Why Does Anyone Think the Fed Will Taper?

Simon Kennedy of Bloomberg claims:

The world economy should brace itself for a slowing of stimulus by the Federal Reserve if history is any guide.

Personally, I think this is nutty stuff. In enacting QE3, Bernanke made pretty explicit he was targeting the unemployment rate; the “full-employment” side of the Fed’s dual mandate. And how’s that doing?

fredgraph (21)

It looks like its coming down — although, we are still a very long way from full employment. And a lot of that decrease, as the civilian employment-population ratio insinuates, is due to discouraged workers dropping out of the labour force:

EMRATIO_Max_630_378 (1)

Moreover, of course, quantitative easing — substituting zero-yielding cash into the money supply for low-yielding assets — is about the Federal Reserve attempting to reinflate the shrunken money supply resulting from the collapse of shadow intermediation in 2008. And the broad money supply remains extremely shrunken, even after all the QE:

And the bigger story is that America is still stuck in a huge private deleveraging phase, burdened with a humungous debt load:

Japan, of course, tapered its stimuli multiple times at the faintest whiff of recovery. Bernanke and Yellen will be aware of this.

Much more likely than abandoning stimulus is the conclusion by the next Fed chair — probably Yellen — that the current transmission mechanisms are ineffective, and the adoption of more direct monetary policy, including helicopter money.

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Is the Gold Price Dependent on China?

China now buys more gold than the Western world:


Does that mean, as some commentators are suggesting, that future price growth for the gold price depends on China? That if the Chinese economy weakens and has a hard landing or a recession that gold will fall steeply?

There’s no doubt that the run-up that gold has experienced in recent years is associated with the rise in demand for gold from emerging markets and their central banks. And indeed, the BRIC central banks have been quite transparent about their gold acquisition and the reasons for it.

Zhang Jianhua of the People’s Bank of China said:

No asset is safe now. The only choice to hedge risks is to hold hard currency — gold.

Indeed, this trend recently led the Telegraph’s Ambrose Evans-Pritchard to declare that the world was on the road to “a new gold standard” — a tripartite reserve currency system of gold, dollars and euros:

The world is moving step by step towards a de facto Gold Standard, without any meetings of G20 leaders to announce the idea or bless the project.

Some readers will already have seen the GFMS Gold Survey for 2012 which reported that central banks around the world bought more bullion last year in terms of tonnage than at any time in almost half a century.

They added a net 536 tonnes in 2012 as they diversified fresh reserves away from the four fiat suspects: dollar, euro, sterling, and yen.

The countries driving the movement toward gold as a reserve currency by building their gold reserves is that they are broadly creditor nations whose dollar-denominated assets have been relatively hurt by over a decade of low and negative real interest rates. The idea that gold does well during periods of  falling or negative real rates held even before the globalisation of U.S. Treasury debt.

The blue line is real interest rates on the 10-year Treasury, the red line change in the gold price from a year ago:

fredgraph (15)

The historical relationship between real interest rates and the gold price shows that it is likely not “China” per se that has been driving the gold price so much as creditors and creditor states in general who are disappointed or frustrated with the negative real interest rate environment in dollar-denominated assets. What a slowdown in the Chinese economy (or indeed the BRICs in general) would mean for the gold price remains to be seen. While it is widely assumed that a Chinese slowdown might reduce demand for gold, it is quite plausible that the opposite could be true. For instance, an inflationary crisis in China could drive the Chinese public and financial sector into buying more gold to insulate themselves against falling or negative real rates.

Of course, this is only one factor. That are no hard and fast rules about what drives markets, especially markets like the gold market where many different market participants have many different motivations for participating — some see gold as an inflation hedge, some (like the PBOC) as a hedge against counterparty risk and global contagion, some as a buffer against negative real interest rates, some as a tangible form of wealth, etc.

And with the global monetary system in a state of flux — with many nations creating bilateral and multilateral trade agreements to trade in non-dollar currencies, including gold — emerging market central banks see gold — the oldest existing form of money — as an insurance policy against unpredictable changes, and as a way to win global monetary influence.

So while emerging markets and particularly China have certainly been driving gold, while U.S. real interest rates remain negative or very low, and while the global monetary system remains in a state of flux, these nations will likely continue to gradually drive the gold price upward.

Negative Nominal Interest Rates?

A number of economists and economics writers have considered the possibility of allowing the Federal Reserve to drop interest rates below zero in order to make holding onto money costlier and encouraging individuals and firms to spend, spend, spend.

Miles Kimball details one such plan:

The US Federal Reserve’s new determination to keep buying mortgage-backed securities until the economy gets better, better known as quantitative easing, is controversial. Although a few commentators don’t think the economy needs any more stimulus, many others are unnerved because the Fed is using untested tools. (For example, see Michael Snyder’s collection of “10 Shocking Quotes About What QE3 Is Going To Do To America.”) Normally the Fed simply lowers short-term interest rates (and in particular the federal funds rate at which banks lend to each other overnight) by purchasing three-month Treasury bills. But it has basically hit the floor on the federal funds rate. If the Fed could lower the federal funds rate as far as chairman Ben Bernanke and his colleagues wanted, it would be much less controversial. The monetary policy cognoscenti would be comfortable with a tool they know well, and those who don’t understand monetary policy as well would be more likely to trust that the Fed knew what it was doing. By contrast, buying large quantities of long-term government bonds or mortgage-backed securities is seen as exotic and threatening by monetary policy outsiders; and it gives monetary policy insiders the uneasy feeling that they don’t know their footing and could fall into some unexpected crevasse at any time.

So why can’t the Fed just lower the federal funds rate further? The problem may surprise you: it is those green pieces of paper in your wallet. Because they earn an interest rate of zero, no one is willing to lend at an interest rate more than a hair below zero. In Denmark, the central bank actually set the interest rate to negative -.2 % per year toward the end of August this year, which people might be willing to accept for the convenience of a certificate of deposit instead of a pile of currency, but it would be hard to go much lower before people did prefer a pile of currency. Let me make this concrete. In an economic situation like the one we are now in, we would like to encourage a company thinking about building a factory in a couple of years to build that factory now instead. If someone would lend to them at an interest rate of -3.33% per year, the company could borrow $1 million to build the factory now, and pay back something like $900,000 on the loan three years later. (Despite the negative interest rate, compounding makes the amount to be paid back a bit bigger, but not by much.) That would be a good enough deal that the company might move up its schedule for building the factory.  But everything runs aground on the fact that any potential lender, just by putting $1 million worth of green pieces of paper in a vault could get back $1 million three years later, which is a lot better than getting back a little over $900,000 three years later.  The fact that people could store paper money and get an interest rate of zero, minus storage costs, has deterred the Fed from bothering to lower the interest rate a bit more and forcing them to store paper money to get the best rate (as Denmark’s central bank may cause people to do).

The bottom line is that all we have to do to give the Fed (and other central banks) unlimited power to lower short-term interest rates is to demote paper currency from its role as a yardstick for prices and other economic values—what economists call the “unit of account” function of money. Paper currency could still continue to exist, but prices would be set in terms of electronic dollars (or abroad, electronic euros or yen), with paper dollars potentially being exchanged at a discount compared to electronic dollars. More and more, people use some form of electronic payment already, with debit cards and credit cards, so this wouldn’t be such a big change. It would be a little less convenient for those who insisted on continuing to use currency, but even there, it would just be a matter of figuring out with a pocket calculator how many extra paper dollars it would take to make up for the fact that each one was worth less than an electronic dollar. That’s it, and we wouldn’t have to worry about the Fed or any other central bank ever again seeming relatively powerless in the face of a long slump.

First of all, I question the feasibility of even producing a negative rate of interest, even via electronic currency. Electronic currency has practically zero storage costs. What is to stop offshore or black market banking entities offering a non-negative interest rate? After all, it is not hard to offer a higher-than-negative rate of interest for the privilege of holding (and leveraging) currency. A true negative interest rate environment may prove as unattainable as division by zero.

But assuming that such a thing is achievable, I think that a negative rate of interest will completely undermine the entire economic system in clear and visible ways that I shall discuss below (“white swans”), and probably also — because such a system has never been tried, and it is a radical departure from the present norms — in unpredictable and emergent ways (“black swans”).

Money has historically had multiple functions; a medium of exchange, a unit of account, a store of purchasing power. To institute a zero interest rate policy is to disable money’s role as a store of purchasing power. But to institute a negative interest rate policy is to reverse money’s role as a store of purchasing power, and turn money into a drain on purchasing power.

Money evolved organically to possess all three of these characteristics, because all three characteristics have been economically important and useful. To try to strip currency of one of its essential functions is to risk the rejection of that currency.

How would I react in the case of negative nominal interest rates? I’d convert into a liquid medium that was not subject to a negative rate of interest. That could be a nonmonetary asset, a foreign currency, a digital currency or a precious metal. I would actively seek ways to opt out of using the negative-yielding currency at all — if I could get by using alternative currencies, digital currencies, barter, then I would.  I would only ever possess a negative-yielding currency for transactions (e.g. taxes) in which the other party insisted upon the negative-yielding currency, and would then only hold it for a minimal period of time. It seems only reasonable that other individuals — seeking to avoid a draining asset — would maximise their utility by rejecting the draining currency whenever and wherever possible.

In Kimball’s theory, this unwillingness to hold currency is supposed to stimulate the economy by encouraging productive economic activity and investment. But is that necessarily true? I don’t think so. So long as there are alternative stores of purchasing power, there is no guarantee that this policy would result in a higher rate of  economic activity.

And it will drive economic activity underground. While governments may relish the prospect of higher tax revenues (due to more economic activity becoming electronic, and therefore trackable and traceable), in the present depressionary environment recorded and taxable economic activity could even fall as more economic activity goes underground to avoid negative rates. Increasingly authoritarian measures might be taken — probably at great cost — to encourage citizens into using the negative-yielding legal tender.

Banking would be turned upside down. Lending at a negative rate of interest — and suffering from the likely reality that negative rates discourages deposits — banks would be forced to look to riskier or offshore or black market activities to achieve profits. Even if banks continued to lend at low positive rates, the negative rates of interest offered to depositors would surely lead to a mass depositor exodus (perhaps to offshore or black market banks offering higher rates), probably leading to liquidity crises and banking panics.

As Izabella Kaminska wrote in July:

The simple fact of the matter is that in a negative carry world – or a flat yield environment for that matter  there is no role or purpose for banks because banks are forced into economically destructive practices in order to stay profitable.

Additionally, a negative-yielding environment will result in reduced income for those on a fixed income. One interesting effect of the present zero-interest rate environment is that more elderly people — presumably starved of sufficient retirement income — are returning to the labour force, which is in turn crowding out younger inexperienced workers, who are suffering from very high rates of unemployment and underemployment. A negative-yielding environment would probably exacerbate this effect.

So on the surface, the possibility of negative nominal rates seems deeply problematic.

Japan has spent almost twenty years at the zero bound, in spite of multiple rounds of quantitative easing and stimulus. Yet Japan remains mired in depression. The fact remains that both conventional and unconventional monetary policy has proven ineffective in resuscitating Japanese growth. My hypothesis remains that the real issue is the weight of excessive total debt (Japan’s total debt load remains as precipitously high as ever) and that no amount of rate cuts, quantitative easing or unconventional monetary intervention will prove effective. I hypothesise that a return to growth for a depressionary post-bubble economy requires a substantial chunk of the debt load (and thus future debt service costs) being either liquidated, forgiven or (often very difficult and slow) paid down.

The Unstimulus

If your predictions are wildly out-of-whack with reality, you need to change your approach.

Here’s a 2009 Obama administration graph authored by Jared Bernstein and Christy Romer showing their calculations for future unemployment levels with and without the Obama stimulus, updated by James Pethikoukis to show the actual figures:

These predictions have been an unmitigated disaster. Not only did the real figures not match up to the advertised ones, but they are also much worse than the baseline expectations. Romer and Bernstein appear to have both severely under-estimated the depth of the crisis, and over-estimated the effectiveness of the stimulus package.

The stimulus is a large and complex piece of legislation, and it sent lots of money to lots of different places. Money went both to projects like building roads and bridges, as well as to projects like Solyndra, and to many other kinds of projects. Here’s a rough breakdown (a deeper breakdown is available here):

To get the full picture, we need to look at the broad outcomes. So, who benefited in the wake of the stimulus?

Wages and salaries as a percentage-of-GDP in blue, corporate profits after tax as a percentage-of-GDP in red:

Obama might talk about spreading the wealth around, but the aggregate effect of the policies pursued during his administration have squarely benefited large corporations and the financial sector, and not the middle class or small business. Is reinflating financial bubbles and pumping up corporate profits Obama’s idea of recovery? The money isn’t trickling down, and small businesses and the middle class are more in debt than they were before the crisis started. Income inequality is soaring. The financial sector is richer than ever. American infrastructure is still crumbling. Housing starts are still deeply depressed, even as homelessness rises. And of course, employment is still deeply, deeply depressed. The stimulus didn’t get America working again. With a monstrous and broken financial sector still totally failing to provide adequate capital to Main Street, totally broken algorithm-driven markets that have alienated retail investors, and budget deficits that remain persistently high, this should surprise precisely nobody.

The Great Pacification

Since the end of the Second World War, the major powers of the world have lived in relative peace. While there have been wars and conflicts  — Vietnam, Afghanistan (twice), Iraq (twice), the Congo, Rwanda, Israel and Palestine, the Iran-Iraq war, the Mexican and Colombian drug wars, the Lebanese civil war — these have been localised and at a much smaller scale than the violence that ripped the world apart during the Second World War. The recent downward trend is clear: Many thinkers believe that this trend of pacification is unstoppable. Steven Pinker, for example, claims:

Violence has been in decline for thousands of years, and today we may be living in the most peaceable era in the existence of our species. The decline, to be sure, has not been smooth. It has not brought violence down to zero, and it is not guaranteed to continue. But it is a persistent historical development, visible on scales from millennia to years, from the waging of wars to the spanking of children.

While the relative decline of violence and the growth of global commerce is a cause for celebration, those who want to proclaim that the dawn of the 21st Century is the dawn of a new long-lasting era of global peace may be overly optimistic. It is possible that we are on the edge of a precipice and that this era of relative peace is merely a calm before a new global storm. Militarism and the military-industrial complex never really went away — the military of the United States is deployed in more than 150 countries around the world. Weapons contractors are still gorging on multi-trillion dollar military spending. Let’s consider another Great Moderation — the moderation of the financial system previous to the bursting of the bubble in 2008.

One of the most striking features of the economic landscape over the past twenty years or so has been a substantial decline in macroeconomic volatility. Ben Bernanke (2004)

Bernanke attributed this outgrowth of macroeconomic stability to policy — that through macroeconomic engineering, governments had created a new era of financial and economic stability. Of course, Bernanke was wrong — in fact those tools of macroeconomic stabilisation were at that very moment inflating housing and securitisation bubbles, which burst in 2008 ushering in a new 1930s-style depression. It is more than possible that we are in a similar peace bubble that might soon burst. Pinker highlights some possible underlying causes for this decline in violent conflict:

The most obvious of these pacifying forces has been the state, with its monopoly on the legitimate use of force. A disinterested judiciary and police can defuse the temptation of exploitative attack, inhibit the impulse for revenge and circumvent the self-serving biases that make all parties to a dispute believe that they are on the side of the angels. We see evidence of the pacifying effects of government in the way that rates of killing declined following the expansion and consolidation of states in tribal societies and in medieval Europe. And we can watch the movie in reverse when violence erupts in zones of anarchy, such as the Wild West, failed states and neighborhoods controlled by mafias and street gangs, who can’t call 911 or file a lawsuit to resolve their disputes but have to administer their own rough justice.

Really? The state is the pacifying force? This is an astonishing claim. Sixty years ago, states across the world mobilised to engage in mass-killing the like of which the world had never seen — industrial slaughter of astonishing efficiency. The concentration of power in the state has at times led to more violence, not less. World War 2 left sixty million dead. Communist nations slaughtered almost 100 million in the pursuit of communism. Statism has a bloody history, and the power of the state to wage total destruction has only increased in the intervening years. Pinker continues:

Another pacifying force has been commerce, a game in which everybody can win. As technological progress allows the exchange of goods and ideas over longer distances and among larger groups of trading partners, other people become more valuable alive than dead. They switch from being targets of demonization and dehumanization to potential partners in reciprocal altruism. For example, though the relationship today between America and China is far from warm, we are unlikely to declare war on them or vice versa. Morality aside, they make too much of our stuff, and we owe them too much money. A third peacemaker has been cosmopolitanism—the expansion of people’s parochial little worlds through literacy, mobility, education, science, history, journalism and mass media. These forms of virtual reality can prompt people to take the perspective of people unlike themselves and to expand their circle of sympathy to embrace them.

Commerce has been an extremely effective incentive toward peace. But commerce may not be enough. Globalisation and mass commerce became a reality a century ago, just prior to the first global war. The world was linked together by new technologies that made it possible to ship products cheaply from one side of the globe to the other, to communicate virtually instantaneously over huge distances, and a new culture of cosmopolitanism. Yet the world still went to war.

It is complacent to assume that interdependency will necessitate peace. The relationship between China and the United States today is superficially similar to that between Great Britain and Germany in 1914. Germany and China — the rising industrial behemoths, fiercely nationalistic and determined to establish themselves and their currencies on the world stage. Great Britain and the United States  — the overstretched global superpowers intent on retaining their primacy and reserve currency status even in spite of huge and growing debt and military overstretch.

In fact, a high degree of interdependency can breed resentment and hatred. Interconnected liabilities between nations can lead to war, as creditors seek their pound of flesh, and debtors seek to renege on their debts. Chinese officials have claimed to have felt that the United States is forcing them to support American deficits by buying treasuries.

Who is to say that China might not view the prize of Japan, Taiwan and the Philippines as worthy of transforming their giant manufacturing base into a giant war machine and writing down their treasury bonds? Who is to say that the United States might not risk antagonising Russia and China and disrupting global trade by attacking Iran? There are plenty of other potential flash-points too — Afghanistan, Pakistan, Venezuela, Egypt, South Africa, Georgia, Syria and more. Commerce and cosmopolitanism may have provided incentives for peace, but the Great Pacification has been built upon a bedrock of nuclear warheads. Mutually assured destruction is by far the largest force that has kept the nuclear-armed nations at peace for the past sixty seven years.

Yet can it last? Would the United States really have launched a first-strike had the Soviet Union invaded Western Europe during the Cold War, for example? If so, the global economy and population would have been devastated. If not, mutually assured destruction would have lost credibility. Mutually assured destruction can only act as a check on expansionism if it is credible. So far, no nation has really tested this credibility. Nuclear-armed powers have already engaged in proxy wars, such as Vietnam. How far can the limits be pushed? Would the United States launch a first-strike on China if China were to invade and occupy Taiwan and Japan, for example? Would the United States try to launch a counter-invasion? Or would they back down? Similarly, would Russia and China launch a first-strike on the United States if the United States invades and occupies Iran?

Launching a first-strike is highly unlikely in all cases — mutually assured destruction will remain an effective deterrent to nuclear war. But perhaps not to conventional war and territorial expansionism. With the world mired in the greatest economic depression since the 1930s, it becomes increasingly likely that states — especially those with high unemployment, weak growth, incompetent leadership and angry, disaffected youth —  will (just as they did during the last global depression in the 1930s) turn to expansionism, nationalism, trade war and even physical war. Already, the brittle peace between China and Japan is rupturing, and the old war rhetoric is back. These are the kinds of demonstrations that the Communist Party are now sanctioning:

And already, America and Israel are moving to attack Iran, even in spite of warnings by Chinese and Pakistani officials that this could risk global disruption. Hopefully, the threat of mutually assured destruction and the promise of commerce will continue to be an effective deterrent, and prevent any kind of global war from breaking out. Hopefully, states can work out their differences peacefully. Hopefully nations can keep war profiteers and those who advocate crisis initiation in check. Nothing would be more wonderful than the continuing spread of peace. Yet we must be guarded against complacency. Sixty years of relative peace is not the end of history.

Explaining Hyperinflation

This is a post in three sections. First I want to outline my conception of the price level phenomena inflation and deflation. Second, I want to outline my conception of the specific inflationary case of hyperinflation. And third, I want to consider the predictive implications of this.

Inflation & Deflation

What is inflation? There is a vast debate on the matter. Neoclassicists and Keynesians tend to define inflation as a rise in the general level of prices of goods and services in an economy over a period of time.

Prices are reached by voluntary agreement between individuals engaged in exchange. Every transaction is unique, because the circumstance of each transaction is unique. Humans choose to engage in exchange based on the desire to fulfil their own subjective needs and wants. Each individual’s supply of, and demand for goods is different, and continuously changing based on their continuously varying circumstances. This means that the measured phenomena of price level changes are ripples on the pond of human needs and wants. Nonetheless price levels convey extremely significant information — the level at which individuals are prepared to exchange the goods in question. When price levels change, it conveys that the underlying economic fundamentals encoded in human action have changed.

Economists today generally measure inflation in terms of price indices, consisting of the measured price of levels of various goods throughout the economy. Price indices are useful, but as I have demonstrated before they can often leave out important avenues like housing or equities. Any price index that does not take into account prices across the entire economy is not representing the fuller price structure.

Austrians tend to define inflation as any growth in the money supply. This is a useful measure too, but money supply growth tells us about money supply growth; it does not relate that growth in money supply to underlying productivity (or indeed to price level, which is what price indices purport and often fail to do). Each transaction is two-way, meaning that two goods are exchanged. Money is merely one of two goods involved in a transaction. If the money supply increases, but the level of productivity (and thus, supply) increases faster than the money supply, this would place a downward pressure on prices. This effect is visible in many sectors today — for instance in housing where a glut in supply has kept prices lower than their pre-2008 peak, even in spite of huge money supply growth.

So my definition of inflation is a little different to current schools. I define inflation (and deflation) as growth (or shrinkage) in the money supply disproportionate to the economy’s productivity. If money grows faster than productivity, there is inflation. If productivity grows faster than money there is deflation. If money shrinks faster than productivity, there is deflation. If productivity shrinks faster than money, there is inflation.

This is given by the following equation where R is relative inflation, ΔQ is change in productivity, and ΔM is change in the money supply:


This chart shows relative inflation over the past fifty years. I am using M2 to denote the money supply, and GDP to denote productivity (GDP and M2 are imperfect estimations of both the true money supply, and the true level of productivity. It is possible to use MZM
for the money supply and industrial output for productivity to produce different estimates of the true level of relative inflation):

Inflation and deflation are in my view a multivariate phenomenon with four variables: supply and demand for money, and supply and demand for other goods. This is an important distinction, because it means that I am rejecting Milton Friedman’s definition that inflation is always and only a monetary phenomenon.

Friedman’s definition is based on Irving Fisher’s equation MV=PQ where M is the money supply, P is the price level, Q is the level of production and V is the velocity of money. To me, this is a tenuous relationship, because V is not directly observed but instead inferred from the other three variables. Yet to Friedman, this equation stipulates that changes in the money supply will necessarily lead to changes in the price level, because Friedman assumes the relative stability of velocity and of productivity. Yet the instability of the money velocity in recent years demonstrates empirically that velocity is not a stable figure:

And additionally, changes in the money supply can lead to changes in productivity — and that is true even under a gold or silver standard where a new discovery of gold can lead to a mining-driven boom. MV=PQ is a four-variable equation, and using a four-variable equation to establish causal linear relationships between two variables is tenuous at best.

Through the multivariate lens of relative inflation, we can grasp the underlying dynamics of hyperinflation more fully.


I define hyperinflation as an increase in relative inflation of above 50% month-on-month. This can theoretically arise from either a dramatic fall in ΔQ or a dramatic rise in ΔM.

There are zero cases of gold-denominated hyperinflation in history; gold is naturally scarce. Yet there have been plenty of cases of fiat-denominated hyperinflation:

This disparity between naturally-scarce gold which has never been hyperinflated and artificially-scarce fiat currencies which have been hyperinflated multiple times suggests very strongly that the hyperinflation is a function of governments running printing presses. Of course, no government is in the business of intentionally destroying its own credibility. So why would a government end up running the printing presses (ΔM) to oblivion?

Well, the majority of these hyperinflationary episodes were associated with the end of World War II or the breakup of the Soviet Union. Every single case in the list was a time of severe physical shocks, where countries were not producing enough food, or where manufacturing and energy generation were shut down out of political and social turmoil, or where countries were denied access to import markets as in the present Iranian hyperinflation. Increases in money supply occurred without a corresponding increase in productivity — leading to astronomical relative inflation as productivity fell off a cliff, and the money supply simultaneously soared.

Steve Hanke and Nicholas Krus of the Cato Institute note:

Hyperinflation is an economic malady that arises under extreme conditions: war, political mismanagement, and the transition from a command to market-based economy—to name a few.

So in many cases, the reason may be political expediency. It may seem easier to pay workers, and lenders, and clients of the welfare state in heavily devalued currency than it would be to default on such liabilities — as was the case in the Weimar Republic. Declining to engage in money printing does not make the underlying problems — like a collapse of agriculture, or the loss of a war, or a natural disaster — disappear, so avoiding hyperinflation may be no panacea. Money printing may be a last roll of the dice, the last failed attempt at stabilising a fundamentally rotten situation.

The fact that naturally scarce currencies like gold do not hyperinflate — even in times of extreme economic stress — suggests that the underlying mechanism here is of an extreme exogenous event causing a severe drop in productivity. Governments then run the printing presses attempting to smooth over such problems — for instance in the Weimar Republic when workers in the occupied Ruhr region went on a general strike and the Weimar government continued to print money in order to pay them. While hyperinflation can in theory arise either out of either ΔQ or ΔM, government has no reason to inject a hyper-inflationary volume of money into an economy that still has access to global exports, that still produces sufficient levels of energy and agriculture to support its population, and that still has a functional infrastructure.

This means that the indicators for imminent hyperinflation are not economic so much as they are geopolitical — wars, trade breakdowns, energy crises, socio-political collapse, collapse in production, collapse in agriculture. While all such catastrophes have preexisting economic causes, a bad economic situation will not deteriorate into full-collapse and hyperinflation without a severe intervening physical breakdown.

Predicting Hyperinflation

Hyperinflation is notoriously difficult to predict, because physical breakdowns like an invasion, or the breakup of a currency union, or a trade breakdown are political in nature, and human action is anything but timely or predictable.

However, it is possible to provide a list of factors which can make a nation or community fragile to unexpected collapses in productivity:

  1. Rising Public and-or Private Debt — risks currency crisis, especially if denominated in foreign currency.
  2. Import Dependency — supplies can be cut off, leading to bottlenecks and shortages.
  3. Energy Dependency — supplies can be cut off, leading to transport and power issues.
  4. Fragile Transport Infrastructure — transport can be disrupted by war, terrorism, shortages or natural disasters.
  5. Overstretched Military — high cost, harder to respond to unexpected disasters.
  6. Natural Disaster-Prone — e.g. volcanoes, hurricanes, tornadoes, drought, floods.
  7. Civil Disorder— may cause severe civil and economic disruption.

Readers are free to speculate as to which nation is currently most fragile to hyperinflation.

However none of these factors alone or together — however severe — are guaranteed to precipitate a shock that leads to the collapse of production or imports.

But if an incident or series of incidents leads to a severe and prolonged drop in productivity, and so long as government accelerates the printing of money to paper over the cracks, hyperinflation is a mathematical inevitability.

Glenn Greenwald on Indefinite Detention

I expected to spend quite some time writing about the Obama administration’s successful appeal against Katherine Forrest’s historic gutting of the indefinite detention provision of the NDAA. Yet I can add very little to Glenn Greenwald’s summation:

In May, something extremely rare happened: a federal court applied the US constitution to impose some limits on the powers of the president. That happened when federal district court judge Katherine Forrest of the southern district of New York, an Obama appointee, preliminarily barred enforcement of the National Defense Authorization Act (NDAA), the statute enacted by Congress in December 2011 with broad bipartisan support and signed into law by President Obama (after he had threatened to veto it).

That 2011 law expressly grants the president the power to indefinitely detain in military custody not only accused terrorists, but also their supporters, all without charges or trial. It does so by empowering the president to indefinitely detain not only al-Qaida members, but also members of so-called “associated forces”, as well as anyone found to “substantially support” such forces – whatever those terms might mean.wrote about that decision and the background to this case when it was issued.

What made Judge Forrest’s ruling particularly remarkable is that the lawsuit was brought by eight journalists and activists, such as former New York Times reporter Chris Hedges, Daniel Ellsberg, Noam Chomsky, and Birgitta Jónsdóttir, who argued that their work, which involves interactions with accused terrorists, could subject them to indefinite detention under the law’s broad and vague authority, even for US citizens on US soil. The court agreed, noting that the plaintiffs presented “evidence of concrete – non-hypothetical – ways in which the presence of the legislation has already impacted those expressive and associational activities”. The court was particularly disturbed by the Obama DOJ’s adamant refusal to say, in response to being asked multiple times, that the law could not be used to indefinitely detain the plaintiffs due to their journalistic and political activities.

I was one of a chorus of writers who thanked Katherine Forrest for her intervention:

These new powers have nothing to with combatting terrorism. If the government has no evidence that can stand up in a court of law it has no business detaining anyone. No, this new power grab has an entirely different target — like the plaintiffs in this case: writers, investigative journalists, bloggers, philosophers, dissidents, human rights activists, libertarians, free-thinkers, tax protestors, critics of fractional-reserve banking, whistleblowers — people like Chris Hedges, Noam Chomsky, Daniel Ellsberg, Jennifer Bolen, and Birgitta Jonsdottir. People like Congressman Justin Amash and Congressman Adam Smith who tried to amend indefinite detention out of the bill. People like me — and to some degree, if you are reading this, people like you. 

The fact that the Obama administration could not give assurances about those who simply criticise U.S. foreign policy indicates very strongly that this power grab is about shutting-up and frightening critics of the U.S. government and the Obama administration.

But — for now —  §1021 of the NDAA, that implement of fascism, has been struck down and thrown out as “facially unconstitutional” as well as having a “chilling impact on First Amendment rights”.

We should thankful for this brave judge’s actions, and for the plaintiffs actions in standing up to tyranny, and vigilant against future incursions.

On the other hand, every politician involved in writing, legislating and authorising this hideous unconstitutional law should be reminded of the words of the Declaration of Independence — it is the right of the people to alter or abolish any government that becomes destructive to liberty.

And last week, Katherine Forrest demolished the Obama administrations protestations once again:

Last week, Judge Forrest made her preliminary ruling permanent, issuing a 112-page decision explaining it. Noting that the plaintiffs “testified credibly to having an actual and reasonable fear that their activities will subject them to indefinite military detention”, she emphasized how dangerous this new law is given the extremely broad discretion it vests in the president to order people detained in military custody with no charges:

forest ruling

The court also brushed aside the Obama DOJ’s prime argument, echoing the theories of John Yoo: namely, that courts have no business “interfering” in the president’s conduct of war. After acknowledging that the president is entitled to deference in the national security realm, Judge Forrest dispensed with the Obama DOJ’s claim with this vital observation: one that should be unnecessary but, in the 9/11 era, is all too commonly ignored:

forest ruling 2

In other words: while the president is entitled to deference in his conduct of war, he’s not entitled to wield the power to order people, including American citizens, indefinitely imprisoned in military detention. Regardless of how he claims he intends to exercise this power, the mere act of vesting it in him so chills the exercise of first amendment and other protected rights that the constitution can have no meaning if courts permit it to stand.

Yet the Obama administration, it seems, does not like the Constitution:

In response to this ruling, the Obama administration not only filed an immediate appeal, but they filed an emergency motion asking the appeals court to lift the injunction pending the appeal. Obama lawyers wrote a breathless attack on the court’s ruling, denouncing it as “vastly troubling” and claiming that it “threatens tangible and dangerous consequences in the conduct of an active military conflict” and “threatens irreparable harm to national security”.

While the Bush and Obama DOJs have long absurdly interpreted the 2001 AUMF to apply to this broader range, and while some courts have accepted that interpretation, the law itself vested no such power. The NDAA did. That is why civil liberties groups such as the ACLU denounced Obama’s signing of it so vociferously, and it is why the Obama DOJ is so horrified, obviously, by the prospect that it will be invalidated: precisely because it so drastically expands their detention power. Both the court’s ruling and the Obama DOJ’s reaction to that ruling prove that the NDAA does indeed provide the president with significantly enhanced authority of indefinite detention.

Greenwald draws a brilliant and frightening parallel:

On the very same day that the Obama DOJ fights vigorously in US courts for the right to imprison people without charges, the Afghan government fights just as vigorously for basic due process.

Remember: the US, we’re frequently told, is in Afghanistan to bring democracy to the Afghan people and to teach them about freedom. But the Afghan government is refusing the US demand to imprison people without charges on the ground that such lawless detention violates their conceptions of basic freedom. Maybe Afghanistan should invade the US in order to teach Americans about freedom.

This development should be deeply troubling for all Americans, and all of us who believe that the values of the American revolution — freedom of speech, liberty, representation, due process — should be a light unto the world.

This is Blowback

The YouTube video depicting Mohammed is nothing more than the straw that broke the camel’s back. This kind of violent uprising against American power and interests in the region has been a long time in the making. It is not just the continuation of drone strikes which often kill civilians in Pakistan, Yemen, Somalia and Afghanistan, either. Nor is it the American invasions and occupations of Iraq and Afghanistan. Nor is it the United States and the West’s support for various deeply unpopular regimes such as the monarchies in Bahrain and Saudi Arabia (and formerly Iran). Nor is it that America has long favoured Israel over the Arab states, condemning, invading and fomenting revolution in Muslim nations for the pursuit of nuclear weapons while turning a blind eye to Israel’s nuclear weapons and its continued expansion into the West Bank.

Mark LeVine, Professor of Middle Eastern history at U.C. Irvine, writes:

Americans and Europeans are no doubt looking at the protests over the “film”, recalling the even more violent protests during the Danish cartoon affair, and shaking their heads one more at the seeming irrationality and backwardness of Muslims, who would let a work of “art”, particularly one as trivial as this, drive them to mass protests and violence.

Yet Muslims in Egypt, Libya and around the world equally look at American actions, from sanctions against and then an invasion of Iraq that killed hundreds of thousands of Iraqis and sent the country back to the Stone Age, to unflinching support for Israel and all the Arab authoritarian regimes (secular and royal alike) and drone strikes that always seem to kill unintended civilians “by mistake”, and wonder with equal bewilderment how “we” can be so barbaric and uncivilised.

All of these things (and many more) have contributed to Muslim and Arab anger toward the United States and the West. Yet the underlying fact of all of these historical threads has been the United States’ oil-driven foreign policy. Very simply, the United States has for over half a century pursued a foreign policy in the region geared toward maintaining the flow of oil out of the region at any cost — even at the cost of inflaming the irrational and psychopathic religious elements that have long existed in the region.

This is not to defend the barbaric elements who resort to violence and aggression as a means of expressing their disappointment with U.S. foreign policy. It is merely to recognise that you do not stir the hornet’s nest and then expect not to get stung. 

And the sad thing is that stirring the hornet’s nest is totally avoidable. There is plenty of oil and energy capacity in the world beyond the middle east. The United States is misallocating capital by spending time, resources, energy and manpower on occupying the middle east and playing world policeman. Every dollar taken out of the economy by the IRS to be spent drone striking the middle east into the stone age is a dollar of lost productivity for the private market. It is a dollar of productivity that the market could have been spent increasing American energy capacity and energy infrastructure in the United States — whether that is in oil, natural gas, solar, wind or hydroelectric.

And this effect can spiral; every dollar spent on arming and training bin Laden and his allies to fight the Soviet Union begot many more thousands of dollars of military spending when bin Laden’s mercenaries turned their firepower onto the United States, and the United States chose to spend over ten years and counting occupying Afghanistan (rightly known as the graveyard of empires). It is likely that the current uprisings will trigger even more U.S. interventionism in the region (indeed it already has as marines have already been dispatched to Yemen) costing billions or even trillions of dollars more money (especially if an invasion of Iran is the ultimate outcome). This in turn is likely to trigger even fiercer resistance to America from the Islamist elements, and so the spiral continues on.

The only way out of this money-sucking, resource-sucking, life-sucking trap that is very literally obliterating the American empire is to swallow pride and get out of the middle east, to stop misallocating American resources and productivity on unwinnable wars.

But neither major Presidential candidate is interested in such a policy. Perhaps it is because war is a great profit source for the military-industrial complex, the force to which both the Democratic and Republican parties are beholden?

In any case, we should expect to see much more of this:

Source: Reuters

QE ∞

The Keynesians and Monetarists who have so berated the Federal Reserve and demanded more asset purchases and a nominal GDP target to get GDP level up to the long-term growth trend have essentially got their wish.

This is a radical departure:

To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month.  The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities.  These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.

The Committee will closely monitor incoming information on economic and financial developments in coming months.  If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.  In determining the size, pace, and composition of its asset purchases, the Committee will, as always, take appropriate account of the likely efficacy and costs of such purchases.

I tweeted this earlier in favour of the idea that the Fed would adopt open-ended asset purchases:

Those who didn’t anticipate the possibility of open-ended asset purchases should have looked much more closely at Bernanke’s words at Jackson Hole:

If we are willing to take as a working assumption that the effects of easier financial conditions on the economy are similar to those observed historically, then econometric models can be used to estimate the effects of LSAPs on the economy. Model simulations conducted at the Federal Reserve generally find that the securities purchase programs have provided significant help for the economy. For example, a study using the Board’s FRB/US model of the economy found that, as of 2012, the first two rounds of large scale asset purchases may have raised the level of output by almost 3 percent and increased private payroll employment by more than 2 million jobs, relative to what otherwise would have occurred.

Essentially, this is nominal GDP level targeting. The reason why Bernanke has framed it in terms of lowering unemployment is that his mandate relates to price stability and unemployment, not nominal GDP level. But as Bernanke himself noted in his academic days:

Estimates based on data from more recent years give about a 2% decrease in output for every 1% increase in unemployment.

To those who accept Okun’s Law, raising nominal GDP level and lowering unemployment are effectively the same thing. Bernanke seems to believe unemployment will fall in a (roughly) linear fashion as asset purchases increase. By itself, this is a problematic assumption as the past is not an ideal guide to the future.

Yet more importantly the data shows no real job recovery in the post-2008 quantitatively-eased world. This is the prime-age employment-population ratio:

And even if unemployment falls without triggering large-scale inflation as per the Fed’s design, this is no cure for the significant long-term challenges that America faces.

As I wrote back in November 2011, when nominal GDP targeting was just appearing on the horizon America faces far greater challenges than can be solved with a monetary injection. Financial fragility, moral hazard, energy dependency, resource dependency, deindustrialisation, excessive private debt, crumbling infrastructure, fiscal uncertainty, and a world-policeman complex. The underlying problems are not ones that Bernanke really has power to address.

And how long before rising food prices cause more riots and revolutions? After, all handing over more firepower to speculators tends to result in increased speculation.

Meanwhile, US creditors and dollar-holders (particularly China) would seem from past comments to be deeply unhappy with this decision.

President Hu Jintao:

The monetary policy of the United States has a major impact on global liquidity and capital flows and therefore, the liquidity of the US dollar should be kept at a reasonable and stable level.

The dollars they accrued will lose purchasing power to every new dollar printed and handed over to the American banks in exchange for mortgage backed securities. The Chinese perspective on this will be that Bernanke is essentially engaging in theft. On the other hand, they should have considered this likelihood before they went about accruing a humungous pile of fiat dollars that can be duplicated at a press of a button. No, matter; China won’t get burnt like this again.

As PBOC official Zhang Jianhua noted:

No asset is safe now. The only choice to hedge risks is to hold hard currency — gold.

Chances of future trade and currency wars between the United States and China seem to be rising as fast as Chinese gold accruals.

Bernanke’s Jobs Estimate

Ben Bernanke at Jackson Hole:

If we are willing to take as a working assumption that the effects of easier financial conditions on the economy are similar to those observed historically, then econometric models can be used to estimate the effects of LSAPs on the economy. Model simulations conducted at the Federal Reserve generally find that the securities purchase programs have provided significant help for the economy. For example, a study using the Board’s FRB/US model of the economy found that, as of 2012, the first two rounds of large scale asset purchases may have raised the level of output by almost 3 percent and increased private payroll employment by more than 2 million jobs, relative to what otherwise would have occurred.

Bernanke’s estimate of two million jobs created as a result of his policy appears to be a stitched-together estimate based on two research papers: Fuhrer which estimated a gain of 700,000 jobs from QE1, and Chung et al which estimated 1,800,000 jobs.

The methodology here is interesting, to say the least. From the (unfortunately titled) Fuhrer paper:

Given the range of estimated effects on real spending (GDP), the translation to employment effects is accomplished by use of an Okun’s Law relationship that links GDP growth and changes in the unemployment rate. The typical relationship expressed in quarterly changes is summarized as: Change in unemployment = -0.125 (GDP growth – potential GDP growth).

GDP growth for one-quarter that exceeds potential GDP growth by 1 percentage point results in a one-eighth (0.125) percentage point decline in the unemployment rate. Equivalently, quarterly growth in GDP that exceeds potential growth by 1 percentage point for a year typically lowers the unemployment rate by about one-half percentage point.

Combining this simple Okun’s Law with the estimated effects on GDP discussed in the preceding section implies a decline in the unemployment rate of 30-45 basis points over the 2-year period it takes for the spending rate change to feed through the economy. With the U.S. labor force currently at just over 150 million people, this translates to an increase of about 700,000 jobs, a figure quoted by Boston Fed President Eric Rosengren in his speech of November 17, 2010.

The number of layers of uncertainty is problematic. First we have uncertainty over the level of GDP growth provoked by QE. Second we have uncertainty as to the reliability of the measure and concept of potential GDP growth. And third we have uncertainty as to the extent of the relationship between GDP growth, potential GDP growth and unemployment in this specific case.

Essentially, the equation assumes that because GDP growth has historically resulted in job growth, we should assume it will do so in the future. But this is a very different economy to the one we had fifty years ago. Today it’s possible for the financial sector to generate profits (and thus, GDP) by passing liquidity around the financial sector. And today, any American demand boom will create jobs in China and Mexico (etc), because that’s where the industrial and manufacturing jobs have been shipped to.

So Bernanke’s figure is a guess based on a guess based on a guess based on old data. Maybe 2 million. Maybe, maybe, maybe, maybe.

How do we know that after a big, painful bust that after a short burst of deflationary pain that job growth wouldn’t have come roaring back? After all that happened multiple times in the 19th century.

Hank Paulson might claim that he saved the world from a thousand year nuclear winter by bailing out his former employer Goldman at par on its credit default swaps. You can claim anything about what might have happened otherwise. Maybe, maybe, maybe. Such claims are junk science because they are unfalsifiable.

Yet the reality is very clear — either people have jobs or they don’t. That’s what the regime will be judged on.

The present policy of tripling the monetary base via monetary easing hasn’t solved the jobs problem, because we’re still in the woods. Trillions of easing — which we can say quite confidently has enriched the financial sector far more than any other sector of the economy — and yet we still have a jobs depression (of course, financial sector profits have come roaring back). This is the prime age employment-population ratio:

Quantitative easing hasn’t been about jobs. If this was about jobs or stimulating demand, Bernanke would have aimed the helicopter drops at the wider public, as many economists have suggested. This policy of dropping cash directly to the banks is bailing out a dangerous and morally-hazardous financial sector and too-big-to-fail megabanks that remain dangerously overleveraged and under-capitalised, needing endless new liquidity just to keep past debts serviceable. There has been plenty of cash helicopter-dropped onto Wall Street, but nobody on Wall Street has gone to jail for causing the 2008 crisis. Criminal banksters get the huge liquidity injections they want, and the rest get less than crumbs.