighten those idiots - Washington, Jefferson, Madison, et al - as to why they should have taken the advice of 1990's economists. That way our country could have much sooner enjoyed the many benefits of all-time record trade deficits, inflation, faltering standards of living, and loss of economic sovereignty.

finster, i think you missed the main point i was trying to make. i am not trying "to instruct [you] or anyone else." i think your posts have been in general well-informed and valuable contributions to the dialogues here. i'm glad you're here. i, myself, however, just don't care about theories for an alternate, better world. i don't care what we woulda, shoulda, coulda done differently.

HERE we are, with our current economic policies and institutions, flawed and screwed up as they are. where exactly is HERE? are we perceiving our current situation accurately? and where to next? what are the alternative futures we can imagine for the system in which we actually live, and what are the probabilities for those scenarios? those questions interest me. this is not to disparage those who wish to engage in speculative debates on theory. those do serve a purpose in honing analytical tools. i am just expressing my preference for the direction of the discussion.

[Finster]

Re: Fed Credibility

finster, i think you missed the main point i was trying to make. i am not trying "to instruct [you] or anyone else." i think your posts have been in general well-informed and valuable contributions to the dialogues here. i'm glad you're here. i, myself, however, just don't care about theories for an alternate, better world. i don't care what we woulda, shoulda, coulda done differently.

HERE we are, with our current economic policies and institutions, flawed and screwed up as they are. where exactly is HERE? are we perceiving our current situation accurately? and where to next? what are the alternative futures we can imagine for the system in which we actually live, and what are the probabilities for those scenarios? those questions interest me. this is not to disparage those who wish to engage in speculative debates on theory. those do serve a purpose in honing analytical tools. i am just expressing my preference for the direction of the discussion.

Okay, we can go with that. Probably the simplest way to describe where we've been, where we are, and where we're going, is to acknowledge that while history doesn't exactly repeat, it does rhyme. With that in mind, I claim that we can understand a great deal about our present situation by examining 1974.

In the 1960s we had a stock market bubble (albeit not quite as extreme as that of the 1990's). We also had a foreign war with no clear goal or exit strategy. In 1971, Nixon closed the gold window (in 2003, the Fed put on an "emergency" 1% Fed funds rate). In the 1970's we also saw soaring prices for oil and other commodities as the Fed kept trying to fight an economic slowdown and inflation accelerated.

There are of course some differences that remain after merely sliding the calendar 32 years. The deepest part of the stock market decline occured not in 1970, but 1974. 2006 already couldn't be an exact repeat of 1974. But the peak occured in 1968 - 32 years prior to the one we just experienced. And gold and silver prices have undergone their first doubling-tripling, with at least another doubling-tripling apparently ahead. Finally, the Fed will have to pay for its reticence in raising interest rates, they will soar to incredible levels, and a depression will occur. If for whatever political expediency it refuses to act, hyperinflation will result and the American middle class will be destroyed.

[jk]

Re: Fed Credibility

Okay, we can go with that. Probably the simplest way to describe where we've been, where we are, and where we're going, is to acknowledge that while history doesn't exactly repeat, it does rhyme. With that in mind, I claim that we can understand a great deal about our present situation by examining 1974.

In the 1960s we had a stock market bubble (albeit not quite as extreme as that of the 1990's). We also had a foreign war with no clear goal or exit strategy. In 1971, Nixon closed the gold window (in 2003, the Fed put on an "emergency" 1% Fed funds rate). In the 1970's we also saw soaring prices for oil and other commodities as the Fed kept trying to fight an economic slowdown and inflation accelerated.

There are of course some differences that remain after merely sliding the calendar 32 years. The deepest part of the stock market decline occured not in 1970, but 1974. 2006 already couldn't be an exact repeat of 1974. But the peak occured in 1968 - 32 years prior to the one we just experienced. And gold and silver prices have undergone their first doubling-tripling, with at least another doubling-tripling apparently ahead. Finally, the Fed will have to pay for its reticence in raising interest rates, they will soar to incredible levels, and a depression will occur. If for whatever political expediency it refuses to act, hyperinflation will result and the American middle class will be destroyed.

my mainline and not too-pessimistic scenario is also a replay of the 70's. but i think now it would be worth our whiles to try to focus on the differences from the 70's.

with the reappearance of the word "stagflation" not all that long ago, i have been reading more and more commentators analogizing to the 70's.
i don't think the 70's analogy has become the standard assumption set YET. [i think the "common wisdom" is a somewhat more benign muddle-through.] but the 70's analogy is spreading rapidly and was the driver of gold's move up to recent levels.

so stagflation is not yet old news, but is becoming so. during this process inflation hedges should do ok. but now we need to think of how it might diverge from our 70's analogy, what signs or symptoms we need to watch for in order to monitor the value of this analogy, and how to take advantage of deviations from the 70's path.

[Finster]

Re: Fed Credibility

my mainline and not too-pessimistic scenario is also a replay of the 70's. but i think now it would be worth our whiles to try to focus on the differences from the 70's.

with the reappearance of the word "stagflation" not all that long ago, i have been reading more and more commentators analogizing to the 70's.
i don't think the 70's analogy has become the standard assumption set YET. [i think the "common wisdom" is a somewhat more benign muddle-through.] but the 70's analogy is spreading rapidly and was the driver of gold's move up to recent levels.

so stagflation is not yet old news, but is becoming so. during this process inflation hedges should do ok. but now we need to think of how it might diverge from our 70's analogy, what signs or symptoms we need to watch for in order to monitor the value of this analogy, and how to take advantage of deviations from the 70's path.

There are of course risks to assuming everything will be the same - as noted, it's not so much a matter of repeating but of rhyming! The main one is the possibility that things may resemble Japan time-shifted forwards by 10 years, rather than the US by 32 years. In other words, a long protracted period of deflationary malaise.

IMO such a course can't be ruled out, but is definitely a lower probability likeness. The main argument in favor is the extremely high debt level of the American consumer and American government. This creates a high latent demand for dollars. And given that the Fed's modus operandi for creating money is to lend it into existence, could be difficult for it to counter.

On the other hand, we have "Helicopter Ben" at the helm! That traditional modus operandi could change, and money might be created with no corresponding debit entries. The Fed could, for example, simply purchase and extinguish government debt. Even if that were not resorted to, the momentum behind inflation at this time seems sufficient to undergird its continuation. Interest rates - even after this Fed hiking cycle - remain below inflation (the real rate of inflation, not the government's representation). Regardless it seems virtually inevitable that hard assets will continue to rise relative financial assets. That, for example, the stock market will decline as measured in gold. Personally I favor inclusion of as much as 25% hard money (gold, silver, copper, platinum) in one's portfolio, along with about 25% cash and bonds, and 50% stocks. And the latter including a liberal proportion of energy and commodity producing companies and dividend paying stocks as well as being globally diversified.

Thoughts?

[Jim Nickerson]

Re: Fed Credibility

There are of course risks to assuming everything will be the same - as noted, it's not so much a matter of repeating but of rhyming! The main one is the possibility that things may resemble Japan time-shifted forwards by 10 years, rather than the US by 32 years. In other words, a long protracted period of deflationary malaise.

IMO such a course can't be ruled out, but is definitely a lower probability likeness. The main argument in favor is the extremely high debt level of the American consumer and American government. This creates a high latent demand for dollars. And given that the Fed's modus operandi for creating money is to lend it into existence, could be difficult for it to counter.

On the other hand, we have "Helicopter Ben" at the helm! That traditional modus operandi could change, and money might be created with no corresponding debit entries. The Fed could, for example, simply purchase and extinguish government debt. Even if that were not resorted to, the momentum behind inflation at this time seems sufficient to undergird its continuation. Interest rates - even after this Fed hiking cycle - remain below inflation (the real rate of inflation, not the government's representation). Regardless it seems virtually inevitable that hard assets will continue to rise relative financial assets. That, for example, the stock market will decline as measured in gold. Personally I favor inclusion of as much as 25% hard money (gold, silver, copper, platinum) in one's portfolio, along with about 25% cash and bonds, and 50% stocks. And the latter including a liberal proportion of energy and commodity producing companies and dividend paying stocks as well as being globally diversified.

Thoughts?

Below is from http://www.financialsense.com/fsu/ed...006/0807c.html that shows that at least some are concerned about deflation.

Deflationists at the moment are very thin on the ground and on the verge of becoming an endangered species.
Devil’s Advocate: “What if the Deflation Monster is not dead, but merely hovering in the wings, waiting to strike should the world economies ultimately buckle and implode under an enormous and increasingly onerous debt burden?”
The question is…”Are there any true contrarians left out there to argue the case?”.
Three who seem ready to rise to the challenge are the irrepressible Robert Prechter (www.elliottwave.com ), Michael Shedlock, The Survival Report (www.whiskeyandgunpowder.com ), and Antal E. Fekete, Professor Emeritus, Memorial University of Newfoundland.
These deflationists might argue that Central Banks and Governments are still fighting the last war.
Like the out-of-touch Generals of World War I who threw cavalry and infantry with bayonets against machine guns entrenched in gun pits to be slaughtered. Like the French who built the “impregnable” Maginot Line after World War I to defend from future German invasion only to have the Nazi blitzkrieg bypass it altogether with lightning speed.Or the British Forces who waited in Singapore with heavy artillery pointed defiantly out to sea, only to be overwhelmed in weeks by a Japanese force that appeared from the rear on bicycles.
“Mish” Shedlock argues that Inflationist's are confident that Central Bankers understand they have no choice but to “inflate or die”; that recession can only be averted by prolonging the monetary expansion so that the world-wide real estate and credit bubbles can be given time to deflate slowly and the consumer can continue to prop up the economy through continued spending.
Shedlock tells us: “It seems that everyone feels the Fed is all powerful, and that the Fed can defeat the business cycle by forever printing money. That is the fallacy of the inflationist arguments. It can not be done. The root cause of the great depression was an overexpansion of money and cedit. “Helicopter Drop Bernanke” (cannot) cure that by printing more money…
Banks can print but they can not force consumers to either borrow or spend. If bankruptcies expand faster than borrowing, the net of money supply and credit will contract. That is deflation.”
Thus it seems a lot depends on the consumer remaining confident and prepared to keep on spending. The moment that confidence evaporates and consumers become unwilling to go deeper into debt, or begin to reduce debt and increase savings…that is the moment the Fed will find itself “pushing on the proverbial piece of string”.
Professor Fekete adds this insight: “…in our more sober moments we should admit that inflation cannot survive as a permanent monetary policy…just print money rain or shine. We know from history how inflationary adventures inevitably end. There could be nuances of difference, but deflation that follows inflation as night follows day cannot be avoided, no matter how much government is monetized by the central bank.
They tried that approach in Bolshevist Russia, with results only too well known. The experiment was discontinued in Russia’s “Evil Empire” in 1990. Now they try it again in the U.S…. As Benjamin Franklin has said, experience runs an expensive school, but fools will learn no other.”
Anatole Kaletsky (The Times) writes that “while the Japanese economy is now clearly growing (after 15 years of falling prices) most prices are still falling and therefore deflation, rather than inflation, remains the main risk to price stability.
The talk about shareholder value, corporate governance and profitability…seems to have been replaced by the old mantra about expanding sales and profit share, regardless of profits or costs.
One of Japan’s biggest companies boasted… “In flat-screens today there are many intense competitors, but in the end there will be only two or three survivors. We are determined to be one of those survivors and to make sure of this we must naturally undertake huge investments without worrying about profits too much.”
And finally, Robert Prechter’s take on the situation: … “ Because of the tremendous, unprecedented build-up in credit, the deflation will probably be swift. So many debtors are on the margin of survival today, and so many others are right behind them, that once the weakest hands default, the dominoes will fall fast. When it hits, the whole system will succumb. Banks will fail. Insurance companies will fail. Many values that people think they own – in the form of mutual funds, stock portfolios, bond portfolios, commodity-indexed funds, bank accounts, insurance contracts, real estate, etc, - will evaporate.”

It appears to me that deflation is rather dismissed as a possibility in our future.

P.S. Finster, what does "IMO" mean? To me it means jive talk.

[Finster]

Re: Fed Credibility

Below is from http://www.financialsense.com/fsu/ed...006/0807c.html that shows that at least some are concerned about deflation...

It appears to me that deflation is rather dismissed as a possibility in our future.

A lot of the question turns on semantics. Unfortunately, much discussion of inflation and deflation is confused by people using different meanings of the terms. For example, the common ordinary meaning of "inflation" is a falling value of the currency and the corresponding increase in prices. Deflation is a rising value of the currency and corresponding decline in prices. Economists, however, especially those of the Austrian school, often use the term inflation to denote an increase in the supply of money. Other times, the supply of money and credit. Or even just credit.

And then there’s the question of what units you denominate prices in or the amount of money or credit. As a result, if I am referring to any meaning other than the common one, I try to take care to explain what meaning I’m using.

Now with that out of the way, we see that "deflation" according to the first meaning isn’t even necessarily a fundamental economic condition. It depends on which currency you’re using. You might have inflation in dollars and deflation in euros or yen - all at the same time.

More significantly, you could have inflation in dollars and deflation in gold. This is what happened in the 1970’s. Prices as measured in dollars rose as dollars lost value, but prices as measured in gold declined as gold gained in value.

From the standpoint of the economist’s definition, the 1970’s could also be characterized as either inflationary or deflationary, depending on whether you measured the nominal value of credit or the real value. The former rose, the latter fell.

In the most fundamental sense, the 1970’s were hugely deflationary. In the 1960’s the Fed had pumped up credit to unsustainable levels, and it had to contract. There were simply far more paper claims on real stuff than there was real stuff to back it up. Like a game of musical chairs, when the music stops and everybody looks to find a seat, there turns out to be not enough to go around.

Pretty much the same thing happened as in the 1930’s. In the 1920’s the Fed also artificially over-expanded credit, and in the 1930’s it deflated. But in the 1970’s the deflationary process was papered over with inflation. By creating massive amounts of dollars, the dollars were devalued so that even as real values fell the value of the dollars fell even faster, causing prices to rise. Only if you persistently measured the values in a non-inflatable currency such as gold, did you see them fall.

Now we face the same kind of damned-if-you-do-damned-if-you-don’t situation all over again. The Fed grossly overexpanded credit in the 1990’s and it must deflate. The only question is will the value of the dollar be driven down fast enough so that stock prices rise in dollar terms. Probably is the best guess I can give. Regardless, stock prices are very likely to fall in terms of gold. They have so far, and if the process is similar to that which occurred in the 1930’s and 1970’s they still have quite a ways to go.

P.S. Finster, what does "IMO" mean? To me it means jive talk.

Guess it is a sort of Internet jive - abbreviation for "in my opinion". You'll also see variations like "IMHO" - "in my humble opinion" and "IMNSHO" - "in my not-so-humble opinion" ... :cool: