One hates to think of buying a currency with a decent chunk of one's savings only to have it crash and burn, but it really seems unlikely that the already too-cheap renminbi would be allowed by the Chinese government to become even more underpriced. To me that's the renminbi's big attraction.

I'll grant though that it's not crystal clear how the pressures on them to revalue upward might evolve in a dollar crisis. (I keep reading mpettis and bsetster and hoping enlightenment just comes.)

kackermann said, " I want someone to explain to me why the economy seems to tank when taxes are at their lowest, and why the outrageously high tax rates in the decades following WWII were coincident with an extremely stable economy and massive wealth creation." OK… I'll take an armchair-economist stab at that one. (Real economists please do weigh in an clear up the mud.)

High top-bracket tax rates sap the drive to rape and pillage, financially speaking, and so lead to greater income equality. Low top rates mean that the reward for bad behavior at the top is radically increased, and the incentive forces associated with the phrase "the scum floats to the top of the pond" are at their maximum. We get things like a mortgage industry riddled with fraud, as per William Black's recent comments, and we get enormous income inequality in that a decent fraction of all income is going to ultra-high-"earners".

But that's not all we get. Great income inequality means large amounts of income accrue to those who can't possibly consume it all, so consumption is weak and there are excess savings. All the stuff we've been reading about of late from the Neo-Keynesians. But great income equality, by contrast, means essentially all income is associated with consumption, so consumption is adequate to drive full employment. All this is another way of saying that collectively (!) speaking, the workers need to be paid enough to afford to buy what they are, as a group, producing.

We should not be motivating economic rape and pillage. There was a time when doing the CEO job responsibly had an other motivations besides financial gain. Some people simply want to make a mark on the world, do something great, build a great firm, etc. We should not be encouraging the low-morals charlatans to rush out in front of them to grab the jobs instead. We need high top tax rates again. There's no excuse for letting them drop below 50%.

There is no excuse for excusing capital gains and dividends either. Yes, double taxation is horrible, so just abolish the corporate income tax and admit that in the end, only people pay taxes.

I can't help but come back to fundamentals, and the fundamentals say we go back to a credit-fueled consumptive economy again any time soon.

I realize that is what the banks want, but unless they unveil a program to train everyone as a banker, and create an economy where everyone creates synthetic CDO's comprised of everyone else's synthetic CDO's, and declare us all systemmically important and elegible to borrow free money and receive bailouts, then I see nothing but trouble.

I see a financial system that put the theory to test, and won. The banks called all the shots for themselves in this. They created a risk tranch called public compulsory, and now the only thing to do is fine tune it.

There are people running around still talking about how stupid AIG was, and point to their being on the wrong side of all those bets.

They honestly don't see it for the nuclear option that is was. Why go out with a whimper, when you can strap up and threaten to take a bunch with you when you go?

I'm keeping one neighbor partly employed right now, and other than despair and feelings of worthlessness, he's doing fine.

It's my other unemployed neighbor that worries me. He lost his job of 21 years, and if he looses his house, he will snap.

I want someone to explain to me why the economy seems to tank when taxes are at their lowest, and why the outrageously high tax rates in the decades following WWII were coincident with an extremely stable economy and massive wealth creation.

I'm at the point where globalization can go to hell. I can't afford $8.00 workboots from China if I don't have a job. Slap a tarriff on imports, and open up a boot factory here. I know the banks don't want to hear that, but they have had their fill.

We are not buying anything these days anyway.

Eventually you all will come around to my thinking

Well, there's one more institution that has to get religion about debt. It's the one that's leveraging up right now – government. In fact, aren't we in the middle of the "final" bubble – the government bubble – with t-bills as the inflated asset?

About #2 – if the Fed even hints that it might inflate, won't the Chinese pull the trigger on their SDR idea and/or require the US to write RMB paper instead of USD paper? And if that happens…

@Hugh – The banks' big mistake was to not unionize!

I don’t see wage inflation as a huge threat at this point. What I do see as the inflationary threat are the two things I identified: excess reserves being lent and commodity prices going through the roof/the dollar getting killed.

I just wrote a follow-up to this post in which I have pinpointed a statistic that I call the Consumption-to-Income Gap which should help gauge which outcome is likely to prevail.

Deleveraging is in progess and attempts to demonstrate that this is not the case ignore the collapse of the shaddow banking system (e.g., Downsouth’s reference to Setser).

There is no sign or prospect of wage inflation.

Impact of commodity prices on medium term core inflation is not significant because supply/demand forces for commmidities act in the shorter term.

Recent increase in equities could well be due to speculation – or simply normalisation – but either way the movement is a short term one of no great significance to the macroeconomic reality.

The inflation risk from the excess reserves is negligible whilst deleverage continues – and that process has a long way to run.

So I expect your outcome 1 will endure for many months and potentially several years to come.

Which bit of this don’t you agree with?

On the psychological spectrum, with “debt revulsion” on one end and “speculative infection” (this is what you call “animal spirits,” no?) on the other, I’m not sure where we are right now.

Frederick Lewis Allen in Only Yesterday recounts that in the 1920s, in spite of the popping of a nationwide real estate bubble, a “marked recession” and in February, 1928, unemployment “more serious than at any time since immediately after the war,” this did nothing to dampen the speculative fever and the Big Bull Market. (see my comment on todays Links for more detail)

Aaron L. Friedberg in The Weary Titan: Britain and the Experience of Relative Decline 1895-1905 points out a similar phenomenon. Great Britain, “from the 1860s at least,” experienced a negative trade balance and began “living off its capital.” Between 1872 and 1896 was the “Great Depression.” Friedberg concludes that “the beliefs of national leaders are slow to change.” Lord Bolingbroke wrote: “They who are in the sinking scale…do not easily come off from the habitual prejudices of superior wealth, or power, or skill, or courage, nor from the confidence that these prejudices inspire.”

Friedberg cites the work of Kenneth Boulding who speculated that the citizens of a country as a whole may come to share a historical “national image” that extends “backward into a supposedly recorded or perhaps mythological past and forward into an imagined future.” Boulding argues that adjustments to this national image occur “rarely, if at all,” while John Stoessinger asserts that change “is possible only as the consequence of some monumental disaster.” The process of change is “driven by gradual developments in the thinking of ‘change agents,’ middle- and upper-level officials whose views begin to deviate from the norm and who are abile to recive a wider hearing only at moments of intense crisis.”

In Great Britain, the “change agents,” the most promient and strident being colonial secretary Joseph Chamberlain, were not successful in the period 1895-1905 in altering the “national image” of the country. “The consensus (free-trade and laissez-faire dogmatism) that had grown up over the course of the preceding sixty years would not be easily shattered,” Friedberg writes. “Most people probably…believed their country was still the world’s industrial leader and that, under a policy of free trade, it would be able to continue in that role.” Chamberlain’s calls for reform therefore went unheeded.

To give an idea of the spirit of the debate here’s a quote from the reform-minded Chamberlain:

Granted that you are the clearing-house of the world, but are you entirely beyond anxiety as to the permanence of your great position?…Banking is not the creator of our prosperity, but is the creation of it. It is not the cause of our wealth, but it is the consequence of our wealth, and if the industrial energy and development which has been going on for so many years in this country were to be hindered or relaxed, then finance, and all that finance means, will follow to the countries which are more successful than ourselves.~

Charles Ritchie, president of the Board of Trade and later chancellor of the Exchequer, an adamant defender of the status quo and Chamberlain’s principle obstacle to reform, issued this statement:

The solution of the question of how best to develop and increase our competing power is one to which the State can only give limited assistance… What the Government can do is to facilitate the supply of accurate and carefully collected information and in the dischage of this duty…we are somewhat behand-hand.