Tuesday, October 1, 2013

What is a Healthy Economy?

Cartoon by Jim Gibson


Your tweenage daughter wants to know when she can start dating guys with beards and motorcycles. Your first reaction is to tell her she can have her way when hell freezes over. But you are smarter than that. You tell her she is free to date whomever she pleases once she shows more maturity. Satisfied she goes back to texting her best friend about when they will meet at the mall.

This approach has great merit. What does it mean to show more maturity? Does it mean that she makes her bed every morning or does it mean that she has saved enough money for retirement? Clearly, any time she comes to you with another reached milestone in maturity, you can tell her she is still deficient and cannot yet date guys with beards and motorcycles.

Where is this heading? Has LSD been into the JD this morning? It sure sounds like it. My point is that this is exactly how the FED is treating us. Mr. Bernanke tells us that the economy is not mature enough yet to let it go out alone without a chaperone (Mr. Bernanke).  But Ben, when will we be mature enough to stand on our own? The answer is – when Ben says you can stand alone. Be good and go to the mall and spend a lot of money. Ask Ben again tomorrow.

When will the economy be strong enough for the Fed to taper? When will it be strong enough for the Fed to remove all that unwanted and unneeded monetary flab from the system?

Macro does not make this question easy to answer because there are so many ways to judge the present and expected future health of an economy. Most of us think the unemployment rate is a great macro indicator but we also know that the unemployment rate can go lower simply because more people give up looking for work. So it is possible that the unemployment rate could go to 6.9% and the Fed would still judge the economy too weak to walk without a cane.

So maybe if the unemployment rate was falling AND employment was growing, that would be good evidence of strength? But what if most of the new jobs were low-wage and/or part-time? What if most of the jobs were in occupations featuring pole dancing? 

What if employment was growing while events abroad portended a weakened China, Brazil, Canada or parts of Europe? What if those and other countries actively depreciate their currencies against the dollar? Wouldn’t we worry about exports and the President’s goal to double exports as our engine of growth and stability?

Or perhaps employment and unemployment are both improving but continued ambiguity about regulation in housing and financial markets leaves housing demand and supply weak. With housing at present depressed levels it would be hard to conclude that the US economy was out of the woods. What if interest rates start rising as employment improves? Won’t we worry about another housing crash?

You should be getting my point. If not, try a little more Soju. The Fed says the economy needs to be out of the woods but there always are and there always will be conflicting signals in the US economy. Business investment could remain weak for quite a while. The consumer has not exactly rebounded. So what really matters is not so much this excuse about the strength of the economy but rather the Fed’s intent.

This might sound blasphemous but whether it is Bernanke or Yellen, the truth is that we have two popular leaders who will always have a tendency to see weakness in the economy and worse yet – will not cherish the long fight for Fed independence and credibility. Without an independent and credible Fed we might as well let the Department of the Treasury spew money from helicopters as the government deems necessary. And of course, that will lead us sooner or later to catastrophe.

Surely I exaggerate? I don’t think so. Government debt is in outer space and on a trajectory to reach the sun. Yet the government has no plan to constrain our nation’s debt. Notice that the current congressional debate has almost nothing to do with future debt issues.We have known since about 1964 that the baby boom generation would bust the budget today and have had almost 60 years to deal with that – yet we are not much better off in 2013 than we were when I was 18 years old. 

What does Congress and national debt have to do with the Fed? This government debt has to be sold each year. The Treasury has been selling roughly a trillion dollars of debt each year. While the economic recovery is reducing that amount, the respite is temporary and the government will continue selling a s---load of debt each year. Someone has to buy it. That’s a lot of US bonds to soak up. To make this avalanche of bonds desirable the markets would ordinarily need to raise interest rates on the debt. While this is wonderful for the bondholder we all know this would be bad for the economy.

So the Fed plows in with its capacity to create infinite waves of money and buys government bonds. A trillion dollars for bonds? No problem. Ben just writes a check. One does not need to be conspiratorial to believe Obama “makes” Bernanke buy those bonds – one can simply believe the Fed is trying to help the economy overcome this giant wake of the government’s incessant and huge demands for credit. Thus the Fed acts “as if” it were a part of the liberal democratic administration.

In doing so, the Fed abdicates its independence and along with that goes its credibility and ability to function. You know why credibility is important. Without credibility your threats as a parent go ignored. Honey – don’t put that screwdriver in the electrical outlet or I will put you in timeout with Dr. Phil. If the kid never gets put in timeout – the chances are she will ignore your directions. Likewise if the Fed puts in a policy designed to reduce interest rates and we all know that the Fed never acts against rising inflation – then it is likely that at some point a policy designed to reduce rates and stimulate the economy will fail. Future attempts to reduce interest rates will raise inflation expectations and will raise, not lower, interest rates. The Fed at that point becomes largely redundant.

The Fed needs to be independent. The Fed needs credibility. The Fed needs to point its boney fingers and forcefully lecture the government about proper fiscal finance. The Fed has to admit that the economy is ready to walk if not run. They will always find some data or some excuse to postpone proper monetary policy so long as they are in denial about proper central banking and its limits in solving all of man’s problems. The Fed can wait but in doing so it risks a jump from the frying pan into a volcano!

13 comments:

  1. I thought the FED was part of the Liberal Democratic Progressive Movement. No you say? I would say that even the worst judge would agree...the evidence is there. Who is running the economy anyway. Is this not just a diversion so people think all is good and the bad old GOP is trying to hurt them. Well CNN canceled the Elect Hillary documentary. So the Democrats have to reach for something else.

    Meanwhile back at the White House the Democrats are working up the blame spin for the GOP on shutting down the country. ....the same day that Obamacare rolls out with a process that is more difficult than filling out a tax form or reading your phone bill. ....and job creation continues it's slide.

    Jobs you say! Who needs them? There are more than sufficient government subsidies.

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  2. James, I hope you feel better now. As for the Fed it was purposely made independent in its day to day decision making. And at times it has used its independence to our national advantage. But as I said in the post, their job is made difficult by governments that cannot live within their means. I'd like to see a better Fed but the real problem is government. While I think liberal democrats deserve most of the blame I cannot believe that republicans don't share some of it. After all, they too have had their chances to balance the budget for the last 60 years and they didn't do such a good job. The essence of democratic government is the almost infinite ability to satisfy voters with benefits. It is tempting for legislators on both sides of the aisle to be sucked into that competition. It takes quite person to see the folly in that.

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  3. Dear LSD. The Fed(up) originally was chartered by Congress to mitigate bank failures but also to stabilize the currency, manage prices, and maximize employment. On the first it is an abject failure. On the second and third, the dollar’s value is a fraction of what it was worth in the early 1900s—second and third abject failures. Maximize employment?—fourth abject failure—despite adding trillions to its balance sheet via QE1, QE2, QE3, . . . QEn. To your statement, “The Fed at that point becomes largely redundant,” I add feckless. It has lost credibility but still continues to function—with the exception of being the most prolific ATM machine ever. Point a boney finger at the govomit—ya mean that decisive org called (in)Congruous? Oh, shure! Yeah, the Fed(up) needs to get out of the private sector and put its tranche of trillions back in the ATM genie. Now, that could be a credible move—but even though the Fed(up) is supposed to be independent and apolitical—I think Emperor Obummer & Kingdom would surreptitiously whisper in Big Ben’s ear to taper the tapering—lest Joe B’s fourth summer of recovery be put back in ICU.

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  4. The Fed was created to stabilize the banking system and determine which banks would survive a banking crisis. That is what they do regardless of the implications of the true economy where something is produced and exchanged for something else of value.
    The link below provides what they did for banks outside of TARP and Government oversight

    http://www.bloomberg.com/news/2011-11-28/secret-fed-loans-undisclosed-to-congress-gave-banks-13-billion-in-income.html

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    1. Dan you have a very narrow interpretation of the Fed. It was not directly set up to determine which banks would fail or survive. And the regulation over banks has come to be split among several agencies including the Comptroller of the Currency and the FDIC. After the Great Depression it became recognized that the Fed should be a lender of last resort during times of financial crises. What the Fed did in 2008 was to go well beyond what the Fed had done in the past. The article you cite is a good one and it explains what the Fed did. The Fed felt these loans to banks were part of their responsibility in a crisis. Many of us wanted the Fed to play its lender of last resort role but we did not necessarily agree with these secret loans. Nevertheless, these early actions in 2008 might have been important for preventing the crisis from being even worse. We will never know what would have happened if the Fed has simply provided generally liquidity to a financial system that was freezing up.

      I think people in the banking and financial system would take offense at your insinuation that they are not part of the true economy and do not produce anything of value. Services, including financial and banking services are the mainstay of your economic system.

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  5. Larry,
    From what I have read about the origin of the Fed, the Secret Hunting trip to Jekyll Island only included representatives of the wealthiest banking families in the US, maybe the world. The Financiers sold their plan to Congress, which was instituted 2 years later. The stability of the banking institutions was the primary selling point.

    The Fed has been really good at supporting banks that are too big to fail. The same was not true for the smaller banks whose real estate collateral was deemed as insufficient reserve for their loans. Then the local small banks were forced to sell to the large banks.

    Regarding my comment about producers and providing value: Banks and Financial Institutions do provide a value; because, they provide the function of storing, loaning and transferring currencies which allows businesses and individuals not to have to barter their goods and services. That is a valuable function.

    By producers I do suggest that the real Middle Class Economy depends on Agriculture, Mining, Engineering and construction, manufacturing, energy production, etc. That is where you find the potential for most middle class jobs.

    The Fed has provided plenty of dollars to the banking institutions through QE, but this has not translated to sufficient jobs for the middle class.

    I think we agree the BIG GOV is the problem, not the Fed. However, lately it seems that the Fed is an extension of the big government liberal establishment.

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  6. Dan,

    Of the 136.1 million non-farm workers in the USA, 117,500 are listed in services. Sorry but that is where the maximum potential for middle class jobs are. Manufacturing accounted for 11.9 million and construction for 5.8 million.

    As for secret hunting trips and other conspiracies it is interesting that some 100 years later there have been few if any reported and tried illegal relationships between these rich folks and the Fed. This makes this a very successful conspiracy. You gotta admit they they deserve a ton of credit for staying out of jail so long.

    I guess I prefer to believe that the Fed operates in a complicated world where sometimes I don't agree with their policies but where they have honest motives in doing the stupid policies they do.

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  7. I am not getting into that one. In a free market system supply and demand dictate. Does the same apply to money or are there special rules? The FED is catering to the bankers as in investment bankers. Yes, their investment cash is the primary source of growth capital...which they are not exactly spreading around

    Secondly, yes the GOP holds some accountability for helping set up the economy over the past 30 years. Since 1980 The GOP has occupied the supreme leader position for 18 years and the DEMs for the balance. During that time all of the mechanisms and trip cords were being put in place either intentionally or by accident that have left us with the myriad of unsolved issues we have today...including the FED who at this moment is catering to the market (Wall Street) It seems like they keep testing the water....like let's start tapering..oops the market does not like that so let's go back to QE.

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  8. James, the Fed mostly controls the supply of money though through the money multiplier the market does influence how much money is in circulation. But let's say the Fed mostly controls the supply so it is not a fully free market system as you described. In an environment of great risk it is not unusual that creditors are stingy and borrowers are tentative. It is also not unusual that the Fed would try to elicit more lending. Of course, sometimes more is less and some of us are critical of the Fed right now for doing too much. As you say, the time for tapering is here.

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  9. Since we are picking on the FED, let us not forget who developed the concept of a central bank and also some of the foundations of financial investment as we know it today. Alexander Hamilton. A transplant from the Caribbean Islands who saw trade, financial houses and central banking as necessary.

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  10. Good point James. No matter what one thinks of central banks, it is a central fact that nearly every country has one. It is sort of like -- you can't live with them and you can't live without them!

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  11. Larry; 1964 to now is only about 50 years, not 60. I thought economists knew math. Perhaps that's why we have a mess.

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  12. Dear Anony -- Guilty as charged. Don't you think you are giving a little too much power to economists? I think you can spread the blame for this mess a bit wider -- how about pusillanimous politicians?

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