Economies, Central Banks with Napoleonic Complex: On to Moscow!

By Bill Bonner

Last week, the European Central Bank squared its shoulders and joined ranks of the damned. The Times of London reported that in joining up with the US Federal Reserve Bank and the Bank of England, the European Central Bank “pulled out all the stops” in their drive to revive their economies. The ECB announced that it will cut its key lending rate to its lowest level ever and begin a form of “quantitative easing,” in which it will buy corporate debt in order to reduce commercial interest rates. Details to follow, it said. “Stops” are to central bankers what safety fuses are to electricians. You may take them out when you really want to get the juice flowing; but your house might burn down.

But thus did the European troops pull out the stops and get under-way. Reluctant allies, they set off to join the battle against capitalism…with no reliable maps…with insufficient supplies and a strategy elaborated by incompetents. Of course, the gods must have laughed at Napoleon too. His armies had been cut off and destroyed in Egypt. Then, his Peninsular Campaign was a disaster. But the plan to attack Russia topped them all; even the draft horses must have snickered.

It doesn’t seem to bother the Europeans that their American commander is the same fellow who failed to spot the biggest bubble in history until it blew up in his face. Nor that their field marshal has no idea of the lay of the land; nor that anyone on either side of the Atlantic seems to know where they are going; nor that, wherever it is, it will cost more to get there than they’ve got.

This week the Obama government revealed its new budget deficit. If nothing goes wrong, it will reach $1.84 trillion this year – nearly 400% of the record set last year. In 2009, the US government will borrow 50 cents for every dollar it spends. Accumulated deficits to 2019 will reach $7.1 trillion, says the forecast. Moody’s was so alarmed it warned that the US may lose its Triple-A bond rating, which it has had since 1917.

But even as bad as it looks, Obama’s budget map is still fanciful – its mountains are made of whipped cream and its rivers run with Scotch. It imagines a loss of only 1.2% of GDP in the current downturn…and a quick return to growth, with a 3% increase in 2010. Yet, the last report showed the US economy contracting at a 6% annual rate. As for growth in 2010…where would it come from? Consumer credit is falling at its fastest pace in 18 years. Consumer incomes are falling too – down 1.2% in the last 12 months. If there were any lasting consequences of this downturn, opines the New York Times, it is likely to be the “shift to savings” by the US consumer.

Meanwhile, businesses aren’t exactly hankering to spend either. Even if they had the money, businesses wouldn’t expand; they don’t have to. Spiders build their webs on America’s remaining assembly lines with little risk of being disturbed; one out of every three factories is quiet. Until existing capacity is put to work, businesses will have no power to raise prices and no need to add to their facilities.

And yet, Napoleon Bernanke is upbeat. The troops will be home “before Christmas,” he says. But the central banks’ calendars are no better than their maps. In 2004, Mr. Bernanke credited improved monetary policy with having created what he called “the Great Moderation” – the period of strong growth and low-inflation since the mid-’80s. Specifically, he was referring to the Fed’s policy of ‘inflation targeting,’ which presumes that the inflation numbers carry all the information the Fed needs to guide an economy.

This was the map the Fed was using seven years ago. Then, a tiny recession took GDP down to all of 0.2% over an 8-month period. The Fed panicked. Its emergency policy pushed the fed funds rate well below the rate of consumer price inflation and left it there for two years. This was not merely a slight miscalculation. It was a fatal strategic error, say professors Carr and Beese of the University of Akron. Not only did the Fed’s map fail to warn them; it actually sent the economy over a cliff:

The low interest rates signaled…that credit was inexpensive and readily available…[then] the Federal Reserve moved from a low accommodative interest rate policy to one of a steady and consistent increasing of interest rates between 2004 and 2007…and became a prime cause of the financial services mortgage crisis of 2008.

Today, central banks use the same computers, same theories, and same maps they had seven years ago. With these feeble instruments, they set out to go where no central bank has ever gone before – borrowing, inflating, and intervening on a scale that would have been unimaginable a few years ago. Where will they end up?

We will take a guess: this grande armee sets off on the road to recovery with the wind at its back; it will end up in Moscow with snow on its face.

Enjoy your weekend.

Comments

[Missing_Link:]

What a scrumptious article, simply dripping with delicious sarcasm. You have done our endlessly tragic economic crisis poetic justice.

I salute you, sir, on your erudition and wit, and I hope to dine here again.

May 15 10:33 PM

[History Buf...:]

L'audace, toujours l'audace!

Translation: audacity, always audacity.

I wonder what circle of hell Dante reserved for central bankers?

May 15 11:34 PM

[venividivici:]

Splendid article. It would be very amusing but for the fact that the real life consequence of this unmitigated incompetence is pain and heaps of it down the road.
All through this crisis the overriding objective has been to mitigate the pain or put it off to another day. The trouble is there can be no lasting solution without pain and the longer they put it off, the worse the pain will be.

May 15 11:46 PM

[Leftfield:]

Our leaders are completely depending on a quick return to "normalcy." Which means we are to go further bankrupt. To use what cushion of credit is left to pay to the rich shysters who led us here. This, along with our citizenry who's skills tend towards sitting at a desk and passing edicts and paperwork along rather than anything useful, stands to make us worse off than we were in the Great Depression. Are they actually trying to destroy us?
Great imagery. Anything short of longshot success in this damn the torpedoes plan will land us outside of Moscow frozen solid.

May 16 12:36 AM

[Alan Young:]

As an artist myself, I enjoy it on those rare occasions when a financial writer employs imaginative literary devices, such as metaphors and conceits. I like the whole Napoleonic theme.

But you lost me at this: " 'Stops' are to central bankers what safety fuses are to electricians."

Sorry, wrong. "Pull out the stops" is not a banking term, but a musical metaphor—on a pipe organ, the stops control how many ranks of pipes get activated. When you pull them all out, you are using the entire instrument, to get a really massive sound.

So, will the European economy dance to this music before the air supply is exhausted? I have no idea. It's certainly a risk. What's a better idea? Turn off the organ and have everyone just hold hands and sing Kumbaya (or La Marseillaise, to use your Napoleonic conceit?)

Maybe music doesn't provide such good metaphors the economy after all. I've had better luck with images from sailing. But that would be another article.

May 16 02:19 AM

[Moon Kil Woong:]

Thanks Alan for your organ metaphor correction. You are absolutely correct. As for wind. We have plenty of it from the Treasury and the administration on down to the Fed, unfortunately there is not alot of substance and the organ is off tune. It keeps going eeeek. I think that's the sound of inflation.

May 16 02:26 AM

[Ferdinand E...:]

A very well written put-down. If you look at it very carefully though, and do a little thinking, then you realize that it's entertainment and not economics. That's OK of in this day and age, although one thing amazes me, and that is the 'annoyance' with the governors of central banks. Where the EU central bank is concerned, I'm in the author's corner, because there shouldn't be an EU, but to ridicule Mr Ben for trying to do his job, is something that I find a little sick. Of course, I can imagine the kind of reaction that we'll see in this forum if Ben and Larry win this thing.

May 16 08:29 AM

[Blackeyebart:]

Ferdinand says " one thing amazes me, and that is the 'annoyance' with the governors of central banks. Where the EU central bank is concerned, I'm in the author's corner, because there shouldn't be an EU but to ridicule Mr Ben for trying to do his job, is something that I find a little sick"

Why shouldn't there be an EU?
Some people argue that there shouldn't be a Federal Reserve.
Many criticised the Alan & Ben policies before the recent problems, surely it's not "sick to point out the areas of disagreement.

May 16 08:52 AM

[Dave Wrixon:]

As usual you are just way too optimistic. Not only did they ignore the requirement for monetary discipline, but the statistics they are working to are political propaganda. The CPI has no credibility. Growth has been at unsustainable rates for a decade because most of what was actually being counted as growth was in fact misreported inflation.

May 16 10:00 AM

[MarkitWacha:]

You're right. If we would have included residential housing in the CPI, it would have scared the bejesus out of people. It also would have bankrupted the CPI-linked Social Security payments and many pensions.

It would have been the right thing to do, though, because what you pay for your house is an inseparable cost of living. Perhaps if that would have been included in the CPI, people would have reacted sooner to this crisis.

I place the blame for this crisis upon the citizenry, because this is, after all, a financially illiterate democracy. Think of all the millions of 401k holders that put their faith in the financial system devised by their voted leaders, yet don't know anything about the yield curve.



On May 16 10:00 AM Dave Wrixon wrote:

> As usual you are just way too optimistic. Not only did they ignore
> the requirement for monetary discipline, but the statistics they
> are working to are political propaganda. The CPI has no credibility.
> Growth has been at unsustainable rates for a decade because most
> of what was actually being counted as growth was in fact misreported
> inflation.

May 16 11:04 AM

[markfl:]

Using the GDP Deflator measure of inflation a $1.50 coffee bought in 1999 should cost $1.78. Using the CPI, it should cost $1.92. The inflation numbers used to calculate gdp make economic growth look larger than it really is. This masks the severity of the contraction and will make any recovery appear better than it really is. This explains in part why economic growth doesn't translate into the real world experience of costs in the marketplace versus wages
and income. Just because the government says something should cost 1.78 doesn't mean it is possible to purchase that product for the lesser amount.

The thing seldom ever discussed about the severity of the housing bubble is the fact that the spike in prices itself didn't precipitate a recession. At the same time prices went through the roof, the median family income dropped from 59,088 in 1999 to $58,407 in 2006. Meanwhile, your $1.50 coffee went up as well. If productivity and GDP were really as great as claimed by statistics, incomes should be rising.

A housing bubble and a recession might still have been inevitable, but would not have been nearly as severe. Most people feel as though they prospered between 1993 and 1999. In fact income went up by about $7,000. When this trend stopped, the economy headed on a collision course with armageddon. Until this changes, there can be no meaningful recovery.

On May 16 10:00 AM Dave Wrixon wrote:

> of what was actually being counted as growth was in fact misreported
> inflation.

May 16 11:21 AM

[fireball:]

i take your letter on a daily basis. it is always fun and funny. the absurdity of our situation needs some comic relief.
as a younger man when i ran low on money instead of seeking credit or raiding my savings i spent less. that worked out well.

May 16 11:47 AM

[Clive Corcoran:]

It wasn't just Napoleon's defeat on the Russian front that could be used to illustrate the ultimate calamity of dictatorial overstretch - the greatest folly of the Third Reich was Stalingrad.
Let's hope that there is some follow though and substance to the discussions about a new financial architecture which began at the recent G20 meeting, otherwise we may be looking at a bunker full of central bankers and politicians trying to hide from a bombed out financial system.

May 16 01:07 PM

[dcb:]

If we were truly in the time of Napoleon most of those in power would have been captured by the mob and had their heads cut off in the central square. My own personal view is that this would be an appropriate response.

May 16 01:08 PM

[rosey99:]

I think you nailed it. Stagnant/falling wages get relatively short shrift in the prevailing discussion. It sure does make for a combustible mixture when combined with an explosion in credit.

Nice post too, and refreshingly literate for SA.

On May 16 11:21 AM markfl wrote:

> Using the GDP Deflator measure of inflation a $1.50 coffee bought
> in 1999 should cost $1.78. Using the CPI, it should cost $1.92. The
> inflation numbers used to calculate gdp make economic growth look
> larger than it really is. This masks the severity of the contraction
> and will make any recovery appear better than it really is. This
> explains in part why economic growth doesn't translate into the real
> world experience of costs in the marketplace versus wages
> and income. Just because the government says something should cost
> 1.78 doesn't mean it is possible to purchase that product for the
> lesser amount.
>
> The thing seldom ever discussed about the severity of the housing
> bubble is the fact that the spike in prices itself didn't precipitate
> a recession. At the same time prices went through the roof, the median
> family income dropped from 59,088 in 1999 to $58,407 in 2006. Meanwhile,
> your $1.50 coffee went up as well. If productivity and GDP were really
> as great as claimed by statistics, incomes should be rising.
>
> A housing bubble and a recession might still have been inevitable,
> but would not have been nearly as severe. Most people feel as though
> they prospered between 1993 and 1999. In fact income went up by about
> $7,000. When this trend stopped, the economy headed on a collision
> course with armageddon. Until this changes, there can be no meaningful
> recovery.
>
> On May 16 10:00 AM Dave Wrixon wrote:

May 16 03:03 PM

[Fighting Yoda:]

Yes this is unchartered territory. Author is right - Fed is playing out of the same play book - cut interest rates - easy cheap money. But this got us into trouble in the first place.

Unless we get some leadership that would force down some strong bitter medicine - we will simply create a bigger mess. We should simply take a big recession and setup for the rebound. Obama's policies are simply too socialistic to ultimately succeed - too much money is being spent to achieve too very little - debt & interest payments would kill us down the line.

May 16 03:57 PM

[Fighting Yoda:]

markfl:
Inflation was hugely unreported during the boom - thus inflating GDP, now deflation is being under estimated. The problem with inflation computation is with the basket and 'hedonics' (price quality adjustments).


On May 16 11:21 AM markfl wrote:

> Using the GDP Deflator measure of inflation a $1.50 coffee bought
> in 1999 should cost $1.78. Using the CPI, it should cost $1.92. The
> inflation numbers used to calculate gdp make economic growth look
> larger than it really is. This masks the severity of the contraction
> and will make any recovery appear better than it really is. This
> explains in part why economic growth doesn't translate into the real
> world experience of costs in the marketplace versus wages
> and income. Just because the government says something should cost
> 1.78 doesn't mean it is possible to purchase that product for the
> lesser amount.
>
> The thing seldom ever discussed about the severity of the housing
> bubble is the fact that the spike in prices itself didn't precipitate
> a recession. At the same time prices went through the roof, the median
> family income dropped from 59,088 in 1999 to $58,407 in 2006. Meanwhile,
> your $1.50 coffee went up as well. If productivity and GDP were really
> as great as claimed by statistics, incomes should be rising.
>
> A housing bubble and a recession might still have been inevitable,
> but would not have been nearly as severe. Most people feel as though
> they prospered between 1993 and 1999. In fact income went up by about
> $7,000. When this trend stopped, the economy headed on a collision
> course with armageddon. Until this changes, there can be no meaningful
> recovery.
>
> On May 16 10:00 AM Dave Wrixon wrote:

May 16 04:55 PM