naked capitalism

ndk says:

Not too surprising to me, and probably not that important, IMO. I don’t think the status of the Fed’s balance sheet is in much doubt anymore either, though the handwaving about TARP’s profitability for taxpayers makes me grin. It doesn’t interest me much anymore, because it’s clear that it’s dreck. In particular, its inability to appropriately match its new flaming bag of assets to a set of liabilities really limits its policy options.

It’s also probably not in question anymore whether the Fed will become the banking system itself. Even beyond buying more trash, the Fed is now up to owning 19.3% of the CP outstanding, and on-the-run TIPS continue to underperform the nominal securities. Lending by private entities and securitization continue to be, shall we say, unenthusiastic. Would you try to compete with the sovereign? Anyone have a fresh Treasury CDS quote?

Anyway, combined with our other policies in place, I continue to believe this replacement of the private financial system with a public system that has limited influence on monetary velocity and multipliers is itself deflationary. I’m not convinced by Buiter’s elegant defense largely because it has no empirical basis, and because he doesn’t address the situation where the sovereign cannot reasonably recapitalize itself through seigniorage.

Thus, I still anticipate portfolio crowding out(yes, I know what IS/LM says about liquidity traps and horizontal line segmants; see conversations on Econbrowser). It’s already clear that there is very little empirical evidence that either fiscal policy nor quantitative easing works when moved from Keynesian frameworks to the real world. There are strong theoretical reasons to doubt either program’s success, too. I continue to believe that these are inherently deflationary programs, and see scant solace in the widespread newfound market optimism.

So, three real questions linger.

#1: Can the Fed really create inflation, and stabilize inflation if it is successful? I’m spending a lot of time thinking through transmission mechanisms now. How can the Fed create both the expectation and reality of, say, a 5% sustained inflation rate and have that percolate throughout the economy?

I have strong doubts that such a policy is realistic, which I’ve expressed previously. That leads to the second major question.

#2: Inflation, if it is to help us out of this hole, needs to feed through to consumers, preferably through wages. Doing so is very difficult while high-quality, cheap foreign labor, services, and goods are available. That means the dollar must weaken against trading partners. But, how well can the USG affect the value of the dollar, which, as a reserve currency, is dependent on many influences beyond the U.S. itself? And, will major surplus nations play along, or does the prisoner’s dilemma cement itself as it appears to be doing? The only alternative is even cheaper debt service, which it seems likely we’ll have. The impact of that is probably limited in our current environment and the consumer’s developing mindset. And, worse, if it succeeds, we only end up deeper in the hole in a few years, as we have after 2002’s low rates.

#3: The most important question is, does the Fed’s balance sheet matter? It’s clear that in an abstract and eventual sense, it does. But does it matter in any immediate sense? Who knows. It will if and when market participants decide it matters. On this, I have no insights, because I suck at trading. But it’s definitely the most important question you should ask yourself right now.

p.s. Is the Fed charging 2-and-20?

Yves Smith says:

ndk,

Although my gut reaction is in line with your views, I am loath to buck conventional thinking along the line of Bernanke’s “a determined central bank can always reflate” (not an exact quote, but close), particularly since I am contrary on so many fronts.

Bernanke’s helicopter drop depends on consumers spending (he has said that explicitly) and I don’t see that happening anytime soon, given consumer debt loads, rising unemployment, and falling wages (Fedex 5% wage cut, for instance; I know of management offers in the paper industry of zero wage increases over the next four years with benefit cuts).

I have heard the claim made that the Fed can set the value of the dollar where it wants via the dollar swap lines. But the Fed has seen quite indifferent to the dollar, save perhaps when its weakness made the commodities bubble look even worse in dollar terms.

And given the seeming importance of going off the gold standard and devaluing the currency in 1934 in America getting out of the Depression (recovery seemed underway in 1936 until miscues put the economy in reverse gear in 1937), one would think Bernanke would want to engineer a gradual but sustained fall of the dollar. The sharp drop on the QE2 announcement says that traders are well aware that policy + trade deficits ought to lead to a much lower dollar. I think we have a real risk of a disorderly decline.

Agree that solvency worries could lead to much higher rates. The combination of much bigger fiscal deficits and the burgeoning Fed balance sheet is going to put investors on edge, even more so as it plays out.

ndk says:

Although my gut reaction is in line with your views

And I should’ve credited you and Hamilton explicitly for voicing such views more eloquently, sorry. I’m honored to be nakedly contrary in your comments, even if you feel reluctant.

… one would think Bernanke would want to engineer a gradual but sustained fall of the dollar. The sharp drop on the QE2 announcement says that traders are well aware that policy + trade deficits ought to lead to a much lower dollar. I think we have a real risk of a disorderly decline.

I fully agree, but this is where we get into the whole discussion about competitive devaluation and trade wars. An orderly decline in the dollar with the pegs in place mostly helped China and hurt Europe over the last several years, and I see no reason to expect different in the present morass. The market reaction was impressive and benevolent, though it reversed violently today. Asia’s where the real disparity lies, and Japan and China have already explicitly threatened to intervene/are intervening against the USD’s orderly devaluation. That leaves disorderly devaluation or deflation as the only choices…

gold standard and devaluing the currency in 1934 in America getting out of the Depression

Fascinating that a gold standard to devalue against almost seems like an advantage at this point, isn’t it? Anyway, it’s nice that the oil standard doesn’t matter much anymore. Still bludgeoning myself for getting that one so wrong.

Agree that solvency worries could lead to much higher rates. The combination of much bigger fiscal deficits and the burgeoning Fed balance sheet is going to put investors on edge, even more so as it plays out.

Yes. It will be very difficult to detect this in the markets since deflationary expectations are clouding nominal interest rates, and other risk measures are so high. For the peanut gallery, official debt-to-GDP isn’t a useful metric. That’s why I’m watching the TIPS and Treasury CDS so closely, since it’s the only place I can think of. If any readers or our esteemed blogger have any further suggestions, I’m ears.

Yves Smith says:

ndk,

True, China will just bring the RMB down with the dollar. japan is more complicated. When the yen first went through 95, they weren’t worried, but going above 85 is a different matter. It isn’t the direct effects, but the indirect. The Nikkei and the yen trade in an almost direct inverse. Japanese banks have big equity stakes in other companies that they get to count at 50% of market value in equity for Basel II. So the issue is the impact on banks.

Now if you have yen appreciating and a higher Nikkei, they’d tolerate a higher yen.

And from what my (very plugged in) buddies have said, despite the effective (for now) jawboning, the Japanese would not intervene to lower the yen alone. But who possibly would join them?

Of course, that posture might change, but there is a gap between talk and immediacy of action.

doc,

I do not know what Frank is up to, I once had some respect for him, but his conduct during the TARP in particular and some of his recent remarks have been troubling. A lot of pandering too.

Yves Smith says:

I think the line of though below is sufficiently important that I am also putting this post by Tim Duy in Links. He argues that the Fed is not trying to create inflation, they really are (for now) just trying to lower spreads over risk-free assets. Key section:

The Fed apparently views deliberate expansion of liabilities – a commitment of x% percent growth in some monetary aggregate via Treasury purchases – as quantitative easing. A commitment to increase the balance sheet at a steady pace (the first derivative) rather than maintain a high level. We are not there yet.

Is this distinction important? Or just semantics? I believe it is important, as the latter, a move to target the liabilities side of the balance sheet, would imply that the Fed is deliberately trying to stoke an inflationary fire. This may become the future policy, but for now the Fed is simply trying to keep the financial system from collapsing. Inflation would be an accident, not a deliberate policy effort, at least from the Fed’s point of view. For the moment, the policy remains insufficient to ward off deflationary pressures long as the rest of the world refuses to accept the burden of global adjustment.

Anonymous says:

Where is the reset button? I want to push it!

ndk says:

It is very difficult to foresee the future course of global economy because now we are away from simple econmic realm and increasingly politics, sociology and mass psychology will matter more. Discontinues, tipping points, reversal of perceptions and social norms will complicate our humble analysis.

I totally agree, kaan. That’s what makes this situation so dang frustrating for me. Good policy, good economics, good foresight? Worthless. Instead, psychology and politics are our proximate drivers.

That’s why I spend my time thinking about the boundaries of reality that confine the activities of that machine. I have no idea what will emerge from this mass of people, but I can get a pretty good idea of what is possible and what’s not. That knowledge is almost as useful as knowing what’s likely.

ruetheday says:

ndk said: “Inflation, if it is to help us out of this hole, needs to feed through to consumers, preferably through wages.”

This is what is starting to worry me more than anything. Inflation has many forms. The economy has demonstrated that it can react very differently to money supply increases under different circumstances. There was the wage price spiral of the 1970’s (which is what many people have in mind when “inflation” is mentioned). But then the easy money policies of the late 1990’s and early 2000’s primarily led to asset market inflation rather than consumer price inflation. Finally, we got a whiff of commodities only inflation late last year and early this year.

What happens if the Fed’s QE policy manages to revive the more recent commodities only variant of inflation? Wages remain stagnant or fall, while food and energy prices skyrocket. Inflation is only a palliative against depression when it reduces the real burden of debts, which it would not do in that case. It would only make things worse.

Anonymous says:

hehe… I always phrase the question differently.

Why can’t I have a window at the Fed??

I can develop and build crappy cars with over paid labor, or any other product so desired. Lend money to bums of all stripes, hedgies, alt A, sub prime etc and award myself a huge bonus into the bargain.

Fact is, them pouring money into the top to the banks just put us where the Fed was in 1930. They gotta grease the wheels at the bottom. Since they won’t give me my window, how’s about a $1500 stimulus check every month for the next 10 months?? I promise to spend it!!
Eric

Anonymous says:

I predicted this.

When Paulson first started making the rounds on TV selling the bailouts, he was asked point blank if hedge funds would be excluded and he completely ducked the question. Citizens helping an enterprise like this is beyond the pale. No wonder they released it on a Friday before a holiday.

Michael Fiorillo says:

“so we’re all Marxists now”

If so, then Marxists of a very odd sectarian bent: immiserating the working and middle classes in order to subsidize the collective delusions, parasitism and predation of finance capital.

“From most according to their abilities, to a few according to their greed.”

I doubt if Old Whiskers, who by the way would have been prescient on these matters, would agree.

Or perhaps we should look at another Golden Oldie: Malthus, where overpopulation (of an increasingly parasitic financial class) amid finite resources (an ever-dwindling and leeched-off-of productive economy) leads to a crash.

Though not a involved in finance, except for my apparently foolish participation in my pension plan and Tax Deferred Annuity, I’ve found it fascinating to observe as an ecological system that has grown, overpopulated, overshot, and now crashed.

Fascinating, and frightening in its ramifications.

Anonymous says:

Yves and ndk,

So, I am reading The Shock Doctrine and am wondering if we are facing the economies of Argentina, Bolivia and Poland? What is to keep the overlords from treating labor like in those countries?

The Other Katherine Harris says:

I’ve been lurking on boards like yours for several years, seeking to understand what even I could see was a lunatic financial system careening toward collapse.

As an outsider schooled in the arts and humanities, whose only brush with the investment world (besides a lot of reading lately) was writing some analysis back when the the market was sane, I’m hesitant to post anything among so many experts. However, it would be great to have your thoughts on my theory that our “bailout” funds are being used to pay off massive losses on derivative bets. This would seem to be reinforced by letting hedge funds at the public trough, since they’re also huge players in the stupid shadow economy that dwarfs the size of the real one.

Do you think that’s true? Also, do you think — as I suspect — that we’d have no economic crisis at all, if these bets that should never have been made had simply been nullified on a no-winner/no-loser basis?

To me, it’s insane that the public would be forced to perpetuate a secret casino in which the richest of the rich are allowed to bet more money than even exists on matters that don’t even concern them directly.

Am I crazy or am I onto something?

Thanks so much for all I’ve learned here, Mr. Smith, both from you and your erudite readers.

doc holiday says:

I’m fairly bored with pension stuff these days, but here is an interesting old story, which might be an example of the eagerness of people to burn their cash:

FYI: “You further represent that Mr. Adler believes that Madoff would effectively manage assets for the IRA, but that Mr. Adler’s IRA does not meet the minimum capital requirements (currently $1 million) for investment management by Madoff. You represent, however, that Madoff will manage the IRA’s assets if it invests with Madoff through the Partnership, even though the IRA by itself otherwise would not meet the minimum capital requirements. You further represent that all of the assets of the Partnership are liquid marketable securities. You also represent that none of the funds contributed by the IRA is required to be used, or will be used, to liquidate or redeem any other partner’s interest in the Partnership.”

Pension Protection Act, my ass

David says:

There is actually another way out that the Chinese might prefer. That is the US dramatically raising taxes on the rich so that Keynesian government spending can make up for the demand deficit. The rich do not spend as much anyway and so this does not result in as much deflationary pressure as raising taxes on the middle class. This might be the preferable solution for China. This has to happen to some degree anyway.

But, as you might imagine, the US will fight this and what can the Chinese do to force the issue? Any kind of protectionist measures would hurt their economy more than ours. Dumping the dollar just leads to what they would be trying to prevent. If they do the opposite and inflate their own currency or buy even more dollars, this just increases their vulnerability to our future devaluation. Plus we can always raise tariffs on China if push comes to shove. Anyway, devaluing the Yuan will lead to inflation at home and ultimately probably make them uncompetitive as a manufacturing powerhouse since they won’t be able to afford commodity imports.

China is in a weak position for at least three reasons. 1) They hold massive amounts of our currency which we can devalue at will. 2) Their economic strength demands on manufacturing which is in essence a commodity. It goes wherever the labor is the cheapest. 3) massive job losses will likely lead to social revolution and the end of the current government.

The US’s bargaining position is strong in the same way that Walmart’s is strong. They have an enormous ability to buy. Countries like China are dependent on the US demand in the same way that a commodity pickle company become dependent on Walmart’s demand. Walmart can always find another pickle company if the first one gets too testy. Pickle’s are commodities which gives their producing companies little bargaining power. But the pickle companies can’t find another Walmart. No other company can provide that large source of demand. Likewise China can’t find another US.

VoiceFromTheWilderness says:

oh goody, more support from public institutions and funding for private — explicitly and legally non-public entities.

The final outcome of ‘free market capitalism’? An entrenched aristocracy which government is the servant of. An aristocracy of ever dwindling numbers using government (public) money for further conquest and consolidation.

Nobody ever could have predicted that! well, except Karl Marx

Michael Fiorillo says:

To Anonymous, re “The Shock Doctrine:”

Exactly. Naomi Klein is prophetic on this.

We are probably in the initial stages of structural readjustment programs here in the US, with attacks on labor and the public sector used to shore up credit and (prospective) currency crises, a la Mexico, Argentina, et. al.

The strong likelihood is that we will see escalating attacks on labor (witness the current aggression against the UAW and teacher’s unions) and the public sector. This will include efforts to privatize public assets, with the fiscal crises of states and localities serving as the rationale. The NYT has already reported that Governor David Patterson of NY is looking into the sale of state assets. Patterson has suggested that those unhappy with his cuts propose an alternative, yet nowhere is there mention of a Stock Transfer Tax, which NYS had from 1907, I believe, until the early ’80’s, and by itself would go a long way toward alleviating the state’s fiscal problems. Governor Corzine, formerly of serial financial conspirator Goldman Sachs, was agitating to sell the Jersey Turnpike even before the crisis reached its full proportions. Public facilities in Philadelphia are at this moment being turned over to private entities. I’m sure that readers of this blog from other regions could add to this very incomplete list.

We are likely in the early stages of a Final Offensive against the notion of public anything, with public education targeted by the corporate/foundation and academic complex for “reform” (read privatization through Charter and contract schools), eventually to be followed by the gravitational force of capital going after The Big One: Social Security. Though Obama campaigned on a platform of increasing Social Security taxes on high incomes, don’t be too surprised if he betrays that promise. It’s private government, with tax dollars going to opaque financial bailouts, mercenary armies and contractors, publicly funded private schools (aka charters), private-managed prisons, highways, etc.

Obama (”Change We Can Deceive In”) is integral to this process, having received the nod of finance capital years ago. His appointment of Geithner, Summers, etc., along with Duncan as Ed Secretary, suggest that there is consensus regarding this among political and economic elites. How ironic – but actually not that surprising, since corporate America has spent a fortune cultivating and domesticating the new generation of Black leadership, who by and large are awful – that our first Black president should be the point of the spear of declining living standards in the US.

If I am right, look for an ever-louder chorus of attacks on Greedy Baby Boomers and their entitlements, in an attempt to disguise class warfare as generational warfare, and the opening PR attack against Social Security.

Anonymous says:

The FT article and Yves’ commentary needs to be disseminated — this is indeed an outrage – This is an important development

Anonymous says:

Hasn’t this been rehashed and rehashed before? US Treasury asks and is granted immunity…it’s all downhill from there.

Taking the bailout monies to start a new National bank instead of propping up principles and/or at the very least just sending the consumers the money directly so they can prop up the economy…..would have done wonders (deposits never hurt a bank). Just enforcing monetary laws and regulations would help.

It will take some time for all the request money to filter through the system but then when it does, price inflation will arrive.

Stop whining and plan accordingly.

Bernard says:

The dilemma of dilemmas:

You need to devalue the currency in order to prevent a deflationary debt death spiral.

That same currency has been amassed in staggering quantities by foreign creditors.

What do you do???

(P.S. Bernanke studied the Great Depression and based on that undoubtedly looks at devaluation as the “solution”)