The Fed vs. the Tipping Point

Ambrose Evans-Pritchard collects some more timely quotes and adds one truly scary metaphor in an attempt to give proper context to all the actions taken by central banks around the world over the last few weeks, notably the Federal Reserve.

You pretty much know where things are probably headed just from having a quick look at the title - Federal Reserve is damned either way as it battles debt and deflation - but there's a surprising amount of nuance involved too, beginning with the scary metaphor.

"Such a disaster is somewhat like the capsizing of a ship which, under ordinary conditions is always near stable equilibrium but which, after being tipped beyond a certain angle, has no longer this tendency to return to equilibrium, but a tendency to depart further from it," he said.

Today we call this "Gladwell's tipping point". Once it goes, you can't get back up. This is why the Federal Reserve has resorted to emergency measures that seem mad at first sight.

Ruh-roh. "The bond markets could go into free fall," said Marc Ostwald from Monument Securities. Hopefully, we're not yet past the point where "it goes". The subject then turns to the reason for the tipping - debt deflation.

Brian Reading from Lombard Street Research has revived this neglected thesis and come up with some disturbing figures. US household debt is now $13.9 trillion, down just 1pc from its peak last year. Meanwhile household wealth has fallen 14pc as property crashes, a loss of $6.67 trillion. The debt-to-wealth ratio is rocketing.

Clearly the US is already in the grip of debt-deflation. "The obvious conclusion is that the Fed should print money to purchase private sector assets so as to drive up their price," he said.

Fed chief Ben Bernanke does not need prompting. He made his name as a Princeton professor studying the "credit channel" causes of depressions. Now fate has put him in charge of the channel.

Or, so they say.

That much should be obvious by now, the real question becomes whether it will work.

Ambrose notes that Ben Bernanke is "deliberately stoking inflation", but clearly, a better characterization at the moment would be the breaking of ever larger smelling salts under the nose of a prostrate fighter who, so far, has failed to stir.

The final notable quote pertains to what might happen when consciousness returns and all the liberally applied money, credit, government guarantees, low interest rates, and asset purchases gain traction sometime next year causing the "Treasury bubble" to burst

"The Fed went into this all guns blazing just as the Neo-cons went into Iraq thinking it was a great idea to get rid of Saddam, without planning an exit strategy. As soon as we get the first uptick in inflation, the markets are going to turn and say this is what we feared would happen all along. Then what?" he said.

Exit strategy?

Time and again, economists have cautioned that you can't worry about water damage when you're trying to put out a once-in-century fire.

Besides, in-flation is a lot easier to tame than de-flation.

Comments

[L Moore:]

row row row your boat...life is but a dream

Traders will anticipate Bernanke's moves and game him. In the end his actions will be thwarted.

2008 Dec 19 02:39 PM

[bosun.j:]

Economists practice a "science", or perhaps more accurately a black art, that uses hypothesis to justify policies. Hypothesis that aren't often cognizant of facts.

As any one who understands metacentric height and damage control will tell you battling the fire without dewatering the hull renders both efforts mute.

2008 Dec 19 06:37 PM

[investor88:]

Doesn't look cheery come 2009. Now deflation next inflation. These are tumultous times.

2008 Dec 19 07:01 PM

[John Lounsbury:]

Good article with interesting metaphors and references.

For recent articles on the same subject (and interesting comment streams) on Seeking Alpha, see the following recent articles:

The Deflation Scam by Investor Nirav

Is Inflation Dead by Steven Hansen

Our Economic Crisis: The Grand Experiment by John Lounsbury

2008 Dec 20 01:53 AM

[punk_ash:]

Ben and Paulson and even George W have been doing a good job. There is a smallish problem though. There need to be more value added jobs in US and not just buy and sell from one to another. Once we have value added jobs added by the millions, we will have no problem servicing the debt.

We are trying to solve all issues with pump and dump and printing the money...

I am hoping Obama will do better and please do something about SEC

2008 Dec 20 03:45 AM

[henarl:]

"in-flation is a lot easier to tame than de-flation" Yeah, just look at Zimbabwe.

2008 Dec 20 01:57 PM

[auto44:]

This isn't Zimb abwe


On Dec 20 01:57 PM henarl wrote:

> "in-flation is a lot easier to tame than de-flation" Yeah, just look
> at Zimbabwe.

2008 Dec 20 02:31 PM

[auto44:]

They are trying to save Detroit but those are mostly value subtracted jobs. Sorry UAW but thats the real deal. Only drastic wage and benifit reduction can save your jobs. Hopefully some of the debit you took on which you very fairly felt would be covered by your pay will be absorb by the bailout funds. Good luck, Don't dispair, but make some adjustments for foul weather.


On Dec 20 03:45 AM punk_ash wrote:

> Ben and Paulson and even George W have been doing a good job. There
> is a smallish problem though. There need to be more value added jobs
> in US and not just buy and sell from one to another. Once we have
> value added jobs added by the millions, we will have no problem servicing
> the debt.
>
> We are trying to solve all issues with pump and dump and printing
> the money...
>
> I am hoping Obama will do better and please do something about SEC

2008 Dec 20 02:39 PM

[henarl:]

Okay then Blitz, how about Weimar Germany? My point is that hyper- inflation is at least as big a problem as deflation.

2008 Dec 20 04:29 PM

[bosun.j:]

@ BLITZ :

Not quite yet its not. Wait a few months.

On Dec 20 02:31 PM BLITZ wrote:

> This isn't Zimb abwe
>
>
> On Dec 20 01:57 PM henarl wrote:

2008 Dec 20 07:36 PM

[Jason Rines...:]

President Bush trusts but does not verify, end of story. The Central Banks preserve there own interests first. End of story and what we have already seen despite the publics dismay the leadership in Washington does what our debtors want first.

In deflations, the cash dries up. How to provide stimulus to the broader economy through job creation is very important, government will be lender of last resort to small business/entrepenuars/... However, this group in America will likely to be last in line to actually see such stimulus. I will not get into encapsulation effects or the morality of whether this is right or wrong. I will say other government leadership will emerge at a later date that have become seasoned through hardships but such things take a few years. In the meantime do your research and make sure you are on the right side of the trade.


On Dec 20 03:45 AM punk_ash wrote:

> Ben and Paulson and even George W have been doing a good job. There
> is a smallish problem though. There need to be more value added jobs
> in US and not just buy and sell from one to another. Once we have
> value added jobs added by the millions, we will have no problem servicing
> the debt.
>
> We are trying to solve all issues with pump and dump and printing
> the money...
>
> I am hoping Obama will do better and please do something about SEC

2008 Dec 22 06:00 PM