Humpty Dumpty and the Broken Economy

August 10, 2010

It's the time of the year when I feel somewhat melancholy because I wish that time could stand still. The climate and natural beauty of Bend are powerfully seductive and everyday is perfect. I live in the here and now and doubt that tomorrow can possibly better than today. That said, I'm grateful that I'm not a citizen of the state of Oregon. Dominated by socialist turds, (ie. progressives or liberals or whatever misleading appellation, they hide behind), we rank right up there in taxation and unemployment. The major political question seems to be do we spend our revenues on trees or welfare. Progrowth, proemployment policies are beyond their limited intellectual capacities. If I want a downer, I read the editorial page of the Oregonian. Thank God for Fox news. But I digress.

In my last discourse, I talked about the notion of deflation and the predictable spinalcord response of quantitative easing by Bernake's buddies on the Fed. To date, neither the initial 2 trillion of money printing, zero interest rates forever , the stimulus nor all the King's men have put Humpty Dumpty together again. In defense of the concept of stimulus, this was no Hoover Dam creating stimulus; PORK to medicaid, unemployment benefits,and most outrageously to maintain the employment of unionized, overpaid, nonproductive state workers. No one can accuse Obama of not delivering to those who own him....the public sector unions. Incidentally, he took good care of his buddies, the trial attorneys by excluding tort reform in Obamacare. Enough proselytizing!

A point about unemployment benefits, if you will permit. Rogoff, in his soon to be classic, This Time is Different, notes that unemployment following a financial crisis if far less severe in developing economies, lacking a welfare system. People withour govt. largess will perform different jobs for less, rather than starve. How many times have we heard that immigrants, legal or otherwise, do the work that American's refuse to perform. Irradicate unemployment benefits and we will simultaneouly cure our unemployment AND immigration problem.

Anyway, where do we go from here? We know what doesn't work. Money printing and borrow and spend seem to have limits. Will additional money printing work? An important point to make at this juncture,is that today's Fed statement indicated that they will use the proceeds of their RMBS payments to purchase Treasuries. Therefore, their balance sheet remains constant and as such does not constitute quantitative easing. It is true that allowing the RMBS to roll off their balance sheet might actually be contractionary.

The problem lies in the future economic news. If, as I believe, economic contraction continues, unemployment remains intractable, the housing market does not recover, Bernake will be under enormous political pressure to do something. At that time, he will be forced to initiate quantitative easing which means printing $ to monetize the debt. Now, the fact is that the process has not worked to date and never worked in Japan. (If Keynsian economics and quantitative easing had merit, Japan would be rivaling China in economic vitality). Consider that the banks have over one trillion $ on deposit with the Fed garnering a modest 0.25%. The problem is not the absence of $. Unfortunately, as noted previously, the Fed controls only M1. Credit markets control M2 and M3 and the absence of credit expansion yields no moneymultiplier effect. Think about it. If you had a trillionbucks and 5 trillion bucks of bad debt, what would you do? The banks are reserving these funds and praying that things improve so that they do not have to realize these losses. So I figure that the $ printing exercise will not obtain the desired effects. What of the unintended consequences? The intentional debasement of our currency will have significant consequences. Stuff, gold, food oil, copper, etc. is denominated in $ and will rise in $ price as the dollar sinks. Therefore, the cost of living increases for the American public. Don't worry because your govt. doesn't include these essentials in calculating the core CPI. The core parameters of inflation, wages, technology prices, real estate, etc. will continue to decline. Deflation in all but the essentials of life will receed. Maybe a burger will cost more than a smart phone. Corporate margins will be squeezed by higher input costs and falling output prices; unemployment will be the natural consequence of falling profit margins. Perhaps, most ominously, our creditors may resist the urge to subsidize our flagrant fiscal irresponsibility. Would you spend perfectly good money to buy the bonds of an entity which is effectively bankrupt and has a receeding currency?

I believe, at risk of being repetitive, that the US Treasury market is the greatest bubble in human history. It's not if but when. In short, I believe that the negatives far outweigh the benefits of quantitative easing. What should the government do? Absolutely nothing. Thank God that after Nov., additional fiscal stimulus will be impossible. We are in the midst of a debt induced process of delevering and liquidation. Allow the free market to transfer debt and assets from weak hands to strong hands. Happened all the time in our economy in the nineteenth century and despite some wild panics,(the subject of a future correspondence), we prospered. Long live the Austrians, say I!

-Guga