Fighting A Rhetorical Rearguard Action
As a result of the ever more evident failure of his money printing exercise to produce anything beside overvalued stock prices and soaring commodity prices, Ben Bernanke is now forced to fight a rhetorical rearguard action. The speech he gave yesterday was basically a slightly extended and embroidered version of the past 20 or so FOMC statements. A summary of the salient points has been provided by Marketwatch.
As a slightly more expansive report on the speech notes in its preamble:
|“Federal Reserve Board Chairman Ben Bernanke said Tuesday that he is not in the camp of economists worried about a double-dip recession as he defended the central bank from accusations it’s fueled a boom in commodity prices.”|
In short, Bernanke is either as dense as a fence post, or he's pulling a JC Juncker on us. As we have previously noted, the Fed's quantitative easing program has done far more than just 'increase excess bank reserves at the Fed' as many defenders of the exercise would have it. The most commonly heard argument is that since these bank reserves remain for now sequestered on the Fed's balance sheet and it doesn't seem likely that private sector credit growth will spur the 'money multiplier' into action, the Fed's activities have been neutral with regard to money supply inflation. This is belied by the fact that the true money supply TMS-2 is currently up almost 43% since the beginning of 2008.
The broad US 'true money supply' TMS-2, as per Michael Pollaro (for a definition and detailed explanation see here). This measure stood at $5.3 trillion as at January 1 2008. Today it stands at $7.574 trillion, an increase of 42.9%. Since January of 2000, the true money supply has increased by 151%. It has been the biggest monetary inflation of the entire post WW2 era in such a short time period.
Evidently then, the Fed has done precisely what Ben Bernanke said it would do when he was . It has printed plenty of money. If you wonder how this feat was accomplished in the face of private sector credit deleveraging, consider that the Fed buys securities not only from banks, but also from non-banks, which increases both deposit money (i.e., perfect money substitutes) and bank reserves concurrently. In addition, the banks are not as idle as is generally supposed. They are reinvesting the proceeds from 'QE' by buying more government securities. Thus, although the debt monetization by the Fed bypasses the treasury (it is not allowed to buy treasury debt directly from the government), it finances the government's spending excesses indirectly, via the detour of the commercial banking system and other market participants that receive checks from the Fed in the course of QE (for details on the mechanics of QE, we refer you to an earlier article). We mention all this mainly to make one point perfectly clear: there has been inflation, and lots of it. When Ben Bernanke references 'inflation', he talks about the rise in consumer prices, but that is not what inflation is. Inflation is the increase in the supply of money. Rising consumer prices are just one possible effect of inflation, and not the most important one.
The defenders of inflation as a viable method of combating recessions should therefore explain how it was possible that the decade that has brought us the worst economic performance since the Great Depression coincided with the biggest monetary inflation since WW2. If inflation worked as a panacea that 'fixes' the economy as they assert, then why has the exact opposite happened? Evidently their theory has a major flaw – and the same obviously goes for the defenders of deficit spending (more on those further below).
Hence the rhetorical 'rearguard battle' Ben Bernanke is forced to fight these days. He has inflated the money supply massively and has nothing to show for it. Hence his assertion that the current slide back into recession is of course only 'temporary'. As Marketwatch reports further:
“Although he acknowledged the economy has been surprisingly weak so far this year and there have been recent signs of a loss of momentum in the labor market, Bernanke was sanguine about the outlook, saying that both jobs and growth would pick up in the final six months of the year.
“I expect hiring to pick up from last month’s pace as growth strengthens in the second half of the year,” Bernanke said in a speech to international bankers meeting in Atlanta.”
Home prices have just slipped to a new low, employment is weakening again, the ISM diffusion indexes are plunging – but don't worry. Bernanke just knows that all his money printing must have worked somehow. Indeed, it has. It has distorted the economy's productive structure further and thus weakened the economy structurally, while creating an all too brief illusion of 'recovery'. How Bernanke knows that 'growth will pick up in the second half' he didn't say. Given his forecasting track record, we can take this assertion almost as a guarantee that a recession is all but imminent.
The report continues:
|“Overall, the economic recovery appears to be continuing at a moderate pace”, Bernanke said, but it will continue to be uneven across sectors and “frustratingly slow” from the point of view of unemployed workers.”|
Translation: there is no recovery.
“The highlight of the speech was an exchange during the question-and-answer session between Bernanke and J.P. Morgan Chase JPM -0.59% Chief Executive Jamie Dimon.
The JP Morgan chief presented Bernanke with an exhaustive list of the sea-changes in financial markets, from the vanished products to the forced regulatory changes and strongly suggested they were to blame for the sluggish U.S. outlook. Bernanke said no comprehensive study of the economic impact of the new rules on credit has been conducted.
“It’s been the most comprehensive financial reform since the 1930s, we don’t have quantitative tools to do that,” Bernanke said. “There is going to be some trade-off here,” he said, adding the rules could be tweaked later.”
As we have noted previously, the Frank-Dodd regulatory monstrosity is an attempt to close the barn door long after the horse has escaped. It will have far more unintended than intended consequences, as is always the case with such interventions. So they have imposed endless new regulations on top of the existing regulatory jungle without 'conducting a study on their economic consequences'? Instead the new rules will be 'tweaked' later (every time an intervention predictably fails, new interventions are heaped on top of it to 'repair' the failings of the previous ones, and so forth, ad infinitum).
“For his part, Bernanke blamed the sluggish outlook for the April-to-June quarter on the effects of the Japanese earthquake. This is likely to dissipate in coming months, he said. At the same time, there is some prospect of lower gasoline prices.
With these two factors in train, “growth seems likely to pick up somewhat in the second half of the year,” he said.”
This is too funny. The mainstream experts all assured us sotto voce back in March that the 'broken window' in Japan would have no adverse economic effects – see 'Japan disaster will have limited impact on global economy' as a pertinent example. Now all of a sudden it is to blame for the US slowdown? And of course the somewhat 'higher' gasoline prices that preceded the prospect of 'lower gasoline prices' in coming months had absolutely nothing to do with the Fed's policies. That goes without saying.
“The fact that Bernanke did not sound overly alarmed about a slowdown was taken as a sign that the Fed would be in no hurry to launch another asset buying program, or quantitative easing plan, once its current $600 billion program ends in June.
Stocks wilted after Bernanke’s speech, perhaps on disappointment the Fed was not planning to ride to the rescue with another asset-buying plan.
Bernanke signalled he was also in no hurry to exit, saying that the zero-interest rates and bond purchase plan are still needed.
“Until we see a sustained period of stronger job creation, we cannot consider the recovery to be truly established,” Bernanke said.”
The markets know of course that without a further acceleration in monetary pumping, the bubble activities that have held the prices of titles for capital aloft will come under pressure. We can start speculating now on how many SPX points will need to be lost before 'QE3' comes down the pike.
“The Fed chairman spent a large portion of the speech trying to calm market fears about inflation.
The latest data show that inflation “should moderate” assuming that commodity prices stabilize and inflation expectations remain stable, he said.
Bernanke also made a strong defense of the Fed’s bond buying programs, saying it was not the root cause of this year’s surge in commodity prices.
He said that fundamentals of global supply and demand played the “central role” in the recent swings in commodity prices.
Bernanke ended his remarks by stressing the central bank would remain alert for signs that inflation may flare up.
“Most FOMC members see the recent increase in inflation as transitory and expect inflation to remain subdued in the medium term,” he said.
“Should that forecast prove wrong, however, and particularly if signs were to emerge that inflation was becoming more broadly based or that longer-term inflation expectations were becoming less well anchored, the FOMC would respond as necessary,” he said”
The pace of monetary inflation should indeed 'moderate' once QE2 ends, but that is of course not what Bernanke is talking about. As regards commodity prices, it is clear the Fed is not the only central bank responsible for their sharp rise, as other CB's have been inflating copiously as well (especially the PBoC). However, when the money supply is pumped up, some prices, somewhere in the economy will always rise. That Bernanke is trying to take credit for pumping up stock prices while refusing to acknowledge the Fed's role in increasing commodity prices only shows how disingenuous he is. The central bank has absolutely no control over where the money it creates goes. It didn't go into houses, that much is clear. But it sure did go into financial assets and commodities.
The part we have highlighted above is testament to the bureaucracy's hubris. Listening to these guys one always gets the impression that without our vaunted 'policy makers' we would have been in a permanent financial and economic crisis since at least anno domini 1374, when the Venetian banking system crashed after an economic boom turned to bust (this particular bust was the result of the banks creating a boom by practicing fractional reserve banking, in the main to finance the extravagant expenditures of the government – sound familiar?).
Whether or not rising prices are a 'transitory' phenomenon depends not only on the increase in the supply of money, but also on the demand for money. The fact that inflationary effects on final goods prices have so far remained subdued owes much to the public's much greater demand for money (i.e. cash balances) in the wake of the bust. Should people alter their assessment of the likely future purchasing power of the money unit, the bureaucrats could be in for a surprise, given how much additional money they have already created since 2008. Meanwhile, as the recent example of the BoE shows (which keeps its administered short term interest rate at 0.50% in spite of 'CPI inflation' increasing to nine times as much, at the current level of 4.50%), the promise that the monetary bureaucracy will 'respond as necessary' is a hollow one. Similar to the BoE, we expect the Fed to eventually come up with all sorts of excuses as to why the 'necessary response' must be delayed.
Koo To Krugman: I'm The Better Keynesian
Richard Koo, the man who recommends massive government spending as the 'cure' for recessions, in spite of the fact that he resides in Japan, where the failure of this policy could be observed first hand for over 20 years running, has taken it upon himself to snipe at a fellow Keynesian, Paul Krugman. Allegedly, Krugman's recommendations are not favoring deficit spending enough.
This is of course incredibly funny, given that Krugman has yet to encounter a government deficit he thinks is big enough. His main failing, according to Koo, seems to be that he wanted a lot of money printing from the Fed as well, or that he expected it would 'work'.
“Paul Krugman's belief that further monetary stimulus, specifically QE2, would be capable of supporting the U.S. economy misled the Obama administration and has put the U.S. in a difficult economic policy position, according to Nomura's Richard Koo.
Koo says that while U.S. officials and Paul Krugman read his book on balance sheet recessions, they refused to admit more fiscal stimulus, that is government spending, was the only means by which U.S. could grow. Instead, they convinced themselves that more monetary stimulus would be enough to jumpstart U.S. growth.”
Consider us rolling on the floor with laughter. The economy, according to Koo (and according to Krugman, for that matter) is apparently a stalled engine in need of 'jumpstarting'. Of course we all know how well Mr. Koo's recommendations on deficit spending have worked in Japan – where for some reason, said 'engine' still refuses to be 'jumpstarted', in spite of Japan's government amassing the by far biggest fiscal debt among industrialized nations.
The so-called 'balance sheet recession', which Koo and his fans insist is some kind of great new revelation is of course nothing but the Keynesian 'liquidity trap' concept warmed over. To accuse Krugman of relying solely on more money printing instead of more deficit spending of course laughable. Krugman himself keeps insisting that the government is not spending enough.
“The result of QE2 has not lived up to administration, or Krugman's expectations, according to Koo. Instead, we're left with only two policy choices: protectionism and dollar devaluation, or more fiscal stimulus.
It's important here, to note, WHY QE2 doesn't work, according to Koo… essentially all that happened is that by buying up Treasuries, investors were forced to look for returns elsewhere, in places like stocks and commodities. The latter, the commodity gains, ended up slowing down the economy. What's more, QE2 has had no positive impact on bank lending whatsoever.
Koo notes that, because of the current political situation, fiscal stimulus now seems unlikely. Consensus has formed around austerity, and that would need to change for more government spending to be put in place. Standing in the way is Republican opinion, Democrat acquiescence, and ratings agencies who seem prepared to downgrade the U.S.
The alternative, protectionism and dollar devaluation, could be disastrous if history is any example, according to Koo.”
It should be noted that Koo's critique of 'QE2' is entirely correct – it has had precisely the effects he mentions and bank lending to the private sector has certainly remained subdued. He is also correct that 'protectionism and dollar devaluation would be disastrous'.
However, he presents us with a set of false choices, under the erroneous assumption that the government must intervene in the economy to 'save it'. He says ' we're left with only two policy choices: protectionism and dollar devaluation, or more fiscal stimulus', but that is simply untrue. As Ludwig von Mises noted a long time ago already, the best thing the government can do when faced with an economic bust is absolutely nothing. The only way to bring the economy back to a sound footing is to allow market forces to correct the imbalances in as unhampered a fashion as possible. The problem of the economy is not a 'liquidity trap', even if it comes by another name, its problem is that the previous credit expansion has left it with a discoordinated productive structure and a grave imbalance between production and consumption.
No amount of government intervention can alter this fact in a positive manner – it can only lead to even more distortions. In what way any of the tree 'policy choices' we are now allegedly left with would improve this situation is a complete mystery. It should be obvious that neither protectionism nor dollar devaluation can possibly improve the economy's status. However, it should be just as obvious that deficit spending is likewise destined to fail. Every single cent the government spends must be taken from the private sector, since the government produces no wealth and possesses no hidden stash of resources it can draw on. So to the exact same extent as the government increases its spending, the private sector will be forced to reduce its spending and investment. Resources will then simply be commandeered by bureaucratic fiat instead of the voluntary decisions of market participants. How is that going to improve the economy? As a matter of fact, the past decade has not only seen the biggest bout of monetary inflation of the entire post WW2 era, it has also seen the biggest increase in deficit spending since WW2. Obviously, neither the former nor the latter have had any positive effect so far. We will never understand why people like Koo and Krugman do not for once stop to think about this and consider that their theories might simply be wrong.
Of course, we still find it eminently entertaining when these Keynesians begin sniping at each other and start arguing over who has the 'better plan'. Why not just abolish capitalism and be done with it? If these people were right, the Soviet Union's GOSPLAN agency would be the institution most worthy of emulation. A pure command economy provides after all the best conditions for statist intervention. According to people like Koo and Krugman nothing could be better, since that would enable all their plans to be implemented in full.
Richard Koo: 'I'm the better Keynesian. Spend, spend, spend!'
(Photo via Businessinsider.com)
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