Monetary Policy-Not Obama's Stimulus-Is What Needs Watching

by: Gerard Jackson

Let us take stock for a moment of Obama's brilliant economic management. The Democrats just bulldozed through the biggest barrel of pork in American history, the stock market dives, long term treasuries rise, manufacturing is stagnant, unemployment is still rising. Americans are being ruled by the most reckless and self-serving bunch of greedy political partisans to have ever held power. And what makes them especially dangerous to the country's prosperity is their utter stupidity.

Obama's mindless adherence to Roosevelt's destructive economic policies have the appearance of a tragic comedy in the making — minus a happy denouement — given his attack on what he called "the same tired arguments and worn ideas that helped to create this crisis". This is a man who is incapable of grasping his own contradictions. A man who whines bitterly about his inherited deficit and the doubling of the national debt under Bush nevertheless intends to do great violence to the country's finances by doubling or perhaps even tripling the current deficit. The man does not even have a sense of irony.

And how did the markets greet the Democrats' triumph of power over reason and good governance? They sliced about 4 per cent of the Dow and S&P averages. Surely the markets must be insane. Did not The One who Must be Obeyed state:

So then you get the argument, well, this is not a stimulus bill, this is a spending bill. What do you think a stimulus is? That's the whole point. . No, seriously. That's the whole point.

After listening to this nonsense it's a wonder that the markets did not collapse. In case anyone missed the logic of Obama's observation, any government spending by definition promotes economic growth. Of course, this elicited peals of laughter from those — unlike Obama — who do have some training in economics. And they were right to laugh at the man. There is just one little problem. John Maynard Keynes basically said the same thing:

. . . 'wasteful' loan expenditure may nevertheless enrich the community on balance. Pyramid-building, earthquakes, even wars may serve to increase wealth. . . (John Maynard Keynes, The General Theory of Employment Interest and Money, Macmillan-St. Martin’s Press, pp. 128-129)

Keynes basically argued that government spending on anything — including bottles filled with pound notes — amounted to investment provided the money was borrowed from the banking system, meaning that it was created out of thin air. (Ibid. pp. 128-129 footnote). Of course, we must bear in mind that Keynes was writing during an unprecedented period of mass unemployment and idle capital. Nevertheless, it was witchcraft then and it still is.

(Incidentally, in 1937 Keynes warned the British government against any further increases in government spending for fear it would trigger inflation. Unemployment then stood at 12.5 per cent. So Obama and his advisors are not quite the sophisticated Keynesians they imagine themselves to be).

One is always tempted to have a little fun at Obama's predicament. He is basically an Alinsky street activist and he will never be anything else. Because of this he is clearly out of his depth, bereft of patriotic moorings and basically ignorant of the world around him. He is in fact a disaster in the making and that makes it very difficult to laugh at his efforts to appear magisterial. America has indeed made a terrible mistake. However, there are still four more years to go and they are going to be memorable ones — in the same way that Carter's still are.

As things are now the economy is shaping up to be a disaster for the Democrats in Congress, the great majority of whom are too dumb to realise it, particularly Pelosi and Reid. So while most eyes are focused on Obama's gigantic pork barrel some are focused on the money supply (AMS*). It is not good. Since last September it has been expanding at an annual rate of about 20 per cent. These obervers have concluded that the US is heading for another monetary boom, and I am inclined to agree with them. It defies common sense to think that the Fed can expand the money supply at this rate without triggering inflation.

With the Fed turning on the monetary spigots and government letting loose with treasuries things could turn very unpleasant. Obama's irresponsible pork-barrel politics is going to require staggering amounts of borrowing and this means vast numbers of treasuries. There is a little thing in economic called supply and demand. With more and more treasuries hitting the market one should expect their prices to fall and their yields to rise leading to a large amount of short selling. This now appears to be the case with the yield on 30-year treasuries apparently on the rise. This is something to watch because these bonds are considered to be highly sensitive to inflationary expectations.

However, some market advisors are forecasting a decline in yields and a rise in the price of treasures as the Fed is forced to enter the market. I don't buy this analysis. They are overlooking the extent to which Bernanke's thinking has been coloured by his view of the Great Depression. This has led him to concentrate on monetary policy regardless of the inflationary threat. To him inflation trumps deflation and unemployment any day of the week.

This is why he is allowing money supply to rapidly expand and this is why he will buy bonds. The problem with Bernanke's dismal view — though there is much to be dismal about — of the situation is that it never was a case of deflation v. Inflation. I do not believe for a moment that the US faced a monetary implosion. What I believed — and still do — is that an over reaction by central banks would send the world's monetary stocks on another upward spiral resulting a world-wide inflation and perhaps even stagflation.

It needs to be understood that the only money the Fed ever really has is what it prints. To buy its own bonds, or any assets, it will have to keep on expanding the money supply. In case anyone has forgotten, this is called inflation. I simply do not see vast numbers of creditors holding on to bonds if inflation is wiping out their yields. (It is very unusual for yields on long-term treasuries to go negative). What I can imagine is that expectations of accelerating inflation will cause a great sell off in which yields rocket as treasury prices dive.

Even if the Fed was successful in manipulating the market for treasuries the collapse of other securities, municipal bonds for example, could not be avoided. Moreover, it's inconceivable that foreign investors will tolerate being paid in rapidly depreciating dollars. A point would be reached where these investors — including governments — will decide that America's monetary policy and its fiscal conditions require them to dump their US holdings.

On the one hand the US faces a massive boondoggle that has greatly disturbed the markets and threatens to destabilise the economy. On the other hand the threat of inflation is looming up as the money supply expands. This is a truly terrible witches' brew and like it or not Obama and his crew of economic vandals need to be held accountable for it.

*Money supply as defined by the Austrian school of economics: Cash, demand deposits with commercial banks, and thrift institutions, government deposits with banks and the central bank.