Stephen Roach Takes the Fed to the Woodshed

While the Fed appears to be getting nervous about increasing (and long overdue) criticism for its undue coziness with banks, it has for the most part ignored opponents of its aggressive monetary policies. And for good reason. Most of them have been fixated on the risk of inflation, which is not in the cards as long as labor bargaining power remains weak. There are other, more substantial grounds for taking issue with the central bank’s policies. For instance, gooding asset prices widens income and wealth inequality, which in the long term is a damper on growth. Moreover, one can argue that the sustained super-accommodative policy gave the impression that Something Was Being Done, which took the heat off the Administration to push for more spending. Indeed, the IMF recently found that infrastructure spending pays for itself, with each dollar of spending in an economy with high unemployment generating nearly $3 in GDP growth. And a lot of people are uncomfortable for aesthetic or pragmatic reasons. Aesthetically, a lot of investors, even ones that have done well, are deeply uncomfortable with a central bank meddling so much. And many investors and savers are frustrated by their inability to invest at a positive real yield without being forced to take on a lot of risk.

Stephen Roach, former chief economist of Morgan Stanley and later its chairman for Asia, offers a straightforward, sharply-worded critique: just as in the runup to the crisis of 2007-2008, the Fed’s failure to raise rates is leading to an underpricing of financial market risk, or in layspeak, to the blowing of bubbles. He argues that has to end badly. Key sections of his article at Project Syndicate:

Steeped in denial of its past mistakes, the Fed is pursuing the same incremental approach that helped set the stage for the financial crisis of 2008-2009…[T]he Fed’s incremental approach led to the near-fatal mistake of condoning mounting excesses in financial markets and the real economy. After pushing the federal funds rate to a 45-year low of 1% following the collapse of the equity bubble of the early 2000s, the Fed delayed policy normalization for an inordinately long period. And when it finally began to raise the benchmark rate, it did so excruciatingly slowly…

The Fed, of course, has absolved itself of any blame in setting up the US and the global economy for the Great Crisis. It was not monetary policy’s fault, argued both former Fed Chairmen Alan Greenspan and Ben Bernanke; if anything, they insisted, a lack of regulatory oversight was the culprit.

Yves here. Note that these causes are not mutually exclusive. As we discussed in long-form in ECONNED, it was a particular combination of financial market “innovations” that created the “wall of liquidity” that by early 2007 had led to extreme underpricing of risk across all credit markets. The big driver was leverage on leverage strategies, such as hedge fund of funds borrowing when the underlying hedge funds they had invested in were levered too, and CDOs, which were resecuritizations of junior mortgage bond tranches and thus effectively turbo-geared. These would not have been attractive if risk were not widely underpriced.

But a still-not-well understood aspect of the crisis is that these strategies became even more active as the Fed was raising rates. That’s the opposite of what normally happens in credit cycles. When the central bank starts tightening, what normally gets choked off first is the most speculative activities. Indeed, in 2004, Countrywide predicted that its mortgage originations would fall in 2005. Instead, as prime mortgage originations fell, subprime mortgage originations rose. Why?

The culprit was CDOs. They were insulated from the Fed’s tightening because the bulk of the CDO was rated AAA, which made it less vulnerable to the effects of the Fed’s tightening. Worse, for Eurobanks and even some US firms, retaining an AAA tranche hedging it with an AAA rated counterparty allowed book all discounted future profits in the current period. These were massively profitable trades, and a big reason why so many banks were stuck with so many toxic CDOs when the music stopped. Another big contributor was the heavily synthetic CDOs (as in made largely of credit default swaps) devised by Magnetar, which drove demand to the very worst mortgages.

None of the financial regulators had any idea that this was happening. Indeed, as the crisis was escalating, the authorities were still not looking in the right places for trouble. For instance, it was clear that when Bear Stearns was rescued, one of the big reasons was concerns about its credit default swaps counterparty exposures. As we said at the time, the Fed, in concert with the Bank of England and the ECB, should have gone into overdrive to understand the who was exposed to whom, and in what types of risks. Instead, they went into Mission Accomplished mode.

And the Fed is as in the dark about shadow banking now as it was in 2006. As the Wall Street Journal wrote earlier this week:

The so-called shadow-banking system is growing again in the U.S. after declining from 2008 through 2011 in the wake of the financial crisis. The value of U.S. financial assets held by money-market funds, hedge funds, trust companies and financial firms other than banks reached $25.2 trillion in 2013, for the first time exceeding the precrisis peak of $24.9 trillion, according to a November report by the Financial Stability Board, an international body of regulators.

U.S. shadow-banking assets accounted for about one-third of the global total of $75.2 trillion in 2013, which was up from $70.5 trillion the year before. And in the U.S., shadow banking is bigger than the more tightly regulated traditional banking system, which according to the FSB had $20.2 trillion in assets as of 2013….

“No U.S. agency yet has access to complete data regarding bank and nonbank financial activities,” Fed governor Lael Brainard, a member of the committee, said in a speech earlier this month…

Aside from the gray area about its authority to oversee nonbank financial firms, the Fed lacks some “macroprudential” regulatory and supervisory tools used by other central banks in recent years. Such macroprudential measures aim to maintain the stability of the whole financial system, in contrast with “microprudential” efforts to ensure the soundness of individual institutions.

The Fed, for example, can’t impose limits on loan-to-value ratios for home or business loans, as some other central banks have done.

Yves again. So this is a long-winded way of saying that monetary policy alone isn’t to blame for the last crisis. Bank deregulation created a lot of dry kindling that the easy credit match set ablaze. But since perilous little has been done in the way of reregulation, Roach is correct that the general conditions look a lot like those of the pre-crisis era, where easy money is going to all the wrong places. Stephen Roach again:

[O]fficials..focus on a new approach centered on so-called macro-prudential tools, including capital requirements and leverage ratios, to curb excessive risk-taking by banks. While this approach has some merit, it is incomplete, as it fails to address the egregious mispricing of risk brought about by an overly accommodative monetary policy and the historically low interest rates that it generated…

[T]oday’s Fed seems likely to find any excuse to prolong its incremental normalization, taking a slower pace than it adopted a decade ago…In these days of froth, the persistence of extraordinary policy accommodation in a financial system flooded with liquidity poses a great danger. Indeed, that could well be the lesson of recent equity- and currency-market volatility and, of course, plummeting oil prices…

Central banking has lost its way. Trapped in a post-crisis quagmire of zero interest rates and swollen balance sheets, the world’s major central banks do not have an effective strategy for regaining control over financial markets or the real economies that they are supposed to manage. Policy levers – both benchmark interest rates and central banks’ balance sheets – remain at their emergency settings, even though the emergency ended long ago.

While this approach has succeeded in boosting financial markets, it has failed to cure bruised and battered developed economies, which remain mired in subpar recoveries and plagued with deflationary risks. Moreover, the longer central banks promote financial-market froth, the more dependent their economies become on these precarious markets and the weaker the incentives for politicians and fiscal authorities to address the need for balance-sheet repair and structural reform…

The unprecedented financial engineering by central banks over the last six years has been decisive in setting asset prices in major markets worldwide. But now it is time for the Fed and its counterparts elsewhere to abandon financial engineering and begin marshaling the tools they will need to cope with the inevitable next crisis. With zero interest rates and outsize balance sheets, that is exactly what they are lacking.

Roach isn’t the first to point out that the Fed and other central banks have painted themselves into a corner, but his article make a particularly terse and urgent statement of the severity of the problem. But what seems particularly troubling is the degree to which the Fed is in denial. The central bank spends so much time cheerleading that it seems to believe that the economy is well on the way to normal and that the markets are healthy. While the degree of delusion may not be as bad as in 2005, when economists at Jackson Hole tore into Raghuram Rajan for outlining why financial deregulation had made the world riskier, this degree of difference does not appear to amount to a difference in kind. The Fed is wedded to being overly solicitous about the markets it can see, and that perversely includes the stock market, which prior to Greenspan was never considered to be relevant to central bank policy. Just like a decade ago, the Fed’s drunk under the streetlight behavior has high odds of producing bad results.

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  1. jgordon

    “…with each dollar of spending in an economy with high unemployment generating nearly $3 in GDP growth.”

    And if you feed an anorexic girl with three pounds of high fructose corn syrup every day she’ll gain plenty of weight in no time. She’ll also start resembling a beach ball and probably get diabetes eventually–but hey she gained weight so it’s a success, right? No, not really. Instead of this unthinking adulation of growth at any cost, why not look for ways to proactively shrink the economy before environmental collapse shrinks it for us? We should be appreciative to the central bankers, politicians and elites who are all doing their level best to hollow out and destroy what’s left of the industrial economy.

    1. Ben Johannson

      We should be appreciative to the central bankers, politicians and elites who are all doing their level best to hollow out and destroy what’s left of the industrial economy.

      If everyone were sharing pain equally you might make an argument, but under the current conditions you so vociferously praise the many suffer while the few live ever higher off the hog. How unethical can you be?

      1. jgordon

        Your value system is completely in opposition to mine. I consider the products of our industrial society to be a disease for the most part, not things to be sought after and glorified. In all honestly I pity the central bankers and politicians and other “winners”. They have cut themselves off from nature and live in an unreal world full of delusion and hubris.

        1. zapster

          The fact is, there’s no reason why we can’t have both. Infrastructure spending for switching to alternative energy, pollution cleanup, insulating homes, on and on and on pays *just as well* and can leave the environment in better shape. FDR employed hundreds of thousands in the CCC. Why can’t we? And we know that private investors sure as hell won’t. The answer is not in anything the fed can do, really. If it raises rates, it rewards the wealthy with free money, increasing the wealth gap. If it doesn’t, investors might be blowing bubbles–but with no fiscal spending going on those bubbles are literally the *only* “growth” still happening. Building expensive condos that just sit empty is stupid, but some construction workers get to stay in their homes a bit longer. All misdirected, but until congress gets it’s head out of it’s…sand…it’s still probably better than siphoning what little is still in circulation into treasuries. Just a guess…

          1. Procopius

            Right. I’ve been baffled by the “explanation” that we couldn’t have more stimulus because there weren’t any shovel-ready projects. Heck, there weren’t any shovel-ready projects back in 1934, either. A common joke at the time was that people were hired to stand around holding a shovel. And yet we had the CCC planting trees. It didn’t take long to produce plans to build hundreds of school buildings, court houses, and federal office buildings. Hundreds? I suppose more like thousands. Did they spend federal money on gravelling country roads? Dunno. Of course in the Great Depression Hoover’s policies were so unpopular that the Republicans couldn’t have hoped to completely block Roosevelt as they have Obama, although the Supreme Court sure tried.

            1. zapster

              You know, what no one ever really talks about is *why* they’re so opposed to spending on stuff we so obviously need. With wallstreet people in nearly every advisory position in government now.. could it be because government debt *competes* with wall street usury?? If people have real money, they don’t submit to the tender mercies of banks…

        2. MRW

          I consider the products of our industrial society to be a disease for the most part, not things to be sought after and glorified.

          Hunh? No doctors? No teachers? No planes or cars? No resorts selling leisure trips to families? No heaters in the winter? No independent writers and artists? No food at the grocery? Just scavenging for food in “nature?”

          If this idiocy constitutes your “value system,” you’re one mean sonofabitch. And you have zero understanding of macroeconomics and the constitutional edict (in the preamble) that the government must provide for the “general welfare” of the people. Why else would we have that social compact?

          1. jrs

            Many people have said no planes if there is any desire to control carbon output. No cars might be nice but hard with current city design many places.

          2. Fiver

            I value the rest of the living world a good deal more than I do the value of a humanity that insists on mindlessly destroying it. We already are a major extinction event in terms of all species extant since we showed up, and if we persist in this perverse ‘maximum capacity’ consumption model we will by the close of this century have created the boundary layer in future rock marking The Great Simplification of Life on Earth. A job well done.

    2. not_me

      Let’s us PLEASE leave behind the idea that FINANCIAL growth requires growth in the use of resources with the possible exception of energy* use. The former is NECESSARY because of our usury-based money system; the latter is NOT because of recycling, the increasingly efficient use of materials and because some industries such as education and dog walking require no resources beside human ones to begin with.

      That said, we would be far better off with regard to sharing and equity (puns intended) and justice IF we removed all subsidies for private credit creation and encouraged the use of shares in equity (common stock) as private money since common stock ALLOWS but does NOT REQUIRE even financial growth, much less growth in the use of resources.

      And while we’re at it, let us PLEASE leave behind the idea that we have free markets when we have government subsidies for private credit creation which, btw, subsidize rich equity owners at the expense of the poor and other non or less credit worthy.

      *And the use of energy should eventually level off to a sustainable level as the population levels off due to widespread economic security with a decent standard of living.

    3. James

      And if you feed an anorexic girl with three pounds of high fructose corn syrup every day she’ll gain plenty of weight in no time. She’ll also start resembling a beach ball and probably get diabetes eventually–but hey she gained weight so it’s a success, right?

      Nice analogy. And I read your last statement to the effect that since the current industrial economy’s due to collapse sometime soon anyway for any number of reasons, it’s nice (and deliciously ironic) that our knuckleheaded “leaders” are, in their efforts to save it, actually hastening its demise. Which is probably to be expected, given American Exceptionalism and all that.

    4. diptherio

      Yves, citing the IMF, is referring specifically to infrastructure spending, which is far from the equivalent of empty calories in a lot of places. NOLA still needs work on its levies, bridges everywhere need repair, etc.

      While I would prefer a low/no-growth economy, in terms of resource use, I don’t really feel comfortable arguing against policies (like fiscal stimulus) that would immediately make people’s lives better. Besides infrastructure, I would suggest home care for the elderly and rehab of vacant homes. Not all stimulus is the equivalent of high-fructose corn syrup.

      1. jgordon

        Sorry, but infrastructure spending is exactly what I was referring to as empty calories–you don’t build out or maintain a national highway system when liquid hydrocarbon energy is on the verge of becoming impossible to obtain for the average person.

        1. OpenThePodBayDoorsHAL

          Um, no. Americans need to get out more, visit a few places where the infrastructure is a delight. Almost any G-20 country’s airports (and lots of BRICS countries as well). Highways anywhere in France. Trains and trams in Switzerland. Anything in Singapore. Good reliable high-speed infrastructure not only pays for itself by reducing lost productivity but improves the quality of life, too. Instead the American Death Cult just wants to borrow and spend on new ways to kill people, I say bring back the Army Core of Engineers, yes they built lots of useless dams but the country seriously needs a makeover. If someone could just figure a way for one billionaire to make all the money from it I’m sure it would start immediately.

          1. jgordon

            All of that infrastructure you are admiring requires cheap, abundant energy in order to function. Cheap abundant energy is a temporary phenomena at best in nature, and we humans started discovering just how temporary our current glut is back in 2005 when our access to fossil fuels peaked out. Building out new airports at this point is like doing hip replacement surgery on someone in hospice dying of terminal cancer.

            1. MRW

              how temporary our current glut is back in 2005 when our access to fossil fuels peaked out.

              No, they didn’t.

        2. zapster

          Why can’t “infrastructure” spending be more rail? Invest in infrastructure that *reduces* consumption. Who said it has to be more highways? More windmills, convert the grid for the use of alternative energy sources, heck..install Solaroads everywhere ;)

          Allowing civilization to collapse instead will lead to forests being burned for firewood. Not exactly carbon-neutral. We can do this better.

    5. Code Name D

      Please, the central bank is not “hollowing out” the economy to save the planet. They are simply concentrating wealth at the top leaving the economy hollowed out for the rest of us.

      I also reject your argument that economic contraction at any cost is some how better than economic growth at any cost. The economy is the metabolism of human society. Its size/growth/contraction needs to be dictated by the needs of human society. If you want to save the planet from over consumption, I suggest you work on reducing the scale of that society. (Reducing access and waste would be a start, contracting the human population is another approach worth exploring.)

      1. jgordon

        Whatever your ideology happens to be, it does not trump the laws of physics. At the rate things are going now, the overwhelming majority of people on this planet are scheduled to die off for precisely the same reason that yeast in a petri dish die off when they run out of augur.

        The fact that our elites are destroying the industrial economy is simply a fortuitous happenstance that may allow some remnants of a functional ecosystem to still exist in the future–if they do it fast enough. A planned shrinkage of the economy would be ideal, but it seems like that is a process that will have to happen locally as the wider culture appears to have no stomach for it.

        1. Code Name D

          Please, the central bank is not “hollowing out” the economy to save the planet. They are simply concentrating wealth at the top leaving the economy hollowed out for the rest of us.

          I also reject your argument that economic contraction at any cost is some how better than economic growth at any cost. The economy is the metabolism of human society. Its size/growth/contraction needs to be dictated by the needs of human society. If you want to save the planet from over consumption, I suggest you work on reducing the scale of that society. (Reducing access and waste would be a start, contracting the human population is another approach worth exploring.)

    6. sgt_doom

      Stephen Roach? Morgan Stanley, which would have exploded if not for TARP bailouts/giveaways to the banksters, and which would profit also from TARP, by being one of those firms, along with BlackRock, to oversee the disbursement of TARP giveaway funds, is a valid reference?

      Don’t really give a fig what a Roach, or a Zandi or any other highway robbers, have to say!

  2. Robert Kelly

    Current policy makers have taken fiscal policy off the table. Contemporary politics favors an economy based on credit versus an economy based on income. So that only leaves the Fed and it’s monetary policy machinations as the only tools in the toolbox. Main St. is beholden to the trickle down of the wealthy. And the wealthy see how well it has worked for Japan, right?

    1. James

      And the wealthy see how well it has worked for Japan, right?

      Beside the point. The wealthy see how well it works for them.

    2. Yves Smith Post author

      So you are seriously saying that you should treat diabetes with antibiotics because that’s all you have?

      That is basically what the Fed is doing.

      1. Robert Kelly

        I guess I should have used an emoticon. I am in full agreement. My point is Congress leaves everything up to the Fed. They have all the fiscal tools (or medication) they need to stimulate Main St. But Wall St. advises them to stick with monetary policy. Japan is the best example of extended monetary policy. And every once in a while they get a spurt of growth and then they screw it up by raising taxes and slow it right down again.

  3. Jim Haygood

    ‘Now it is time for the Fed and its counterparts elsewhere to abandon financial engineering and begin marshaling the tools they will need to cope with the inevitable next crisis.’

    It always helps to read the minutes of the last meeting, which Roach has thoughtfully provided:

    ‘The Fed delayed policy normalization for an inordinately long period (2002-2004). And when it finally began to raise the benchmark rate (2004-2006), it did so excruciatingly slowly …’

    In this, our sixth year of blessed ZIRP, we’ve blown away those old records for inertia and intransigence. As poor Dr. Hussman has pointed out in a brief moment of lucidity, Greenspan-style 25-bip ‘baby step’ rate hikes will take years to have any effect on QE’s mountains of excess reserves. Thus one of the Fed’s levers for restraining bank credit expansion is immobilized with duct tape. Trying to do it with heroic rate hikes alone will cause serious distress in large swaths of the world running quasi-dollar pegs (I’m lookin’ at you, China).

    If I were Mr Yellen, I’d book a plastic surgeon appointment in Rio, then buy me a one-way ticket. When Bubble III blows, you don’t want to be here, with Jamie Dimon calling at all hours of the night to wheedle and harangue.

  4. Dino Reno

    And so where was Mr. Roach during the last crisis? Working for Morgan Stanley and keeping his mouth shut.
    Now he is free to speak out, but nobody still in power cares a fig about what he’s yammering on about. Telling the Fed to pull up its boot straps and allow price discovery at this stage of game is a fool’s errand. It’s not going to happen. We have gone all in on central planning and the entire world has taken up the game. Allowing market forces to determine real value would result in chaos and political collapse. This is just the beginning of growing trees to the sky.

    1. DCR

      Roach actually spoke out more than any of the prominent Wall Street economists prior to the last crisis, and his candor was rewarded with a one-way ticket to Asia where he would be less visible. It’s a miracle he wasn’t cashiered, which is the fate which fell to most of a very small group of Wall Street investment professionals who challenged the sanity of the negative-real interest rate monetary policy bringing riches to the Wall Street powers at the time.

    2. Jim Haygood

      Where was Steve Roach during the last crisis? Making the exact same point he is now. This is from April 2005, as Bubble II was inflating:

      ‘In an extraordinary display of policy accommodation, the real federal funds rate is only now moving above the zero threshold after having spent three years in negative territory. Of course, a central bank has little choice to do otherwise if it has made a conscious decision to underwrite the Asset Economy.’

      Roach also presciently pointed out that ‘Courtesy of an extraordinary shift to monetary accommodation, the pendulum quickly swung into property markets; US house-price inflation has since surged to a 25-year high.’

      It’s a mystery how Roach managed, in Clintonian terms, to ‘remain viable within the system.’ But he’s always been a skeptical voice, and anything but a Wall Street tout.

      1. sgt_doom

        I would categorically state that anyone “within the system” cannot remain viable!

        Reading recommendation: Jack London’s The Iron Heel — next, read Hellen Keller’s evolvement into a radical socialist.

    3. MikeNY

      I echo what others said above. Roach was a strident and vociferous critic of the Greenspan Fed, I remember, as early as 2002. And he never relented in his criticism. And he was right.

  5. Jackrabbit

    I feel that the “debate” about blowing bubbles was short-lived and one-sided. That’s probably because there never really was a “debate”. Just some prominent “private” economists giving cover to Fed policy. TINA!

    H O P

  6. NOTaREALmerican

    Sounds like people WANT the Fed to impose (GASP) AUSTERITY on the economy to punish the winners?

    But, if the “Progressives” can’t figure out why austerity is (GULP) “morally good”, how are they going to frame an argument that The Fed should impose (SHUDDER) austerity on “the economy” (the horror, the HORROR).

    No, I think the real problem is the “Progressives” and “Krugmanians” believe in the same thing: perpetual non-austerity eventually leads to goodness. So, if you click your heals together and wish real REAL hard, the non-austerity fairy will bring goodness to all the politically connected boys and girls throughout the land.

    1. Yves Smith Post author

      You apparently missed that:

      1. Real incomes of the top 1% have gone up considerably post crisis, while real wages for the bottom 90% have fallen

      2. We clearly called for more fiscal spending.

      1. DCR

        Real incomes of the top 1% in the U.S. have exploded due to the negative-real interest rate monetary policy championed by the MMTers. Something for nothing at its finest! And the same thing has happened in Japan where fiscal spending is perpetually reckless. Middle class real incomes are falling even faster over there. Congratulations!

          1. DCR

            All should listen for themselves to assess what the MMTers recommended in the past, and who on this blog lies to obfuscate their past when things deteriorate as a result of nations following their economic lunacy. Here are Dr. Stephanie Kelton, Dr. L. Randall Wray, and Dr. William Black discussing in October of 2013 their views on where the film “Money For Nothing” went awry. The interest rate discussion really begins about the 36:20 mark. They state categorically that they are fine with zero percent interest rates, fine with printing money to facilitate fiscal deficit spending, and unconcerned with any possibility of currency effects. Millions of Japanese are now suffering the declining real incomes which result.


            1. Yves Smith Post author

              All you have done is demonstrate that you don’t know what MMT is, nor do you understand the difference between monetary operations and fiscal spending.

              Abenomics were not about zero interest rates. Japan has already had them.

              Fiscal spending is also not Abenomics OR QE.

              You’ve basically demonstrated that you are deeply confused but are still eager make off base accusations and vent your spleen at people who recommend policies that have NOTHING TO DO with QE or Abenomics.

              And the Japanese desperately want the yen at below 120 to the dollar. That is the one positive thing that Abenomics might have achieved. The US also should want the dollar to be a ton cheaper, but since everyone wants their currency to be cheaper right now, no country will be allowed to get very far playing that game.

              1. DCR

                As I have stated before, since it’s such a great thing you and any of the other MMTers are more than welcome to sell to me all of your yen or your dollars for an exchange rate far cheaper than that which exists right now. Funny that no one has ever taken me up on my offer! I guess it’s only a great thing when you impoverish others.

                1. Joe Firestone (letsgetitdone)

                  You’re deliberately missing the point. The Japanese are keeping their currency lower than it ought to be to export more to ourselves and other nations. In doing so they are increasing domestic employment and also the price of imported goods and services to their people. That’s a bad choice because with a lower yen they could lower the prices of imported goods, and also have full employment, if they also implemented a job guarantee program.

            2. Joe Firestone (letsgetitdone)

              Actually, that’s not exactly what they say. If you go to the beginning of the interview, you and others will find Stephanie Kelton pointing out that when there is deficit spending, the natural tendency of overnight interest rates is to fall to zero and that the Fed must always ACT to counteract this tendency to produce higher interest rates. The three are also quite clear that the reason why they’re happy with low interest rates, is because they think the Fed ineffective in creating a better economy through monetary policy, and that they’d prefer that the Fed not monkey with rates, but that instead business cycle and unemployment problems are best addressed through fiscal policy.

              I don’t believe Randy, Stephanie, and Bill said they are OK with “printing money.” That’s your terminology, not theirs. That said, the following should be noted.

              1. Since the US left the gold standard in 1971, all High-powered US money has been created by the institutions of the Federal Government including the Fed. So, you can’t distinguish between Money that exists and money that is newly created by using the epithet “printing money” to describe it in comparison to the money that had existed before its creation.

              2. Deficit spending can be done along with debt issuance, or without it. Perhaps it’s the last circumstance that leads to you to talk about “printing money”. If so, you show know that yes, MMT economists are OK with deficit spending not matched by debt issuance. the reason is that with it or without it deficit spending always leaves new net financial assets in the private economy in the amount of the deficit spending.

              If debt is issued the NFAs involved are the securities the Treasury sells, and if debt is not issued the NFAs are in the form of the reserves created by Treasury spending. MMT analyses by Scott Fullwiler and myself, using Scott’s framework show that when debt issuance is used that is more inflationary than the result when it is not used. That’s because the Treasurys can be leveraged at private banks, and also because the government pays more interest on securities than it does on reserves.

              3. The Japanese have never followed MMT-based policies and are not doing so now. They practice QE and keep low interest rates. But by itself that I not an MMT regime. They provide no Job Gurantee to workers and also their fiscal policies are not guided by an analysis of the likely impacts of those policies, nor are guided by any considerations related to the Sectoral FInancial Balances (SFB) model. Without these elements and others related to containing inflation, you are not talking about anything near MMT – like.

              4. I don’t know what you mean when you blame MMT for the currency effects creating hardships in Japan. Japan generally doesn’t allow its currency to float against the dollar but instead tries to maintain a weaker currency because it wants to be able to continue to have a trade surplus with us. MMT says that Japan is compromising its fiat currency sovereignty by doing things in this way, and says that it is better for one’s consumers to allow one’s currency to float.

        1. stf

          we had negative real rates quite a bit b/n 1940-1970 and income inequality generally decreased over that period.

  7. pigeon

    There is another aspect why the Fed policy should fail. It creates exactly what it wants to prevent, i.e. deflation. This is because in a world starved of demand, reducing the cost of capital leads to speculative investment that ends up as overcapacity of some sort, depressing prices. The first price that is depressed is that of money itself. This would only be helpful in a supply constrained world but apart from that only be one important part of deflation. The second price appears to be labour, since now capital investment has gained a competitive advantage over labour. Then, with the evolution of large overcapacities in the housing and industrial sector, the prices of goods become depressed. The first casualties are the miners, then it will move on to higher stages of production. All this is a long way of saying that monetary pumping cannot stave off a deflation cycle. It can only make the final deleveraging process more painful. I have the impression that the people at the Fed misread the current deleveraging cycle. The compare it to the great depression and therefore employ strategies that might have worked then but do not now, since the current situation is in many ways different.

  8. fresno dan

    “Most of them have been fixated on the risk of inflation, which is not in the cards as long as labor bargaining power remains weak”

    The FED has the good fortune, just as Bill Clinton did, of having the screwiest enemies drowning out the very serious and valid criticism of the FED’s kowtowing to banks.

  9. Roland

    Good article, but it still repeats the old-fashioned idea that price inflation depends on workers’ earning and negotiating power. One of the lessons of our own interesting little era is that centrally-stimulated lending can maintain a surprisingly steady and grinding price inflation, even in the face of stagnant wages for the mass of the people.

    I agree that hyperinflation is not the concern. But inflation doesn’t have to be hyper to be harmful. The inflation rate just has to exceed your earning power over a period of time, in order for it to effectively liquidate you.

    One might ask, “how can that go on for any significant length of time?” The answer is easy: where income cannot provide purchasing power, debt substitutes.

    But why would anyone lend ever-increasing sums to large numbers of people whose income is flat or declining? Easy: central authorities artificially lower the risk. Bad risks become good risks, just like that! Isn’t that part of what this article is all about?

    Result: the bourgeoisie’s asset values are boosted, while the proletariat bury themselves in debt. The central authorities have so decreed.

    Bonus points: poor borrowers are in a weaker social and political position than poor earners, even if their standard of living and level of education appear higher. That might be just one more reason why the proletariat in most of the developed world have at least so far proven to be politically supine.

    At this point, though, raising interest rates would probably only serve to “lock in” the imbalance that has built up. With low interest, the proles borrow more to cope with rising prices. With high interest, the proles can never pay it back. With low interest rates, the bourgeoisie make nice capital gains. With high interest rates, the bourgeoisie who own the debts do just fine. I believe this is what the bourgeoisie refer to as a balanced portfolio.

    As long as the bourgeois class controls the central authorities, the decrees of those authorities will serve bourgeois interests. The bourgeoisie don’t require any particular monetary policy–they just require control of the policy-making organs.

    1. cnchal

      At this point, though, raising interest rates would probably only serve to “lock in” the imbalance that has built up.

      I think of this imbalance as a tightly wound spring on a hair trigger, and a little jolt in interest rates will trip it.

      With low interest, the proles that borrowed have lower payments to the bourgeoisie that lent them the money.

      With high interest, the bourgeoisie will end up with a capital loss on the value of their loans to the proles, and the proles stop or reduce their borrowing.

      The financial system is saturated with debt at low interest rates and any debt that cannot be rolled over at higher interest rates is a stick of financial dynamite.

      Locked and loaded.

      1. Llewelyn Moss

        And as a Super Bonus to the Bourgeoisie, the #Cromnibus spending bill just made automatic banks bailouts into standard operating procedure (if I understood it correctly). So no more messy voting on TARP authorizations with the next financial collapse? All the bad debt gets automatically transferred to the taxpayers and the bankersters award themselves huge bonuses. Will the collapse happen on Groundhog Day and Bill Murray wakes up in Punxsutawney PA?

        My questions are:
        1) At what point does the taxpayers debt from future bank bailouts reach an unserviceable level?
        2) When does the Fed reach a debt level that prohibits it from buying up more bad debt to save the bankers?

  10. Pwelder

    Thanks for this link. Roach is always worth the time, and this column is no exception.

    Speaking of Ghosts of Christmas Past, ECONNED is now on sale, cheap. (It shouldn’t be, but it is.) This book is a long-term keeper; and an ideal gift for any of your kids, nephews, nieces, etc. who are into current events, economics, money & banking, that sort of thing. In the $1 – $5 range, which seems to be the going rate for a decent hardcover copy, it’s a screaming steal.

    To my eye the book is not dated at all. (Yves might think differently on some points, as she watches this stuff every day). If enough of us buy it, and put some of the money we save into the fundraiser, maybe we can get Yves to do a What-I-Know-Now-That-I-Didn’t-Know-Then post. That alone would be worth more than the book is going for.

    Here’s a link to the book on Ebay’s

    Happy Holidays to all, and best wishes for the New Year.


  11. nothing but the truth

    the long term problem is that dissent has been silenced. if you disagree with the Fed/Obama view you are “out” and cronies will take over your domain.

    this has become more and more a “political economy” ie cronyism. this necessarily leads to weakening of the immune system by inbreeding of ideas.

  12. Jay M

    inhale: steve has been over in hong kong
    exposulation: he was too negative, long risk short intelligence he said
    Well did crater, though the craters were in the other neighborhood
    was quite the coup de grace and scooped up the foreclosed at bottom price
    inhale: Wouldn’t be a profit if there wasn’t the other person.
    damn, where’s the roach clip?

  13. ewmayer

    Roach writes: While this approach has succeeded in boosting financial markets…

    Anytime you hear anyone speaking of the Fed’s (in)famous “dual mandate” ([1] full employment and [2] stable prices – note *not* the ‘stable price inflation’ the Fedsters natter on about), check yourself and bear in mind that the only mandate the FedHeads really care about is the above, unwritten third one. These folks see *everything* through the at-best-highly-distorted lens of the financial markets.

    Since they have done a miserable job addressing mandate [1] and blithely ignore mandate [2], instead claiming to target ‘stable inflation’ which they simultaneously grossly mis-measure with their made-up bogus metrics (e.g. Owner’s Equivalent Rent as a supposed proxy for home prices, which conveniently omits bubble-priced housing from their readings of inflation). Thus, they are in flagrant, black-letter violation of their own charter every second of every day. Not that such considerations carry any weight whatsoever in post-rule-of-law America.

  14. Fiver

    The very idea that there was a throttle on the economy, and that’s all that mattered, strikes me as Second Industrial Revolution, whereas the financial system now resides in the Third, or rather, the Third’s virtual projection of itself – a giant romper room of predatory wealth extraction that must be ‘saved’ at all cost.

    It certainly appears Roach, by his comparison places the ‘next crisis’ a couple years down the road, as all those spectacular, unearned, Fed-induced gains for those wealthy whose money actually is the shadow banking system looks for ‘gains where there be no gains’ in some sort of blow-off like the last crisis. That places it around the 2016 elections. If that were to occur, I would consider it pretty much conclusive the 8-yr Presidential cycle bust is a feature.

    Stupid question for the day: if the assets won’t hold value unless constantly inflated, inflated so much a ‘shadow banking system’ of already artificially appropriated ‘wealth’ has been re-created, even exceeded, why not think the line is already crossed, i.e. instead of looking around and seeing ‘froth’ today, why wouldn’t it already be ‘Bubbles’ – and big ones, too? There are countries going down like duckpins, which unlike some very big players recently, won’t have their salvation tucked into a Budget by the President’s Banker. Roach’s apparent assumption, that there’s nothing else ‘out there’ right now, of any size large enough to cause the ‘next crisis’, sounds almost reassuring – as if the ‘oil shock’ bought some time (note: I see it reported that the Saudi budget puts oil at $80). We’ll see. Meanwhile, a line up at the IMF is forming.

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