Bernanke

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Central Banker Problems

The more I think about Bernanke’s press conference and the ongoing fiscal mess in Europe the more I learn to lower my expectations about central bankers. They all appear to be mere appendages of the banking system. By which I mean they see all the world’s problems through the prism of the magic of the credit markets, sovereign debt levels, and the intricacies of the international financial system. Apparently they cannot tell the difference between the idiocy of the banks, and a government deficit problem. In other words the emphasis in the phrase ‘central banker’ is decidedly on the banker.

And that is not good.

They are all treating the existence of high government debt to GDP ratios as an outcome of irresponsible policy. They thus rush to urge austerity measures to bring deficits under control, and to advocate higher interest rates to forestall the inflation that believe to be an inevitable consequence of those deficits.

This is rubbish.

Why?

Because in most cases – Greece is the exception – the current bout of sovereign debt growth is a consequence, not of bad policy, but of toxic banking. It was the private, not the public, sector that precipitated the crisis.

So they are busy curing the wrong disease. Which means, of course, that we will fall sick again. High debt levels are a symptom of bad banking. Inflation is not just around the corner. Austerity will slow economies not fix them.

Consequently, pretty much all policy, as it now is conceived, is wrong. The old adage of ‘first: do no harm’ evidently didn’t make it into the hallowed halls of central banking. In their rush to protect their banking buddies, and to stabilize the ‘system’, central bankers have deliberately overlooked, forgotten, or just excused the real culprits.

The banking system doesn’t need saving.

It needs fixing.

By ignoring this simple fact, the central bankers have become accessories to the enormous scam the banks have run. They have added to, not diminished, the moral hazard they all bemoan.

Foisting the full cost of fixing everything onto various nation’s households is a terrible dereliction of duty. They were, by and large, innocent bystanders. The creditors, shareholders, and managers of the banks should have paid the price. They didn’t. You and I did.

And when I say that the banking system needs fixing, I do not mean a tweak here and there. Or the adoption of a few cool looking back-up plans to expedite the dissolution of big banks. Those plans will be worthless the first time they are needed. They will fail under the strain of international argument over jurisdiction. And the banks will find ways to bamboozle politicians into bailing them out again.

No doubt the central bankers will aid and abet that bamboozlement too.

After all they went to the same school[s]. No?

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Fed Failure

Paul Krugman is apoplectic. He is right to be. He even has this nifty ‘cloud’ of the words used in Bernanke’s speech and press conference to back up his assertion that the Fed has taken its eye off the ball. I would give him credit for that cloud had my friend Stephan not brought a similar one to my attention two weeks ago. So kudos to Stephan: you beat Krugman to the punch.

But what of that Bernanke speech? Why is Krugman right to be mad?

Simple: the Fed has two goals in its charter. One is to keep prices within the bounds of reason. This means bottle up inflation when it seems like getting out of hand. Or get rid of it when it is already out of hand in the manner of Paul Volcker’s famous attack that precipitated the 1980 recession. Volcker’s method may have been draconian, but it set the stage for thirty years of quiescence.

The second goal is to foster full employment. Whatever that is.

So. How is the Fed doing with respect to its goals?

Not very well. Badly in fact.

This is the setting within which Bernanke made his views known at his press conference this week: we have around 14 million people unemployed, and millions more underemployed – working part time when they would prefer to be full time. Plus we have core inflation below the Fed’s target range.

So the Fed is failing on both its goals. Having inflation too low is just as bad, in many ways worse, than having it too high. And we all know the economy is a very long way from full employment.

Given this failure, a reasonable guess would suggest plenty of discussion about further efforts to boost the economy, encourage hiring, and even push up inflation.

This would be wrong. Very wrong.

The entire preamble by Bernanke went in that direction, getting our hopes up that he was going to prolong the Fed’s easy money, and perhaps, launch QE3. Then, suddenly and out of nowhere, he vectored off into how urgent it was to watch inflation and begin the exit from easy money. Heck, the only thing he didn’t do was raise rates.

This was, and is, absurd.

The economy is still mired in no-man’s land. Neither strong enough to encourage investment and expansion by business, nor weak enough to stop the hawks from whining about their fears of inflation. We are truly stuck. Because of this, each side in the debate is able to cancel the other out and our policy makers stumble about trying to appease the more vociferous. That would be the hawks. Apparently we need a cataclysm to persuade the Fed to take a look at its charter and to follow through with expansionary policy. Barring such a disaster they are content to appear ‘serious’ by running on about the woes of inflation, and the horrible things the bond markets will do if we don’t act like grown-ups. Which in this case means being stupid and pretending inflation is high enough to cause disruption to our supply of credit. Even if it’s not.

My father had useful words for this kind of nonsense. Unfortunately I cannot use them in public.

One of them describes Bernanke really well.

I have said this before, but it bears repeating: for some reason that is not at all supported by facts known to me, our leadership – in both business and politics – has decided that it is time to move on from solving the problems caused by the crisis, and look to the future. They have begun to squabble aboutsolve longer term problems, whilst leaving the shorter term ones to resolve themselves. They have abandoned the unemployed and have become obsessed over something that has no manifestation here on earth, but which exerts an incredible hold over their imaginations.

Some of them never did care. They are the ideologically driven ones who despise all aspects of government intervention in the economy. They think markets fix themselves, and that we should allow the disease to run its natural course. Even if we have discovered the cure. Next time one of them is sick we should remind them that the human body is also fairly adept at fixing itself, so they should grin and bear all the consequences of fever, and so on. After all, why truncate the full cycle of nature by resorting to man-made palliatives? It’s healthier to avoid intervention. So they say.

That is, of course, hogwash.

It’s actually mean spirited and anti-social.

But what of those who are not motivated by anti-social ideology? They know we have the cure. Why not use it?

Fear. They don’t want to be seen as frivolous, or non-serious. And right now ‘serious people’ know – they just know and don’t ask how – that there are awful consequences lurking around the corner waiting to undermine us. These are the monsters in the closet we all used to fear as children. They go bump in the night. The bump is imagined to be so big that we need to abandon our weak and poor and cave into to the bankers and traders who are sending a very strong message that we need to rein in spending and curb imminent inflation. Or at least the fear crazed think that’s the message.

In truth, the message is so weak, if it exists at all, that it scarcely registers. Standard and Poor’s made some noise about the debt, but it had no effect on interest rates. The markets yawned. If there are fears of inflation out there in the markets they are very well hidden. Besides, the biggest mover of inflation, the thing that can set off the dreaded inflationary spiral we all fear most is wage costs. Not just absolute wages, but wage costs. This morning we heard that the wage cost index rose – roll the drums – 0.6% in the first quarter. Of that paltry number over half came in the form of rising health care costs. Less than half came from actual wages going up. Wages are going nowhere. Hence inflation is going nowhere. Yes, there are concerns over raw materials, food, and oil. But those either form a small part of the overall cost base, or are highly volatile and will ebb once we experience a good harvest or quiet in the Middle East. Those may be big “ifs”, but they are not so permanent as to justify abandoning our poor, weak, or unemployed. Besides, as I have said before, a little burst of inflation, say at about 4%, would do us all good. It would lower real interest rates and ameliorate debt burdens. Two things we need right now. But, no, that’s not being serious.

So the fear factor, the need to appear serious, is now so pervasive that even Bernanke cannot resist the hawks. He is being bullied by superstition and those funny sounds in his closet. He is seeing ghosts and hiding under his pillow.

Too bad. There are a whole lot of real grown-ups who need his help.

Giving the Fed its deserved failing grade is scant compensation for those folks. They need help. They won’t get it. The Fed is acting grown-up. Which in our topsy-turvy world is actually much like a frightened child.

Don’t say “BOO” too loudly, the Fed may raise interest rates.

Fed failure indeed.

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Ideology, The Fed, and The Blame Game

Here we go.

The next couple of years promise to bring us lots of fun as the newly elected Republicans bring their libertarian notions into the public gaze and out from the shadows where they have lurked hitherto. Today we got off to a good start as Ben Bernanke was quizzed in one committee, while in another we heard from a professor who call Abe Lincoln a tyrant. According to him secession is the only way to bring back the liberties stolen from us by the big bank, counterfeit money socialists who now infest Washington DC.

Fun times indeed.

This is not a time to be Chairman of the Fed. The Republicans have long had a visceral dislike for anything that smacks of a central bank intent on using monetary policy to solve our unemployment problem. There are rumblings that we will see an initiative to strip the Fed of its dual mandate – on both inflation and employment – and instead restrict it to just inflation. This is in reaction to all the unconventional efforts the Fed has made to help lift the economy over the last two years. In particular opposition to QE2 has crystallized around the dual drum beats of inflation fears and Fed over reach.

So in his appearance before a Congressional committee today poor old Bernanke was grilled relentlessly about the way in which Fed policy was threatening to undermine the economy by stoking uncontrollable inflation.

‰ÛÏMy concern is that the costs of the Fed‰Ûªs current monetary policy ‰ÛÓ the money creation and massive balance sheet expansion ‰ÛÓ will come to outweigh the perceived short-term benefits,‰Û?

This was how Representative Paul Ryan, the lead GOP spokesman, put it. Those costs being a burst of inflation. Not that Ryan backed up his argument with much data about that burst. He simply pointed to rising commodity and raw material prices, and higher bond yields. Since there isn’t any sign of a surge in inflation just yet, he had to limit himself to dark warnings that if, and when, such a surge crops up it would be hard to contain.

I agree. It would be hard to contain. Inflationary expectations, once baked into prices, wages, and contracts, are hard to reverse without vigorous counter measures, usually the inducement of huge slack in the economy sufficient to eliminate both pricing power and expectations simultaneously. Those of us who lived through the Volcker recession back in the early 1980’s can recall the amount of pain needed. We all want to avoid a repeat.

So, is inflation a threat? No. This is a problem for those ideologically inclined to look for it.

Prices are rising in some economies, especially in emerging nations, where demand has increased rapidly. In other places supply constraints caused by crop failures are putting pressure on food prices. These are both real issues and we need to follow them closely. But neither have anything to do with recent Fed policy. And the US economy is not showing much, if any, sign of those problems occurring here. So Ryan’s fears are entirely hypothetical at the moment. Which, unfortunately, doesn’t prevent him from encouraging the Fed to cease its support for the recovery.

We all need to take a deep breath and be sensible here. Core inflation was 0.7% in 2010, and trending down still. In the last year before the recent calamity it was 2.7%. Since 0.7% is both negligible and below the Fed’s target range, there is no current need to react by raising interest rates. At least if you are driven by data. To raise rates now would blunt and possibly reverse the recovery. We should wait a while longer, at least until unemployment has started to trend down consistently.

If you are driven by ideology the story is very different. Hence the Wall Street Journal’s almost daily headlines about inflation fears spreading [From where to where? Perhaps from the editorial page to the front page?] The point being that there is a large group of politicians and others who are motivated not by any facts they can gather, but by an opinion they hold. That opinion being the Fed has no business helping prop up the economy. We should, they say, let the market do its work. We have heard this story before. These folks overlook the inconvenient, but noticeable, fact that it was the market that sent us tumbling into the abyss. It was a private sector failure, not a government policy failure that launched us into crisis.

Or was it?

That is, of course, just my opinion. It would be nice if we could get some objective agreement about what started the crisis boiling up.

Then again, if you read the Financial Crisis Inquiry Report published last week, the ideological divide is so wide there is no agreement about the true causes of the crisis. One side – the Democrats – gave us a dull recitation of events, and ended up blaming banks, deregulation, and the rating agencies; while the other side blamed the government. Actually the Republicans were divided into two factions. One blamed the government. And the other blamed the government even more. Overall the most reasonable comment in the entire 500+ pages of the report came from a lone right wing dissenter who wondered out aloud why American banks and personalities like Greenspan could be blamed, when a real estate bubble blew up in so many other countries too.

No one, apparently, wants to admit that economic policy in the US has been off track for decades and that the entire world was awash with cash needing a home. That cash ended up fueling ridiculous home price increases wherever delinquent bankers could get their hands on it, and wherever lax oversight, a collapse of credit standards, and mass hysteria on the part of home buyers combined to destabilize things enough. Which is to say in plenty of places. Not just in the US.

Given that the FCIC was ideologically split from the beginning it was always a long shot that it would produce anything useful. Besides it published its findings long after politicians had embarked on whatever ideologically predetermined course they chose.

Personally I go a little deeper and argue that the crisis was the logical outcome of three decades of illusion during which we undertook a sustained experiment in market based solutions to problems; reduced the government’s ability to act as a bulwark; and engaged in social engineering to induce more home ownership than is either sensible or sustainable over the long haul. In the US both political parties are culpable. And along the way no one paid attention to the huge inequality in incomes that inevitably distorted both the shape and source of demand. Of course a whole lot of people did stupid things like overpay and under save with respect to real estate. We were encouraging them to. We gave them incentives to. And getting deeply into debt was the only possible way to keep the “dream” alive: wages were stagnant.

It was this rotten wage performance that drove so many people over the edge, and made them very vulnerable to the siren song sung by the banks and other mortgage lenders who were trying to find uses for the enormous flood of credit slopping about the globe. When regular people felt their living standards under pressure, and when bankers saw an opening for enormous profit, it became a perfect storm. Desperation met lack of scruples. In other words it was government – both inaction in the form of deregulation, and action in the form of housing policy -that did it. And the private sector too. There was fraud, a remarkable collapse in ethics, greed, shiftiness, and plain stupidity. The system went haywire. We collectively lost our minds and created conditions in which predators could stalk the streets uncaring and untouched.

In such circumstances, establishing blame is simply an attempt to meet the ideological need to avoid taking responsibility.

Stagnant wages; excess credit creation; and inequality. Excessive deregulation; unfettered capitalism; and lost ethics. Imbalances all.

We need policies that re-establish balance. Not ideological bun fights over Fed activity.

How the heck calling Lincoln a tyrant fits into anything remotely useful I have no idea. But these are the things we will be hearing about for a while now.

As I said: fun days indeed.

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Sticky Unemployment – Okun’s Law

A regular correspondent of mine – Stephan – suggests that I add an addendum to my comment yesterday about the current hyperbole in the media. To refresh your memory, one of my points was that even rapid GDP growth in 2011 is not likely to reduce unemployment significantly, and that to restore the economy to more normal levels of unemployment, or to reach the level economists call full employment, could take years. Lots of years. The point being that we should not get carried away by all the current breathless talk of “surges” or “booms”. That seems just to be Wall Street speak. Stocks may do well. Regular folks less so.

At any rate the basis for my assertion is something called Okun’s law, and it is to this that Stephan thinks I should make specific reference. So here goes.

Like many so-called laws in economics Okun’s law is really more a rule of thumb based upon a detailed review of history. The essential conclusion is that there is not a one-for-one relationship between shifts in GDP and changes in unemployment. For unemployment to move by 1% the typical shift in GDP has to be about 2%. Interestingly one of the authors who has articulated this relationship in detail is none other than Ben Bernanke. So we should assume he is well aware of the hill we still need to climb to get back to health.

Putting this in our current context we can see that growth has to do two things. First it has to cover, or absorb, growth in the workforce due to population changes. A good rule of thumb in the US is that GDP needs to rise by about 2.5% for unemployment just to stay even with such changes. Only after that does Okun’s law kick in. This suggests we need to see GDP growth of 2.5% + 2.0%, i.e. 4.5%, per annum just to bring the unemployment rate down by paltry 1%. And we need to keep repeating this for years on end to undo the terrible damage wrought during the crisis.

So movements in unemployment are “sticky” with respect to overall economic growth. The two do not move in tight lock step.

Growth at those heady 4.5%+ annual rates is well above the long term average for the US.The last time we saw such a string of years was at the end of the 1990’s. For the four years 1997 through 2000 GDP grew at an average of 4.45% per year. We remember those years as exceptional rather than the norm. Given the hobbled nature of our economy and its financial imbalances, not to mention the possibility of anti-growth government spending cuts at the federal and state levels in the near term, I just don’t see the economy making the headway we need.

Most forecasts are for the economy to grow around 3.5% to 4.0% this year, and then to taper off beyond that as various stimulus efforts fade, the atmosphere of crisis gives way to the need to rein in debt, and the emphasis turns to spending cuts or tax increases. It is very difficult to construct a credible forecast for growth sufficient to bring unemployment down to acceptable or more normal levels during this entire decade. Our economy is mature and still very vulnerable to the whims of an unrestrained banking sector. Also, the likelihood, in my opinion, is that somewhere in the next ten years we will see another recession caused by financial instability, an event that would undo all the good work up to that point.

So, putting this all together: Okun’s law provides us with an empirical basis for making the assertion that we will not return to normal unemployment rates during this decade. Further, current and likely policy will make matters worse. This is the reason some observers, like Paul Krugman, talk of a Japanese style “lost decade”. History supports that pessimistic view. The counter view, the more optimistic spin churned out on Wall Street and similar upbeat places, is not based upon a review of facts, but is simply opinion. There is no hard evidence to support the optimists, and no amount of wishful thinking can substitute for empirical study.

In the absence of such hard evidence to the contrary I will go with Okun and his law.

We are in for a long slog. Get ready.

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What Inflation?

If there is one economic factor that the experts on Wall Street have consistently been wrong about, it is inflation. Ever since the great intervention in the economy after the Lehman implosion these analysts have been explaining that the consequent huge increase in the money supply would inevitable – inevitably – produce a sharp increase in inflation. This line of reasoning has been taken up by the right wing echo chamber and is now approaching full blown cacophony.

For two straight years we have been lectured by these orthodox economists and their various political hanger-on that the policies of the Fed and our neo-socialist government will do nothing but untold harm to our economy. Those policies will, they say, lead not to economic health, but to economic ruin brought on by the debasement of the dollar and an associated, uncontrolled, burst of inflation. It is this prospect, so they say, that is preventing businesses from investing, and is undermining consumer confidence.

Government is the problem.

Where have we heard that before?

Those of us who argue differently are dismissed as crazy interventionists who don’t realize the consequences of this supposedly reckless monetary regime.

Well.

Let’s look at the facts.

Inflation, when we take away the volatile stuff like food and fuel, has steadily chugged down a disinflationary path. The experts have been wrong in their forecasts for twenty-four months and counting. It is this adjusted, or core, measure of inflation that we look at to understand the trend of prices within the economy. Food and fuel prices jump about all over the place and tend to mask the underlying trend. This is not to say that those jumps are not real, but that they do not signify anything of deeper meaning within the overall price structure of the economy.

And what is today’s news about consumer prices?

The unadjusted Consumer Price Index rose just 0.2% in October. Core inflation was flat for the third month in a row, and has risen only 0.6% over the last year. This is the lowest level of core inflation ever reported. The trend line is still downward. We are perilously close to deflation and getting closer each passing month.

In other words the facts completely refute the imminent inflation disaster argument. Utterly and totally refute it.

Not that I expect it to go away. Those who fan fears of inflation do so on the basis of two things:

  1. An ideological dilike of government intervention in the economy
  2. A misreading of the economic situation

The ideology is well known and often drives otherwise sensible people to hold odd and anti-socail policy positions. The second is less well known, but is more pernicious since is based upon wrong headed economic theory.

So, to make my case once again: We are stuck in an odd economic situation. The normal outcomes from an expansionary monetary policy, assuming strong employment and demand, could be upward pressure on prices. That assumes the economy fails to expand in real terms in response to the change in money supply. But. These are not normal times. In fact we are so far from normal that we may not return there for a decade or more. We have an economy with a very large gap between its capacity or potential and its actual level of activity. We are going through a steady reduction in debt, and that implies a loss of cash for spending. We have very weak employment to go with this weak demand. Flooding money into this kind of economy may reduce interest rates enough to stimulate activity, but it will not shift prices.

Think about this from a practical business point of view. In the face of weak demand for your products, it makes no sense to raise prices. It makes sense to cut them.

If enough businesses cut enough prices we enter deflation.

If demand for the stuff needed to make consumer goods is sufficiently weak, those prices will drop too. And that includes wages.

The only reason that commodity prices are jumping about at the moment is that many emerging economies are growing well. It is not a reflection of overly strong demand in the developed economies.

So the experts are absolutely wrong. Inflation is nowhere in sight. Those folks who signed the letter published in the Wall Street Journal two days ago were urging the Fed to back away from its “inflation inducing” policies. Their point of view is thoroughly debunked by today’s news.

Will we see them change their mind in view of the new facts?

Of course not. Why let facts get in the way?

Fact based policy making is so yesterday.

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