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Wednesday, August 17, 2011

Moneyness, Deflation And Policy I

I have written before about the Levy Economics Institute at Bard College. I have a high regard for their work, although its derivations are about as far removed from my methods as you can get other than that the US model is accounting based rather than theory-based. That may be one reason why I bother with their output; these days a high quality parity check is hard to find.

A couple of papers:

The first is a position paper which the Levy Institute published. It is not their position, but an argument they found worthy for substantive debate. The paper is "It's Time To Rein In The Fed". It was written last year after the Fed had announced QE2 but before it had begun the buying program. They do note that the program could prove to be deflationary in the long run by reducing private sector incomes. I believe that has happened.

This paper should be read because the authors present statistics showing how the US is following a Japanese-like strategy, and as we can see we are getting Japanese-like results.


As far as QE2 went, it is succeeded in moving that Japanese peak up a couple of years in the sequence. Unfortunately, absent a major change in US fiscal policy, we appear doomed to have even a deeper fall after that peak.

This is not what I would consider "progress".





The paper is quite critical of concentrating solely on monetary policy and neglecting fiscal policy. I agree. I would have even harsher words, but we will let the comparatively gentlemanly scholars discuss the effect of inflicting serial asset bubbles on the "real" economy:
It is also important to recognize that monetary policy “works” only if it can alter the private sector’s preference for debt over saving out of current income. That is, adjusting interest rates up or down can only affect the economy if the private sector then decides to borrow less or more. Similarly, even if QE did work as both its proponents and some critics insist, it would only be through encouraging the private sector to spend more out of its existing income—which, again, is a highly questionable strategy in a deep recession where the private sector is (rationally) trying to deleverage. Consequently, a strong case can be made that, while monetary policy is relatively impotent when it comes to stabilizing our real, productive economy, it has played a big role in pumping up asset prices that then collapse in a speculative bust. Meanwhile, our monetary policymakers have chosen to leave the financial sector largely unregulated and unsupervised. That is, they have refused to exercise their authority in the one area over which they do have substantial control: regulation and supervision of financial institutions.
The section entitled "Democratic Accountability and Transparency of the Fed" is a must read. Ron Paul is not the only person out there with concerns.

The second paper is the March 2011 Strategic Analysis. This is the official position of the institute. Those who read the paper will note the similarity to certain aspects of the grimly sardonic but not scholarly Snarky Mark. The Levy Institute's jobs graph doesn't look any better than Mark's. See Figure 3 on page 4.

I do not want to warp anyone's perception of the March SA by discussing it before you read it. I think you should read it, and here is a graph from it to give you incentive to read it:


If the black baseline projection for unemployment doesn't trigger your appalled interest, nothing I could write about this would!












However, if you don't want to read the analysis, you probably want to read about shipping rates on the Asia/US West route. China is tinkering with its currency; I think it has to reverse the minor upward moves due to angst among the exporters, but how then can China control domestic inflation?

Comments:
"China is tinkering with its currency; I think it has to reverse the minor upward moves due to angst among the exporters, but how then can China control domestic inflation?"

Rock -> China <- Hard Place
 
Low real interest rates require rational savers to increase their saving (and reduce spending) in order to compensate. I'd like to think I am somewhat rational and that is what I have done.

Contrary to popular opinion, this country has many savers (as can be seen simply by looking at the number of fully paid off primary homes).
 
Mark is quite right on his comment about increased savings and reduced spending. At this point all of us on the front end of the baby boomers have had all our financial planning dashed with this continuing ZIRP. It is the same with those already retired. We will be forced to eat out capital because it cannot earn anything. It is either that or move into riskier investments which will likely have the same, or worse, effect.

I am glad Perry talked about Bernanke and treason. It has put the Fed front and center and limited what the Fed can do about QE3 (or whatever they choose to call it). The damage the Fed has done is incalculable. For some reason, Bernanke seems to equate the health of the stock market to the health of the economy.

Now I see Obama wants another round of "not so much" stimulus. Likely, though, he will not actually proposed any plan, because that will be risky. He will follow in his old ways and complain until someone else puts plan to paper.
 
Rick,

"For some reason, Bernanke seems to equate the health of the stock market to the health of the economy."

Ben Bernanke's Street Creds

My WV is brush. I'm having a "brush" with great depressionists!
 
Rick C. said, "It is the same with those already retired. We will be forced to eat out capital because it cannot earn anything. It is either that or move into riskier investments which will likely have the same, or worse, effect."

Just so. I managed to escape the 2008 debacle with only 20% losses. At that time I was about 20% equities and 80% bonds and other income types (mostly CDs and preferreds.) I recognized that I could no longer be an "investor" as I don't have time to recover from these big down legs and get the income I need. My new tactics are 80% laddered CDs and short term treasuries with 20% which I trade in and out of the market. So far, I have been able to achieve 6% returns on an annual basis. That has kept me ahead of the game. This year has been a challenge. If we get another up leg in equities or precious metals before the end of the year, I should make my goal. Mr. Market combined with the Bernank and the insane clown fiscal policy coming from the Obamaites does not make it easy.

At one time there was a recognition that most people over 40 were invested in the market via their pension plans, 401ks, or IRAs. Their financial well being depended on a growing economy and investments that grew into decent sized retirement nest eggs. With the way Obama has attacked capital and capitalism, he has set retirement savings and investment back immeasurably.

I have been thinking a lot about the way Japan has failed to recover from their deflationary crisis and have come to the conclusion that they are in a very tough spot because they have no natural resources. Their wealth is based on their hard work and crteativity at manufacturing and marketing products (Toyotas, Hondas, Sonys, etc.) to the world. They add value to the resources they buy. (Iron, copper, rare earths, rubber, etc) That is much more difficult than creating wealth directly from natural resources. (Iron, oil, gas, coal, timber, ag products.) We are in a position to create that wealth except that much of it has been hamstrung by government regulation. IMHO, the way forward for us is the recognition of how real wealth is created. It is not with the printing press or redistribution.
 
Jimmy, I second your comments. We are hugely fortunate in our natural resources, but it is time to destroy the EPA and exploit them.

I am strongly in favor of environmental regulation, but we have gone too far and are now cutting our own throats.

I am expecting market catastrophe as the Chinese run into the wall, the Japanese fail to get over the wall, the Europeans agree to a consensus that there is no wall and therefore they have no need to climb over it, Congress tries to figure out what year it is, our president wanders in circles fantasizing and taking advice only from people who find his fantasies credible, and the Fed realizes it is up the creek without a paddle.

Production is folding up all over the world, and it won't pick back up until prices correct. This can only happen with massive destruction of money, so it ain't gonna be a pretty six months.
 
OK, I don't understand:

"... and it won't pick back up until prices correct. This can only happen with massive destruction of money, so it ain't gonna be a pretty six months."

Does that mean you are still in the deflation camp or have I completely misunderstood?
 
I can't speak for MoM, but it sounds like a price correction IS deflationary BUT the Executive, Legislative, and Banking branches of government do not want deflation (aka price discovery/correction) under any circumstances and will destroy middle class capital to avert deflation.
 
MOM, said, " am expecting market catastrophe as the Chinese run into the wall, the Japanese fail to get over the wall, the Europeans agree to a consensus that there is no wall and therefore they have no need to climb over it, Congress tries to figure out what year it is, our president wanders in circles fantasizing and taking advice only from people who find his fantasies credible, and the Fed realizes it is up the creek without a paddle."


Huge guffaws at this end. Adroit yet humorous description of our situation. Sometimes we have to laugh, or we'd be sobbing into our beer all the time.
 
Jimmy - and that would be a tragic waste of good beer. First things first!
 
Rick - a lot depends on how you define your terms. Do you mind if I defer your question until I get to some of those definitions on the next installment?
 
Charles - I continue to believe that too many policy makers are focusing on the effects rather than the causes, which is doomed to produce bad results.

Declining prices are an effect, but failing to correct the causes of declining prices and instead just booting prices upward doesn't correct the structural defect - instead it magnifies it.
 
M_O_M, the potential fly I see in your ointment is the Middle East. With the U.S. withdrawing and generally losing focus on the region, the local rivalries are bubbling. There's an increased risk of somebody miscalculating and blowing up one of these rivalries into a real bullets-and-bombs event.

That'd put a different light on oil prices.
 
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