Bernanke and Obama's Advisors Are Wrong: Deflation Didn't Threaten the U.S. Economy 11 comments
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I was going to explain in greater detail why Obama's economic stimulus would fail and why his view that only the government, meaning his administration, can get the economy moving is unadulterated nonsense. However, we are still being regaled with tales of how deflation is a dangerous threat, that the fall in asset prices needs to be reversed and that pumping unprecedented amounts of newly-created money into the economy is vital if recession is to be avoided, and so on.
The striking thing about the warnings of impending deflation is that they never tell us what deflation is. If the public doesn't understand the nature of deflation then it will be misled into supporting monetary policies that are guaranteed to bring surging inflation in their wake followed by yet another recession. Without a doubt deflation is a greatly misunderstood phenomenon. The basic problem is that falling prices are not always a symptom of deflation. Moreover, the downward adjustment in prices between overvalued assets should not be confused with deflationary pressure.
Although falling prices can never be deflationary, they can be a symptom of deflation. On the other hand, falling prices can be the favourable result of a productivity-induced change in purchasing power. This is precisely what we would expect in a progressing economy, i.e., one in which per capita investment is growing. It ought to go without saying that this investment embodies technological improvement that raises the productivity of capital and hence labour.
On the other hand, deflation occurs where the absolute quantity of money shrinks. This invariably happened when there was a run on the banks. When depositors withdrew their money, a reverse multiplier set in and a rapid monetary contraction occurred bringing a recession in tow. The result was that prices had to fall if the number of transactions was not to fall. Of course, true deflations are always accompanied by depressions because what is contracting is not notes or coins, i.e., cash, but fictitious bank deposits, the product of credit expansion produced by a fractional reserve banking system. This is where we get our reverse multiplier.
Strictly speaking, these monetary disturbances could not occur in an economy based on the gold standard. Even today the great majority of economists do not understand this fact. Alan Wood, an economics writer for The Australian, is one such economist. He argued against the gold standard on the specious grounds that its "costs in economic and social dislocation are too high." Sheer baloney. The problem was that Britain, like other gold standard countries, was actually operating on a quasi-gold standard.
Sir George Paish stated that before 1913 the Bank of England's gold reserves never exceeded $50,000,000. Jacob Viner was surprised to learn that the British banking system rested on an extremely low ratio of gold to liabilities. He estimated that sometimes the ratio "fell at times to as low as 2 per cent and never between 1850 and 1890 exceeded 4 per cent" (Jacob Viner Studies in the Theory of International Trade, Harper & Brothers, 1937, p. 264).
The problem was not gold but the fractional reserve banking system. I doubt that the low ratio of gold to paper and checking accounts would have posed much of a danger if it had been kept at a fixed ratio. In effect, this would have meant that the aggregate money supply would have been solely determined by changes in the quantity of gold. As the quantity of gold never fell this meant that the gold supply would have dictated the rate of monetary growth without any severe monetary disorders occurring. But credit creation by the banks made this impossible. And it was credit creation that caused the financial crises and still does. So we now find that the gold standard has been successfully blamed for the "costs in economic and social dislocation" that were in fact caused by deviations from the gold standard*.
It should be noted that though money incomes fall during a deflation, real purchasing power rises. Attempts to prevent this adjustment process will prolong the recession. This is exactly what happened under Hoover and Roosevelt. From June 1936 onward America was forced to endure rising prices and mass unemployment. An unprecedented occurrence in US economic history and one that is now taken as normal.
But America in 2008 was not the America of 1930. There was never any danger of mass runs on the banks. The vast majority of Americans are of the opinion, rightly in my view, that the fed would not allow the banking system to collapse, an opinion that Bernanke's monetary policy has strongly reinforced. The danger is that by flooding the system with money, Bernanke will trigger a wave of inflation. Considering his unwavering devotion to the Keynesian faith, I think this is a highly likely outcome. To top it off, the crisis was the outcome of Keynesian policies that have given Obama the excuse to massively increase government spending. I think the results are going to be pretty ugly.
No doubt some of you have still have doubts about the benefits of productivity-induced falling prices, particularly when so many economic commentators, including supply-siders, argue that a stable price level is necessary if recessions are to be avoided. In support of this opinion some have drawn attention to the British experience in the last quarter of the nineteenth century that was labelled the "Great Depression".
In fact, during the nineteenth century Britain experienced more than 50 years of falling prices, even though living standards rose at an unprecedented rate. From 1875 to 1895 wholesale prices fell by about 45 per cent while industrial output and real wages continued to rise. Unfortunately some financial advisers took this to mean that deflation is not a real danger. Unfortunately for them they were not describing deflation.
Prices fell in nineteenth century Britain because productivity outstripped the gold supply. Because prices were flexible and price changes fairly slow wages and costs adjusted themselves easily to changing monetary conditions. This meant that as output grew faster than the gold supply prices not only fell but the benefits of increasing productivity were more evenly spread and living standards steadily rose as did money wages. The following chart shows the movement of prices in nineteenth century Britain.
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| Source: S. B. Saul: The Myth of the Great Depression 1873-1896, 2nd edition,Macmillan Publishers LTD, 1985. |
[T]he price level fell to half its initial level in the course of less than fifteen years and, at the same time, economic growth proceeded at a rapid rate. The one phenomenon was the seedbed of controversy about monetary arrangements that was destined to plague the following decades; the other was a vigorous stage in the continued economic expansion that was destined to raise the United states to the first rank among the nations of the world. And their coincidence casts serious doubts on the validity of the now widely held view that secular price deflation and rapid economic growth are incompatible. (Milton Friedman and Anna J. Schwartz, A Monetary History of the United States 1867-1960, Princeton, N.J.: Princeton University Press, 1971, p. 15.)
What the monetarists cannot see, anymore than the other neo-classical economists, is that price-level stabilisation policies must eventually create a boom-bust situation. In the 1920s qualitative economists like Benjamin M. Anderson, Ludwig von Mises and Frederich von Hayek, Felix Somary, etc., warned that the fed's price stabilisation policy had generated a boom and created imbalances that would have to liquidated once the recession struck. It was pointed out later on in the depression that the current
...difficulties are viewed largely as the inevitable aftermath of the world's greatest experiment with a "managed currency" within the gold standard, and, incidentally, should provide interesting material for consideration by those advocates of a managed currency which lacks the saving checks of a gold standard to bring to light excesses of zeal and errors of judgment. (C. A. Phillips, T. F. McManus and R. W. Nelson, Banking and the Business Cycle, Macmillan and Company 1937, p. 56.)
Keynes strongly disagreed with these economists' analysis of the fed's monetary policy, stating:
The successful management of the dollar by the Federal Reserve board from 1923 to 1928 was a triumph - mitigated, however, by the events of 1929-30 - for the view that currency management is feasible, in conditions which are virtually independent of the movements of gold. (John Maynard Keynes A Treatise on Money , Vol. II, Macmillan and Co., Limited, 1953, p. 258.)
It is now impossible to discuss Obama's 'economic policy' without referring to the Great Depression, and that is as it should be. Hence my all too brief tour of the 1930s. But if the lesson of the 1920s and the 1930s had been properly understood there would be no financial crisis today and no Obama. As he is clearly ignorant of these events, and the controversies they gave rise to, and has no apparent inclination to learn, I fear the US and the rest of the world is in for a very interesting four years.
*After the war there were three gold standards: the gold standard as it is commonly understood, the gold bullion standard and the gold exchange standard. Their differences were not trivial and had severe economic consequences and political repercussions. Unfortunately Australia's rightwing are as ignorant of these facts as they are of Austrian capital theory.
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Mr Obama has to take the advice of advisors, he can't know everything, especially on such intricate matters. So, we're screwed. Everyone thinks it's credit we need, but it's need we need. As in, I don't need another house, car, dog, so just let us pay off the debt we have.
On Jan 19 04:56 PM Top Gun wrote:
> Let's just guarantee deposits to, say $500k for individual accounts
> and $5 million for business accounts, then let the chips fall where
> they may.
>
> Mr Obama has to take the advice of advisors, he can't know everything,
> especially on such intricate matters. So, we're screwed. Everyone
> thinks it's credit we need, but it's need we need. As in, I don't
> need another house, car, dog, so just let us pay off the debt we
> have.
> especially on such intricate matters."
Obama will do nothing but peddle the liberal elite conventional wisdom as the 'thing to do'. That is why it is so frightening how wrong that liberal elite just at a moment when economic decisions will have great consequence.
The 'stimulus' bill is nothing but a trillion dollar boondoggle stuffed with all the Democrats' campaign promises. It's a fraud on the American people to call this spending bill a 'stimulus' - less than 3% of it is infrastructure, and less than 25% of it is real tax cuts, and none of them of the type (tax rate reductions) that spur growth. It will throw money at the liberals' favorite pet priorities, adding to programs already fully funded, bailout states from making sound fiscal decisions, yet do nothing for the economy.
Their TARP 'bailout' will now have enough strings to do more harm than good for banks, it will not revive lending (as if that is the right goal anyway), and will, at best, end up only a partial loss for taxpayers and another nothing for the economy, as banks slog through anyway. For every dollar the Govt put in, the private sector pulls out a dollar in fear. The Govt is simply (and thankfully) too small to replace an active risk-accepting private sector; thus, NO AMOUNT OF GOVT INTERVENTION CAN POSSIBLY WORK. Only reviving acceptance of risk in the private sector can work. And govt meddling only makes that worse. The crying shame here is that the systematic risk issues could have and should have been dealt deftly by Fed engagement in certain limited operations, eg., pre-pack BK for Lehman that kept all counterparty risks at bay and kept debtholders in better shape . In fact, you see some of that now; with the fed selling treasuries and using it to buy commercial paper; this is another way of offloading risk from the risk-fearing market. yet the Fed will make money on these transactions.
The best we've got to shake up the economy is the 0% interest rate, and that's a sure fire 'enjoy now pay later' deal for the monetary system.
This is Keynesianism on crack. The only thing that has me thinking this wont end badly is that the economy has an underlying strength and capability that will come through, the recession wil end and we will grow again in 2010, but it wont be for lack of trying by the Democrats to hobble it.
In simplistic terms, its about that tiger called leverage. if you never have margin, you cant have a margin call; if you never have debt, you cant have a debt-induced bankruptcy; if you dont have credit ratios, you cant have credit contractions (when creditors fail) that induce panics, recessions and depressions.
Is that the point?
"No doubt some of you have still have doubts about the benefits of productivity-induced falling prices, particularly when so many economic commentators, including supply-siders, argue that a stable price level is necessary if recessions are to be avoided."
Any who dispute this: Let us know which depression was caused by the million-fold reduction in DRAM prices per bit since 1970. And I think supply-sider and technophile George Gilder for one would be on board that point btw. falling prices dont cause money contraction, that reverses cause and effect. Deflation like inflation is a monetary phenomenon and one, but not the only, source of falling prices. Another one - which we see since July 2008, is change in asset price due to supply and demand.
If Bernanke thinks the falling price of oil since july, by adding to 'deflation' , is a threat to our economy, lets fire him before he does more damage.
(B)--Because our government printed more paper money as was Gold held in Trust. Therefor the US could not satisfy "International Trade Accounts", FDR ordered all of US Citizens and Inhabitants to give up their Gold Coinage to a Bank with a severe penalty (not to do so). After this, Interational Trade Accounts could be satisfied in Gold Payments as was usually heretofor done..
(C)--When the Supreme Court of 9 told FDR he could not take us of the Gold Standard and impose penalties on its people. FDR nominated 6 more additional Supreme Court Justices (to 15) and got his way.
(D)--The imprint of the paper dollars were heretofor in Gold Denomination. The new demonination were at first in "Silver Certificates", later changed to small inscriptions on the paper dollars reading:--"This note is legal tender for all debts public and private and is redeemable in lawful money by the US Treasury or the Federal Reserve." This was still in keeping with the Article 1, Section 10 of the Constitution. The present paper dollar only says:-- "This note is legal tender for all debts public and private." -- "AND IS REDEEMABLE IN LAWFUL MONEY BY THE US TREASURY OR THE FEDERAL RESERVE." has been eliminated.
(E) It is a shame that not one lawyer or politician has been found to rectify this matter for the people in Congress.
Dave
On Jan 20 10:38 AM msgtb wrote:
> The reason that the Government wants inflation is for its own reasons.
> That reason is to be able to repay its huge national debt with dollars
> in the future that are a worth less. It is pure and simple and it
> has nothing to do with helping the common man.
>
> Dave
There will be massive inflation.
We (the U.S. Govt.) will screw all debt holders especially the foreigners.
Only real assets and commodities will hold a true intrinsic value.
What this means is dump your money into real estate if you can, leverage it up on fixed rates, and wait for the tsunami of inflation to make your loan worthless. Then you can pay your loan off a few years later with your pocket change, and live like the landed gentry of the old days.
This is the reset you are looking for. It doesn't matter that your starbucks coffee is $1500 per cup, it is all relative. If you are making $250,000 per year now, you will be making $250,000,000 per year before you retire. You still won't be able to buy a 250 foot yacht. I gurantee that you can still live like kings compared to the average Chinese citizen in 20 or 50 years.
BTW we will all be debt free, and there will be NEW banks and brokerages in place. We will still have our place among nations, because we are still the most free country on the planet, and our system of graft is premium compared to damn near everyone else's.
As long as our assets continue to throw off returns, this is all a big exercise in perception management i.e. jerking us around. We still need the foreigners to invest their money here, so that we can buy their stuff up for an even better price, and have their citizens work in our factories to ship us goods that we can consume at low prices with money we have borrowed at really good rates from them.
By the way, this was planned from the beginning. How the hell were we going to beat the communist on the god damned gold standard. Their system gave them tons of gold for FREE. Our government is wisely not saying this because as bumbling as they are, in the big picture, we are a nation of pure pimp daddys and the rest of the world works for us!