greenspan

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The Shape of 40 Years of Inflation

I have written before that there is no single rate of inflation, and that different individuals experience their own rate dependent on their own individual spending preferences. This — among other reasons — is why I find the notion of single uniform rate of inflation — as central banks attempt to influence via their price stability mandates — problematic.

While many claim that inflation is at historic lows, those who spend a large share of their income on necessities might disagree. Inflation for those who spend a large proportion of their income on things like medical services, food, transport, clothing and energy never really went away. And that was also true during the mid 2000s — while headline inflation levels remained low, these numbers masked significant increases in necessities; certainly never to the extent of the 1970s, but not as slight as the CPI rate — pushed downward by deflation in things like consumer electronics imports from Asia — suggested.

This biflationary (or polyflationary?) reality is totally ignored by a single CPI figure. To get a true comprehension of the shape of prices, we must look at a much broader set of data:

Yet the low level of headline inflation has given central banks carte blanche to engage in quantitative easing, and various ultra-loose monetary policies like zero-interest rates — programs that tend to benefit the rich far more than anyone else. Certainly, lots of goods and services — especially things like foreign-made consumer goods and repossessed real estate — are deflating in price. But you can’t eat an iPad or a $1 burnt-out house in Detroit. Any serious discussion of monetary policy must not only consider the effects on creditors and debtors, but also the effects on those who spend a larger-than-average proportion of their income on necessities.

Another issue is that CPI leaves out both house prices as well as equity prices.

Below is CPI contrasted against equities and housing:

It is clear from this record that a central bank focused upon a price index that fails to include important factors like stock prices and house prices can easily let a housing or stocks bubble get out of hand. CPI can — as happened in both the 1990s as well as the early 2000s — remain low, while huge gains are accrued in housing and stocks. Meanwhile, central bankers can use low CPI rates as an excuse to keep interest rates low — keeping the easy money flowing into stocks and housing, and accruing even larger gains. However, because such markets are driven by leverage instead of underlying productivity, eventually the ability to accrue new debt is wiped out by debt costs,  hope turns to panic, and the bubble bursts.

Both of the above examples indicate that the contemporary headline price index measures of inflation are deeply inadequate. Attempts to measure the rate of inflation that ignore data like house or stock prices will lead to flawed conclusions (rendering any such notions of “price stability” as meaningless), which has tended to lead to failed policy decisions such as those which led to the bust of 2008.

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Should the Rich Pay More Taxes?

It’s a multi-dimensional question.

The left says yes — income inequality has soared in recent years, and the way to address it (supposedly) is to tax the rich and capital gains at a higher rate. The right says no — that the rich already create more jobs and wealth, because they spend more money, and why (supposedly) should they pay more tax when they already pay far higher figures than lower-income workers?

Paul Krugman made the point yesterday that the tax rate on the top earners during the post-war boom was 91%, seeming to infer that a return to such rates would be good for the economy.

Yet if we want to raise more revenue, historically it doesn’t really seem to matter what the top tax rate is:

Federal revenues have hovered close to 20% of GDP whatever the tax rate on the richest few.

This seems to be because of what is known as the Laffer-Khaldun effect: the higher rates go, the more incentive for tax avoidance and tax evasion.

And while income inequality has risen in recent years, the top-earners share of tax revenue has risen in step:

So the richest 1% are already contributing around 40% of the tax revenue, taxed on their 34% share of the national income. And even if the Treasury collected every cent the top 1% earned, America would still be running huge deficits.

Yet the Occupy movement are still angry. A large majority of Americans believe the richest should pay more tax. More and more wealthy Americans — starting with Warren Buffett, and most recently Stephen King are demanding to pay more taxes.

King writes:

At a rally in Florida (to support collective bargaining and to express the socialist view that firing teachers with experience was sort of a bad idea), I pointed out that I was paying taxes of roughly 28 percent on my income. My question was, “How come I’m not paying 50?”

How come? Well, the data shows pretty clearly that it’s unlikely that revenues would increase.

They may have a fair point that capital gains above a certain threshold should probably be taxed at the same rate as income, because it is effectively the same thing. And why should government policy encourage investment above labour by taxing one more leniently?

But more simply, people like King think the status quo  is unjust far beyond the taxation structure. A lot of people are unemployed:

A lot of people are earning less than they were five years ago:

28% of homeowners are underwater on their mortgages. Millions of graduates face a mountain of student debt, while stuck in dole queues or in a dead end job like Starbucks.

We live in dark times.

From Reuters:

Nearly 15 percent of people worldwide believe the world will end during their lifetime and 10 percent think the Mayan calendar could signify it will happen in 2012, according to a new poll.

With all this hurt, there’s a lot of anger in society. Those calling for taxing the richest more are not doing the same cost-benefit analysis I am doing that suggests that raising taxes won’t raise more revenue.

But they’re not unfairly looking for a scapegoat, either. While probably the greatest culprits for the problems of recent times are in government Americans are right to be mad at the rich.

Why?

This isn’t about tax. This is about jobs, and growth.

The rich, above and beyond any other group have the ability to ameliorate the economic malaise by spending and creating jobs, creating new products and new wealth. The top 1% control 42% of all financial wealth. But that money isn’t moving very much at all— the velocity of money is at historic lows. It should not be surprising that growth remains depressed and unemployment remains stubbornly high.

And every month that unemployment remains elevated is another month that the job creators are not doing their job. Every month that the malaise festers, the angrier the 99% gets.  It is, I think, in the best interests of the rich to try and create as many jobs and as much wealth as they can.  A divided and angry society, I think, will find it even more difficult to grow and produce.

America needs the richest Americans to pay more tax dollars — but as a side-effect of producing more, and creating growth.

If the private sector doesn’t spend its way out of the current depression, eventually the government will have to, of course. But it can do that with borrowed money, not taxed money.

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Bernanke vs Greenspan?

Submitted by Andrew Fruth of AcceptanceTake

Bernanke and Greenspan appear to have differing opinions on whether the Fed will monetize the debt.

Bernanke, on behalf of the Federal Reserve, said in 2009 at a House Financial Services Committee that “we’re not going to monetize the debt.”

Greenspan, meanwhile, on Meet the Press in 2011 that “there is zero probability of default” because the U.S. can always print more money.

But they can’t both be true…

There is only 0% probability of formal default if the Fed monetizes the debt. If they refuse, and creditors refuse to buy bonds when current bonds rollover, then the U.S. would default. But Ben said the Fed will never monetize the debt back on June 3, 2009. That’s curious, because in November 2010 in what has been termed “QE2” the Fed announced it would buy $600 billion in long-term Treasuries and buy an additional $250-$300 of Treasuries in which the $250-$300 billion was from previous investments.

Is that monetization? I would say yes, but it’s sort of tricky to define. For example, when the Fed conducts its open market operations it buys Treasuries to influence interest rates which has been going on for a long time — way before the current U.S. debt crisis.

So then what determines whether the Fed has conducted this egregious form of Treasury buying we call “monetization of the debt?”

The only two factors that can possibly differentiate monetization from open market operations is 1) the size of the purchase and 2) the intent behind the purchase.

This is how the size of Treasury purchases have changed since 2009:

Since new data has come out, the whole year of 2011 monetary authority purchases is $642 billion – not quite as high as in the graph, but still very high.

Clearly you can see the difference in the size of the purchases even though determining what size is considered monetization is rather arbitrary.

Then there’s the intent behind the purchase. That’s what I think Bernanke is talking about when he says he will not monetize the debt. In Bernanke’s mind the intent (at least the public lip service intent) is to avoid deflation and to boost the economy – not to bail the United States out of its debt crisis by printing money. Bernanke still contends that he has an exit policy and that he will wind down the monetary base when the time is appropriate.

So In Bernanke’s mind, he may not consider buying Treasuries — even at QE2 levels — “monetizing the debt.”

The most likely stealth monetization tactics Bernanke can use — while still keeping a straight face — while saying he will not monetize the debt, will be an extreme difference between the Fed Funds Rate and the theoretical rate it would be without money printing, and loosening loan requirements/adopting policies that will get the banks to multiply out their massive amounts of excess reserves.

If, for example, the natural Fed Funds rate — the rate without Fed intervention — is 19% and the Fed is keeping the rate at 0%, then the amount of Treasuries the Fed would have to buy to keep that rate down would be huge — yet Bernanke could say he’s just conducting normal open market operations.

On the other hand, if the banks create money out of nothing via the fractional reserve lending system and a certain percentage of that new money goes into Treasuries, Bernanke can just say there is strong private demand for Treasuries even if his policies were the reason behind excessive credit growth that allowed for the increased purchase of Treasuries.

Maybe Bernanke means he will not monetize a particular part of the debt that was being referred to in the video. Again, though, he could simply hide it under an open market operations 0% policy or encourage the banking system to expand the money supply.

Whatever the case, if you ever hear Bernanke say “the Federal Reserve will not monetize the debt” again, feel free to ignore him. When he says that, it doesn’t necessarily mean he won’t buy a large quantity of Treasuries with new money created out of nothing.

Remember, Greenspan says there’s “zero probability of default” because the U.S. can always print more money. Does Greenspan know something here? There’s only zero probability if the Fed commits to monetizing the debt as needed. If Greenspan knows something there will be monetization of the debt, even if Bernanke wants to call it something else.

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Ignoring the Correlation

Paul Krugman waxes about income inequality:

Apologists for rising inequality often argue that since most Americans’ income has risen despite rising inequality, there’s no reason to complain about inequality other than envy.

You see the contrast: a doubling of family incomes in the post war generation compared with maybe 20 percent since, and family incomes growing in line with GDP before, lagging far behind since, with the difference basically being the rising share of the 1 percent.

This is real stuff, not some trivial envy-driven concern. But we must be very, very quiet about it, right?

Krugman is very quiet about one thing: the fundamental change in the monetary system that took place in 1971, the year that Richard Nixon made the dollar a completely fiat currency by removing its peg to gold. After that event, income inequality has really raced ahead.

Now I know full well correlation does not imply causation. But I also know that giving central bankers free rein to print as much money to hand out like candy to their friends in big finance does imply that they will do it. How do I know that? Because they do:

From the Levy Institute:

The bottom line of crisis of 2007-9: a Federal Reserve bailout commitment in excess of $29 trillion.

My hypothesis is that leaving the gold standard was a free lunch: headline GDP growth could be achieved without any real gains in productivity, or efficiency, or in infrastructure, but instead by pumping money into the system and assuming that this would have a positive effect on the economy as a whole. After all — say the Keynesians — “aggregate demand (i.e. money circulation) is the state of the economy”.

But in reality “higher GDP” and “higher aggregate demand” just mean more money circulating. It’s perfectly possible for more money to circulate while the real economy (productivity, labour, technology, infrastructure, etc) deteriorates. In fact, in many respects this is exactly what happened during the Bush administration, where trillions of dollars of productive capital was burnt up on military adventurism.

Now maybe I have a thick skull. If so, could someone explain to me what I’m missing? The Federal Reserve was set free to print as much money as it wanted and give it to its friends with little oversight, and in the following years income inequality soared.

Seems like simple cause and effect.

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Why Warren Buffett Is Wrong

From the Telegraph:

“Gold really doesn’t have utility, the 80-year old told shareholders at Berkshire Hathaway’s annual general meeting. “I’d bet on a good producing business to outperform something that doesn’t do anything.”

And so would I. My entire economic position is founded on the idea that productivity is better than non-productivity. So why am I so bullish on gold? And why am I so convinced that Warren Buffett — a man who has had such a successful investment career — is so out of step with reality?

The answer is really very simple — Warren Buffett’s investment career, starting seriously in 1947, has existed in the shadow of the greatest sustained gains in stocks & GDP in the history of the world. Let’s look at the S&P500, mapped against GDP from 1950 to 2010:

Continue reading →

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Why Cash Is Not King

This is a strange and beautiful crisis. For the last century, at times of change and instability, nervous investors have traditionally piled their money in two directions, into Treasury Bonds, and into cash. This time, the fortifications underlying the entire financial system are straining beneath the weight of change, the weight of systemic debt, and the rise of China, Brazil, India and Russia. From The Economist’s resident cartoonist, KAL:


And the most common response to these wild and whirling winds of change is money flowing into the asset class that has just been downgraded, the US Treasury, slashing yields by half a percent. Why? Because it is the most widely traded and the most liquid asset in the world. Put money in Treasuries — goes the common logic — and you will get your money back. The United States Treasury cannot, will not default. Why? The answer has been spoken explicitly in the past few days, most prominently by former Federal Reserve Chairman Alan Greenspan:

The United States can pay any debt it has because we can always print money to do that. So there is zero probability of default

Sadly, Chairman Greenspan is sorrily wrong. There are others kinds of defaults, and currently one is ongoing as a policy choice. With rates low, it is only necessary to have a small rate of inflation for real rates to be negative.

So are real interest rates really negative? It depends how we measure inflation. A huge aspect of my economic case is that — really — there is no such thing as a uniform inflation (or uniform inflation expectations), because there are different rates for different people, different communities and different strata of society. For welfare-recipients on a fixed income, food and fuel make up a much higher proportion of their income, leading to a much higher inflationary rate. For large corporations importing vast quantities of goods from China, inflation is undoubtedly lower. But no matter who you are, the rate of inflation is high enough to yield a negative real rate on cash.  On Treasuries, this is not necessarily true. But real rates on Treasuries are undoubtedly close to zero, if they are not negative.

Of course as I noted above that is the point of the zero interest rate policy: it is designed to spur holders of cash and Treasuries out of merely holding onto wealth, and instead into more productive ventures. The ostensible goal of the Federal Reserve’s policy, at this stage is to gradually increase productivity, output and unemployment and kick the can down the road for long enough to be able to get the burden under control. This is why Bernanke has called for further fiscal stimulus, as well as continuing monetary stimulus. In this environment, cash and Treasuries cannot be king, because cash and Treasuries are being deliberately throttled (even as the market deludes itself by pushing them to ever-greater heights).

What is king? Returns above the rate of inflation, at least. Right now that includes gold, silver, stocks from various countries and continents, and corporate bonds — so long as they are not in default. But in the long run, the winner will be quality productive assets built around solid companies, solid entrepreneurs, solid products and solid ideas. Value investors have known this for an eternity. But in tempestuous markets, getting in at the right price and at the time is difficult. That is why so many investors are waiting on the sidelines in cash and treasuries.