Obama + Bernanke = Inflation

[msj]

Isn't there the same problem as Japan had in the 1990's? Didn't they cut their interest rate to 0 too for like 10 years and the solution was hyperinflation caused by the government. Economics sometimes escapes everyone I think.

That's exactly my point - Japan has not had hyperinflation yet and they have been working on it since at least 1994 (to be fair, there are differences).

Supposedly the US is better than that because the US will quickly resolve the problems in the banks and write off the bad debts and everything will come out good again (well, after the hyperinflation).

That's the storyline but I don't think it's going to work that way because there are still too many bad loans that need to be written off, the US banking system needs more time to write them off (the system really is near-insolvent if not out right insolvent - I mean technically speaking) so that they can slowly write down loans rather than take the hit all at once (which would lead to a deficit rather than equity on the banks statement of retained earnings - this is what I mean by technically insolvent), and the taxpayers/government/banks/auto industry/porn industry/real estate industry/everyoneandthekitchensink are asking for a hand out and, apparently, so far, are getting it so we know moral hazard will continue to be a problem until the money either runs out or the hyperinflation leaves all the debt behind in devalued dollars.

Edited January 28, 2009 by msj

[August1991]

August, you are forgetting about the velocity of money.

The graphs are meaningless unless this concept is understood - and neither graph consider this, ergo, it is not being understood.

Then there is the question of putting the cart before the horse.

That graph shows two (possibly three) supposed counter-examples: the 1930s and WWII.

During WWII, there were price controls and constant efforts to sell government bonds. The 1930s are hardly a good example of economic stability and that brings us to the 1970s - another time when velocity rose precisely because of inflation. The 1970s lead to Volcker and extremely high nominal interest rates as the Fed refused any. more. money.

----

Bernanke has drawn the Friedman-Monetarist lesson from the Fed's actions after the Stock Market Crash of October 1929. Friedman referred to the Great Depressiona s The Great Contraction because in his view, the Fed caused the Great Depression by reducing the money supply. Bernanke has chosen to do the opposite.

It appears that we are all living through a great experiment to determine whether Milton Friedman was right. He may well have been - but as they say, the operation was a success but the patient died. We may survive a recession only to face inflation.

If you had been in the Oval Office when Bernanke and the others explained the details to Bush Jnr, what would you have done? Bush Jnr. explained this dilemma in his final press conference. I think he took the right decision.

Edited February 3, 2009 by August1991

[Oleg Bach]

Fiatism is religion. A certain class of personally entitled people simply declare ' we are rich and you are poor so take your station in life and believe...and serve - us! This con game has been played for the last 60 years. The basis for this game is a mental seduction...and most will submit and comply to it...BUT in the long rug physics prevail. You can not keep generating something out of nothing for a long period of time and expect the illusion to continue to sustain...The status quo is such that they actually started to believe their own ruse - NOW - they are finding that the house of cards can not stand. So their quick fix is to create more illusion and continue to declare that they have wealth....It's like taking a scrap of news paper and making a 20 on it and expect to continue to get what.....................................................

you want with what is nothing ---- more and more paper will not solve the problem. This is class struggle at it's finest...The high and mighty say they are gods and expect us to believe we are work dogs...well - It looks like that jig is up and now there is the devil to pay...but of course the proverbial devil just loves this crap and it will go on and on .......it's hopeless because people don't care about the others...My dad had one rule of civlity "THERE ARE OTHERS"....The powers that be don't give a damn if we live or die - so why should we care about them - OR CONTINUE TO HAVE FAITH IN THEM AND BELIEVE THEM?

[msj]

August, the graphs show exactly what you were attempting to show: that money supply grows and we either get inflation or not.

The reasons why we are staring down deflation right now are because of the reasons in the article.

Part of it is understanding inflation (i.e. getting the horse/cart order right).

Part of it is understanding the remaining words of the article.

Here is another one to chew on:

The Velocity of Money and Economic Deflation

As for what I would have done - none of your business.

I have provided more than enough links to provide rational for what should have been done all along.

Why pick GWB in 2008? Why not back in 2003 or 2004 when Greenspan should have been fired (or, better still, shot) for what he was doing?

No, I'm not going to waste my time explaining what should be done to rectify this mess to someone who has been so slow to recognize this mess in the first place.

[Pliny]

Government + Central Bank = Inflation.

The whole operation of the central bank and government is to keep inflation going at around 2% per annum. The graphs you posted, August illustrate that quite well, I think.

Deflation, from the viewpoint of government, is to be avoided at all costs. Deflation is the crisis that government is attempting to cure at the moment. Re-inflating the money supply is Bernanke's solution and is the expected course of action. The question is can they control the resulting rise in prices.

Economically, deflation is necessary to a healthy economy and is a more natural inclination than inflation. A stable money supply would be deflationary. Deflation is more of a crisis for government than it is to society in general.

In my view, the reason governments detest deflation lies in their inability as an organization to contract. It grows despite the state of the economy. Recognizing it as a cost to society seems to be lost. Although the economy shrinks the cost of government increases.

Tax cuts are only half an equation. They need to downsize and cut spending to match their decreased revenues.

Instead they start public works projects to fix the infrastructure under the guise of getting the economy going and creating jobs. They didn't think of fixing the infrastructure when they had surpluses though.

GostHacked Posted Jan 28 2009, 12:53 PM

War on Terror

Financial Crisis

Failing manufacturing sector.

This leads to inflation.....

If those things create government spending and an increase in the money supply, yes - because that is what inflation is. I don't know if you are thinking inflation is a general rise in prices or not but it isn't. A general rise in prices is the result of inflation.

War on terror = create money to fight war.

Financial Crisis = create money to save financial sector.

Failing manufacturing sector = create money to bail it out.

The above inflation, i.e. increases in the money supply, results in a general rise in prices.

Governments do like some inflation so they are not averse to economic crises to pump up the money supply.

Any reason to keep inflation going is welcome.

You will notice they often say they are "fighting inflation", so why is it they are in crisis mode whenever deflation appears?

[Pliny]

MSJ,

I would follow the advice of the first guy you posted. The guy talking about the velocity of money I wouldn't.

[msj]

MSJ,

I would follow the advice of the first guy you posted. The guy talking about the velocity of money I wouldn't.

Well given that if velocity decreases then it is still possible to have deflation even with an increase in money supply, I don't really see your point.

The thing is that most people don't understand this crisis and its effect on such things.

[Huston]

Greenspan would have done what he has always done - lowered interest rates and blathered on about how the free market is self-correcting - i.e. fiddling while the mess got worse (hey, that's pretty much what Bernanke did! oh, but it helps when you are cheered on by recession deniers and poor information [poor statistical methodologies for example]).

I always found the interesting, and so hypocritical.

Beleiving in a Free market, yet artificially adjusting interest rates.

[Pliny]

Well given that if velocity decreases then it is still possible to have deflation even with an increase in money supply, I don't really see your point.

I agree that it is possible to have deflation even with an increase in the money supply. We are in a period of deflation right now and the money supply has increased dramatically. Time however must play it's role. Increasing the money supply does not immediately inflate prices, bankers and money men get to enjoy the new money first before prices rise. There is a lag that could be as long as a year.

The author of the article on velocity declares that government does control the money supply but not what people will do with it. It doesn't tell them to spend it or save it. I think this is misleading. Government encourages people to spend. Then he proceeds to tell us that the money supply is proportional to velocity in the formula Y=VM (where Y is the nominal gross domestic product (not inflation-adjusted here), M is the money supply, and V is the velocity of money) indicating fully that the velocity of money can be manipulated by the money supply. In other words the money supply can determine whether people will spend or save. Increase the money supply, diluting it's purchasing power and people will tend to spend, decrease the money supply and people will prefer to save. Remember the actions of inflating and deflating the money supply are not concurrent with the results which are latent. Velocity decreasing means spending is decreasing and decreases in prices are the result. In a period of falling prices government inflates the money supply.

It seems supply and demand are forgotten when government just wants to stimulate the economy. They just want people to spend.

It isn't directly controlling what people will generally do with money but it is directly encouraging what they will prefer to do with it.

Manipulating the money supply by controlled inflation gives us the advantage of not having to adjust prices and wages downward but doing so dilutes the purchasing power of money and thus the quantity of money is no longer an honest measure of the value of GDP. Coupled with intervention to prevent market corrections, protectionist tariffs, and taxes introduced at the whim of government the result is an unstable, unwieldy, inflationary economy.

A constant or nearly constant quantity of money will adjust it's purchasing power naturally upward if it is based upon production. Moneys true purchasing power is a better measure of wealth than it's quantity but somehow that cart got put before the horse and quantity is what counts. Bernanke thinks so.

The thing is that most people don't understand this crisis and its effect on such things.

I agree. They will go along with infusions of cash for bailouts and economic stimulus.

Edited February 4, 2009 by Pliny

[Pliny]

I always found the interesting, and so hypocritical.

Beleiving in a Free market, yet artificially adjusting interest rates.

Or believing in a free market and having a fiat monopoly currency.

[msj]

This Krugman article makes a beautiful and simple point regarding liquidity traps and money supply:

Hey, who you callin’ neo-Wicksellian? (wonkish)

[msj]

Another one sort of related: Return of depression economics

All this talk about hyperinflation - I can't help but wonder if these people realize that yes, it will come one day, but they are too busy fighting the economic demons from the past while ignoring the economic demons that are in the present.

[August1991]

This article by an economist at the US Fed St. Louis discusses this topic well:

The monetary base is the sum of currency in circulation and bank deposits at Federal Reserve Banks. Between mid-September and December 31, 2008, the U.S. monetary base increased from approximately $890 billion to $1,740 billion, doubling in a little more than 3 months. This is a concern because, under normal circumstances, we would associate such a rapid rise in the monetary base with a sharp acceleration of inflation. But today, more people seemed to be worried about deflation than a sudden rebound of inflation.

Link

The paper's third act is unnerving and brief:

When the time comes to shrink the monetary base, the Fed could allow the lending programs to expire as loans mature and sell the assets that it holds outright. If the crisis is over, the assets should be priced in the market and the Fed should expect to recover most of its investment in such assets.

Inflation does not appear to be a risk in the current environment: The economy is in recession. Inflation is falling and is not expected to return before the recession ends. If inflation resumes but the economy does not recover, policymakers will face a difficult choice. Monitoring the size and composition of the monetary base as the economy recovers will help us understand what actions are needed (and should be taken) by the Fed and the Congress to prevent a return to a high-inflation economy.

----

The US government is pressing on the gas with both pedals - and that's what macroeconomic orthodoxy up to about 1975 said it should do. With less aplomb, Bernanke is doing what Greenspan always did - twiddle the knobs.

My fear is that the Fed (and the US Treasury) cannot steer the US economy. First of all, they don't understand it well enough. But in addition, the US economy amounts to hundreds of millions of people who learn and change. What worked 30 years ago won't work now.

When the economy picks up again, the Fed will either 1) raise nominal interest rates too soon and choke off the recovery, 2) raise nominal interest rates too late and then face inflation or 3) something strange will happen - we'll face no growth, but price inflation. This happens when credit markets don't function properly. (For example, when real interest rates are negative.)

=====

Incidentally, the article goes into detail about something noted in passing elsewhere. The US Fed now has on its balance sheet a strange array of private securities. Perhaps I have this wrong but as part of its stabilization package (Maiden Lane), it appears that the US Fed is slowly buying up toxic assets. These purchases would not show up in the US federal government's budget.

Edited March 12, 2009 by August1991

[msj]

Incidentally, the article goes into detail about something noted in passing elsewhere. The US Fed now has on its balance sheet a strange array of private securities. Perhaps I have this wrong but as part of its stabilization package (Maiden Lane), it appears that the US Fed is slowly buying up toxic assets. These purchases would not show up in the US federal government's budget.

Good of you to finally notice.

[August1991]

Good of you to finally notice.

Uh, msj, are you Robert Lucas?

[msj]

Are you saving the character assassination for when I reply "yes?"

[August1991]

Are you saving the character assassination for when I reply "yes?"

Well, msj, if you're not Robetrt Lucas, what do you think of this Ben Bernanke quote:

In pursuing our strategy, which I have called "credit easing," we have also taken care to design our programs so that they can be unwound as markets and the economy revive. In particular, these activities must not constrain the exercise of monetary policy as needed to meet our congressional mandate to foster maximum sustainable employment and stable prices.

We are also committed to working with the Administration and the Congress to develop a new resolution regime that would allow the U.S. government to effectively address, at an early stage, the potential failure of systemically critical nonbank financial institutions. As this audience well knows, the lack of such a regime greatly hampered our flexibility in dealing with the failure or near-failure of such institutions as Bear Stearns, Lehman Brothers, and American International Group (AIG).

Federal Reserve

Unwound?

[Pliny]

The monetary base is the sum of currency in circulation and bank deposits at Federal Reserve Banks. Between mid-September and December 31, 2008, the U.S. monetary base increased from approximately $890 billion to $1,740 billion, doubling in a little more than 3 months. This is a concern because, under normal circumstances, we would associate such a rapid rise in the monetary base with a sharp acceleration of inflation. But today, more people seemed to be worried about deflation than a sudden rebound of inflation.

>>It doubled in a little more than 3 months.<<

The monetary supply has been inflated.

>>Under normal circumstances we would associate such a rapid rise in the monetary base with a sharp acceleration of inflation. <<

Yes but that doesn't occur until the inflated monetary supply trickles down. Remember the first people who use the new "money" do have to use it before prices will start to rise. Once it is in the economy and circulating, prices start to rise.

>>But today, more people seemed to be worried about deflation than a sudden rebound of inflation.<<

The government is worried about deflation. People like lower prices and bargains. Deflation is occurring right now. When the new money starts to trickle down after the first users of the new money have used it to make purchases at current deflated prices(those bastards), and that new money has now entered the economy, prices will start to rise.

The amount of new money used to be kept to about 2 or 3% and inflation was kept to that rate. Now it is 100%.

What will be the rate of inflation?

The American Dollar is heading for a crash and the whole reason is that a North American currency is planned. "There is talk of a One world global currency but that's impossible so a North American currency would be the best thing to happen since sliced bread. What do you think? A global currency is a stupid idea but perhaps we need a North American currency, something to rival the Euro." - I believe this is the thought processes and the drift of the Elite.

Obama will see the light and save the economy by doing this.

You know, the stimulus package is supposed to get the economy going again. It is supposed to encourage banks to lend and get spending happening again. It is astounding to me that some of the very same people proposing this are those who were admonishing banks for their lack of prudence in lending when the economy crashed?

Edited April 4, 2009 by Pliny

[benny]

Inflation triggers the only kind of race or competition where the poor (who cannot afford to plan far ahead) have an advantage over the rich (who have savings that can lose their purchasing power). In a sane economy anyway, money would try to mimic everything that really has a value by having a due date.

[Pliny]

Inflation triggers the only kind of race or competition where the poor (who cannot afford to plan far ahead) have an advantage over the rich (who have savings that can lose their purchasing power). In a sane economy anyway, money would try to mimic everything that really has a value by having a due date.

In my view, inflation really harms the poor the most. The rich buy assets with their "money" that hold or accrue value over time. The poor never get ahead because of the lengthy time it takes for them to save and their inability to take the risks of investment, or to even make investments, in assets.

Consumers in a free market dictate prices in a free market. In today's market the money supply is the tool used to keep prices constantly inflating.

I don't know where you got the idea that money should have a due date, unless by money you mean fiat paper currencies. They did indeed used to have a due date and since they are not "money" proper but contracts of promises to accept in future trade they should have a due date. A contract always contains the time when it expires.

Formerly, the expiry of the dollar bill was upon redemption. When it was redeemed it was considered expired. Actual "money" fulfills the contract at the time of the trade and needs no expiry because the terms of the contract are ended and payment in full is agreed upon. With money substitutes, i.e., IOU's, bills, promises to pay, paper currencies, cheques, etc., they do not meet the criteria for fulfillment of a contract until they are redeemed for money proper or traded for goods and/or services of a value considered equal, by the person accepting the money substitute, to what was originally traded. Fiat currencies are thus an infringement upon property, the law insists you accept what they say in trade for your property. This works well enough until, as Voltaire stated, the paper currency eventually returns to it's intrinsic value of nothing.

[benny]

In my view, inflation really harms the poor the most. The rich buy assets with their "money" that hold or accrue value over time. The poor never get ahead because of the lengthy time it takes for them to save and their inability to take the risks of investment, or to even make investments, in assets.

Consumers in a free market dictate prices in a free market. In today's market the money supply is the tool used to keep prices constantly inflating.

I don't know where you got the idea that money should have a due date, unless by money you mean fiat paper currencies. They did indeed used to have a due date and since they are not "money" proper but contracts of promises to accept in future trade they should have a due date. A contract always contains the time when it expires.

Formerly, the expiry of the dollar bill was upon redemption. When it was redeemed it was considered expired. Actual "money" fulfills the contract at the time of the trade and needs no expiry because the terms of the contract are ended and payment in full is agreed upon. With money substitutes, i.e., IOU's, bills, promises to pay, paper currencies, cheques, etc., they do not meet the criteria for fulfillment of a contract until they are redeemed for money proper or traded for goods and/or services of a value considered equal, by the person accepting the money substitute, to what was originally traded. Fiat currencies are thus an infringement upon property, the law insists you accept what they say in trade for your property. This works well enough until, as Voltaire stated, the paper currency eventually returns to it's intrinsic value of nothing.

I think we are not living through a type of crisis that should leave our economic system in place. It is time to get ride of the fetishistic element in money. It is this element that creates the illusion that one can store wealth without consideration of how weak social relationships have or may become. We blame Obama for being too soft on incompetent executives but only because we forget that he can punish them not only by firing them by also by drowning them into black ink.

[August1991]

Robert Lucas:

This $600 billion is -- this is a system that operated with $50 billion in reserves last August. So, I mean, it's just a mountain of new reserves. Now, the size of these actions -- and they're going to get bigger we're told -- and the nature of the assets the Fed has bought, has been controversial; you know, how could it -- how could it not be? You can't spend a trillion-plus (dollars) without raising a few eyebrows.

So I want to tell you why I think this is the right thing to do and what's the case for it.

...

So, it's absolutely necessary for the Fed to be able and willing to reverse course and sell off the assets its acquired over these years, to keep this inflation -- the inflation is going to get out of hand. This is almost -- we don't know when that it's going to hit. I don't see any reason to start cutting back now because you're going to hit it. But, it's something you might as well think about it, because we're going to get there.

There's nothing technically hard about unwinding these Fed positions fast. And the markets you need to operate in to do that -- the Fed needs to operate are there and working. But, it's going to take political courage, or some kind of consensus -- the kind of courage that Paul Volcker showed in the 1980s when he brought -- adopted policies that brought the 1970s inflation to an end, that same kind of courage and independence is going to be called for in a few years. I don't think it's an argument against the policy that's being followed, and I hope, when the crunch comes we'll do the right thing, but it's a concern that everyone who's watching these policies has, and we'll see.

Link

[benny]

A fiscal policy can undo what a monetary policy is doing so, by publishing grey and black lists of tax heavens, G20 countries will be able to deal with inflation.

[August1991]

Martin Feldstein:

The deep recession means that there is no immediate risk of inflation. The aggregate demand for labour and goods and services is much less than the potential supply. But when the economy begins to recover, the Fed will have to reduce the excessive stock of money and, more critically, prevent the large volume of excess reserves in the banks from causing an inflationary explosion of money and credit.

This will not be an easy task since the commercial banks may not want to exchange their reserves for the mountain of private debt that the Fed is holding and the Fed lacks enough Treasury bonds with which to conduct ordinary open market operations. It is surprising that the long-term interest rates do not yet reflect the resulting risk of future inflation.

FT

The Fed is now in unchartered waters because it has never pursued so large an expansionary monetary policy as it has recently. It will have to unwind its position at some point and no one is quite sure how to do that. If the Fed attempts to raise interest rates too soon, it risks choking the economy and slowing the climb out of recession (or even pushing us back into another one). If it waits too long, and inflationary expectations take hold, then it will have a greater problem on its hands.

[Riverwind]

If it waits too long, and inflationary expectations take hold, then it will have a greater problem on its hands.

The US is going to need to get its debt to GDP ratio down. The only way to do that is to grow or inflate. The US is likely facing a decade of slow growth which leaves inflation as the only option.