Obama's Sure-Fire Formula for Accelerating Inflation

The US economy is facing a challenging time for which Americans can thank the Fed's appalling monetary mismanagement, not to mention the lousy economics of the economics profession that is telling us that what the "good ole US of A" needs now is damn good dose of inflation. In the meantime, the Obama administration's spending spree would shame a bunch of drunken sailors. At least sailors spend their own money.

Obama is not only going to spend the earnings of the present generation of Americans but also their grandchildren's earnings and probably their grandchildren's as well. Come to think of it, the way his atrocious spending mania is going future Americans might not have much of an income to spend. (I am still getting emails from Obama cultists telling me that Bush is making him do it).

Bernanke's disgusting monetary policy is building up a massive head of inflationary steam, symptoms of which are already making their presence felt. For some months now the prices of long-term treasuries have been trending down, meaning that yields have been rising. People who bought treasuries last year have suffered significant losses. I think even more losses are on the way.

Last week China and Russia publicly declared that they are taking steps to diversify their foreign currency reserves, code for dumping dollars. Who can blame them? Under Obama American finances have become a total mess: deficits are absolutely massive and unsustainable, government spending is out of control, debt is rocketing while monetary expansion is unprecedented. This is a sure-fire formula for rising interest rates and accelerating inflation.

None of this fazed the media Pollyannas who reported that last week's 30-year bond market auction was a success and signaled the beginning of an upward trend in bond prices. These commentators overlooked two vital points. About half the bonds were bought by central banks. A clear case of collusion that cannot be maintained. The second point is that when inflation starts to accelerate bond yields will have to rise. There will be no stopping them unless the Fed decides to withdraw all those greens it printed. Not very likely.

The principal problem is Bernanke's vulgar Keynesianism. (I think the major difference between Keynes and today's Keynesians is the same difference between a social drinker and a dipsomaniac). Despite the historical fact that forcing interest rates down below their market clearing rates does not bring lasting employment and a permanent boom central banks still insist on doing it, egged on by academic economists.

Mankiw is right to point out that Bernanke is targeting inflation. But it's the only thing that Mankiw got right as evidenced by his view that "the goal could be to produce enough inflation to ensure that the real interest rate is sufficiently negative… " Apart from the fact that it is impossible to target the rate of inflation Mankiw's prescription would make for more unemployment in the future.

Even if interest rates became sufficiently negative to generate an expansion in production and an increase in the demand for labor, the resulting 'recovery' would be unsustainable. Prices would rise as would interest rates. The dollar would come under increasing pressure and balance-of-payments problems would emerge. The Fed would find itself having to slam on the monetary brakes again.

As for government borrowing raising aggregate demand, which is what Obama's supporters are claiming, this is plain nonsense. Genuine borrowing always means a transfer of purchasing power and not an aggregate increase in purchasing power. Of course, when government borrowing is funded by monetary expansion then total purchasing power in terms of dollars does increase. We call this inflation.

The borrowing angle that critics of Keynesianism are using to condemn Obama's reckless borrowing is sound economics but still misses the point. Keynesians argue that borrowing in a recessions does not crowd out investment because of the existence of idle resources in the form of unemployed labor and capital. The critics respond that the crowding out occurs when taxpayers find they have to fund the interest repayments on the loan. Moreover, there is no guarantee that the projects on which the funds were spent will not involve future economic losses that will have to be made up out of increased government spending which means either more borrowing, higher taxes or both.

Although this criticism is sound it cannot capture the full picture: that requires capital theory. Even where the government engages in genuine borrowing this could still seriously damage investment even if there exists a significant amount of idle resources. It can do this by directing expenditure toward consumption instead of investment. If one looks at the so-called boom of 1936-37 one will see that most of the expansion took place in the consumer goods industries while the capital goods industries badly lagged. (And it was the capital goods industries that won the war despite the level of capital consumption during the 1930s).

But of course we have to deal with Bernanke's reckless monetary policy. When monetary expansion is used to fund government spending crowding out occurs when the increased spending raises the demand for consumer goods and thereby attracts resources from the higher stages of production which in turn shortens the production structure. We call this capital consumption.

As a rule new money enters the economy through the capital market as a result of interest rates being forced down. This results in a disproportional increase in the demand for capital goods because the further away the capital good is from consumption in terms of time the greater will be the effect on its value as the discount rate falls. This results in greater investment in more productive but time consuming projects that ultimately increase total output. We call this the "Wicksell effect".

We have now returned to bond prices and interest rates. Because the long term rate is rising — and is expected to continue to rise — we should not expect to see an expansion of investment in more productive though more time consuming projects. Should long term rates continue to climb, the distinct possibility of capital consumption in the higher stages of production could emerge.

Whichever way one looks at it, Obama's economic policies are — at the very least — a recipe for stagnant living standards.

Comments

[GregZw:]

I smell the same fish. A salary of $250,000/year will be in the highest tax bracket and below the poverty level within 5 years!

Jun 17 08:52 AM

[Long Silver...:]

I think we should be allowed to print our own money on home computers. When the paper runs out, we just use thin slices of baloney. That removes any pretense as to what's going on. I would like to know the Fed's exit strategy for removing excess reserves. Don't they have to sell something? Like toxic assets on their balance sheet? Or can they just tell the banks to give the money back?

Jun 17 08:55 AM

[jamookey:]

I think we should put the author Jackson in charge of the fed.He seems to have all the answers.He complains alot,but offers no other solution to the problems Bush left behind.Typical pundant.Talk about spending,Jr. never vetoed one spending bill.Since the republicans owned congress for 90% of his term it makes one wonder what this jackass is talking about.

Jun 17 09:12 AM

[John Bowman:]

Where has defation occurred? Except for home prices returning to pre-bubble levels and the material and services which support that industry, what items are cheaper than a couple of years ago?

Homes are an infrequent investment, so a lot of the hype about deflationary trends due to that collapsing industry should be automatically discarded. And for equivalent rental prices, I know they are still increasing around here.

Taxes and heathcare costs have been and will keep on increasing in the future.

Sorry, but I don't buy the deflation scenario.

Jun 17 09:28 AM

[wtp:]

jamookey -- sorry, I meant "thumbs up," and chewed off my finger after I hit the wrong button. Some Republican partisans do seem to have short memories, so I hope they appreciate your reminders.

Jun 17 11:50 AM

[jack kreg:]

the blame throwers want it both ways,
every thing good is cause of BO
every thing bad is cause GW!!

that sounds like logic used in government not in real world.

Jun 17 12:36 PM

[Bob 123:]

Exactly. Good NYT piece the other day pointing out that all of the spending and deficits the wingnuts are so upset about -- it is nearly all Bush and the continuation by Obama of Bush policies. Namely the Bush tax cuts (mostly to the wealthiest) and Medicare prescription drug benefit. Of course, Obama did the right thing and put the cost of the dirty wars back on the books. Obama's spending (so far) accounts for only 3% of the deficits he inherited. Let the loonies spin all they want about it.


On Jun 17 09:12 AM jamookey wrote:

> I think we should put the author Jackson in charge of the fed.He
> seems to have all the answers.He complains alot,but offers no other
> solution to the problems Bush left behind.Typical pundant.Talk about
> spending,Jr. never vetoed one spending bill.Since the republicans
> owned congress for 90% of his term it makes one wonder what this
> jackass is talking about.

Jun 17 12:37 PM

[Thomas J. G...:]

A lot of people demonize Bernanke. Bernanke wasn't the one who decided to spend 300 bill deficit during late Bush, and 2 trillion deficit now. The fed chairman has to deal with the gov't deficit spending that is there. Maybe the fed should just say "we manage the money supply, if treasury needs to borrow extra, that's their problem". From 1988 to now, inflation has been under control in the u.s.. the guys running the fed did what they did and didn't cause any obnoxious inflation. I think they deserve some credit for that. I don't understand the motive of all this fed chairman bashing. I don't think Greenspan and Bernanke are secretly making money because of the policies they implement.

Jun 17 01:18 PM

[Spartacuss:]

Wake up people, you are systematically being robbed and your freedoms are being taken away as we move to becoming a fascist state with all the trimmings.

It is analagous to the Titanic's captain telling the crew, "if we cutout the damaged section of the hull all will be OK again".

Jun 17 02:16 PM

[taoprod:]

Good article. Very informative.
My major was Banking,Finance,and Economics,with a minor in accounting.
I make a successful living in the futures and options market.
I find it annoying to read some comments by tree hugging,Obama koolaid drinking,
pinkos who think the can fix fiscal problems by blaming someone else,
or they can fix Capitalism with socialism.
Don`t let the ignorant bother you.
They appear on other sites all parroting the same nonsense
Keep up the good work.

Jun 17 03:26 PM

[john j:]

I totally agree, more should have been invested in educaton instead of builidng new schools, pools, football fields. Kool aid drinking liberals have not bothered to wonder where they are going to create jobs at. Our manufacturing sector was sold to china and third world nations years ago. Was Von MIses who in his work explained that you cannot import your capital is rolling over in his grave. Circular arguments to blame the other party accomplishes nothing. I personally have no faith in Bernake or his buddy from the treasury, Gethner, whatever his non taxpaying name is. Our government's best bet was to stay out of this mess and let the markets settle themself, bailouts were a waste, letting AIG default would have been much better, as well as GM, Chrysler, Citi, etc................

Jun 17 07:22 PM