The 2% Catastrophe

http://www.theatlantic.com/business/archive/2012/04/the-2-catastrophe-how-one-number-explains-the-miserable-economy/256382/

Recommended reading

"When we talk about the Fed creating inflation we're talking about wage inflation."


the article was not making sense from the begining but when i reached the quote above i just stopped reading. This would simply be suicide, its the type of idea a 10 year old would consider

zizzle wrote:"When we talk about the Fed creating inflation we're talking about wage inflation."


the article was not making sense from the begining but when i reached the quote above i just stopped reading. This would simply be suicide, its the type of idea a 10 year old would consider

yeah that quote doesn't make sense to me either, but i saw the point the writer was trying to make. the problem with what they were saying is that they imply wages automatically increase if there is inflation, and that isn't the case. incomes aren't responsive to inflation

Can you further explain what you thought made no sense?

lenear1030 wrote:yeah that quote doesn't make sense to me either, but i saw the point the writer was trying to make. the problem with what they were saying is that they imply wages automatically increase if there is inflation, and that isn't the case. incomes aren't responsive to inflation

Yes they are, in the long term. Income is only sticky downwards. And in the short term while wages are still adjusting businesses will have further capital to invest/deleverage/whatever.

the quote in itself is correct but the suggestion behind it is just naive. It's equivilent to asking "why dont the goverment just print more money" and no country have tried this and got out with positive results

That's not correct. Look at the US, had it not been for "the printing of money" via QE2 (which was all virtual, so it wasn't actual printing, so the phrase is really a misnomer) the US would have had deflation in 2009, which is worse than inflation because then your debts get more expensive over the years. And that's simply the most recent example. Coming from a country with inflation rates of 25% p/year, not that I advocate such high levels, I find it ridiculous that the Fed is so scared of going over 2% to 3%. The benefits would be very substantial.

BarrileteCosmico wrote:

lenear1030 wrote:yeah that quote doesn't make sense to me either, but i saw the point the writer was trying to make. the problem with what they were saying is that they imply wages automatically increase if there is inflation, and that isn't the case. incomes aren't responsive to inflation

Yes they are, in the long term. Income is only sticky downwards. And in the short term while wages are still adjusting businesses will have further capital to invest/deleverage/whatever.

in some cases, you could right, but i really didn't clarify my statement enough. in the short run, inflation doesn't just instantly drive up wages. over time though, wages could increase but it's dependent on other factors. besides, we've already seen wages stagnate through inflation here in the US.

but when you say 'in the short term while wages are still adjusting' that doesn't make too much sense to me. firms dont just decide to pay their employees more because the Fed inflates the economy. if they do, that can cause further inflation. those firms will have an easier time clearing their debts though (if they dont increase their employee's wages).

those business wont necessarily have more capital to invest either like you said.

BarrileteCosmico wrote:That's not correct. Look at the US, had it not been for "the printing of money" via QE2 (which was all virtual, so it wasn't actual printing, so the phrase is really a misnomer) the US would have had deflation in 2009, which is worse than inflation because then your debts get more expensive over the years. And that's simply the most recent example. Coming from a country with inflation rates of 25% p/year, not that I advocate such high levels, I find it ridiculous that the Fed is so scared of going over 2% to 3%. The benefits would be very substantial.

well its not that simple, a weaker dollar means more expensive imports, and since the US hardly manufactures anything these days the common man will have to pay more for his daily purchases. That is not an incentive to buy more stuff and pay old loans

Interesting article gaucho, with some interesting ideas. Ill be back soon, but ill leave this here till then.

Article made quite a bang at the FT

Our central bankers are intellectually bankrupt


The financial crisis has fully exposed the intellectual bankruptcy of the world’s central bankers.

Why? Central bankers neglect the fact that interest rates are prices. Manipulating those prices through credit expansion or contraction has real and deleterious effects on the economy. Yet while socialism and centralised economic planning have largely been rejected by free-market economists, the myth persists that central banks are a necessary component of market economies.

These economists understand that having wages or commodity prices established by government fiat would cause shortages, misallocations of capital and hardship. Yet they accept at face value the notion that central banks must determine not only the supply of one particular commodity – money – but also the cost of that commodity via the setting of interest rates.

Printing unlimited amounts of money does not lead to unlimited prosperity. This is readily apparent from observing the Fed’s monetary policy over the past two decades. It has pumped trillions of dollars into the economy, providing money to banks with the hope that this new money will spur lending and, in turn, consumption. These interventions are intended to raise stock prices, lower borrowing costs for companies and individuals, and maintain high housing prices.

But like their predecessors in the 1930s, today’s Fed governors behave as if the height of the credit bubble is the status quo to which we need to return. This confuses money with wealth, and reflects the idea that prosperity stems from high asset prices and large amounts of money and credit.

The push for easy money is not new. Central banking was supposed to have ended the types of periodic financial crises the US experienced throughout the 19th century. Yet US financial panics have only got worse since the centralisation of monetary policy via the creation of the Fed in 1913. The Depression in the 1930s; the haemorrhaging of gold reserves during the 1960s; the stagflation of the 1970s; the dotcom bubble of the early 2000s; and the current recession all have their root in the Fed’s loose monetary policy.

Each of these crises began with an inflationary monetary policy that led to bubbles, and the solution to the busts that inevitably followed has always been to reflate the bubble.

This only sows the seeds for the next crisis. Lowering interest rates in an attempt to forestall a recession in the aftermath of the dotcom bubble required massive credit creation that led to the housing bubble, the collapse of which we still have not recovered from today. Failing to learn the lesson of the bursting of both the dotcom bubble and the housing bubble, the Fed has pumped trillions of dollars into the economy and has promised to leave interest rates at zero through to at least 2014. This will only ensure that the next crisis will be even more destructive than the current one.

Not content with its failed attempts to prop up the US economy, the Fed has set its sights on bailing out Europe, too. Through currency swaps, it has committed to offering potentially hundreds of billions of US dollars to the European Central Bank and we cannot rule out the possibility of direct intervention.

The Fed’s response to the crisis suggests that it believes the current crisis is a problem of liquidity. In fact it is a problem of poorly allocated investments caused by improper pricing of money and credit, pricing which is distorted by the Fed’s inflationary actions.

The Fed has made banks and corporations dependent on cheap money. Instead of looking for opportunities to invest in real products that will serve the needs of consumers, Wall Street awaits the minutes of each Federal Open Market Committee meeting with bated breath, hoping that QE3 and QE4 are just around the corner. It is no wonder that long-term investment and business planning are stagnant.

We live in a world that seems to have abandoned the concept of savings and investment as the source of real wealth and economic growth. Financial markets clamour for more cheap money creation on the part of central banks. Hopes of further quantitative easing from the Fed, the Bank of England, or the Bank of Japan – or further longer-term refinancing operations from the ECB – buoy markets, while decisions not to intervene can cause stocks to plummet. Policy makers focus on spurring consumption, while ignoring production. The so-called capitalists have forgotten that capital cannot be created by government fiat.

Control of the world’s economy has been placed in the hands of a banking cartel, which holds great danger for all of us. True prosperity requires sound money, increased productivity, and increased savings and investment. The world is awash in US dollars, and a currency crisis involving the world’s reserve currency would be an unprecedented catastrophe. No amount of monetary expansion can solve our current financial problems, but it can make those problems much worse.

Here is another interesting article related

Not Enough Inflation

A few days ago, Alan Greenspan, the former chairman of the Federal Reserve, spoke out in defense of his successor. Attacks on Ben Bernanke by Republicans, he told The Financial Times, are “wholly inappropriate and destructive.” He’s right about that — which makes this one of the very few things the ex-maestro has gotten right in the past few years.

But why are the attacks on Mr. Bernanke so destructive? After all, nobody in America is or should be immune from criticism, least of all those — like the chairman of the Fed — who, by the nature of their positions, have immense power to make our lives better or worse. And while there is an unmistakable thuggishness to the campaign against the Fed, most famously Rick Perry’s warning that the Fed chairman would be treated “pretty ugly” if he visited Texas, surely the bad manners of the critics aren’t the most important issue.

No, the real reason the attacks on Mr. Bernanke from the right are so destructive is that they’re an effort to bully the Fed into doing exactly the wrong thing. The attackers want the Fed to slam on the brakes when it should be stepping on the gas; they want the Fed to choke off recovery when it should be doing much more to accelerate recovery. Fundamentally, the right wants the Fed to obsess over inflation, when the truth is that we’d be better off if the Fed paid less attention to inflation and more attention to unemployment. Indeed, a bit more inflation would be a good thing, not a bad thing.

O.K., I know that many readers are already outraged. But bear with me, and let me take this in stages.

First, about inflation obsession: For at least three years, right-wing economists, pundits and politicians have been warning that runaway inflation is just around the corner, and they keep being wrong. Do you remember the tirades about “debasing the dollar” around this time last year? Do you remember the scorn heaped on Mr. Bernanke last spring when he argued that the bulge in inflation taking place at the time was just a temporary blip caused by gasoline prices and would soon recede? Well, he was right. At this point, inflation is once again running a bit below the Fed’s self-declared target of 2 percent.

Now, the Fed has, by law, a dual mandate: It’s supposed to be concerned with full employment as well as price stability. And while we more or less have price stability by the Fed’s definition, we’re nowhere near full employment. So this says that the Fed is doing too little, not too much. Indeed, some Fed officials — notably Charles Evans, the president of the Chicago Fed — have tried to make exactly that case.

To be sure, more aggressive Fed policies to fight unemployment might lead to inflation above that 2 percent target. But remember that dual mandate: If the Fed refuses to take even the slightest risk on the inflation front, despite a disastrous performance on the employment front, it’s violating its own charter. And, beyond that, would a rise in inflation to 3 percent or even 4 percent be a terrible thing? On the contrary, it would almost surely help the economy.

How so? For one thing, large parts of the private sector continue to be crippled by the overhang of debt accumulated during the bubble years; this debt burden is arguably the main thing holding private spending back and perpetuating the slump. Modest inflation would, however, reduce that overhang — by eroding the real value of that debt — and help promote the private-sector recovery we need. Meanwhile, other parts of the private sector (like much of corporate America) are sitting on large hoards of cash; the prospect of moderate inflation would make letting the cash just sit there less attractive, acting as a spur to investment — again, helping to promote overall recovery.

In short, far from fearing that more action against unemployment might lead to an uptick in inflation, the Fed should actually welcome that prospect. Which brings me back to those Republican attacks and their chilling effect on policy.

True, Mr. Bernanke likes to insist that he and his colleagues aren’t affected by politics. But that claim is hard to square with the Fed’s actions, or rather lack of action. As many observers have noted, the Fed’s own forecasts indicate that while things have been looking up a bit lately, it still expects low inflation and high unemployment for years to come. Given that prospect, more of the “quantitative easing” that is now the main tool of Fed policy should be a no-brainer. Yet the recently released minutes from a March 13 meeting show a Fed inclined to do nothing unless things take a turn for the worse.

So what’s going on? I think that Fed officials, whether they admit it to themselves or not, are feeling intimidated — and that American workers are paying the price for their timidity.

Here is Azizonomics reading of these two articles

Ron Paul believes that inflationary interventions into the dollar economy will have unpredictable and dangerous ramifications. Paul Krugman believes that a little more inflation (although he forgets that by the old measure of CPI inflation is already running at 9%, far higher than his supposed target) will spur economic activity and decrease residual debt overhang. Krugman seems to give no credence to the prospect of inflation spiralling out of hand, or of such policies triggering other deleterious side-effects, like a currency crisis.

The prospect of a currency crisis is a topic I have covered in depth lately: as more Eurasian nations ditch the dollar as reserve currency, more dollars (there are $5 trillion floating around Asia, in comparison to a domestic monetary base of just $1.8 trillion — the dollar is an absurdly internationalised currency) will be making their way back into the domestic American economy, and that this may have a steep inflationary impact. Additionally, many of the deflationary pressures that existed in 2008 or 2009 (e.g. shadow bank deleveraging) aren’t there anymore.

I don’t really know how much of this is to do with the Fed’s inflationary policies, and how much is to do with the United States’ role as global hegemon coming to an end. I tend to think that the dollar hegemony has always been backed by American military force, and with the American military overstretched and its funding increasingly debt-fuelled, the dollar’s role is naturally threatened. If America can’t play the global policeman for global trade, why would the dollar be the currency on global trade?

However it must be noted that America’s creditors do believe that their assets are threatened by the Fed’s inflationism.

As the Telegraph noted last year:

There has been a hostile reaction by China, Brazil and Germany, among others, to the Federal Reserve’s decision to resume quantitative easing.

Or as a Xinhua editorial put it:

China, the largest creditor of the world’s sole superpower, has every right now to demand the United States to address its structural debt problems and ensure the safety of China’s dollar assets.

Probably, the egg of American imperial decline came before the chicken of the recent inflationism, but that inflationism certainly has the capacity to worsen the problems rather than lessen them. After all, if America’s consumption-based economy is dependent on China’s continued exportation, and Krugman is advocating slamming creditors (i.e. China) by inflating away their debt-denominated financial assets, then surely Krugman’s suggestions imperil the already-fragile trans-Pacific consumer-producer relationship?

And this is a crucial matter — there is nothing, I think, more crucial than the free availability of goods and resources through the trade infrastructure, which is something that Krugman’s policies seem to endanger.

As commenter Thomas P. Seager noted yesterday:

[The situation today] is directly analogous to the first Oil Shock in 1973. In the decades prior, the US had been a major oil producer. However, efficiency gains and discoveries overseas resulting in an incrementally increasing dependence of foreign petroleum. Price signals failed to materialize that would caution policy makers and industrialists of the risks.



Then, the disruption of oil supplies from the Middle East caused tremendous economic dislocations.



Manufacturing is undergoing the same process. The supply chain disruption from the Japanese earthquake and Tsunami was merely a warning shot. Imagine if S Korean manufacturing were taken off-line for any length of time (a plausible scenario). The disruption to US industry would be catastrophic.



In the name of increased efficiency, we have introduced brittleness.

Time will tell which Paul is right. But I know where I stand.

So, the US market is rallying because of talks the Fed will resume QE?

Btw, great articles Yuri. Really showcases the divided opinions on this issue. Do you feel gold has become very very important in the current environment?

zizzle wrote:well its not that simple, a weaker dollar means more expensive imports, and since the US hardly manufactures anything these days the common man will have to pay more for his daily purchases. That is not an incentive to buy more stuff and pay old loans

More expensive imports means higher exports, which means a better balance of trade, which is beneficial towards GDP and by extension employment. As I remember it, exports did go up during the weak dollar, so while the US doesn't manufacture as much as before it's still an important part of its economy.

lenear1030 wrote:in some cases, you could right, but i really didn't clarify my statement enough. in the short run, inflation doesn't just instantly drive up wages. over time though, wages could increase but it's dependent on other factors. besides, we've already seen wages stagnate through inflation here in the US.

but when you say 'in the short term while wages are still adjusting' that doesn't make too much sense to me. firms dont just decide to pay their employees more because the Fed inflates the economy. if they do, that can cause further inflation. those firms will have an easier time clearing their debts though (if they dont increase their employee's wages).

those business wont necessarily have more capital to invest either like you said.

Inflation in the US hasn't been significant though. Core inflation, which is what the Fed tracks because it can control (it excludes the price of energy and food, which have a lot more to do with government policies and higher demand from China & India than the Fed's policies), has averaged 1.8% over the past 5 years. The Fed has a target of 2%. So that's pretty good. As a result, people know that inflation will average about 2%, so most contracts already count on there being a 2% inflation as a cost-of-living-adjustment. If this were to suddenly change from 2% to 4% most people would renegotiate their contracts.

Also, the economic definition of "long-run" is the time it takes for wages to adjust to changes. So in the long run, wages always adjust. This may take longer when the employees have less bargaining power, but it will get there.

While the adjusting phase is happening, businesses will have more capital because even though their revenue and costs are increasing, their salaries won't be as much, so they will have a small amount of surplus capital temporarily.

Interesting articles Yuri. I personally don't see much of an argument made towards the classical approach of "do nothing", I find that some of the claims being made in that FT article would be hard to back up. Such as having nearly every crisis since the creation of the Fed be the direct cause of the Fed.

well the US have a $600 billion trde defict, in such cases a weaker dollar means a larger defict

kiranr wrote:So, the US market is rallying because of talks the Fed will resume QE?

Btw, great articles Yuri. Really showcases the divided opinions on this issue. Do you feel gold has become very very important in the current environment?

Well I guess thats over



I dont know, I dont like gold because there is no valuation to it (no conference calls or management meetings either though) but it does seem that gold rallies whenever there is talk of more inflation. Never bought it and would never buy, there are other more sound hedges.

As far as some ppl talk about a reversion to a gold standard I think thats a terrible Idea, even worse than the current arrangement.

BarrileteCosmico wrote:

Interesting articles Yuri. I personally don't see much of an argument made towards the classical approach of "do nothing", I find that some of the claims being made in that FT article would be hard to back up. Such as having nearly every crisis since the creation of the Fed be the direct cause of the Fed.

The classical approach was never to do nothing but enact structural changes which make competition fiercer, it also means letting the parts of the economy which were inflated get deflated. A big problem with government sanctioned inflation is that it cause miss-allocation of capital, which I think what the author was referring to when he mentioned those crisis.