Neither Easing, Printing, Nor Borrowing Will Work 28 comments
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There has been a tremendous amount of discussion since my last article regarding the amount of money the Fed is putting into the economy -- specifically, what is happening to that money, and what it means in relation to the global collapse of asset prices. While all the comments and exchanges have been engaging (and even, at times, colorful), there have been some particularly compelling counter-arguments to my position that the increase in the amount of money in the economy, along with a collapse in long-term Treasuries, is going to result in huge price and rate spikes in the near future. Here are a few among the most weighty:
1. The Fed is expanding the money supply, but the increase is more than off-set by a retraction of credit, as well as asset prices. And while price and rate increases are surely coming at some point, they probably won't appear for a long time, nor will they be very dramatic.
2. We have been using our homes as sources of cash, and because the real estate market retreated so dramatically, the loss of that source should be considered a reduction in the total money supply -- which also helps offset any printing the Fed is doing.
3. The velocity of the money that the Fed has put into the economy is very low, so it doesn't really matter how much money the Fed prints -- people aren't getting it anyway. Therefore, we shouldn't expect high rates or prices anytime soon.
I'll start with the last argument, if only to re-iterate my point that no matter what side of the debate you're on, I think we all agree the velocity of money has declined to historic levels. Nonetheless, I think we also agree that at some point velocity is going to pick up -- that the dollars being manufactured by the Fed are going to get into the economy one way or another; certainly Ben Bernanke and his cohorts are going to use every tool at their disposal to ensure that outcome. I believe velocity is going to pick up sooner, rather than later, because that's what the Fed wants, and because I believe rates and prices are going to start rising much earlier than expected -- fueled by a collapse in Treasuries.
It's true -- as so many people have pointed out -- that the de-leveraging process has cost the globe tens of trillions of dollars in asset-losses. Likewise, while I'm not sure that looking at houses as "cash" is exactly correct, per se, there is no doubt that many American consumers (and consumers the world over) used the artificially inflated equity in their homes to fuel much of the excess of the last two decades. Further, the calamitous decline in housing prices might actually give rise to a plausible argument that concomitant loss of spending power that came from those loans -- coupled with asset-losses themselves -- dwarfs the amount of new money the Fed has introduced into the system over the last year.
The people who have been pointing out this disparity between what has been lost and what has been printed, however, are looking at the new cash in the system as a static sum, and that is a mistake. They are failing to account for the fact that we operate in a fractional reserve banking system; any money printed by the Fed, once trickling into the economy, gets amplified many times over. So it's not reasonable just to look at the amount of currency being printed as fixed -- it must be looked at for its potential expansionary effect. Yes, the velocity of money is low, but when the Fed finds success at bringing it higher, the money supply will be increased exponentially.
But there's one more part of this story we need to consider: just as some people might want to stretch the definition of the money supply to include such things as houses, and just as these same people want to talk about the destruction of asset prices relative to the amount of currency in circulation, we need to consider what will happen when things turn. The entire objective of the Fed is to spur economic growth through easy money. Simply put, the Fed wants people buying assets again, and more to the point, the Fed has explicitly targeted the housing market.
So at the same time all this new money is finding its way into the economy, asset prices will presumably be increasing. If we use the standard definition of "deflation" being tossed around like a beach ball on a Sunday afternoon, we are being asked to believe that we are in a deflationary environment -- that the collapse in asset prices justifies the printing of so much money, because the former so overwhelms the latter. But if you're going to make that argument, then you have no choice but to accept the not-so-equal and opposite reaction of the reversal; the already expanded money supply will be further increasing its presence through the multiplier effect at exactly the same time asset prices are rebounding. And if falling asset prices are deflationary, then surely rising asset prices are inflationary, right?
As you know, I don't subscribe to these definitions of inflation and deflation (more about my definitions here), but for those who do, you have a lot to think about.
So I again point out that this is uncharted territory -- an incredibly rare confluence of events: yields have nowhere to go but up. The government will have a difficult time finding buyers for new debt. An unprecedented amount of money, and potential money, is in the system, waiting only for velocity to return -- which the Fed will all but guarantee through current policy. And finally, as a result -- and also at the behest of the Fed -- we will see a return to the easy money and mal-investment that got us into this mess in the first place.
But it won't work this time; our currency and our credit are quickly running out of fuel, and no amount of easing, printing, or borrowing will replenish it.
Disclosures: None.
Copyright 2009, Paco Ahlgren. All Rights Reserved.
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What's coming is a reversion to the mean (probably with an overshoot) where equity investors demand 5-6% dividend yield just to keep management honest.
Several years ago, the S&P500 yielded about 1%. Hellooooooooo.
On Jan 24 03:07 PM klarsolo wrote:
> Our credit system worked for a long time and it will all come back.
> What probably won't come back are home loans for people with no income.
> But even that is actually not the problem.
>
> What is the problem is the crisis of confidence in the markets due
> to shaky home loans in 4-5 states coupled with irresponsible journalism
> that keeps preaching gloom & doom every single day regarding
> all asset classes everywhere. Our banking system is not in crisis
> because of those subprime loans anymore but because now people trust
> NOTHING anymore, not prime loans, not agencies, not anything.
I recall one inflationary gimmick a couple weeks ago called a "cram down". That seemed like it could definitely be inflationary.
Print it and pass it out, until everybody starts lending and spending again. Wouldn't velocity be really easy to control, by changing the reserve requirements at the banks?
If/when inflation rears its ugly head, the banks could just be required to hold 25 percent in reserve instead of 8 percent (or whatever the current number is). If that didn't work to slow inflation, then raise the reserve requirement to 50 percent. Etc.
Or is that too simplistic a view of the situation?
"At some point, it should become abundantly clear to policymakers that the notion of prosperity based on asset prices is false. Lasting prosperity can only be based on productive labor, not asset price illusions."
This labor needs a gently growing market to sustain it, and one not fueled entirely by higher wages for increased growth, since overconsumption by individuals evidently corrupts; it should be fueled by gentle population growth.
First of all the tax payers are the ones who are not getting anything in return for the printed money and sooner or later the tax payers are the ones who will have to be responsible for the printed money to be payed back, at the expense of the U.S.tax payer. After all the money doesn't really exist! Who in their right mind would want to borrow anymore money in the first place? They can't even pay it back now! Thus all the defaults and bankruptcys.
As far as asset prices are concerned, the printing of money to increase asset prices is a poor way to increase their value for any length of time. One of the only assets that should truely hold value is a asset that is truely a store of value,that would be gold! The increasing of easy credit,easy money, is the same thing that made realestate and other assets blow a big bubble in the first place. Sooner or later we need to reach a equalibrium price for all assets with out inflating their value by printing money...Then and only then can we start growing a sustainable economy again,off a solid foundation that can last for a extended period of time! Temporary cash injections are just a bandaid for a wound that needs needs major surgery.
great article, I do agree with you... I think all this money being printed is being used by these banks to plug holes... not for lending.. which is why it hasn't gone into the public yet.
figures, doesn't it? It truely is like being on the Titanic, the rich people get the lifepreservers and are saved, while the hard working schmucks in the steerage go down with the ship
So invest in funeral services and cemetaries in prep for the baby boom dieoff.
Only half-kidding, unfortunately.
You're absolutely right, but I reckon the people who bankroll policymakers make far more money for themselves by encouraging asset price illusions than they do by encouraging productive labour.
But you can print all the money in the world and that only inflates the relative price of everything. It does not provide a solution, or does it?
Keep in mind that our problem is debt and who do we owe that debt to? Them damn ferners! ...they're screwed!
--Fred
Truth is, we have gluts of about every commodity. Certainly labor, from foreign assemblers to American boomer ex-managers; oil tankers full of oil out on the ocean; alternative energy technology sitting on the shelf. With all this excess capacity, who will have the pricing power to increase prices?
The bigger threat is that as the money supply remains constrained, and as the government gets involved in picking winners and losers, the excess capacity will become disheartened, and not even present itself to the market. As companies increase prices to try to hit breakeven in a down market, competitive supply will be slow to enter the market for fear of the next time the Fed and government types determine the economy is growing too fast, and jacks up interest rates or raises minimum wages or implements higher taxes.
No, we need more money, sooner, so we can continue the past 30 years work of growing supply by creating new jobs, and new consumers, in parts of the world that were previously unutilized. We need Chinese workers wages to rise so Vietnamese workers wages rise so African workers wages can rise. And nothing supercharges solar energy investment like $100/barrel oil, and as it achieves cost parity, much of the earth's fossil fuel will rot in the ground.
Some commodities will truly skyrocket- paintings by Renoir, an Ivy League education, beachfront property in Cannes, Lebron's contract. But if you think wages for the vast majority of workers will rise faster than their productivity, or prices of commodities faster than the alternatives enabled by technology to obviate them, you've been sleeping the past 30 years.
Printing money and encouraging mal-investment through easy policy is what has caused every boom -- and inevitable bust -- in the last century. I obviously disagree with your prescriptions, but unfortunately, the policies you espouse are going to prevail again.
Fortunately for the rest of us, in the long-term, this will be the final death knell of Keynesianism, Marxism, and every other form of collectivism that has punished progress for so long. We have a very powerful lesson to learn, but I truly believe that when it is all over -- and the dollar has collapsed -- no one will ever tolerate this sort of foolishness again.
On Jan 25 05:58 PM Dirk McCoy wrote:
> Paco, I believe you forget or ignore the most significant factor
> that mitigates price and wages spikes- oversupply. One definition
> of inflation is too much money chasing too few goods and services.
> Right now, we have deflation- too little money chasing too much goods
> and services. So, we need more money, or we need to constrain supply.
> But in a world of 3 billion people living on less than $2.50 a day-
> why would we do that?
>
> Truth is, we have gluts of about every commodity. Certainly labor,
> from foreign assemblers to American boomer ex-managers; oil tankers
> full of oil out on the ocean; alternative energy technology sitting
> on the shelf. With all this excess capacity, who will have the pricing
> power to increase prices?
>
> The bigger threat is that as the money supply remains constrained,
> and as the government gets involved in picking winners and losers,
> the excess capacity will become disheartened, and not even present
> itself to the market. As companies increase prices to try to hit
> breakeven in a down market, competitive supply will be slow to enter
> the market for fear of the next time the Fed and government types
> determine the economy is growing too fast, and jacks up interest
> rates or raises minimum wages or implements higher taxes.
>
> No, we need more money, sooner, so we can continue the past 30 years
> work of growing supply by creating new jobs, and new consumers, in
> parts of the world that were previously unutilized. We need Chinese
> workers wages to rise so Vietnamese workers wages rise so African
> workers wages can rise. And nothing supercharges solar energy investment
> like $100/barrel oil, and as it achieves cost parity, much of the
> earth's fossil fuel will rot in the ground.
>
> Some commodities will truly skyrocket- paintings by Renoir, an Ivy
> League education, beachfront property in Cannes, Lebron's contract.
> But if you think wages for the vast majority of workers will rise
> faster than their productivity, or prices of commodities faster than
> the alternatives enabled by technology to obviate them, you've been
> sleeping the past 30 years.
>
>
>
Another very good article. At the end you state that our currency and credit are running out of fuel. I'd like to hear your rationale for that statement. I don't disagree with it, but like kelm above, I'm wondering how it could play out. I can see that at some point no one will buy our debt for zero interest, which will cause interest rates to rise, which will increase our payment burden, which will increase default risk, etc, but I can't visualize how it plays out the rest of the way. That would make a great article!