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G M
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« Reply #150 on: May 03, 2011, 06:52:16 PM »

You miss the important points, Doug.

Was Stiglitz published in the right journals? Did he cite the right people? Is he well thought of in academic circles?

Worrying about practical matters is for lesser beings.
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G M
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« Reply #151 on: May 13, 2011, 04:51:58 PM »

'Fair trade' is a crock

By DALIBOR ROHAC

Last Updated: 3:55 AM, May 13, 2011

NY Post

If you want to help out Third World farm workers, ignore the "Wake up the World" campaign. Don't have a "fair trade" breakfast -- or anything else. The "fair trade" label is a crock.

You're likeliest to see the "fair trade" label at high-end coffee shops and grocery stores -- especially ones with a "progressive" clientele. The certification is supposed to let you enjoy your latte without feeling guilty for exploiting the Ethiopian or Ecuadoran who harvested the beans.

Oh, the likes of Angelina Jolie and Colin Firth endorse it -- but the main value it brings is the consumer's feeling of socially conscious satisfaction.

Fair-trade-certified products -- coffee, bananas, cocoa, etc. from developing countries -- have boomed this last decade. US sales of fair-trade goods rose from $15 million to $48 million from 2005 to 2009.

Most people think "fair trade" guarantees better pay for agricultural workers in developing countries. The Fair Trade USA Web site insists, "We can change the world by changing our breakfast."

Sorry: What the organized fair-trade movement actually does is simply provide selected producers of cash crops in such nations with guaranteed minimum prices for their products. The direct benefits are small and rarely go to the least well-off. Worse, fair trade can hinder economic development.

Consider how it all works.

Again, "fair trade" merely guarantees certain producers a minimum price for a commodity. This gives farmers a safeguard against price drops, which can come in handy if they can't access more sophisticated forms of financial hedging.

But how much does fair trade actually help poor people? Most fair-trade producers are outside Sub-Saharan Africa, the world's poorest region. Mexico has 51 fair-trade cooperatives; Ethiopia has four and Burundi just one.

And the main benefit flows to fair-trade cooperatives -- groups of landowners, not laborers. The certification includes no incentives for the owners to pay higher wages to farmworkers, who tend to be poorer and more vulnerable.

It even tends to exclude the poorer landowners. Certification involves significant up-front costs -- $2,000 to $4,000 -- and annual inspections that require paying sizable fees. In a developing nation, that's a big hurdle.

And the folks shut out of the scheme are worse off. With a minimum price guaranteed, the fair-trade insiders can produce more with lower risks -- increasing the overall size of the crop and thus depressing prices for the folks who couldn't afford to buy their way in.

Even fair-trade supporters must admit that the scheme doesn't solve the problem of underdevelopment. No nation has become rich by earning a slightly higher return on a cash crop. Most developed countries have succeeded by allowing their economies to grow more sophisticated and diversified -- adding areas of production that pay more to workers and owners.

That is, there's more money in making chocolate than in growing cocoa -- and 90 percent of the world's cocoa, but only 4 percent of its chocolate, is produced in developing countries.

But "fair trade" -- guaranteeing a minimum price for certain crops -- locks part of the labor force into basic agriculture, discouraging it from moving "higher up the ladder" to better long-term opportunities in manufacturing, services or more sophisticated forms of agriculture. A study of Guatemala's fair-trade coffee industry by the Mercatus Center at George Mason University concluded that fair trade strongly encouraged production mediocrity.

Finally, "fair trade" encourages a particular business model at the expense of others. To qualify for registration in the fair-trade scheme, farmers need to form cooperatives that satisfy certain requirements of communal decision-making and transparency. Why, exactly -- other than badly dated ideology -- should we prefer landowner cooperatives over private companies that adhere to high standards of workers' welfare and social and environmental responsibility?

Ultimately, only private entrepreneurship and businesses can pull the developing world out of poverty. But entrepreneurs flourish only in a situation of good governance, stable property rights and business-friendly legal institutions. Rather than falling for marketing ploys that use poor people as pawns, we should work to improve the business environment in developing countries.

Low-income countries around the world don't need our pity and handouts; they need economic policies that work. "Fair trade" may mean well, but that's just not good enough.

Dalibor Rohac is a research fellow at the Legatum Institute in London.
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JDN
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« Reply #152 on: May 13, 2011, 10:11:44 PM »

You miss the important points, Doug.

Was Stiglitz published in the right journals? Did he cite the right people? Is he well thought of in academic circles?

Worrying about practical matters is for lesser beings.

I'm not saying I agree, Doug has some very good points, but Stiglitz won the Nobel Prize in Economics.  Obviously he will well thought of in academic circles.
And obviously he published in the "right" journals.

Don't take him lightly.  He had influence.

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G M
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« Reply #153 on: May 13, 2011, 10:17:54 PM »

You miss the important points, Doug.

Was Stiglitz published in the right journals? Did he cite the right people? Is he well thought of in academic circles?

Worrying about practical matters is for lesser beings.

I'm not saying I agree, Doug has some very good points, but Stiglitz won the Nobel Prize in Economics.  Obviously he will well thought of in academic circles.
And obviously he published in the "right" journals.

Don't take him lightly.  He had influence.



Two words: Paul Krugman.
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DougMacG
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« Reply #154 on: May 14, 2011, 11:08:00 AM »

The observation Stiglitz made was that "We are all Keynesians now" at the financial crisis point of roughly Sept 2008.

That meant Bush the outgoing President, McCain and Obama which means the incoming President no matter who wins, the entire Pelosi-Reid congress that was destined for one reelection and all the columnists and Ivy league economists that he knows.

My point was that before that and after that they were all proven wrong, no matter who they cocktail with.

Making money available during a financial contraction (Monetary policy) is different than running multiple trillions of dollars of deficits for multiple years (Keynesian fiscal policy) with no measurable positive affect.  It is hitting the wrong problem with the wrong solution.

FYI for JDN, Stiglitz colleague at Columbia Robert Mundell has a Nobel prize in Economics as well and holds a very different policy view, unless he has done an about face since designing the Reagan-Volcker two pronged solution to the two-pronged problems of stagflation last time we went down this road.   http://www.columbia.edu/~ram15/

http://www.bloomberg.com/news/2010-12-27/mundell-sees-u-s-growing-2-at-most-in-2011-after-confidence-devastated-.html

Mundell Sees U.S. Growing 2% at Most in 2011 After Confidence `Devastated'
Dec 27, 2010 3:51 PM CT

Robert Mundell, Nobel Prize winning economist and Columbia University professor.

Dec. 27 (Bloomberg) -- Nobel Prize-winning economist Robert Mundell of Columbia University and Bloomberg Businessweek's Peter Coy talk about the outlook for the U.S. economy. They speak with Carol Massar on Bloomberg Television's "Street Smart." (Source: Bloomberg)

The U.S. economy will probably grow no more than 2 percent in 2011, less than what’s needed to lower unemployment, Nobel-prize winning economist Robert Mundell said.

“I don’t see economic growth as being any better than 2 percent,” the Columbia University economics professor said in an interview today on Bloomberg Television’s “Street Smarts” with Carol Massar. “You had this financial shock to the economy which devastated confidence, and there is nothing around the corner that looks like it’s going to be a strong push for the economy.”

The economy grew at an average 2.9 percent annual rate in the five quarters since the worst recession in seven decades ended in June 2009. That pace of recovery has lowered unemployment from a peak of 10.1 percent in October 2009 to 9.8 percent last month.

Mundell, 78, said the Fed’s unconventional monetary policy actions, known as quantitative easing, had the undesired effect of strengthening the dollar.

“The Fed policy was working three or four times before, but then it was cut off because the dollar soared and that’s what really broke the back of the economy,” he said. The Fed has been “negligent” in not taking into account the influence a rising dollar would have on the economy, he said.
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Crafty_Dog
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« Reply #155 on: May 15, 2011, 09:01:03 AM »

Mundell, with very good reason, was the darling of the editorial page of the WSJ in its mighty heyday in the 1980s and '90s and was a huge influence on Jude Wanniski in writing his seminal book "The Way the World Works".

That said,

a) He's saying fed policies have strengthened the dollar?!?
b) Now that we are more than 1/3 the way through the year, how is his prediction of growth rate doing?
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DougMacG
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« Reply #156 on: May 15, 2011, 09:33:09 AM »

Mundell:  On the first point, that surprised me too.  Brilliant guy, I will look into what he was saying.  On the second point , no more than 2% growth which is horrible, he was right on the money so far.  Q1 was 1.8%, surprising everyone else.
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DougMacG
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« Reply #157 on: June 12, 2011, 10:23:52 PM »

"You can see how the types of pro-growth policies in the [Pawlenty] plan would work toward the goal by reducing spending growth enough to balance the budget without tax increases and thereby remove threats of a debt crisis; by lowering marginal tax rates to spur hiring and job growth; by scaling back unnecessary new regulations which impede private investment and higher productivity, and by restoring sound monetary policy to remove uncertainty about inflation or another financial crisis."
----------------
Note: I looked him up because Gov. Pawlenty referred to him this morning on Fox News Sunday

Prof. John B. Taylor
Mary and Robert Raymond Professor of Economics at Stanford University
George P. Shultz Senior Fellow in Economics at the Hoover Institution
Home page: http://www.stanford.edu/~johntayl/
Blog: http://www.johnbtaylorsblog.blogspot.com/

Saturday, June 11, 2011
Why Not Go For 5% Growth?
Some skeptics have complained about the 5% national economic growth target put forth by former Minnesota Governor Tim Pawlenty in his speech this week about his economic plan. They say it can’t be done. But I think the goal makes a great deal of sense. It would focus policymakers like a laser beam on the great benefits that come from higher growth and on the pro-growth policies needed to achieve it. As with any goal, if you take it seriously, you’ll choose policies that work toward that goal and reject those that don’t.

As stated in the speech, “5% growth is not some pie-in-the-sky number.” One way to see why is by dissecting the number into its two parts using basic economics. As we teach in Economics 1, economic growth equals employment growth plus productivity growth. Productivity is the amount of goods and services that workers produce on average in a given period of time. Thus, higher economic growth can come from higher employment growth or from higher productivity growth. Now consider some examples of average growth rates over the next ten years.

First, look at employment growth. Given the dismal jobs situation, that’s the highest priority. Currently the percentage of the working-age population (age 16 and over) that is actually working is very low at 58.4 percent. In the year 2000 it reached 64.7 percent, so that is at least a feasible number. Raising the employment-to-population ratio to 64.7 means an employment increase of 10.8 percent (64.7-58.4/58.4 = .108) or about 1 percent per year over 10 years, even without any growth of the population. Adding in about 1 percent for population growth (from Census projections), gives employment growth of 2 percent per year.

Now consider productivity growth. Since the productivity resurgence began around 1996, productivity growth in the United States has averaged 2.7 percent according to the Bureau of Labor Statistics. So numbers in that range are not pie in the sky. As Harvard economist Dale Jorgenson and his colleagues have shown, the IT revolution is part of the explanation for the productivity growth, and, if not stifled, is likely to continue, as is pretty clear to me as I sit a few hundred yards from Facebook and other high-tech firms.

Now if we add the 2.7 percent productivity growth to the 2 percent employment growth, we get 4.7 percent economic growth, which is within reaching distance of—or simply rounds up to—the 5 percent target set by Governor Pawlenty. Thus, five percent growth is a good goal to aspire to, whereas 3 or 4 percent would be too little and 6 or 7 percent too much. Of course, one can fine-tune these calculations--for example, by estimating changes in hours per worker or the difference between nonfarm business (which BLS productivity numbers refer to) and total GDP--or raise questions about demographic effects on the employment-to-population ratio. And one could use different examples, perhaps lower employment growth and higher productivity growth, but the basic point about the goal would be the same.

You can see how the types of pro-growth policies in the Pawlenty plan would work toward the goal by reducing spending growth enough to balance the budget without tax increases and thereby remove threats of a debt crisis; by lowering marginal tax rates to spur hiring and job growth; by scaling back unnecessary new regulations which impede private investment and higher productivity, and by restoring sound monetary policy to remove uncertainty about inflation or another financial crisis.
Posted by John B. Taylor at 1:34 PM
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ccp
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« Reply #158 on: August 27, 2011, 11:47:04 AM »

From Doug's link from cognitive dissonance of the left moved here:

****No, Paul Krugman, WWII Did Not End The Great Depression
   
“There are three kinds of lies: lies, damned lies, and statistics.” – Benjamin Disraeli

It’s a recurring fantasy for left wing academics fascinated by central planning that in cyclical downturns government should act decisively on a scale equivalent to war. Nobel Prize recipient Paul Krugman exemplifies this intellectual longing to steer our lives.

Krugman effortlessly slides into a war footing espousing intervention comparable to America’s crusade against Hitler, who, take note, centrally planned an economy himself:

“World War II is the great natural experiment in the effects of large increases in government spending, and as such has always served as an important positive example for those of us who favor an activist approach to a depressed economy.”

After WWII until its glaring failures manifest in the Seventies, Keynesianism inundated economic thought. Paul Samuelson’s textbooks became mainstays across the academy. Samuelson championed mathematical analysis, which transformed macroeconomics into a pseudo science spawning waves of budding planners infatuated with statistics.

From this basis the myth prevails that WWII finally overcame the Great Depression. History has revised Hoover, easily the most meddlesome peacetime president before FDR, into a laissez-faire reactionary. The New Deal – a disastrous example of everything not to do during downturns became beneficial, only it supposedly wasn’t aggressive enough.

Hoover tinkered with the economy throughout his term. The Smoot-Hawley Act of 1929 launched the trade war many believe precipitated the stock-market crash and the Depression. Then, fearing falling prices, he signed Norris-LaGuardia, Davis-Bacon and other acts, formed business cartels and farming associations all striving to arrest falling prices. Hoover also authored massive public works as he increased federal spending by 50%.

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Bill Flax
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ccp
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« Reply #159 on: August 27, 2011, 11:49:02 AM »

After campaigning on fiscal discipline, FDR promptly accelerated Hoover’s initiatives, devising new economic experiments almost daily. As FDR’s economist Rexford Tugwell conceded, “We didn’t admit it at the time, but practically the whole New Deal was extrapolated from programs that Hoover started.” Despite ridiculing Hoover’s “extravagance,” FDR increased spending another 83% in his first three years.

The best unemployment result prior to WWII was 14% in 1937. European unemployment was far lower. By 1939, unemployment was back at 19% as FDR increased taxes and cut spending in preparation for war. As the government reined in its make-work projects, rather than weaning a sustainable recovery off the Keynesian incubator, the recovery reversed. The New Deal clearly failed to prime the private pump.

On the surface, wartime spending finally propelled America from the Depression’s pits. As war production expanded from roughly 2% of GDP to almost 40%, statistically, America rebounded. In 1940 dollars, GDP shot from $101.4 billion to $120.7 billion in 1941 up to $174.8 billion by 1945 while unemployment fell below 2%.

America didn’t officially enter the fray until December 1941. FDR had by then rescinded most New Deal regulations, scuttled the WPA and similar agencies and ceased his incessant public bickering with private business. Some surmise he stopped attacking industry recognizing he needed their help attacking fascism.

The pre Pearl Harbor boost stems from three factors: wartime spending by others, which does not reflect stimulus on Washington’s part; Lend-Lease, but giving away munitions abroad promotes no prosperity here, and the demise of the New Deal.

After netting out federal spending, GDP surged 17% from $91.9 billion in 1940 to $107.7 billion in 1941. Once engaged, our non-federal output trickled down to $101.4 billion by WWII’s conclusion in 1945. The private economy reflected little improvement, partly because private consumption was curbed. Living standards didn’t regain 1929 levels until America restored a market based economy in the aftermath of victory.

FDR dreaded the recession’s return as Keynesian theory suggested severe trouble when ten million plus soldiers returned home unemployed. The president proposed a “Bill of Economic Rights” predicated on aggregate demand maintenance. Congress thankfully repudiated it. Tax rates were slashed while war time rationing, price controls and regulations receded.

America was one of few industrial nations with its productive infrastructure intact. Despite federal spending falling from $93 billion in 1945 to under $30 billion by 1948 (in 1945 dollars), unemployment stabilized around 4% as Americans, free of New Deal shackles, launched an economic boom.
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ccp
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« Reply #160 on: August 27, 2011, 11:49:46 AM »

Page 3 of 3

Portraying WWII as bounteous economically because statistical measures bettered is like confusing a high batting average with winning championships. You can hit well and still lose. Normally, hitting safely and decreased joblessness reflect success, but war is different. Unemployment lessened because the draft sent men into combat. Increasing production because women were forced into factories building bombs is deceptive.

Economics studies the transformation of scarce resources into that which best fulfills our unlimited desires. How does blowing up Germany boost American living standards? How is making men sleep in frigid fox holes under enemy fire enriching? How did rationing everything from the enjoyment of luxuries to our clothing and diets lift anyone’s material standing?

The military doesn’t jumpstart the economy, it protects producers. This represents patriotic sacrifice, not prosperity.

Production is the progenitor of wealth, but making things unvalued by markets doesn’t improve life. Neither does working harder to achieve the same result. Repairing damage caused by war or natural calamity through debt encumbrance does nothing to support sustainable growth. Once said project completes, we’re back where we started with debts to boot.

During the postwar era, both parties believed spending was stimulating and thought government intervention essential during downturns. But we almost invariably recovered before the spending packages even passed Congress. Unfortunately, rather than conclude that intervention is unnecessary, now, we rush spending bills through as if racing a deadline to preempt the natural ricochet so politicians can take credit.

Stimulus spending doesn’t augment aggregate demand unleashing our “animal spirits” towards growth. It invites crony capitalism, patronage and dependency. As funds flow through Washington, producers reorient from satisfying customers to lobbying politicians. War spending leads to the dreaded Military-Industrial Complex Republicans like Ike feared, but Neo-Cons today relish.

If resources were unlimited or little effort was necessary to extract value, we could consume at will. Instead, markets prioritize output by channeling resources via price signals. Government spending fails because politicians lack the vital feedback mechanism of profits and losses. It’s not their money. Military outlays exemplify this faulty prioritization. Once Congress gets involved, we can’t even cut defense projects the military finds redundant. What the military does demand is often exorbitantly overpriced.

Stimulus efforts allow politicians to dispense dollars in patronage schemes conferring power upon themselves at taxpayer expense. Congress buys votes with your money. Even if public spending did stimulate, such corruption is too repugnant to condone.

As government grows, it becomes increasingly self serving. Bureaucracy inevitably seeks its own expansion. Businesses succeed by producing efficiently and pleasing customers. Bureaucracies thrive via inefficiency. Exceeding one’s budget makes it easier to ask for more. Failure allows sinecures to grovel before Congress that greater funding can achieve what lower funding merely wasted.

Deficit spending has never once successfully stimulated recovery. Like our failed war on poverty or public education, interventionists consistently claim we haven’t spent sufficiently. Mimicking the New Deal’s failure, Keynesians today decry that the Bush and Obama stimulus bills were half-hearted.

Dr. Krugman so desperately seeks more spending that he wishes Congress would pretend aliens are invading. Washington could then control the economy – for our good, not theirs, he’d have us assume. Krugman assures us liberals have a conscience.

Whether they have any common sense is less certain.
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Crafty_Dog
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« Reply #161 on: August 27, 2011, 07:55:59 PM »

An additional insight to the economics of the FDR and the Great Depression is to be found in a chapter dedicated to it in Jude Wanniski's "The Way the World Works".  Highly recommended.
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DougMacG
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« Reply #162 on: August 28, 2011, 04:31:12 PM »

Trying to figure out what cured the previous great depression and how that could apply today.

WPA spending, the largest new deal program, peaked in 1938 and there were no new 'New Deal' initiatives passed after 1938.  FDR's power was declining.  Unemployment was still 19% at the start of 1939 because programs then, like cash for clunkers and shovel ready projects today, failed in any real way to stimulate private economic growth.  Then, strangely and coincidentally, the unemployment and economic growth situation started improving exactly as the emphasis was shifting away from government-based programs.  (Who knew?)

They say it was the war that brought back the economy but the growth really surged two years before Pearl Harbor and America's direct investment in the war.  The war brewing elsewhere was boosting foreign demand.  Increased demand only has an effect if you are in a position to build and supply what they need and cannot build for themselves.  What products would that be today - as we ban drilling for oil, use up our corn wastefully as energy, close our pipelines, put a noose around coal mining, attack new methods of extracting natural gas, add an extra layer of direct taxation to medical devices, chase out semiconductor fabrication and put federal restrictions on aircraft manufacturers to keep them from addressing their uncompetitive cost structure - what will we build that they will need?

In 1939, we were rich with ready-to-go supplies of natural resources in demand elsewhere and we were filled with idle manufacturing capacity ready to produce the specific goods in demand.  

How does that measure up in 2011-2012?  Not very well.  In the current case the rest of the world is already doing pretty well largely without using many of our products.  They are especially unlikely to purchase from us anything that we are unwilling to produce.
« Last Edit: August 28, 2011, 04:41:43 PM by DougMacG » Logged
Crafty_Dog
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« Reply #163 on: August 28, 2011, 05:33:54 PM »

Winniski says the Smoot Hawley Tariff Act and its analogues abroad (including beggar thy neighbor devaluations) caused the Depression by fragmenting the world economy and that the world economy got going again after its re-integration e.g. the Bretton Woods accords and related agreements.
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Crafty_Dog
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« Reply #164 on: September 24, 2011, 10:46:32 AM »



By HOLMAN W. JENKINS, JR.
Let's face it, the "Chicago School" of economics—the one with all the Nobel Prizes, the one associated with Milton Friedman, the one known for its trust of markets and skepticism about government—has taken a drubbing in certain quarters since the subprime crisis.

Sure, the critique depends on misinterpreting what the word "efficient" means, as in the "efficient markets hypothesis." Never mind. The Chicago school ought to be roaring back today on another of its great contributions, "rational expectations," which does so much to illuminate why government policy is failing to stimulate the economy back to life.

Robert E. Lucas Jr., 74, didn't invent the idea or coin the term, but he did more than anyone to explore its ramifications for our model of the economy. Rational expectations is the idea that people look ahead and use their smarts to try to anticipate conditions in the future.

Duh, you say? When Mr. Lucas finally won the Nobel Prize in 1995, it was the economics profession that said duh. By then, nobody figured more prominently on the short list for the profession's ultimate honor. As Harvard economist Greg Mankiw later put it in the New York Times, "In academic circles, the most influential macroeconomist of the last quarter of the 20th century was Robert Lucas, of the University of Chicago."

Mr. Lucas is visiting NYU for a few days in early September to teach a mini-course, so I dash over to pick his brain. He obligingly tilts his computer screen toward me. Two things are on his mind and they're connected. One is the failure of the European and Japanese economies, after their brisk growth in the early postwar years, to catch up with the U.S. in per capita gross domestic product. The GDP gap, which once seemed destined to close, mysteriously stopped narrowing after about 1970.

The other issue on his mind is our own stumbling recovery from the 2008 recession.

For the best explanation of what happened in Europe and Japan, he points to research by fellow Nobelist Ed Prescott. In Europe, governments typically commandeer 50% of GDP. The burden to pay for all this largess falls on workers in the form of high marginal tax rates, and in particular on married women who might otherwise think of going to work as second earners in their households. "The welfare state is so expensive, it just breaks the link between work effort and what you get out of it, your living standard," says Mr. Lucas. "And it's really hurting them."

Enlarge Image

CloseTerry Shoffner
 .Turning to the U.S., he says, "A healthy economy that falls into recession has higher than average growth for a while and gets back to the old trend line. We haven't done that. I have plenty of suspicions but little evidence. I think people are concerned about high tax rates, about trying to stick business corporations with the failure of ObamaCare, which is going to emerge, the fact that it's not going to add up. But none of this has happened yet. You can't look at evidence. The taxes haven't really been raised yet."

By now, the Krugmanites are having aneurysms. Our stunted recovery, they insist, is due to government's failure to borrow and spend enough to soak up idle capacity as households and businesses "deleverage." In a Keynesian world, when government gooses demand with a burst of deficit spending, the stick figures are supposed to get busy. Businesses are supposed to hire more and invest more. Consumers are supposed to consume more.

But what if the stick figures don't respond as the model prescribes? What if businesses react to what they see as a temporary and artificial burst in demand by working their existing workers and equipment harder—or by raising prices? What if businesses and consumers respond to a public-sector borrowing binge by becoming fearful about the financial stability of government itself? What if they run out and join the tea party—the tea party being a real-world manifestation of consumers and employers not behaving in the presence of stimulus the way the Keynesian model says they should?

Mr. Lucas and colleagues in the early 1960s were not trying to undermine the conventional prescriptions when they began to think about how the public might respond—possibly in inconvenient ways—to signals about government intentions. As he recalls it, they were just trying to make the models work. "You have somebody making a decision between the present and the future. You get a college degree and it's going to pay off in higher earnings later. You make an investment and it's going to pay off later. Ok, you can't do that without this guy taking a position on what kind of future he's going to be living in."


'If you're going to write down a mathematical model, you have to address that issue. Where are you supposed to get these expectations? If you just make them up, then you can get any result you want."

The solution, which seems obvious, is to assume that people use the information at hand to judge how tomorrow might be similar or different from today. But let's be precise, not falling into the gap between "word processor people" and "spreadsheet people," as Mr. Lucas puts it. Nothing is assumed: Data are interrogated to see how changes in tax rates and other variables actually influence decisions to work, save and invest.

Mr. Lucas is quick to credit the late John Muth, who would later become a colleague for a while at Carnegie Mellon, with inventing "rational expectations." He also cites Milton Friedman, with whom Mr. Lucas took a first-year graduate course.

"He was just an incredibly inspiring teacher. He really was a life-changing experience." Friedman, he recalls, was a skeptic of the Phillips curve—the Keynesian idea that when businesses see prices rising, they assume demand for their products is rising and hire more workers—even if the real reason for higher prices is inflation.

"Milton brought this [Phillips curve] up in class and said it's gotta be wrong. But he wasn't clear on why he thought it was wrong." In his paper for Friedman's class, Mr. Lucas remembers reaching for a very rudimentary notion of expectations to try to explain why the curve could not operate as predicted.

Growing up in the Seattle area, Mr. Lucas recalls a road trip he took as a youngster that terminated in Chicago, a city with two baseball teams! Chicago, in his mind, became "the big city," a gateway to a wider world. That, and a scholarship, is how he would end up spending most of his career at the University of Chicago.

We are sitting in an inauspicious guest office at NYU. A late summer sprinkle dampens the city. Mr. Lucas describes his parents as intelligent, reading people, neither of whom finished college—he suspects the Great Depression had something to do with it. "They got into left-wing politics in the '30s, not really to do anything about it, but to talk about. That was our background—me and my siblings—relative to our neighbors and relatives, who were all Republicans." In a community not noted for its diversity, his parents were especially committed to civil rights, his mother giving talks on the subject.

I ask about a report that he voted for Barack Obama in 2008, supposedly only the second time he had voted for a Democrat for president. "Yeah, I did. My parents are dead for a long time, but my sister says, 'You have to vote for Obama, for what it would have meant for Mom and Dad.' I felt that too. It's a huge thing. This [history of racism] has been the worst blot on this country. All of a sudden this charming, intelligent guy just blows it away. It was great."

Related Video
 Steve Moore and Mary O'Grady discuss the week's economic news.
..A complementary consideration was John McCain's inability to say anything cogent about the financial crisis then engulfing the nation. "He didn't have a clue about the economy. I just assumed the guy [Obama] could do it. I thought he was going to be more Clinton-like in his economics and politics. I was caught by surprise by how far left the guy is and how much he's hung onto it and, I would say, at considerable cost to his own standing."

Refreshing, even bracing, is Mr. Lucas's skepticism about the "deleveraging" story as the sum of all our economic woes. "If people start building a lot of high-rises in Chicago or any place and nobody is buying the units, obviously you're going to shut down the construction industry for a while. If you've overbuilt something, that's not the problem, that's the solution in a way. It's too bad but it's not a make-or-break issue, the housing bubble."

Instead, the shock came because complex mortgage-related securities minted by Wall Street and "certified as safe" by rating agencies had become "part of the effective liquidity supply of the system," he says. "All of a sudden, a whole bunch of this stuff turns out to be crap. It is the financial aspect that was instrumental in the meltdown of '08. I don't think housing alone, if it weren't for these tranches and the role they played in the liquidity system," would have been a debilitating blow to the economy.

Mr. Lucas believes Ben Bernanke acted properly to prop up the system. He doesn't even find fault with Mr. Obama's first stimulus plan. "If you think Bernanke did a great job tossing out a trillion dollars, why is it a bad idea for the executive to toss out a trillion dollars? It's not an inappropriate thing in a recession to push money out there and trying to keep spending from falling too much, and we did that."

But that was then. In the U.S. at least, the liquidity problems that manifested themselves in 2008 have long since been addressed. To repeat the exercise now with temporary tax and spending gimmicks is to produce the opposite of the desired effect in consumers and business owners, who by now are back to taking a longer view. Says

Mr. Lucas: "The president keeps focusing on transitory things. He grudgingly says, 'OK, we'll keep the Bush tax cuts on for a couple years.' That's just the wrong thing to say. What I care about is what's the tax rate going to be when my project begins to bear fruit?"


Mr. Lucas pulls up a bit when I ask him what specific advice he'd give President Obama (this is before Mr. Obama's two back-to-back speeches, one promising temporary tax cuts and the other permanent tax hikes, which mysteriously fail to levitate the economy). Unlike many of his colleagues, Mr. Lucas has not spent stints in Washington advising politicians, or on Wall Street cashing in on his Nobel laureate reputation. "No, that doesn't interest me at all," he says. "Now I've taken a salary cut. I don't go to faculty meetings. I don't teach undergraduates. I just write papers. It's great. I feel lucky about this."

Still, an answer comes. Mr. Lucas launches into a brisk dissertation on the work of colleagues—Martin Feldstein, Michael Boskin, others—whom he credits with disabusing him and fellow economists of a youthful assumption that taxes have little effect on the overall amount of capital in society. A lesson for Mr. Obama might be: If you want to stimulate growth in investment, productivity and income, cut taxes on capital.

Alas, don't look for this idea to feature in the next Obama speech on the economy, due any minute now.

Mr. Jenkins writes the Journal's Business World column.

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« Reply #165 on: October 01, 2011, 01:41:15 AM »

IMHO this article has genuine insight and explains something important which has been a mystery to me:

=================

By RONALD MCKINNON
In past decades, tense political disputes over actual or projected fiscal deficits induced sharp increases in interest rates—particularly on long-term bonds. The threat of economic disruption by the so-called bond market vigilantes demanding higher interest rates served to focus both Democratic and Republican protagonists so they could more easily agree on some deficit-closing measures.

For example, in 1993 when the Clinton administration introduced new legislation to greatly expand health care without properly funding it ("HillaryCare"), long-term interest rates began to rise. The 10-year rate on U.S. Treasury bonds touched 8% in 1994. The consequent threat of a credit crunch in the business sector, and higher mortgage rates for prospective home buyers, generated enough political opposition so that the Clinton administration stopped trying to get HillaryCare through the Congress.

In the mid-1990s, Democrats and Republican cooperated to cap another open-ended federal welfare program—Aid to Families with Dependent Children—by giving block grants to the states and letting the states administer the program. Interest rates came down, and the Clinton boom was underway.

Enlarge Image

CloseChad Crowe
 .In contrast, after the passage of ObamaCare in March 2010, long-term bond rates remained virtually unchanged at around 3%. This was despite great doubt about the law's revenue-raising provisions, and the financial press bemoaning open-ended Medicare deficits and the mandated huge expansion in the number of unfunded Medicaid recipients. Even with great financial disorder in the stock and commodity markets since late July 2011, today's 10-year Treasury bond rate has plunged below 2%. The bond market vigilantes have disappeared.

Without the vigilantes in 2011, the federal government faces no immediate market discipline for balancing its runaway fiscal deficits. Indeed, after President Obama finally received congressional approval to raise the debt ceiling on Aug. 2, followed by Standard & Poor's downgrade of Treasury bonds from AAA to AA+ on Aug. 5, the interest rate on 10-year Treasurys declined even further.

Since Alexander Hamilton established the market for U.S. Treasury bonds in 1790, they have been the fulcrum for the bond market as a whole. Risk premia on other classes of bonds are all measured as so many basis points above Treasurys at all terms to maturity. If their yields are artificially depressed, so too are those on private bonds. The more interest rates are compressed toward zero, the less useful the market becomes in reflecting risk and allocating private capital, as well as in disciplining the government.

To know how to restore market discipline, first consider what caused the vigilantes to disappear. Two conditions are necessary for the vigilantes to thrive:

(1) Treasury bonds should be mainly held within the private sector by individuals or financial institutions that are yield-sensitive—i.e., they worry about possible future inflation and a possible credit crunch should the government's fiscal deficits get too large. Because private investors can choose other assets, both physical and financial, they will switch out of Treasurys if U.S. public finances deteriorate and the probability of future inflation increases.

(2) Private holders of Treasurys must also be persuaded that any fall in short-term interest rates is temporary—i.e., that the Fed has not committed itself to keeping short-term interest rates near zero indefinitely. Long rates today are the mean of expected short rates into the future plus a liquidity premium.

The outstanding stock of U.S. Treasury bonds held outside American intergovernment agencies (such as the Social Security Administration but excluding the Federal Reserve) is about $10 trillion. The proportion of outstanding Treasury debt held by foreigners—mainly central banks—has been increasing and now seems well over 50% of that amount. Since 2001, emerging markets alone have accumulated more than $5 trillion in official exchange reserves. And in the last two years the Fed itself, under QE1 and QE2, has been a major buyer of longer-term Treasury bonds to the tune of about $1.6 trillion—and that's before the recently announced "Operation Twist," whereby the Fed will finance the purchase of still more longer-term bonds by selling shorter-term bonds. So the vigilantes have been crowded out by central banks the world over.

Central banks generally are not yield-sensitive. Instead, under the world dollar standard, central banks in emerging markets are very sensitive to movements in their dollar exchange rates. The Fed's near-zero short-term interest rates since late 2008 have induced massive inflows of hot money into emerging markets through July 2011. This induced central banks in emerging markets to intervene heavily to buy dollars to prevent their currencies from appreciating versus the dollar. They unwillingly accept the very low yield on Treasurys as a necessary consequence of these interventions.


True, in the last two months, this "bubble" of hot money into emerging markets and into primary commodities has suddenly burst with falls in their exchange rates and metal prices. But this bubble-like behavior can be traced to the Fed's zero interest rates.

Beyond just undermining political discipline and creating bubbles, what further economic damage does the Fed's policy of ultra-low interest rates portend for the American economy?

First, the counter-cyclical effect of reducing interest rates in recessions is dampened. When interest rates dipped in the past, at least part of their immediate expansionary impact came from the belief that interest rates would bounce back to normal levels in the future. Firms would rush to avail themselves of cheap credit before it disappeared. However, if interest rates are expected to stay low indefinitely, this short-term expansionary effect is weakened.

Second, financial intermediation within the banking system is disrupted. Since early 2008, bank credit to firms and households has declined despite the Fed's huge expansion of the monetary base—almost all going into excess bank reserves. The causes are complex, but an important part of this credit constraint is that banks with surplus reserves are unwilling to put them out in the interbank market for a derisory low yield. This bank credit constraint, particularly on small- and medium-size firms, is a prime cause of the continued stagnation in U.S. output and employment.

Third, a prolonged period of very low interest rates will decapitalize defined-benefit pension funds—both private and public—throughout the country. In California, for example, pension actuaries presume a yield on their asset portfolios of about 7.5% just to break even in meeting their annuity obligations, even if they were fully funded.

Perhaps Fed Chairman Ben Bernanke should think more about how the Fed's near-zero interest rate policy has undermined fiscal discipline while corrupting the operation of the nation's financial markets.

Mr. McKinnon is a professor at Stanford University and a senior fellow at the Stanford Institution for Economic Policy Research.

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« Reply #166 on: October 01, 2011, 08:02:20 PM »

http://sethgodin.typepad.com/seths_blog/2011/09/the-forever-recession.html

The forever recession (and the coming revolution)



There are actually two recessions:
 
The first is the cyclical one, the one that inevitably comes and then inevitably goes. There's plenty of evidence that intervention can shorten it, and also indications that overdoing a response to it is a waste or even harmful.
 
The other recession, though, the one with the loss of "good factory jobs" and systemic unemployment--I fear that this recession is here forever.
 
Why do we believe that jobs where we are paid really good money to do work that can be systemized, written in a manual and/or exported are going to come back ever? The internet has squeezed inefficiencies out of many systems, and the ability to move work around, coordinate activity and digitize data all combine to eliminate a wide swath of the jobs the industrial age created.
 
There's a race to the bottom, one where communities fight to suspend labor and environmental rules in order to become the world's cheapest supplier. The problem with the race to the bottom is that you might win...
 
Factories were at the center of the industrial age. Buildings where workers came together to efficiently craft cars, pottery, insurance policies and organ transplants--these are job-centric activities, places where local inefficiencies are trumped by the gains from mass production and interchangeable parts. If local labor costs the industrialist more, he has to pay it, because what choice does he have?
 
No longer. If it can be systemized, it will be. If the pressured middleman can find a cheaper source, she will. If the unaffiliated consumer can save a nickel by clicking over here or over there, then that's what's going to happen.
 
It was the inefficiency caused by geography that permitted local workers to earn a better wage, and it was the inefficiency of imperfect communication that allowed companies to charge higher prices.
 
The industrial age, the one that started with the industrial revolution, is fading away. It is no longer the growth engine of the economy and it seems absurd to imagine that great pay for replaceable work is on the horizon.
 
This represents a significant discontinuity, a life-changing disappointment for hard-working people who are hoping for stability but are unlikely to get it. It's a recession, the recession of a hundred years of the growth of the industrial complex.
 
I'm not a pessimist, though, because the new revolution, the revolution of connection, creates all sorts of new productivity and new opportunities. Not for repetitive factory work, though, not for the sort of thing ADP measures. Most of the wealth created by this revolution doesn't look like a job, not a full time one anyway.
 
When everyone has a laptop and connection to the world, then everyone owns a factory. Instead of coming together physically, we have the ability to come together virtually, to earn attention, to connect labor and resources, to deliver value.
 
Stressful? Of course it is. No one is trained in how to do this, in how to initiate, to visualize, to solve interesting problems and then deliver. Some see the new work as a hodgepodge of little projects, a pale imitation of a 'real' job. Others realize that this is a platform for a kind of art, a far more level playing field in which owning a factory isn't a birthright for a tiny minority but something that hundreds of millions of people have the chance to do.
 
Gears are going to be shifted regardless. In one direction is lowered expectations and plenty of burger flipping... in the other is a race to the top, in which individuals who are awaiting instructions begin to give them instead.
 
The future feels a lot more like marketing--it's impromptu, it's based on innovation and inspiration, and it involves connections between and among people--and a lot less like factory work, in which you do what you did yesterday, but faster and cheaper.
 
This means we may need to change our expectations, change our training and change how we engage with the future. Still, it's better than fighting for a status quo that is no longer. The good news is clear: every forever recession is followed by a lifetime of growth from the next thing...
 
Job creation is a false idol. The future is about gigs and assets and art and an ever-shifting series of partnerships and projects. It will change the fabric of our society along the way. No one is demanding that we like the change, but the sooner we see it and set out to become an irreplaceable linchpin, the faster the pain will fade, as we get down to the work that needs to be (and now can be) done.
 
This revolution is at least as big as the last one, and the last one changed everything.
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Crafty_Dog
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« Reply #167 on: October 02, 2011, 10:50:48 AM »

The insight in that piece is a good one to keep in mind.

What did you make of the bond vigilante piece I posted?
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« Reply #168 on: October 02, 2011, 12:42:57 PM »

My understanding is that back when the Fed operated under some set of rules, markets dictated interest rates.  Prices and yields of Treasury bonds today are not real because, as he put it, "the Fed's huge expansion of the monetary base" and that a good part of the rest is going to central banks who are looking for storage of funds more than yield.  If we had to sell debt up to the entire revenue shortfall, interests rates would be through the roof.  he is right that the masking of the underlying problem enables it to continue and escalate and he shows how it causes other problems, the pension system collapse and the drying up of private lending and investment as examples prolonging and worsening what is already wrong.  It is a ticking time bomb. 

He says in closing: "Perhaps Fed Chairman Ben Bernanke should think more about how the Fed's near-zero interest rate policy has undermined fiscal discipline while corrupting the operation of the nation's financial markets."

Yes, but when tight money precedes growth policies, like when Paul Volcker tightened while Tip O'Neill's congress delayed tax cuts, the temporary unemploymentsurge was huge.  Today it would be catastrophic.  We need to solve both.
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« Reply #169 on: October 03, 2011, 07:20:57 AM »

The insight in that piece is a good one to keep in mind.

What did you make of the bond vigilante piece I posted?

Doesn't gov't intervention in the economy always result in a distortion of some kind that eventually results in a negative outcome?
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« Reply #170 on: October 03, 2011, 09:27:01 AM »

Exactly so.

And here we have the disappearance of the discipline imposed on both spending and monetization!

This is not good.  How are ordinary people to protect themselves from this war on savings and money itself?
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« Reply #171 on: October 03, 2011, 09:47:14 AM »

"How are ordinary people to protect themselves from this war on savings and money itself?"

Change course.   smiley

Unfortunately, ordinary people right now don't have savings.  Open equity lines with low interest became the new savings and now people have neither.
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« Reply #172 on: October 03, 2011, 09:49:42 AM »

"How are ordinary people to protect themselves from this war on savings and money itself?"

Tangible assets and tangible skillsets.
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« Reply #173 on: October 06, 2011, 08:33:46 AM »



A reader from Germany has questions regarding the role of credit in my deflation thesis. Josef writes:

Hello Mish

I am trying to understand your reasoning in the discussion about inflation vs. deflation.  One of the things I don't understand is the role of "credit". You write that "the market value of credit is collapsing at an amazing rate".  But isn't "credit" the same as "debt"?  When the market value of debt falls, then I wouldn't I need less "real estate" to get rid of my debt? Please, can you spend a minute to clarify this contradiction.
---------------
No Contradiction

Hello Josef,

An accepted offer for credit is a loan, resulting in debt for the borrower, and an asset (the loan) on the balance sheet of the lender (typically a bank or finance company). So yes debt = credit extended (plus agreed upon interest).

When the value of assets (loans) drop significantly, banks become capital impaired and cannot lend. This is happening now even though banks are hiding losses by not marking assets to market prices.

We have heard absurd statements from the Central bank of France that there are no toxic assets on French bank balance sheets. The market price of Greek debt says otherwise.

Plunge in Mark-to-Market Prices of Bank Assets

We can infer marked-to market plunges in value of bank assets by the enormous drops in financial stocks this year. We know the value of debt on the balance sheets of banks has collapsed, even if banks deny it.

Inability to pay back debt also shows up in credit default swaps, sovereign debt ratings, and soaring bond yields of Greece, Portugal, Spain, and Italy vs. Germany.

These credit actions show a demand for safe hiding places such as US and German government bonds and cash. We can see that in record low US treasury yields and German government bond yields.

Debt Not Marked-to-Market

The second question is where your error is "wouldn't I need less real estate to get rid of my debt?"

The debt remains until it is written off. In the US, people still owe more on their houses than they can pay back. The money is owed but will not be paid back. The same applied to may types of loans including auto loans, credit card debt, home equity lines, etc.

Enormous Foreclosure Backlog

US Banks have the value of their assets (mortgage loans, commercial real estate loans, consumer credit loans), at prices that do not reflect likelihood of default and thus that debt is not marked-to-market.

Writedowns are deflation in action, and they are coming.

In many instances, people walk away from mortgage debt. In those cases banks eventually foreclose. The key word is "eventually" as the list of pending foreclosures is measured in decades at the current rate.

Please see First Time Foreclosure Starts Near 3-Year Lows, However Bad News Overwhelms; Foreclosure Pipeline in NY is 693 months and 621 Months in NJ for details.

US Writedowns Coming on REOs

When homeowners walk away or go bankrupt, generally they are relieved of debt. However the problem for banks does not go away.

After foreclosure, banks have a different asset on the books. It is no longer a loan, but rather REO (Real Estate Owned).

What do you think those houses on the balance sheets of banks are worth vs. the value banks hypothesize they are worth?

Once again, this capital impairment shows up in banks inability and unwillingness to lend. When banks don't lend, businesses don't expand, and when businesses don't expand unemployment stays high.

This deflationary cycle feeds on itself until home prices fall to the point where there is genuine demand for them and banks are recapitalized.

European Writedowns

The biggest debt problem in Europe is in regards to loans made by French and German banks to Greece, Spain, Portugal, and Italy.

The ECB, EU, and IMF compounded the problem by throwing more money at Greece, on terms and timelines Greece cannot possibly pay back.

Europe has other huge structural issues regarding productivity in Spain and Greece vs. Germany, and in currency union that cannot possibly work given the lack of a fiscal union.

Poor Policies by IMF, EU, ECB, Fed

EU, IMF, ECB, and Fed policies in the US and Europe were designed to hide losses on real estate loans, to hide losses on sovereign debt loans to Greece, Spain, Portugal etc, and to prevent losses to banks and bondholders.

Barry Ritholtz had an excellent column on that yesterday called Banking’s Self Inflicted Wounds.

Policies of governments and central banks that bail out private banks are wrong because they place more burden on already over-extended and deep in debt taxpayers who are not equipped to take on more debt.

The deflationary backdrop will persist until debt is written off, consumer deleveraging peaks, home prices fall to affordable values, and global structural imbalances fixed. The situation is not encouraging because of five critical problems.

Five Critical Problems


Keynesian clowns everywhere refuse to accept the fact that debt is the problem and one cannot possibly spend one's way out of debt crisis.
Europe has structural problems related to the currency union, productivity, union work rules, pensions, retirement, and country-specific fiscal problems.
The US has structural problems related to prevailing wages, collective bargaining of public unions, corporate tax policies, etc.
Stimulus and bailouts are bad enough in and of themselves, but stimulus and bailouts without fixing structural problems is insanity.
Politicians on both continents refuse to address structural issues

Process is Important, Not the Term

It's important to not get hung up on the term "deflation" but rather to understand the process I am describing, the implications of that process, and why the policy actions taken have not worked (and cannot possibly work), all called well in advance.

For more on the process of deflation (regardless of what one wants to call it), please see Bizarro World Inflation; About that 2011 Hyperinflation Call ...

Yes Virginia, U.S. Back in Deflation; Inflation Scare Ends; Hyperinflationists Wrong Twice Over

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
--------------------------------------------------------------------------------
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DougMacG
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« Reply #174 on: November 28, 2011, 11:19:39 PM »

5 minutes, vintage, very interesting, still relevant.  Bringing it here from the political side by request.

Economics: Equality of rights or results? Sowell, Piven, Friedman 1980

http://www.youtube.com/watch?feature=player_embedded&v=26QxO49Ycx0

Discussion between Thomas Sowell and Frances Fox Piven with Milton Friedman
http://miltonfriedman.blogspot.com/
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« Reply #175 on: November 29, 2011, 12:22:34 PM »

http://reason.com/archives/2011/11/29/we-dont-face-any-good-options

‘We Don’t Face Any Good Options’

Nobel Prize–winning economist Vernon Smith on the financial crisis, Adam Smith’s underrated insights, and his journey from socialist to libertarian

Nick Gillespie from the December 2011 issue

“I remember the ’30s like it was yesterday,” says economist Vernon Smith. And he’s not kidding. In 1935, when the future Nobel Prize winner was 7 years old, his family decamped to their Kansas farm to wait out the hard times. “On the farms,” Smith explains, “you can eat.” His parents only made it to eighth grade, but “they were people who read,” and they expected their son to go to college. They got their wish—and then some.

Smith’s higher education began with remedial work at a local Quaker college (“I was not a good student in high school,” he says) but eventually took him from a Caltech electrical engineering degree to an economics Ph.D. at Harvard. Beginning at Purdue University, and then at the University of Arizona and George Mason University, Smith founded and developed the pioneering field of experimental economics, which studies actual human behavior—a major breakthrough in a discipline obsessed with abstract models. This work culminated in 2002, when Smith was awarded the Nobel Memorial Prize in Economic Sciences “for having established laboratory experiments as a tool in empirical economic analysis, especially in the study of alternative market mechanisms.”

Over that time span, Smith’s political views evolved in tandem with his economic insights. He left behind the socialism he learned at his mother’s knee for a more libertarian outlook. He says “experimental economics destroyed whatever was left in me of the notion that somehow you could do better than to find institutions that organized this decentralized information and create.” Now continuing his lab work at Chapman University, Smith is riding out the second most serious economic crisis of his 84 years in sunny California.



In July, Smith sat down with reason.tv Editor in Chief Nick Gillespie to discuss his ideological journey, how FDR (and perhaps George W. Bush) saved capitalism, why some of Adam Smith’s most important intellectual contributions are overlooked, and what experimental economics has to say about the collapse of the housing market.

reason: We’re sitting in your office at Chapman University, a beautiful campus in Orange County, California. Tell us about your setup here, what kind of experiments you’re running, and what you’re hoping to find with them.

Vernon Smith: We’re asking some questions that came out of the economic crisis. We started doing asset-trading experiments in the ’80s and discovered bubbles, quite unintentionally.

reason: In your experiments, you were able to create bubbles, or did they just pop up?

Smith: They popped up. We thought we would create bubbles, but we never had to.

reason: How does a bubble take place?

Smith: Right now, we don’t understand why people get caught up in self-reinforcing expectations of rising prices. The first time you’re in this experiment, you may have bought early and you may have sold before the break. Bring those same people back in another two or three days, put them in the same environment, and we get a lower-volume bubble. Typically, it booms earlier and crashes earlier; they are expecting a bubble. Bring them back a third time, and they tend to trade fairly close to fundamental value.

reason: How does this type of experiment map onto, say, the last five years in America?

Smith: If you think about the housing bubble, buyers, sellers, borrowers, lenders, real estate agents, government regulators—everybody believed that prices would rise and continue to rise. And that is the essence of a bubble. Suppose a regulator in 2003 or 2004 said, “Hey, this thing is not sustainable. We’ve got to do something to stop it.” I think he’d have been fired. If the bubble had been stopped in 2003 or 2004, it probably would have been a lot less damaging. But who’s going to know that?

(Interview continues below video.)

 

reason: Why has it taken so long for economics to become more seriously empirical in its operations? It really seems like it’s taken forever for economists to want to observe actual human beings trading either in an experimental setting or in the real world.

Smith: Economics enjoyed a major breakthrough in the 1870s: the marginal revolution.

reason: Give us the short definition of the marginal revolution.

Smith: If you go back to Adam Smith, he was puzzled as to why diamonds command a higher price than water, whereas water is more useful. The key idea he didn’t have is the notion of marginal utility or marginal value. Unfortunately, I think we lost a lot of the other insights of Adam Smith because we’d solved this intellectual problem of understanding better the determination of prices. Equilibrium economics really [took] the driver’s seat.

reason: Which holds…

Smith: The idea is an economy consists of preferences and technology for producing goods. This gives you a conjunction of supply and demand where demand depends not on the price of this particular good but the price of the alternatives, because the concept of opportunity cost comes in on both the demand side and the supply side. So it’s a complex problem mathematically and intellectually, but this problem got solved and it helped them to understand the operation of a static, equilibrium world.

Of course the great insight of [economist F.A.] Hayek and his criticism of equilibrium theory was that it began with a bunch of givens that are not, in fact, given to any one mind in the economy. The essential thing about a real economy is that all this information is dispersed. So the name of the game is how people discover this equilibrium. And that’s where I think the experimental work has importantly dramatized the essence of Hayek’s critique. Given the institutions of trading, people are very good in the laboratory at finding these equilibria that they don’t have any understanding of—and they get there by repetition.

reason: You say you’re a libertarian with a lot of reservations. The experiments you have run and the research you’ve done over the years really argue that institutions create good and bad behavior.

Smith: As a libertarian, I’d like to emphasize the property rights aspect of it. People say what we need is more regulation. All markets are regulated in terms of property rights, the dos and don’ts. The important thing is that those property rights provide people with the right incentives. What was so devastating in the mortgage market is this separation of mortgage originations from the lender without properly incentivizing the mortgage originator. What’s your incentive to do due diligence if you get your fee up front and then it goes out the back door and down the line?

reason: You say we got away from understanding that everyone needs to have skin in the game. What was driving that loss of knowledge? Was it federal policy? Was it collective amnesia?

Smith: The way I would describe it is: We created new mortgage and financial institutions too fast. No one had an incentive to think it through. Not only were there bad incentives up front with mortgage origination, but those mortgages then would be packaged, mortgage-backed securities issued, and then they were rated and “insured.” But they weren’t collateralized. They were exempt, you see. And exempt meant that they were exempt from the property rights rules that would have applied if derivatives had been classified as securities.

reason: This has been a very long recession, and whether it has ended or not, we’re facing slow economic growth and high unemployment. What are the forces extending this crisis?

Smith: The main thing is the negative equity problem in households. Or near negative equity. You have something like 22 percent of homeowners now who owe more on their house than the current market value. You don’t feel like spending money; you’re paying down debt.

reason: What do you do? Do you just sit it out until enough of the debt is paid down?

Smith: That’s probably the way we’re going to do it. It was a mistake to subsidize new home buyers. Existing homeowners—many of them have been given a break in their payments, but they’ve done it by giving them a lower interest rate and stretching the loans. They haven’t even changed the principal.

reason: But that’s a disturbing intervention, isn’t it?

Smith: Of course it’s disturbing! Forgiving debt is not a good idea. But you have to realize we don’t face any good options. If it hadn’t been done, the banking system likely would have collapsed. We’d have the same problem we had in the ’30s.

reason: If this is the second worst economic crisis—except for the Great Depression—how does it stack up?

Smith: I remember the ’30s like it was yesterday. See in 1932, I was 5 years old. My father worked for the Bridgeport Machine Company in Wichita, Kansas. He was a machinist. We had a farm. So in 1935 we moved to that farm. In times of stress there often is this reverse migration from cities to farms, because on the farms you can eat. We grew our own vegetables, chickens, hogs, all of that. They were very, very difficult years in terms of wheat harvests and that sort of thing.

reason: You grew up in Kansas in the ’30s and then, in terms of high school—

Smith: I finished high school in January 1944. I was working at Boeing at the time and continued until the following August, and then I went to Friends University, a Quaker college not many blocks from where I lived. And the reason that I went there was to make up for my high school education. I was not a good student in high school, and I did not have the math, physics, chemistry that I needed if I was going to go into science. I made up for all of that at Friends University.

reason: Did either of your parents go to college?

Smith: No.

reason: So how did you gravitate to even thinking of that as a possibility?

Smith: My parents always expected it of me, even though they only had an eighth-grade education. They were people who read. My mother was a socialist and was a political activist.

reason: When you say socialist—she believed that the means of production should be collectively owned by the state, etc.?

Smith: Oh, yes! But that was really common of people in the 1930s.

reason: Especially in that part of the country.

Smith: Oh, yes.

reason: You got a master’s in economics from Kansas, and then you went to Harvard for your Ph.D. What were they teaching in economics classes?

Smith: General equilibrium theory. The course I took from Wassily Leontief, which was the first-year theory class at Harvard, was a very good one. We read Irving Fisher. I’m still a great admirer.

reason: What do you like about him?

Smith: Fisher was a very clear writer. I remember a student once asked Leontief in class why there was no school of economics built around Fisher. And Leontief said: Well, it’s because he wrote so clearly—everyone could understand what he was saying.

reason: Were people free market enthusiasts at that point? Or were they all talking about a command economy?

Smith: I think the only clear-cut free market enthusiast at Harvard would have been Gottfried Haberler. He’d come out of the Austrian school. There was a tremendous exodus, of course, out of Germany and Austria of not only physicists but economists—Fritz Machlup, Jacob Marschak, [Joseph] Schumpeter, of course. And when I got to Harvard, Schumpeter had died only two years earlier and his legacy was very strong.

reason: Was there a sense that FDR’s economic policies had succeeded and that economists could just sort of follow through on that project?

Smith: Yes. Roosevelt, in a way, kind of saved capitalism.

reason: Just like George Bush did more recently.

Smith: Yeah. He kind of saved it. In fact, my grandfather, my mother’s father, who had been a supporter of Eugene Victor Debs in 1932, became a Roosevelt fan, and I think that tells you a lot about what happened in the ’30s.

reason: Let’s talk about that then. It’s also a personal journey for you. And I know you said your first presidential vote went to Norman Thomas, the Socialist in 1948. And then the other presidential vote that was easy for you to make was Ed Clark in 1980, the Libertarian candidate. In a way, your journey—as demarcated by those votes—is part of a larger American story of leaving behind a kind of rule by elites, or control by elites, where “we’ll take care of everything,” to a much more individualistic understanding that it’s a libertarian country.

Smith: Experimental economics destroyed whatever was left in me of the notion that somehow you could do better than to find institutions that organized this decentralized information and create. That’s the engine of wealth creation.

reason: In America since 1950, there’s been a vast increase in the appreciation of and understanding of economics. Will we be better at not being stupid about how we’re acting if we know more about economics?

Smith: The work that has to be done to keep us from getting off track has to be expressed in terms of institutional constraints, when what we do has serious implications for innocent other parties. Margin rules in the stock market confine the damage for the people who are doing it. There’s no external blindsiding of all kinds of people that are innocent. I see it as a property rights problem. And you know what? We got it right in most markets. The vast majority of markets work fine. And the reason why they work is that you can’t steal; you have to trade. Essentially, what we’re doing is asking whether there was a type of theft going on that was not being controlled by the right property rights regime.

reason: Federal spending is currently 25 percent of the economy, a figure that hasn’t been seen since World War II. Deficits loom large in absolute numbers as well as a percentage of the economy. Is that a form of theft as well? Is that something that concerns you and needs to be reined in?

Smith: We’re primarily going to solve that problem by inflating out of it.

reason: I’m very sorry to hear that.

Smith: I’m sorry to say it! But I think that will be the way we reduce the burden of the debt. It won’t be intended. [Federal Reserve Chairman] Ben Bernanke talks about the tools he has. One of the tools he has is to raise the interest rate he pays on excess reserves—in other words, pay them to not expand loans rapidly. But right now he’s got the other problem.

reason: But is this also the delusion of the economic planner, that once things start happening—he’s very smart, he’s going to be able to control this? We’ve seen this before, where inflation isn’t a problem until it’s beyond control.

Smith: It’s really interesting to look at the Federal Open Market Committee press releases in 2007. On August 7, 2007, the press release said the housing market is going through an adjustment; we’re still concerned about inflation. Three days later, because of the collapse in the credit default market, that completely changed. The Federal Reserve, Bernanke realized they had a financial crisis on their hands. That’s how quickly it happened, and the signal came from a market. It did not come from the econometric models. I think to Bernanke’s credit that he changed. He turned on a dime. How many times had he said it was not the business of the Federal Reserve to rescue investors from the consequences of their own decisions? That’s exactly what he ended up doing. I don’t believe he wanted to do it. I think he meant the earlier statements, but he had no choice.

reason: If we hadn’t bailed out the banks, if we hadn’t passed TARP, the economy would have ceased to exist?

Smith: I think the more important thing is what the Federal Reserve did, not the Treasury program. You can always go back and say, well things should have been done earlier to prevent that from happening. Yes, yes, I agree. But the point is, what do you do in that case? Here it is, in spite of whatever mistakes had been made before. And Bernanke is testing the Friedman-Schwartz hypothesis right now—that if the Fed had acted and flooded the system with liquidity in the early ’30s, that we’d have prevented the Great Depression.

reason: Economists enjoy a possibly unprecedented kind of cultural power now. They can write best-selling books. They can run the world economy. Where does economics as a serious discipline need to be moving next?

Smith: To me, the major problem in economic theory is the preoccupation with modeling for its own sake and not asking the fundamental questions. These fundamental questions have to do with dynamics; they have to do with property rights. Basic questions like: “How can it be that specialization, exchange, and property rights came about?” You can’t have one without the other. We think today of property rights as something that comes from the state. That couldn’t possibly be how they originated. Our small-group experiments are trust games. Imagine a trust game in which I’m a first mover and you’re the second mover. I move first. I can choose $10 for each of us, or I can pass to you. If I pass to you, the $20 becomes $40. You can give me 15 and keep 25, or you can give me nothing and get the whole 40. Game theory says I should never pass to you, because if you’re self-interested, you’ll take the 40. But what’s remarkable is half the people we recruit in the undergraduate lab—half of the first movers [pass] to the second. And two-thirds to three-quarters reciprocate with 15/25—they don’t take the total. You can’t understand that with game theory. You can understand it by reading The Theory of Moral Sentiments.

reason: Is that a learned behavior, or is that an innate behavior? Or is that dichotomy not really relevant?

Smith: It’s Adam Smith! He says imagine a human being is brought up in complete isolation from any member of the species. That person can’t have an idea of what it means for his mind to be deformed any more than he has an idea for what it means for his face to be deformed. Bring him into society, and you give him the mirror he needs. In The Theory of Moral Sentiments, Adam Smith is saying munificence is the only thing that requires reward. You don’t reward justice; what you do is punish injustice. Justice is what’s left over after you prevent injustice. Property rights come out of human sociality and then eventually get into civil government. But they arise originally in small groups.
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« Reply #176 on: November 29, 2011, 01:27:39 PM »

In 1987, Mrs Thatcher flew to Moscow to meet the Soviet leader Mikhail Gorbachev. In their famous conversations (not shown in the film), Gorbachev rounded on her. As she recalled it, “His view was that the British Conservative Party was the party of the 'haves’ in Britain and that our system of 'bourgeois democracy’ was designed to fool people about who really controlled the levers of power.” But she hit back: “I explained that what I was trying to do was to create a society of 'haves’, not a class of them.”

http://www.telegraph.co.uk/finance/financialcrisis/8915711/Margaret-Thatcher-knew-that-capitalism-must-deliver-for-the-masses.html
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« Reply #177 on: December 13, 2011, 09:22:40 AM »


http://www.youtube.com/watch?feature=player_embedded&v=xWAgt_YCNuw

Myths of the New Deal

This video by the Center for Freedom and Prosperity does a good job of exploding the key myths that have surrounded the Great Depression and the New Deal for decades. It is remarkable that the facts this video sets forth are starting to become well known, after many years of obfuscation, due to the work of Amity Shlaes and others  http://www.powerlineblog.com/archives/2011/12/myths-of-the-new-deal.php
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« Reply #178 on: December 14, 2011, 09:24:44 AM »

An extension of the Keyfabe post, that pro wrestlers may not really be trying to destroy their opponent, is the misunderstanding of the concept of greed in economics.  An implication is falsely made that in a free market we are all trying to destroy each other, and the rich will take all and leave you with nothing if we don't stop them.  But that doesn't make any sense.

Greed in economics means acting in your own self interest and may include providing for your spouse and your children, maybe your parents, other family members and your place of worship, your charities, your neighborhood, community, your boy scout troop, your environment, your nation, etc and the need to keep your own business interests moving forward to provide for all those 'self' interests.

The fact that people act in their own long term self interest in business and economics is a central tenet in a logic based system that allows the players in the economic system to understand what the other players will do and to make adjustments so that transactions take place and business relationships prosper.  The successful business (the butcher, the baker and the candlestick maker) will seek to get the best price (low) from his suppliers and labor, etc. and to get the best price (high) from his customers in a competitive environment, not to destroy them but to keep them as suppliers and customers and to grow the business with them.
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« Reply #179 on: April 23, 2012, 12:58:34 AM »

BOE: A Very Model of Dismal Forecasting



By SIMON NIXON

"Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist." Keynes's words today seem truer than ever. In the early stages of the crisis, there was a lot of talk of "model risk". Banks were said to have relied too heavily on models based on flawed assumptions, fuelling a disastrous misallocation of capital. But what of the models used by policy makers to guide their decisions? These rely heavily on similar academic theories about how economies behave. Yet the longer the crisis continues, it is becoming clear that central banks are also susceptible to model risk—not least the Bank of England.

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Bloomberg

Mervyn King, governor of the Bank of England,

The BOE's dismal forecasting record is now a matter of serious concern. Official data last week showed inflation actually rose in March to 3.5% from 3.4% in February, putting it not only well above the BOE's 2% target for the 28th consecutive month, but also more than one percentage point higher than the BOE had forecast as recently as November. Indeed, the BOE has got all the big calls consistently wrong. This time last year, it expected the economy would now be growing by around 3%; this week, the Office for National Statistics is likely to confirm the U.K. barely grew in the first quarter and may even have slipped into technical recession. Indeed, throughout the past five years, the BOE has never stopped predicting the economy will be growing by at least 2.5% two years later.

True, some of this is down to bad luck rather than bad judgment. The BOE couldn't have been expected to predict last year's escalation in the euro crisis or the Arab Spring. But the BOE must take the blame for grossly over-estimating the impact of sterling's devaluation. It has also badly under-estimated the weakness of the money supply: Despite pumping £325 billion ($523.98 billion) into the economy, equivalent to 20% of GDP, the U.K. broad money supply suffered its biggest quarterly drop in February since records began in 1963. Add the BOE's failure to predict the crisis—even in May 2008 it was still attaching a virtual zero probability of a recession—and it is clear something is wrong with it's models.
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Of course, the BOE is not alone in struggling to make sense of the crisis. Few forecasters have done much better—hardly surprising since most rely on similar academic theories. The International Monetary Fund seems similarly adrift, judging by its latest World Economic Outlook. Until recently, it was a leading advocate of austerity in the euro zone. Now it is hard to know what it believes; it still says fiscal retrenchment is essential while warning it may prove counter-productive. Similarly, the IMF led calls for European bank recapitalization yet now warns bank deleveraging could knock 1.4 percentage points off euro-zone growth by the end of 2013.

Where did the economics professsion go wrong? One answer was offered by BOE Deputy Governor Charlie Bean in a speech last year: Modern economic theory largely ignores the role of banks. "The canonical macroeconomic model for thinking about the design of monetary policy is that of the New Keynesian synthesis. This focuses on the consequences of real and nominal rigidities in goods and labor markets… The behavior of financial intermediaries was seen as being of marginal relevance to the understanding of macroeconomic fluctuations."

Some U.K. policy makers now privately admit their biggest mistake was to underestimate the dynamics and impact of bank deleveraging. No wonder, then, that BOE chief economist Spencer Dale announced this month that the BOE has adopted a new model, partly to address this deficiency. Even so, the role of banks won't be hard-wired into the new "framework" but will be offered as a separate "suite" to provide the Monetary Policy Committee with alternative "insights". Indeed, the new model is apparently unlikely to make much difference to BOE forecasts—not least because it could be 10-15 years before the academic literature is sufficiently advanced to assign a meaningful role for banks into macroeconomic models.

To a layman, this seems extraordinary. Didn't modern economics grow out of a financial crisis? The profession claimed to have learned all the lessons from the 1930s and subsequent crises about how to engineer a recovery. After this crisis, history may need to be rewritten. Perhaps devaluation is a double-edged sword in an open economy. Maybe Keynesian fiscal stimuluses don't work in economies with debt to GDP ratios approaching 100% and deficits in double figures—a situation Keynes could barely have imagined. Perhaps trying to drive down the price of money by buying government bonds is ineffective if a broken banking system is pushing up lending rates—and may even be counter-productive if it boosts inflation. Perhaps the real significance of the collapse of the gold standard was that it paved the way for an expansion of credit—whereas this generation of BOE officials is presiding over an ongoing contraction.

Either way, the BOE shows little sign of changing its approach despite its new model: Astonishingly, the words "deleverage" or deleveraging" haven't appeared once in the last five Inflation Reports, notes Citigroup. The MPC is still not consulted on crucial decisions regarding the banking system: The decision to force banks to repay early emergency funding provided under the Special Liquidity Scheme—arguably the BOE's most successful policy since the start of the crisis—was taken without reference to the MPC. Policies on bank capital and liquidity ratios are the preserve of the separate Financial Policy Committee. And BOE Governor Mervyn King refuses to allow the MPC a say on whether it should buy private-sector assets as part of its quantitative easing program or engage in other measures to ease the pressure on bank funding costs.

Meanwhile five years after the crisis hit, the U.K. is in the midst of the biggest squeeze on living standards in modern history, with output still well below its peak, weak-to-non-existent growth, a deteriorating debt profile, and inflation so far above target the BOE may no longer have scope to deploy its sole policy tool. But don't worry: In two years, inflation will be back below 2% and the economy will be ticking along nicely, growing by 3%. At least, that's what the model says.

Write to Simon Nixon at simon.nixon@wsj.com
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JDN
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« Reply #180 on: April 30, 2012, 11:48:18 AM »

Maybe the economy is not so bad.....

http://www.thedailybeast.com/newsweek/2012/04/29/myth-of-decline-u-s-is-stronger-and-faster-than-anywhere-else.html
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G M
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« Reply #181 on: April 30, 2012, 05:01:54 PM »


http://www.usdebtclock.org/

Let me know when the red numbers start moving backwards.
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DougMacG
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« Reply #182 on: April 30, 2012, 06:08:40 PM »

GM,  It would be interesting to get a version of that clock that shows the debt since Democrats took power in Nov 2006 / Jan 2007 - and the 'growth' we bought with it.  The new Senators that year are up for discipline (re-election) this year.  The majority of women in 2010 already voted the first woman Speaker.   The de facto leaders of the Senate then and Executive Branch now, Obama, Hillary and even Biden are also up for second thoughts by the electorate.

All they can say it was worse before they "got here' and point to when they instead controlled congress.
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Crafty_Dog
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« Reply #183 on: May 01, 2012, 05:15:13 AM »


Though I find JDN's posted article to be rather vapid and glib, the larger question remains and it is one of America, not just its government.  We remain a rather fg amazing country.  If, for example, Romney wins and the Reps do well in Congress, there is a LOT of money sitting on the sidelines just waiting to jump in.  The energy sector e.g. natural gas, is VERY promising and holds profound implications.  Anyway, this thread is more for Economic theory than this.  A better place for this discussion would be the Decline? thread at

http://dogbrothers.com/phpBB2/index.php?topic=2123.0 
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DougMacG
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« Reply #184 on: May 01, 2012, 03:19:35 PM »

This statement of Crafty's in the Calif thread makes a great point that has widespread implications in economics:

"...the high unemployment rate and the closely related decline in discretionary income with its attendant decline in discretionary spending-- which unfortunately for me is how most wives see martial arts-- are really hitting the portion of my income based upon local spending"

We keep trying to target groups for taxation, only the rich, only the business owner, only the other business owner.  But you cannot tax or punish the other guy ("crucify" in the case of coal companies) without taxing yourself or your own family.

In this particular case, let's say we design a big tax increase so carefully that it hits every business except martial arts schools.  Up goes unemployment, down goes take home and discretionary income and instantly the martial arts school is taxed in lost income.

It isn't trickle down; it is interconnectedness.  Tax the business owner, the employees suffer.  Tax the store, the customer gets hit.  Tax the energy used in manufacturing driving costs up, factory jobs go overseas.

If we spend to excess and then don't tax anyone to pay for it, just borrow and print money, everyone is still hurt by the declining value of everything else in diluted dollars.
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G M
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« Reply #185 on: May 01, 2012, 03:39:49 PM »

This statement of Crafty's in the Calif thread makes a great point that has widespread implications in economics:

"...the high unemployment rate and the closely related decline in discretionary income with its attendant decline in discretionary spending-- which unfortunately for me is how most wives see martial arts-- are really hitting the portion of my income based upon local spending"

We keep trying to target groups for taxation, only the rich, only the business owner, only the other business owner.  But you cannot tax or punish the other guy ("crucify" in the case of coal companies) without taxing yourself or your own family.

In this particular case, let's say we design a big tax increase so carefully that it hits every business except martial arts schools.  Up goes unemployment, down goes take home and discretionary income and instantly the martial arts school is taxed in lost income.

It isn't trickle down; it is interconnectedness.  Tax the business owner, the employees suffer.  Tax the store, the customer gets hit.  Tax the energy used in manufacturing driving costs up, factory jobs go overseas.

If we spend to excess and then don't tax anyone to pay for it, just borrow and print money, everyone is still hurt by the declining value of everything else in diluted dollars.

What? There is no magical money tree? When did that happen?
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« Reply #186 on: May 02, 2012, 11:09:16 AM »



http://www.realclearpolitics.com/video/2012/04/30/ron_paul_vs_paul_krugman_on_economics.html


http://www.forbes.com/sites/michaelpollaro/2012/04/27/the-bernanke-bust-the-why-how-and-when/
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« Reply #187 on: May 07, 2012, 11:03:49 AM »

http://www.thedailybeast.com/articles/2012/05/06/paul-krugman-austerity-is-so-wrong.html
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« Reply #188 on: May 10, 2012, 01:42:40 PM »



By ROBERT J. BARRO
The weak economic recovery in the U.S. and the even weaker performance in much of Europe have renewed calls for ending budget austerity and returning to larger fiscal deficits. Curiously, this plea for more fiscal expansion fails to offer any proof that Organization for Economic Cooperation and Development (OECD) countries that chose more budget stimulus have performed better than those that opted for more austerity. Similarly, in the American context, no evidence is offered that past U.S. budget deficits (averaging 9% of GDP between 2009 and 2011) helped to promote the economic recovery.

Two interesting European cases are Germany and Sweden, each of which moved toward rough budget balance between 2009 and 2011 while sustaining comparatively strong growth—the average growth rate per year of real GDP for 2010 and 2011 was 3.6% for Germany and 4.9% for Sweden. If austerity is so terrible, how come these two countries have done so well?

The OECD countries most clearly in or near renewed recession—Greece, Portugal, Italy, Spain and perhaps Ireland and the Netherlands—are among those with relatively large fiscal deficits. The median of fiscal deficits for these six countries for 2010 and 2011 was 7.9% of GDP. Of course, part of this pattern reflects a positive effect of weak economic growth on deficits, rather than the reverse. But there is nothing in the overall OECD data since 2009 that supports the Keynesian view that fiscal expansion has promoted economic growth.

For the U.S., my view is that the large fiscal deficits had a moderately positive effect on GDP growth in 2009, but this effect faded quickly and most likely became negative for 2011 and 2012. Yet many Keynesian economists look at the weak U.S. recovery and conclude that the problem was that the government lacked sufficient commitment to fiscal expansion; it should have been even larger and pursued over an extended period.

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 .This viewpoint is dangerously unstable. Every time heightened fiscal deficits fail to produce desirable outcomes, the policy advice is to choose still larger deficits. If, as I believe to be true, fiscal deficits have only a short-run expansionary impact on growth and then become negative, the results from following this policy advice are persistently low economic growth and an exploding ratio of public debt to GDP.

The last conclusion is not just academic, because it fits with the behavior of Japan over the past two decades. Once a comparatively low public-debt nation, Japan apparently bought the Keynesian message many years ago. The consequence for today is a ratio of government debt to GDP around 210%—the largest in the world.

This vast fiscal expansion didn't avoid two decades of sluggish GDP growth, which averaged less than 1% per year from 1991 to 2011. No doubt, a committed Keynesian would say that Japanese growth would have been even lower without the extraordinary fiscal stimulus—but a little evidence would be nice.

Despite the lack of evidence, it is remarkable how much allegiance the Keynesian approach receives from policy makers and economists. I think it's because the Keynesian model addresses important macroeconomic policy issues and is pedagogically beautiful, no doubt reflecting the genius of Keynes. The basic model—government steps in to spend when others won't—can be presented readily to one's mother, who is then likely to buy the conclusions.


Keynes worshipers' faith in this model has actually been strengthened by the Great Recession and the associated financial crisis. Yet the empirical support for all this is astonishingly thin. The Keynesian model asks one to turn economic common sense on its head in many ways. For instance, more saving is bad because of the resultant drop in consumer demand, and higher productivity is bad because the increased supply of goods tends to lower the price level, thereby raising the real value of debt. Meanwhile, transfer payments that subsidize unemployment are supposed to lower unemployment, and more government spending is good even if it goes to wasteful projects.

Looking forward, there is a lot to say on economic grounds for strengthening fiscal austerity in OECD countries. From a political perspective, however, the movement toward austerity may be difficult to sustain in some countries, notably in France and Greece where leftists and other anti-austerity groups just won elections.

Consequently, there is likely to be increasing diversity across countries in fiscal policies, and this divergence will likely make it increasingly hard to sustain the euro as a common currency. On the plus side, the differing policies will provide better data to analyze the economic consequences of austerity.

Mr. Barro is a professor of economics at Harvard and a senior fellow at Stanford's Hoover Institution.

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« Reply #189 on: May 14, 2012, 04:14:25 PM »



Monday Morning Outlook
________________________________________
Let's Stress Test Governments To view this article, Click Here
Brian S. Wesbury - Chief Economist
Bob Stein, CFA - Senior Economist
Date: 5/14/2012
Several years ago, Treasury Secretary John Snow was testifying to Congress about the federal budget. He worked for President Bush and, after a long career of opposing deficits, was trying to justify a deficit of about 3% of GDP.
Representative Barney Frank was incredulous. He asked Snow how he could now justify deficits. Frank then came up with a theory: He said Snow was opposed to deficits when the president was a Democrat, but didn’t care about them when the president was a Republican.
Frank was being sarcastic, but he had a good point. Nonetheless, his theory is also true when the roles are reversed.
It now seems that deficits don’t matter all over again. Paul Krugman, a leading apostle of fiscal liberalism, consistently denounced President Bush for deficits. Now he is aggressively arguing against austerity around the world and asking for a substantial boost in federal spending despite the largest peacetime deficits in US history. He doesn’t just say “deficits don’t matter,” he suggests that “deficits are necessary.”
If you can’t see the political nature of all this, you are not looking. Barney Frank was certainly right – it depends on which side is in power.
 
No matter who is in office, our view has been consistent. Deficits themselves don’t matter. Ultimately, what matters is how much of the nation’s resources are being spent by the government. Spending is the key…it is what crowds out the private sector.
 
The deficit itself is huge, but interest rates are very low today, emerging market countries have a huge appetite for US debt to back their own expanding currencies, the US has a massive asset base ($150 trillion in the private sector alone), and a budget which freezes spending could eradicate the deficit in five or six years.
 
In other words, right now the deficit itself is not the problem. It is, however, indicative of the problem – that leaders (of both political parties) cannot control their spending habits. This is not about the economy. If spending created wealth, Greece, Italy, Spain, or even California, would be booming. But they aren’t. They are falling apart.
 
California recently announced it’s looking at a $16 billion deficit, not the $9 billion it forecasted in January. The new projected deficit is about 18% of revenues. California already has some of the highest tax rates in the country. It’s not taxes or the deficit that matters, it’s the spending.
 
And the problems go deeper than just money. Big government tends to erode the character traits – motivation, thrift, self-reliance – that make progress and economic growth possible.  The bottom line is that the last thing the economy needs now is more government spending.
 
In light of these budget issues, it’s interesting that a recent series of bad trades at JP Morgan generated a current loss of $2 billion for a company that earned about $5 billion last quarter. The stress tests forced on big banks suggested that losses like this could be absorbed and they were right.
 
But the federal government is running a deficit of more than $3 billion per day, European countries are going bankrupt and California is falling apart financially.
 
Instead of arguing about deficits, why don’t we stress test governments? And then get spending down to fix the problem.
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« Reply #190 on: June 05, 2012, 02:44:05 PM »

How The U.S. Dollar Will Be Replaced
Thursday, 17 May 2012 05:03 Brandon Smith
 
After being immersed in the world of alternative economic analysis for several years, it sometimes becomes easy to forget that most people do not track forex markets, or debt to GDP ratio, or true unemployment, or hunch over IMF white-papers highlighting subsections which expose the trappings of the globalist ideology.  Sometimes, you just assume the average person knows what the heck you are talking about.  This is, of course, a mistake.  However, it is a mistake that is borne from the inadequacy of our age and our culture, and is not necessarily a product of weak character, either of the analyst, or the casual reader.   

The great frustration of being actively involved in the Liberty Movement is the fact that many people are rarely on the same page (or even the same book) during political and economic discussion.  Where we see the nature of the false left/right paradigm, they see “free democracy”.  Where we see a tidal wave of destructive debt, they see a “responsible government” printing and spending in order to protect our “best interests”.  Where we see totalitarianism, they see “safety”.  Where we see dollar devaluation, they see dollar strength and longevity.  Ultimately, because the average unaware citizen is stricken by the disease of normalcy bias and living within the doldrums of a statistical fantasy world, they simply have no point of reference by which to grasp the truth when exposed to it.  It’s like trying to explain the concept of ‘color’ to a man who has been blind since birth.

Americans in particular are prone to reactionary dismissal when exposed to facts that disrupt their misconceptions.  Our culture has experienced a particularly prosperous age, not necessarily free from all trouble, but generally spared from widespread mass tragedy for a generous length of time.  This tends to breed within societies an overt and unreasonable expectation of ease.  It generates apathy, and laziness.  A crushing blubberous slothful cynicism subservient to the establishment and the status quo.  Even the most striking of truths struggle to penetrate this smoky forcefield of duplicitous funk.

In recent articles, I have outlined the very immediate dangers of several potential economic events that are likely to take place this year, including the exit of peripheral countries from the European Union, the conflict between austerity and socialist spending in France and Germany, the developing bilateral trade agreements between China and numerous other countries which cut out their reliance on the U.S. dollar, and the likelihood that the Federal Reserve will announce QE3 before the end of 2012.  All of these elements are leading in one very particular direction:  the end of the Greenback as the world reserve currency. 

In response to these assertions I have received letters from some people (some of them indignant) questioning how it would be even remotely possible that the dollar could be replaced at all.  The concept is so outside their narrow world view that many cannot fathom it. 

To be sure, the question is a viable one.  How could the dollar be unseated?  That said, a few hours of light research would easily produce the answer, but this tends to be too much work for the fly-by-night financial skeptic.  Sometimes, the job of the alternative analyst is to make the obvious even more obvious. 

So, let’s begin…

The Dollar A Safe Haven?

This ongoing lunacy is based on multiple biases.  For some, the dollar represents America, and a collapse of the currency would suggest a failure of the republic, and thus, a failure by them as individual Americans who live vicariously through the exploits of their government.  By extension, it becomes “patriotic” to defend the dollar’s honor and deny any information that might suggest it is on a downward spiral. 

Others see how the investment world clings to the dollar as a kind of panic room; a protected place where one’s saving will be insulated from crisis.  However, just because a majority of day trading investors are gullible enough to overlook the Greenback’s pitfalls does not mean those dangerous weaknesses disappear. 

There is only one factor that shields the dollar from implosion, and that is its position as the world reserve currency.  Without this exalted status, the currency’s value vanishes.  Backed by nothing but massive and unpayable debt, it sits frighteningly idle, like a time bomb, waiting for the moment of ignition.   

The horrifying nature of the dollar is that it is only valuable so long as foreign investors believe that we will pay back the considerable debts that we (the American taxpayer at the behest of our criminally run Treasury) owe, and that we will not hyperinflate in the process.  If they EVER begin to see their purchases of dollars and treasuries as a gamble instead of an investment, the façade falls away.  Yet again this year Congress and the Executive Branch are “at odds” over the expansion of the debt ceiling, which has been raised to levels beyond the 100% of GDP mark:

http://www.nytimes.com/2012/05/17/us/politics/obama-presses-congress-to-act-on-his-priorities.html

Barack Obama has made claims that increases in the debt ceiling are “normal”, and that most presidents are prone to hiking the barrier every once in a while.  Yet, back in 2006, when George W. Bush increased debt limits, Obama had this to say:

"The fact that we are here today to debate raising America's debt limit is a sign of leadership failure. It is a sign that the U.S. Government can't pay its own bills…Instead of reducing the deficit, as some people claimed, the fiscal policies of this administration and its allies in Congress will add more than $600 million in debt for each of the next five years…Increasing America's debt weakens us domestically and internationally. Leadership means that 'the buck stops here.' Instead, Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren. America has a debt problem and a failure of leadership. Americans deserve better."

For once, Barack and I agree on something.  Too bad the man changes his rhetoric whenever it’s to his advantage. 

Today, Obama now asserts that raising the debt ceiling is not an opening for more government spending, but an allowance for the government to pay bills it has already accrued.  This is disingenuous and hypocritical prattle.  Obama is well aware as are many in Congress that as long as the Federal Government is able to raise the debt ceiling whenever it suits them, they can increase spending with wild abandon.  It’s like handing someone a credit card with no maximum limit.  For most men, the temptation would be irresistible.  Therefore, one can predict with 100% certainty that U.S. spending will never truly be reduced, and that our national debt will mount in tandem until we self destruct.

How has this trend been able to continue for so long?  Our private central bank has created the fiat machine by which all economic depravity is possible.  Currently, the Federal Reserve is the number one holder of U.S. debt.  The Federal Reserve creates its own capital.  It prints its wealth from thin air.  The dollar, thus, has become its own lynchpin.  The secretive institution which has never been subject to a full audit is now monetizing endless debt mechanisms with paper promises.  What value would any intelligent investor put on such a fraudulent economic system?           

The epic dysfunction of the dollar is rooted in its reliance on perception rather than tangible wealth or strong fundamentals.  It is, indeed, like any other fiat unit, with all the inevitable pitfalls built into its structure.

Ironically, the value of the Dollar Index is measured not by its intrinsic buying power, or its historical buying power, but its arbitrary buying power in comparison with other collapsing fiat currencies. 

The argument I hear most often when pointing out the calamitous path of the dollar is that it is the go-to safe haven in response to the crisis in Europe.  What the financially inept don’t seem to grasp is that the shifting of savings back and forth between the euro and the dollar is just as irrelevant to our currency’s survival as it is to Europe’s.  BOTH currencies are in decline, and this is evident by the growing inflationary pressures on both sides of the Atlantic.  Ask any consumer in Greece, Spain, France, or the UK how shelf prices have changed in the past four years, and they will say the exact same thing as any consumer in the U.S.; costs have gone way up.  Therefore, it makes sense to compare the dollar’s value not to the euro, or to the Yen, but something more practical, like the dollar of the past….

In 1972, just as Nixon was removing the dollar from the last vestiges of the gold standard, a new car cost an average of $4500.  A home cost around $40,000.  A gallon of gas was .36 cents.  A loaf of bread was .25 cents.  A visit to the doctor’s office was $25.  Wages were certainly lower, but they kept much better pace with the prices of the era.  Today, the gap between wages and inflation is insurmountable.  The average family is unable to keep up with the flashflood of rising prices.

According to the historic buying power of the dollar, the currency is a poor safe haven investment.  With the advent of bailout efforts and debt monetization through quantitative easing, its devaluation has been expedited dramatically.  The Fed has left the door open for what I believe will be a final destructive round of publicly announced QE, weakening the dollar to near death:

http://www.reuters.com/article/2012/05/16/us-usa-fed-idUSBRE84F12320120516

The question then arises; why do foreign countries continue to buy in on the greenback?

The Dollar Dump Has Already Begun

One of my favorite arguments by those defending the dollar is the assertion that no foreign country would dare to dump the currency because they are all too dependent on U.S. trade.  To answer the question above, the reality is that foreign countries ARE already calmly and quietly dumping the dollar as a global trade instrument. 

To those people who consistently claim that the dollar will never be dropped, my response is, it already has been dropped!  China, in tandem with other BRIC nations, has been covertly removing the greenback as the primary trade unit through bilateral deals since 2010.  First with Russia, and now with the whole of the ASEAN trading bloc and numerous other markets, including Japan.  China in particular has been preparing for this eventuality since 2005, when they introduced the first Yuan denominated bonds.  The bonds were considered a strange novelty back then, especially because China had so much surplus savings that it seemed outlandish for them to take on treasury debt.  Today, the move makes a whole lot more sense.  China and the BRIC nations today openly call for a worldwide shift away from the dollar:

http://news.xinhuanet.com/english2010/indepth/2011-08/06/c_131032986.htm

With the global proliferation of the Yuan, and the conversion of the Chinese economy away from dependence on exports (especially to the West) towards a more consumer based system, the Chinese have effectively decoupled from their reliance on U.S. markets.  Would a collapse in the U.S. hurt China’s economy?  Yes.  Would they still survive?  Oh yes.  Far better than America would, at least…

In 2008, I warned of this development and was attacked on all sides by more mainstream economists and Keynesian proponents who stated that such a development was impossible.  Today, it’s common knowledge that our primary creditors are “diversifying” away from the dollar, though MSM talking heads and those who parrot them still claim that this is not a threat to our economy.

To be clear, the true threat to the dollar’s supremacy is not only due to the constant printing by the private Federal Reserve (though that is a nightmare in the making), but the loss of faith in our currency as a whole.  The Fed does not need to throw dollars from helicopters to annihilate our currency; all they have to do is create doubt in its viability.
The bottom line?  A dollar collapse is not “theory” but undeniable fact in motion at this moment, driven by concrete actions on the part of the very nations that have until recently propped up our debt obligations.  It is only a matter of time before the dollar diminishes and fades away.  All signs point to a loss of reserve status in the near term. 

What Will Replace The Dollar?

My next favorite argument in defense of the Greenback is the assertion that there is “no currency in a position to take the dollar’s place if it falls”.  First of all, this is based on a very naïve assumption that the dollar will not fall unless there is another currency to replace it.  I’m not sure who made that rule up, but the dollar is perfectly able to be flushed without a replacement in the wings.  Economic collapse does not follow logical guidelines or the personal pet peeves of random man-child economists.

Though, to be fair, and to educate those unaware, there IS a replacement already conveniently ready to roll forward.  The IMF has for a couple of years now openly called for the retirement of the dollar as the world reserve currency, to be supplanted by the elitist organization’s very own “Special Drawing Rights” (SDR’s):

http://www.guardian.co.uk/business/2011/feb/10/imf-boss-calls-for-world-currency

The SDR is a paper mechanism created in the early 1970’s to replace gold as the primary means of international trade between foreign governments.  Today, it has morphed into a basket of currencies which is recognized by almost every country in the world and is in a prime position to take the dollar’s place in the event that it loses reserve status.  This is not theory.  This is cold hard reality.  For those who claim that the SDR is not considered a “real currency”, they should probably warn the U.S. Post Office, which now uses conversion tables that denominate costs in SDR’s:

http://pe.usps.com/text/imm/immc3_007.htm

So, now that we know a replacement for the dollar is ready to go, the next obvious question would be:

Why would global elites destroy a useful monetary tool like the dollar?  Why kill the goose that "lays the golden eggs"?

People who ask this question are simply unable to see outside the fiscal box they have been placed in.  For global bankers, a paper currency is not important.  It is expendable. Like a layer of snake skin; as the snake grows, it sheds the old and dawns the new. 

At bottom, men who promote the philosophies of globalization greatly desire the exaltation of a global currency.  The dollar, though a creation of a central bank, is still a semi-sovereign monetary unit.  It is an element that is getting in the way of the application of the global currency dynamic.  I find it rather convenient (at least for those who subscribe to globalism) that the dollar is now in the midst of a perfect storm of decline just as the IMF is ready to introduce its latest fiat concoction in the form of the SDR.  I find the blind faith in the dollar’s lifespan to be rife with delusion.  It is not a matter of opinion or desire, but a matter of fact that currencies in such tenuous positions fall, and are in the end replaced.   I believe that the evidence shows that this is not random chance, but a deliberate process, leading towards the globalist ideal; total centralization of the world under an unaccountable governing body which operates a global monetary system utterly devoid of transparency and responsibility.   

The dollar was a median step towards a newer and more corrupt ideal.  Its time is nearly over.  This is open, it is admitted, and it is being activated as you read this.  The speed at which this disaster occurs is really dependent on the speed at which our government along with our central bank decides to expedite doubt.  Doubt in a currency is a furious omen, costing not just investors, but an entire society.  America is at the very edge of such a moment.  The naysayers can scratch and bark all they like, but the financial life of a country serves no person’s emphatic hope.  It burns like a fire.  Left unwatched and unchecked, it grows uncontrollable and wild, until finally, there is nothing left to fuel its hunger, and it finally chokes in a haze of confusion and dread…
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JDN
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« Reply #191 on: June 05, 2012, 11:36:42 PM »

For all the criticism here, actually, the dollar looks pretty strong lately.  We have our problems, but IMHO they are a lot less than the rest of the world.  Others seem to agree.

http://www.google.com/finance?hl=en&client=safari&rls=en&q=CURRENCY:EURUSD&ei=Xd3OT9vBDOGW2QWIhdilDA&sa=X&oi=currency_onebox&ct=currency_onebox_chart&resnum=1&ved=0CHUQ5QYwAA
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Crafty_Dog
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« Reply #192 on: June 06, 2012, 12:21:28 AM »

Certainly there are reasoned arguments to be made contrary to this piece (and if I have time tomorrow I will share my conversation with Scott Grannis about this specific piece) but the one you raise is not amongst them.  As the article itself notes:

"The argument I hear most often when pointing out the calamitous path of the dollar is that it is the go-to safe haven in response to the crisis in Europe.  What the financially inept don’t seem to grasp is that the shifting of savings back and forth between the euro and the dollar is just as irrelevant to our currency’s survival as it is to Europe’s.  BOTH currencies are in decline, and this is evident by the growing inflationary pressures on both sides of the Atlantic.  Ask any consumer in Greece, Spain, France, or the UK how shelf prices have changed in the past four years, and they will say the exact same thing as any consumer in the U.S.; costs have gone way up."

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Crafty_Dog
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« Reply #193 on: June 06, 2012, 02:12:46 AM »

I have Scott's permission to quote his thoughts:

SCOTT GRANNIS:

(From an earlier email:  Interest rates will only go up if the economy does better. Meanwhile, look at Japan where their debt burden and their deficit are both much bigger than ours relative to GDP and yet interest rates are even lower than ours

If the economy strengthens then the tax base expands and tax revenues go up. Meanwhile the average maturity of federal debt is very short. The yield curve is positively sloped so that means that higher interest rates are already factored in to some degree, so higher rates are not a death sentence by any stretch. Moreover, a stronger economy would likely happen if policies improved, so even as interest rates rose the deficit could shrink as a percent of GDP.

The way out of the current predicament is growth. The election this year has a good chance to deliver that.)

Part of his responce to the end of the dollar article I just posted here:

"I'm an original gold bug and no fan of fiat currencies, but I do think you have to acknowledge that the fears of many--including yours truly--that the Fed would print massively and destroy the value of the dollar have not been realized. In fact, the dollar has been rising against most currencies for the past year, and it has been rising against gold and most commodities as well. And inflation has gone down in the past year. To be sure, the dollar is still very weak, but it is most definitely not collapsing against any objective standard in the past year.

"Thank goodness the Fed undertook QE 1 and QE 2, otherwise there would have been a massive shortage of dollar liquidity at a time when the entire world was attempting to deleverage (i.e., when the entire world's demand for dollar liquidity was skyrocketing). If the Fed had not acted, we would have most likely suffered a replay of the Great Depression. The Fed greatly expanded the availability of dollars at a time when the world wanted a ton of extra dollars. That's exactly what they are supposed to do, and it would appear to have worked."

MARC: 
I’d be in over my head even more than usual in a discussion with you of QE1-2 (though perhaps Tom can chime in) (and I do wonder at the costs of it to savers) Yes gold has backed off from over $1800, yet it has not been so long since gold was $250 (back when Glen Beck first recommended IIRC LOL)  and it is now well above $1500.  A six-fold increase seems rather dramatic to me , , ,  Though I cannot cite chapter and verse, I’m rather confident that similar numbers can be found with regard to food, energy, and other commodities. 
 
If I have my numbers right, the Feds borrow 40% of what they spend and get 60-70% of that by printing it!   Each trillion dollars of debt run up by the Feds means about $3333 per citizen and we are projected to run deficits of that magnitude as far as the eye can see and that is with straight line assumptions of revenue increases starting with 1/1/13’s taxageddon.  Baseline budgeting creates an Orwellian newspeak that makes developing understanding of WTF is going on impossible.  Then there is the matter of unfunded liabilities of entitlements in the face of the realities of American demographics. Oh, , , and California is bankrupt.
 
Is The Market efficient (I used to believe so) or is it some giant casino wherein ordinary people like me are pigeons to be plucked and fuct as we are whipsawed by the winds of computer trading programs and other forces having not so much to do with merit?
 
How does all this end well?



SCOTT:    "To be sure there are all kinds of problems out there. The U.S. economy would be booming right now if it weren't for all the fucted up policies coming out of Washington for the past many years. Big Government is smothering economies all over the world. It's awful. The Fed is scaring the sh*t out of everyone because we've never seen them do anything like this.

"But before you jump out the window of the nearest skyscraper, consider the following. There are a number of things that are actually improving.

"To begin with, the Fed has not been printing money, contrary to what everyone seems to believe. The Fed has bought $1.6 trillion of notes and bonds, but they have paid for them not with printed-up dollar bills, but with bank reserves. The vast majority of those reserves have never seen the light of day (in the form of actual money used to run the economy). They are sitting on the Fed's balance sheet. What the Fed has effectively done is to to a massive swap with the rest of the world: the Fed has handed out massive amounts of T-bill substitutes (i.e., reserves that pay interest equivalent to T-bills) in exchange for an equal amount of notes and bonds. Since the dollar has not collapsed and inflation has not gone to the moon and the M2 money supply has not exploded to the upside, we can pretty confidently conclude that the Fed's actions were almost exactly what the world demanded. In short, the Fed expanded the supply of safe-haven dollar liquidity in order to accommodate the world's almost insatiable desire for such liquidity. When money supply rises in line with money demand, this is not inflationary.

"As for federal government finances, it seems to be a well-kept secret that the deficit as a % of GDP (the only sensible way to measure it) has dropped by a lot: from 10.4% to 7.4% in the past two and a half years. That's almost a 30% reduction! And thanks mainly to the fact that federal spending has barely increased at all over that period. Congress has been gridlocked, thank goodness. If we can keep this up the deficit will sooner or later come back down to earth and the world as we know it will not end.

"Imagine if Romney wins (which he will, in a landslide I think) and we get spending restraint and meaningful tax reform (lower rates and a bigger base). And Obamacare gets thrown out (as it will, I predict). And Scott Walker doesn't get recalled (looking very likely at this point). We could get a sea-change in the outlook: a shrinking of Big Government. The possibilities are fantastic.

"As for the market, I really don't think that computer trading programs are distorting things. Logic alone can tell you that. Speculators (or computer programs) cannot survive if they add to the market's volatility, because they can only do that if they buy high and sell low. Before too long, anyone doing that in size will end up bankrupt. They can only survive if they buy low and sell high, and that is a very good thing, since it adds liquidity to the market and minimizes volatility."

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DougMacG
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« Reply #194 on: June 06, 2012, 10:04:31 AM »

Very interesting series of posts, many valid points going in all directions.  I don't buy that there is some currency to take the place of the dollar, IMF special drawing rights or anything else.  The world IMO does not have an economic plan that does not include a safe, strong America leading.  A short term chart of the dollar gaining strength against the Euro while the EU implodes is very unpersuasive.  Same for Crafty's point that gold has retreated but from what levels.

I see things more simply.  Fix what we know is wrong and quit trying to figure how far we can drive with a broken engine and a missing suspension.  A couple of years ago it was agreed widely on the board that this is a two election fix.  Grannis sees the second leg of that coming, even uses the L-word (landslide).  I see that too but my certainty level is way too low.

Interesting that the deficit to GDP ratio shrank, but the debt of the earlier years is still there along with the trillion a year plus still accumulating.  Borrowing 7.4% of GDP on top of our tax burden is still outrageous.  What is the debt burden of the current projection after interest rates return to 5-6% if not 13%.

Beyond whether the policy arrow can shift in Nov, the question becomes what kind of medium growth policies can follow in a still bitterly divided country and a closely divided Senate? 

On the regulatory front, repeal of Obamacare is one big piece but only gets us back to where we were when we imploded.  What other regulatory changes can happen on the employment front? None?  Some movement on energy is about all that I see and maybe repeal of the administrative ruling that CO2 is a poison.

On the spending front, the Ryan plan is getting badly demagogued.  Maybe holding spending at record high levels is what we will call victory on 'spending restraint' and the rest comes down to growing our way back to sane ratios.

On the tax side, is there going to be a consensus for sweeping reforms that come out of this election?  Is there going to a lowering of marginal rates, removal of loopholes and an end to this terrible tradition of making tax rates temporary and uncertain?  I don't know. 

What about the other electoral outcome.  Obama is still ahead in polls; Dems could take the House and hold pretty steady in the Senate.  How do we survive this then?
----
This following exchange excerpt was particularly interesting, excellent question Crafty!

"...If I have my numbers right, the Feds borrow 40% of what they spend and get 60-70% of that by printing it!..."

SG: "To begin with, the Fed has not been printing money, contrary to what everyone seems to believe. The Fed has bought $1.6 trillion of notes and bonds, but they have paid for them not with printed-up dollar bills, but with bank reserves. The vast majority of those reserves have never seen the light of day (in the form of actual money used to run the economy). They are sitting on the Fed's balance sheet. What the Fed has effectively done is to to a massive swap with the rest of the world: the Fed has handed out massive amounts of T-bill substitutes (i.e., reserves that pay interest equivalent to T-bills) in exchange for an equal amount of notes and bonds. Since the dollar has not collapsed and inflation has not gone to the moon and the M2 money supply has not exploded to the upside, we can pretty confidently conclude that the Fed's actions were almost exactly what the world demanded. In short, the Fed expanded the supply of safe-haven dollar liquidity in order to accommodate the world's almost insatiable desire for such liquidity. When money supply rises in line with money demand, this is not inflationary.
----

In that he knows more than me that is partly reassuring.  My theory is that when we are not taxing 40% of what we spend, there is no monetary policy that covers for that kind of fiscal irresponsibility.  It sounds like they did as well as they could, though that is very hard to follow.  We are now invested in Europe's failure too, so one currency is no longer much of a hedge against the other?  My theory further is to judge things like gas prices, interest rates and inflation after demand is restored.  If gas is $4 while people are not working or buying it, what will be the price at these levels of supply in a fully functioning economy?  The amount of liquidity injected matched the shortfall in a disastrous downturn.  How will those expansions look later, assuming we correct our other problems and re-start robust growth? 

One of Crafty's points remains unaddressed, the whole concept of saving has been destroyed for a generation if not forever.  Money to loan doesn't come from savers anymore, it comes from something like that paragraph above of Scott's, "the Fed has handed out massive amounts of T-bill substitutes", etc.  Another consequence of artificially low interest rates is that home mortgages are still being Fed subsidized.  The bubble is far less inflated than it was, but still these phenomena are not free markets but public policy constructs with no end or phase out in sight.
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DougMacG
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« Reply #195 on: June 06, 2012, 10:13:44 AM »

http://www.realclearpolitics.com/video/2012/06/05/john_b_taylor_on_economy_the_problem_is_policy.html

(Video at the link)

John B. Taylor On Economy: "The Problem Is Policy"

John B. Taylor, the Mary and Robert Raymond Professor of Economics at Stanford University and the George P. Shultz Senior Fellow in Economics at Stanford's Hoover Institute, delivers the Manhattan Institute's Eighth Annual Hayek Lecture.

(Transcript begins at 2:10)

"Let me start and talk a little bit about this book, 'First Principles.' It starts with the fact that the American economy is just not doing very well. That's pretty obvious. We had a growth rate of just 1.9 percent [according to] the most recent data, unemployment is very high, long-term unemployment astronomically high. We've just gone through a deep financial crisis and a very serious recession, and the recovery is by any definition unprecedentedly weak compared to American history. So, we've got a problem here. And, also, as Paul [Gigot] mentioned in his introduction, our debt is exploding.

"And my view, looking at this and thinking of alternative explanations, I think the problem is policy. And the way I put it simply is that policy has deviated from the basic principles of economic freedom. Now, if Hayek were here, he'd be saying, 'Tell us what you mean. What do you mean by economic freedom, Taylor?' What I mean is the situation where individuals, families decide what to buy, what to produce -- they decide where they will work, they decide how they're going to help other people. But they do this within a framework. It's kind of the American vision, if you like. And that framework involves five things: 1) predictable policy, 2) rule of law, 3) a reliance on markets, which generates 4) good incentives, and 5) a limited role of government.

"And when you think about America, those five principles have pretty much defined the country since its founding, and I think that's why it's done well. That's why so many people have come here and how so many people have done well by coming here. And we're certainly, over the long span of time, much better than any other country. But we've had our ebbs and flows in the degree to which we adhere to these principles of economic freedom. And I think we can learn a lot from those ebbs and flows, see what happens when you move one way or the other in terms of policy.

"So, just think of it, just think of history. The Great Depression. We deviated from a reasonably predictable policy by cutting money growth. The Federal Reserve did that. Friedman and Schwartz pointed that out long ago. Started things off, made what may have been a minor downturn much worse. So, that's the first deviation, if you like, from good principles. We raised taxes, we raised tariffs big time, and then we put in place this National Industrial Recovery Act, which was price controls, discouraging competition by allowing collusion, all the things that you would define, I would define, based on that definition, as deviations from basic economic freedom. Well, what's happened? Of course, we don't have to repeat that mess in describing it.

"Another example: In the mid-60s all through the 70s, policy also deviated from these principles. We started these kind of temporary stimulus packages, the Federal Reserve was go-stop, go-stop, we had wage and price controls for this entire economy. The performance was terrible. Double-digit inflation came, double-digit unemployment came, growth slowed down dramatically. Of course, interest rates were astronomical.

"OK? Next period: The 1980s, 90s until recently, we seemed to move back, if you like, towards these principles. Temporary stimulus packages of the unpredictable variety, discretionary variety were out. Long-term tax reduction, tax reform was in. Go-stop monetary policy was out. Steady as you go monetary policy came in, focused on price stability, largely under [Paul] Volcker. The remnants of price controls were removed. A major federal welfare program was devolved to the states, a reflection on more limited federal government power. The performance was unbelievably good. Unemployment trickled down all that period, inflation came down, growth started to pick up pretty dramatically, productivity growth. Economists call it the Great Moderation. It was such a good time for performance.

"Unfortunately, now, we've drifted back, in my view, away from these principles. And I can go on with a long, long list in this case. The Federal Reserve, I think, in leading up to the crisis deviated from the kind of rules it was using by and large for most of the 80s and 90s. And they held interest rates too low. The mantra these days is 'too low for too long.' That set off some of the excesses, the housing boom, in my view, particularly. Regulators, I think, of financial institutions failed to enforce the rules. That's a deviation from a rule. On the major financial institutions, risk-taking rules, and especially on institutions like Fannie Mae and Freddie Mac.

"Then the crisis came, and we had massive deviations from predictable policy with the bailouts. I'll come back to the bailouts in a few minutes, but whatever what you think about those, they were massive deviations from predictable kinds of policies. Then we had the stimulus packages. We had one in 2009, but don't forget, we had one in 2008. We had 'cash for clunkers' and first-time home buyers. And we had temporary reductions in the payroll tax…for two months. We had quantitative easing, unprecedented amount of intervention by the Federal Reserve. And policies which will apparently try to hold interest rates to zero through 2014.

"If you look at just some data here, in the three years around 2000, there were 11 provisions in the tax code that were up for grabs, up for a change. Now, there's 131, a massive amount of increase in unpredictability, if you like. And just think of this 'fiscal cliff' everyone's talking about. That just wasn't dropped on us. That is a self-inflicted policy. That is sort of the epitome of unpredictable policy put in place, and rightly, people are concerned about that.

"So, as I look at this situation, it seems to me the evidence is pretty clear, and you can debate this and go back and forth, but I just think it's so powerful, the evidence. And the implications are very clear, aren't they? We should apply those principles, and we should apply them to the current circumstances that we're in."
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Crafty_Dog
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« Reply #196 on: June 20, 2012, 04:56:34 PM »



The death of banks – and the future of money
BY DETLEV SCHLICHTER ON JUNE 20, 2012 • LEAVE A COMMENT
 
Photo: Ballista/wikimedia
UK Chancellor George Osborne and Bank of England Governor Mervin King last week announced another round of fiscal and monetary stimulus measures, including steps to ease the funding for banks and allow them to extend more loans.
If these measures were hoped to instil confidence they must be classified as a failure. We have lived through quite a few years of unprecedented and fairly persistent monetary accommodation and occasional rounds of QE by now, and I doubt that yet another dose of the same medicine will cause great excitement. Furthermore, observers must get confused as to what our most pressing problems really are. Have we not had a real banking crisis in the UK in 2008 because banks were over-extended and in desperate need of balance sheet repair? Is a period of deleveraging and a rebuilding of capital ratios not urgently required and unavoidable? Let’s not forget that the government is still a majority-owner of RBS and holds a large chunk of Lloyds-TSB. If banks are still on life-support from the taxpayer and the central bank, is it wise to already prod them to expand their balance sheets again and create more credit to ‘stimulate’ growth?
The same confusion exists on fiscal policy. Is the Greece crisis not a stark warning to all other sovereign borrowers out there, which are equally and without exception on a slippery slope toward fiscal Armageddon, that it is high time for drastic reduction in spending and fundamental fiscal reform? If the Bank of England or the government assume any of the risk of the latest additional credit measures, then the taxpayer is on the hook.
None of this will instil confidence, not in the economy and not in the banks, and certainly not in politics. UK newspaper ‘The Independent’ headlined: “King pushes the panic button”, which I consider a pretty apt description.
Banks are parastatal dinosaurs
One thing is now clear to even the most casual observer: banks are not capitalist businesses. In their present incarnation they have little to do with the free market and no place in it. They are constantly oscillating between two positions: One moment, they are a state protectorate, in desperate need of support from the state printing press or unlimited taxpayer funds, as, in the absence of such support, we are supposedly faced with the dreaded social fallout of complete financial collapse; the next moment they are a convenient tool for state policy, simply to be fed with ample bank reserves and enticed with low interest rates to create yet more cheap credit and help manufacture some artificial growth spurt. Either the banks are the permanent welfare queens of the fiat money systems, or convenient policy levers for the macro-economic central planners. In any case, capitalist businesses look different.
Central banks and modern fiat money banks are quite simply a blot on the capitalist system. In order for capitalism to operate smoothly they will ultimately have to be removed. I believe that the underlying logic of capitalism will work in that direction. Personally, I believe that trying to ‘reform’ the present system is a waste of time and energy. It is particularly unbecoming for libertarians as they run the risk of getting infected with the strains of statism that run through the system. Let’s replace this system with something better. With a market-based monetary system.
When and how exactly the present system will end, nobody can say. I believe we are in the final inning. Around the world, all major central banks have now established zero or near-zero interest rates and are using their own balance sheets in a desperate attempt to avoid their highly geared banking systems from contracting or potentially collapsing. If you think that this is all just temporary and that it will be smoothly unwound when the economy finally ‘recovers’, then you are probably on some strong medication, or have been listening for too long to the mainstream economists who are, in the majority, happy to function as apologists for the present system.
I still believe that chances are we will, at some point, get the full throttle, foot-on-the pedal monetary overkill, the ultimate Ueber-QE that will push the system over the edge. This will be the moment when central bankers discover – and discover the hard way – that their ability to print their fiat money may well be unlimited but that the public’s confidence in this fiat money certainly is not. The whole system will blow up in some hyperinflationary fireball, which has been the end of most previous experiments with complete fiat money systems, all others having ended with a voluntary return to commodity money before the public had lost complete faith in the system. And the prospect for a voluntary and official return to a gold standard seems slim at present. However, this is not the topic of this essay.
The future of money
I am often asked what will come next after the present system collapsed? Will we have to go back to barter? – No. Obviously, a modern capitalist economy needs a functioning monetary system. My hope is that from the ashes of the current system a new monetary system arises that is entirely private and not run by states – and that does not have the unholy state-bank alliance at its core, an alliance that exists in opposition to everything that the free market stands for. Nobody can say what this new system will look like precisely. Its shape and features will ultimately be decided by the market. In this field, as in others, there are few limits to human inventiveness and ingenuity. But we can already make a few conceptual points about such a system, and we should contemplate working on such a system now while the old system is in its death throes.
A private gold ‘standard’…
Free market monetary systems, in which the supply of money is outside political control, are likely to be systems in which money proper is a commodity of limited and fairly inelastic supply. It seems improbable that a completely free market would grant any private entity the right to produce (paper or electronic) money at will and without limit. The present system is unusual in this respect and it is evidently not a free market solution. Neither is it sustainable.
The obvious candidates are gold and silver, which have functioned as money for thousands of years. We could envision a modern system at whose centre are private companies that offer gold and silver storage, probably in a variety of jurisdictions (Zurich, London, Hong Kong, Vancouver). Around this core of stored monetary metal a financial system is built that uses the latest information and payment technology to facilitate the easy, secure and cheap transfer of ownership in this base money between whoever chooses to participate in this system (Yes, there would be credit cards and wire transfers, and internet or mobile phone payments. There would, however, be no FOMC meetings, no Bank of England governor writing letters to the Chancellor, and no monetary policy!).
Are these gold and silver storage companies banks? — Well, they could become banks. In fact, this is how our present banking system started out. But there are important differences about which I will say a few things later. In any case this would be hard, international, private and apolitical money. This would be capitalist money.
…or Bitcoin
Another solution would be private virtual money, such as Bitcoin.
Bitcoin is immaterial money, internet money. It is software.
Bitcoin can be thought off as a cryptographic commodity. Individual Bitcoins can be created through a process that is called ‘mining’. It involves considerable computing power, and the complex algorithm at the core of Bitcoin makes the creation of additional Bitcons more difficult (and thus more expensive) the more Bitcoins are already in existence. The overall supply of Bitcoins is limited to 21 million units. Again, this is fixed by the algorithm at the core of it, which cannot be altered.
Thus, creating Bitcoin money is entirely private but not costless and not unlimited. Most people will, of course, never ‘mine’ Bitcoins, just as under the gold standard most people didn’t mine gold. People will acquire Bitcoins through trade, by exchanging goods and services for Bitcoins, then using the Bitcoins for other transactions.
Bitcoin is hard money. Its supply is inelastic and not under the control of any issuing authority. It is international and truly capitalist ‘money’ – of course this assumes that the public is willing to use it as money.
There are naturally a number of questions surrounding Bitcoin that cannot be covered in this essay: Is it safe? Can the algorithm be changed or corrupted and Bitcoins thus be counterfeited? Are the virtual “wallets” in which the Bitcoins are stored safe? – These are questions for the computer security expert or cryptographer, and I am neither. My argument is conceptual. My goal is not to analyze Bitcoin as such but to speculate on the consequences of a virtual commodity currency, which I consider feasible in principle, and I simply assume – for the sake of the argument – that Bitcoin is already the solution. Whether that is indeed the case, I cannot say. And it is – again – for the market to decide.
There is one question for the economist, however: Could Bitcoin become widely accepted as money? Would this not contradict Mises’ regression theorem, which states that no form of money can come into existence as a ready medium of exchange; that whatever the monetary substance (or non-substance), it must have had some other commodity-use prior to its first use as money. My counterargument here is the following: the analogy is to the banknote, which started life not as a commodity but as a payment device, i.e. a claim on money proper which was gold or silver at the time. Banknotes were initially used as a more convenient way to transfer ownership in gold or silver. Once banknotes circulated widely and were generally accepted as media of exchange in trade, the gold-backing could be dropped and banknotes still circulated as money. They had become money in their own right.
Similarly, Bitcoin can be thought off, initially, as payment technology, as a cheap and convenient device to transfer ownership in state paper money. (Bitcoins can presently be exchanged for paper money at various exchanges.) But as the supply of Bitcoins is restricted while the supply of state paper money constantly expands, the exchange-value of Bitcoins is bound to go up. And at some stage, Bitcoin could begin to trade as money proper.
A monetary system built on hard, international and apolitical money, whether in form of a private gold-system or Bitcoin, would be a truly capitalist system, a system that facilitates the free and voluntary exchange between private individuals and corporations within and across borders, a system that is stable and outside of political control. It would have many advantages for the money user but there would be little role for present-day banks, which goes to show to what extent banks have become a creature of the present state-fiat money system and all its inconsistencies.
Banks profit from money creation
Banks conduct fractional-reserve banking (FRB), which means they take deposits that are supposed to be safe and liquid and therefore pay the depositor little interest, and use them to fund loans that are illiquid and risky and thus pay the bank high interest. Through the process of fractional-reserve banking, banks expand the supply of money in the economy; they become money producers, which is, of course, profitable. Many mainstream economists welcome FRB as a way to expand money and credit and ‘stimulate’ extra growth but as the Currency School in Britain in the 19th century and in particular the Austrian School under Mises and Hayek in the early 20th century have argued convincingly (and as I explain in detail in Paper Money Collapse – The Folly of Elastic Money and the Coming Monetary) this process is not only risky for the individual banks it is destabilizing for the overall economy. It must cause boom-bust cycles.
It cannot be excluded that banks could conduct FRB even on the basis of a private system of gold-money or Bitcoin. However, in the absence of a backstop by way of a central bank that functions as a lender-of-last resort the scope for FRB would be very limited, indeed. It would be too dangerous for banks to lower their reserve ratios (at least to fairly low levels) as that would increase the risk of a bank-run.
I am sometimes told that I am too critical of the central banks and the state, and that I should direct my ire toward the ‘greedy’ ‘private’ banks, for it is the ‘private’ banks that create all the money out there through FRB. Of course, they do. But FRB is only possible on the scale it has been conducted over recent decades because the banks are supported – and even actively encouraged – in their FRB activities by a lender-of-last resort central bank, in particular as the central bank today has full and unlimited control over fiat money bank reserves. Under a system of hard money (gold or Bitcoin), even if the banks themselves started their own lender-of-last resort central bank, that entity could not create more gold reserves or Bitcoin reserves and thus provide unlimited support to the banks.
FRB is particularly unlikely to develop in a Bitcoin economy, as there is no need for a depository, for safe-keeping and storage services, and for any services that involve the transfer of the monetary system’s raw material (be it gold or state paper tickets) into other, more convenient forms of media of exchange, such as electronic money that can facilitate transactions over great distances. The owner of Bitcoin has an account that is similar to his email account. He manages it himself and he stores his Bitcoin himself. And Bitcoin is money that is already readily usable for any transaction, anywhere in the world, simply via the internet. The bank as intermediary is being bypassed. The Bitcoin user takes direct control of his money. He can access his Bitcoins everywhere, simply via the SIM card in his smartphone.
The tremendous growth in FRB was made possible by the difficulty of transacting securely over long distances with physical gold or physical paper tickets. This created a powerful incentive to place the physical money with banks, and once the physical money was in the banks it became ‘reserves’ to be used for the creation of additional monetary assets.
Channeling true savings into investment is very important, but remember that FRB is something entirely different. It involves the creation of money and credit without any real, voluntary saving to back it. FRB is not only not needed, it is destabilizing for the overall economy. Under gold standard conditions, it created business cycles. Under the system of unlimited fiat money and lender-of-last-resort central banks, it created the super-cycle, which is now in its painful endgame.
Banks make money from payment systems
When I recently made arrangements for a trip to Africa I dealt directly with local tour operators there, which, today, can be done easily and cheaply with the help of email, the internet and skype. Yet, when it came to paying the African tour operators I had to go through a process that has not changed much from the 1950s. Not only were British and African banks involved, but also correspondence banks in New York. This took time and, of course, cost money in form of additional fees.
Imagine we could have used gold or Bitcoin! The payment would have been as easy and fast as all the email-communication that preceded it. There would have been no exchange rates and little fees (maybe in the case of gold) or no fees (in the case of Bitcoin).
Another example: Last year I gave a webinar at the Ludwig von Mises Institute (LvMI). The LvMI is located in Auburn, Alabama, I did the seminar from my home in London, the LvMI’s technology officer sat in Taiwan, and the seminar attendants were spread all over the world. All of this is now possible – cheaply, quickly and conveniently – thanks to technology. Yet, when the LvMI paid me a fee it had to go through a few banks – again, correspondence banks in New York – it took quite some time and it incurred additional costs. And the fee from LvMI was paid in a currency that I cannot use directly in my home country.
Banks make money from monetary nationalism
Future economic historians will pity us for having worked under a strange and inefficient global patchwork of local paper currencies – and for having naively believed that this represented the pinnacle of modern capitalism. Today, every government wants to have its own local paper money and its own local central bank, and run its own monetary policy (of course, on the basis of perfectly elastic local fiat money). This is naturally a great impediment to international trade and the free flow of capital.
If I want to spend the money I got from the LvMI and spend it where I live (in Britain), I have to exchange the LvMI’s dollars for pounds. I can only do that if I find someone who is willing to take the opposite side of that transaction, someone who is willing to sell pounds for dollars. The existence of numerous monies necessarily re-introduces an element of partial barter into money-based commerce. Sure, the 24-hour, multi-trillion-dollar a day fx market can accommodate me, and do so quickly and cheaply, but this market is only a second-best solution, a highly developed make-shift to cope as best as possible with the inefficiencies of monetary nationalism. The better, most efficient and capitalist solution would be to use the same medium of exchange around the world. The gold standard was a much superior monetary system in this respect. Moving from the international gold standard to a system of a multitude of state-managed paper currencies meant economic regression, not progress.
One hundred years ago, you could take the train from London to Moscow and use the same gold coins all along the way for payment. There was no need to change your money even once. (Incidentally, neither did you need a passport!)
The notion of the ‘national economy’ that needs a ‘national currency’ was always a fiction. So was the idea that economies work better if money, interest rates and exchange rates are carefully manipulated by local bureaucrats. (This fiction is still spread by many economists who make a living off this system.) The biggest problem with monetary policy is that there is such a thing as monetary policy. But in today’s increasingly globalized world, these fictions are entirely untenable. Capitalism transcends borders, and what it needs to flourish is simply hard, apolitical and thus international money. Money that is a proper tool for voluntary human interaction and cooperation and not a tool for politics.
Banks benefit from the present monetary segregation. They profit from constantly exchanging one paper money for another and from trading foreign exchange. Non-financial companies that operate internationally are inevitably forced to speculate in currency markets or to pay for expensive hedging strategies (again paying the banks for providing them).
Banks make money from speculation
There is, of course, nothing wrong with speculation in a free market. However, in a truly free market there would be few opportunities for speculation. Today the heavy involvement of the state in financial markets, the existence of numerous paper currencies, all managed for domestic political purposes, and the constant volatility that is generated by monetary and fiscal policy create outsized opportunities for speculation. Additionally, the easy money that central banks provide so generously to prop up their over-extended FRB-industry is used by many banks to speculate in financial assets themselves, often by anticipating and front-running the next move of the monetary authorities with which these banks have such close relationships. And to a considerable degree, banks pass the cheap money from the central banks on to their hedge fund clients.
Remember that immediately after the Lehman collapse, investment banks Goldman Sachs and Morgan Stanley, which previously had shun deposit and retail banking but have always been heavily involved in securities trading, quickly obtained banking licenses in order to benefit from the safety-net the state provides its own fiat-money-deposit banks.
Banks channel savings into investment
Yes, to some degree they still do this, and this is indeed an important function of financial intermediaries. However, asset managers can do the same thing, and they do it without mixing this services with FRB and money-creation. In general, the asset management industry is much more transparent about how it allocates its clients’ assets, it has a clear fiduciary responsibility for these assets, and it cannot use them as ‘reserves’. In the gold or Bitcoin economy of the future, you will, of course, be free to allocate some of your money to asset managers who mange investments for you.
Conclusion
Have I been too harsh on the banks? – Maybe. The bankers, in their defense, will say that they are not the source of all these inefficiencies, that they simply help their clients deal with the inefficiencies of a state-designed and politicized monetary system – and that they reap legitimate rewards for the help they provide. – Fair enough. To some degree that may be true. But it is very clear that the size, the business models, the sources of profitability, and the problems of modern banks are uniquely and intimately linked to the present, fully elastic paper money system. As I tried to show, even if the paper money system was meant to last – and it certainly is not – the forces of capitalism, the constant search for better, more efficient and durable solutions, coupled with technological progress, would put enormous market pressures on the present banking industry in the years to come in any case. But given that our present system is not the outcome of market forces to begin with, that a system of fully elastic, local state monies is not necessary, that it is suboptimal, inefficient, unstable, and unsustainable, and that it is already in its endgame, I have little doubt that modern banks will go the way of the dodo. They are to the next few decades what the steel and coal industries were to the decades from 1960 to 1990. They are parastatal dinosaurs, joined at the hip with the bureaucracy and politics, bloated and dependent on cheap money and state subsidy for survival. They are ripe for the taking.
The demise of the paper money system will offer great opportunities for a new breed of money entrepreneurs. In that role, I could see gold storage companies, payment technology companies, Bitcoin service providers and asset management companies. If some of these join forces, the opportunities should be great. The world is ready for an alternative monetary system, and when the present system collapses under the weight of its own inconsistencies, there would be something there to take its place.
The present fiat money economy is ripe for some Schumpeterian ‘creative destruction’.
In the meantime, the debasement of paper money continues.
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Crafty_Dog
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« Reply #197 on: June 24, 2012, 05:30:01 PM »

Dr. B made a very bold play that cleaned up when the bubble burst.  It takes this commencement speech a few minutes to get going and his delivery is not the greatest, but the content is good.

http://www.youtube.com/watch?feature=player_embedded&v=1CLhqjOzoyE
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Crafty_Dog
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« Reply #198 on: July 05, 2012, 04:30:36 PM »

By JOHN B. TAYLOR
At its annual meeting of the world's central bankers in Switzerland last week, the Bank for International Settlements—the central bank of central banks—warned about the harmful "side effects" of current monetary policies "in the major advanced economies" where "policy rates remain very low and central bank balance sheets continue to expand." These policies "have been fueling credit and asset price booms in some emerging economies," the BIS reported, noting the "significant negative repercussions" unwinding these booms will have on advanced economies.

The BIS emphasizes the view that international capital flows stirred up by monetary policy were a primary factor leading to the preceding crisis and that these flows would lead to the next one. This is in stark contrast to the "global saving glut" hypothesis—which says that the funds pouring into the U.S. in the previous decade originated largely from the surplus of exports over imports in emerging market economies.

The BIS should be taken seriously. It warned long in advance about the monetary excesses that led to the financial crisis of 2008.

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 .The capital-flow story starts during extended periods of low interest rates, as in the U.S. Federal Reserve's low rates from 2003 to 2005 and its current near-zero interest rate policy, which began in 2008 and is expected to last to 2014. These low interest rates cause investors to search elsewhere for yield, and they buy foreign securities—corporate as well as sovereign—for that reason. Global bond funds in the U.S. thus shift their portfolios to these higher-yielding foreign securities and investors move to funds that specialize in such securities.

Low U.S. interest rates also encourage foreign firms to borrow in dollars rather than in local currency. U.S. branch offices of foreign banks play a key part in this process: As of 2009, U.S. branches of over 150 foreign banks had raised $645 billion to make loans in their home countries, making special use of U.S. money-market funds, where about one half of these funds' assets are liabilities of foreign banks.

This increased flow of funds abroad—whether through direct securities purchases or through bank lending—puts upward pressure on the exchange rate in these countries, as the foreign firms sell their borrowed dollars and buy local currency to expand their operations and pay workers. That's when foreign central banks enter the story. Concerned about the negative impact of the appreciating currency on their country's exports or with the risky dollar borrowing of their firms, they respond in several ways.

First, they impose restrictions on their firms' overseas borrowing or on foreigners investing in their country. But the differences in yield provide strong incentives for market participants to circumvent the restrictions.

Second, central banks buy dollar assets, including mortgage-backed securities and U.S. Treasurys, to keep the value of their local currency from rising too much as against the dollar. One consequence of these purchases is a foreign government-induced bubble in U.S. securities markets, as we saw in mortgage markets leading up to the recent crisis, and as we may now be seeing in U.S. Treasurys.

The flow of loans from the U.S. to foreign borrowers is effectively matched by a flow of funds by central banks back into the U.S. There is no change in the current account, and no role for the so-called savings glut.

Third, in order to discourage the inflow of funds seeking higher yields—which would drive up the exchange rate of their own currency—foreign central banks hold their interest rates lower than would be appropriate for domestic economic stability. There is much statistical evidence for this policy response, and, when you roam the halls of the BIS and talk to central bankers, as I did last week, you get even more convincing anecdotal evidence. Call it the lemming effect: Central banks tend to follow each other's interest rates down.

This is what happened in the lead up to the 2008 financial crisis, and it has helped fuel Europe's current debt crisis. In the 2003-2005 period, low interest rates led to a flow of funds into U.S. mortgage markets as foreign central banks bought dollars, aggravating the housing boom and the subsequent bust.

Moreover, the European Central Bank's interest rate moves during 2003-2005 were influenced by the Fed's low rates. By my estimates, the interest rate set by the ECB was as much as two percentage points too low, which also had the effect of spurring housing booms in Greece, Ireland and Spain. Ironically, the European debt crisis, which originated in the booms and busts in Greece, Ireland and Spain, now has come around to threaten the U.S. economy.

The Fed's current near-zero interest rate policy, designed to stimulate the U.S. economy, has made it harder for other central banks to combat credit and asset price booms. A group of 18 emerging market central banks—including Brazil, China, India, Mexico and Turkey—held their interest rates on average as much as five percentage points below widely used policy benchmarks—and global commodity prices doubled from 2009 to 2011, a boom rivaling the excesses leading up to the 2008 financial crisis. This global, loose monetary policy was likely a big factor pushing up commodity prices. The current sharp slowdown in most emerging markets coincides with an inevitable bust of this easy-money induced boom, and the decline of foreign demand for American goods is now feeding back to the U.S. economy.

The Fed needs to pay closer attention to global capital flows and the reactions of other central banks to its decision to set interest rates very low for long periods of time. This does not mean taking one's eye off the U.S. economy, but rather preventing booms and busts abroad from slowing growth at home precisely when we need it most.

Mr. Taylor, a professor of economics at Stanford University and a senior fellow at the Hoover Institution, is the author of "First Principles: Five Keys to Restoring America's Prosperity (Norton, 2012).

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DougMacG
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« Reply #199 on: July 05, 2012, 06:13:48 PM »

Excellent insights.  Please put Prof. Taylor on the short list for Bernancke replacement. 

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