Friday, June 12, 2009

TIme for economic doom and gloom post again

Flow of Funds data out yesterday.

Private borrowing still contracting at faster rate than government borrowing is expanding, and there is not yet any signs of overall upward pressure on interest rates, the much-ballyhooed rise in long-term Treasury rates was caused by China deciding to go with short-term Treasuries rather than long-term Treasuries for their borrowing (which is another sensitive subject). Treasury borrowing at the moment appears to be recycling mattress money -- i.e., money that if not lent to the Treasury, would be disappearing under (virtual) mattresses instead (i.e., into banks that are stashing the funds into the Fed's vaults rather than lending them out) and thus basically disappear as far as the economy is concerned, causing deflationary pressure beyond those currently coming from job losses and wage cuts.

There is a recipe for dealing with high debt loads upon an economy. It's called inflation. Inflation effectively decreases the value of debt as the value of currency declines. Unfortunately the wage declines over the past year are putting significant deflationary pressures upon the economy, which does exactly the opposite -- effectively increases the value of debt as the value of currency increases. The overall conclusion: The Federal Reserve is being much too cautious with its current open market operations. There is no inflationary overhang in the current economy -- the Treasury borrowing is effectively draining mattress money that could otherwise creep out of hiding during an upturn and cause unexpected inflation and the Fed could abruptly raise the reserve ratio if it wished to keep the mattress money in its vaults from leaving there -- and there is a surplus of excess / idle resources that could be put to work if there were sufficient demand in the economy to warrant it. The so-called 'stimulus' was one attempt to deal with demand but is taking much too long due to limitations of federal contracting -- I've bid on govt. contracts before and it can be six months from initial bid request to when work actually starts. Federal grants to the states, funded by selling long-term 0% interest treasuries directly to the Fed (i.e. printing money that does not necessarily ever have to be paid back since it can just be rolled over into new 0% interest t-bills at expiration), could start putting inflationary pressure into the economy while preventing deflationary pressure of all those state workers losing their jobs, and would be an effective way to do monetary inflation (i.e. start shrinking the debt in real terms) without the wait or risk of waiting for fiscal expansion via "stimulus".

One thing that is not working and will not work is the Fed giving more money to banks. Banks aren't lending because of the core solvency problems that occur with deflation, they're shoving the money under a virtual mattress (i.e. into the Fed virtual vaults) where it does nothing to create economic activity. All the Fed is accomplishing there is creating inflationary overhang when the economy does turn up and that money comes out from those virtual mattresses and re-enters the marketplace (via the wonders of fractional reserve lending and the multiplier effect as bank reserve ratios effectively plummet, yippee). Ben Bernanke must be tearing his hair out, he did exactly what all the textbooks said he was supposed to do -- print money -- and nothing happened because he forgot that banks won't lend when they have deflationary expectations (i.e. when they expect the money to be worth more to them in the future) and thus as he admitted in recent speeches, the money never actually left the Fed, it just moved from one ledger entry to another.

Yet as Rome burns, a thousand thousand Neros fiddle in a political system that has proven far too dysfunctional to deal with this crisis, and half of that thousand-thousand Neros even wish to pour gasoline upon the fire because of a religious belief in "creative destruction" that is eerily similar to Abbot Arnaud-Amaury's recipe for the redemption of the human soul, "Caedite eos! Novit enim Dominus qui sunt eius." Unfortunately Tuxology has no afterlife, thus I prefer to save the current life err economy rather than engage in wishful thinking about a wonderful hypothetical afterlife err economy that happens after the demise of the current one.

And so it goes. Six months from now I expect to be employed. A year from now... I do not think that far ahead anymore, it is too depressing.

-- Badtux the Economics Penguin


  1. Tux, what is your take on Bernanke saying that he is not going to monetize the debt? Similarly, with the restlessness of the bond "vigilantes". It almost seems that the banks, through the fed and bond "vigilantes", are saying we got ours and the rest of you can do without.

  2. I think it's a serious mistake. Right now there's no need to monetize the debt because current Treasury short-term rates and the flow of funds data shows that current Treasury borrowing is in fact draining mattress money rather than eating into investment funding destined for other parts of the economy. But monetizing debt is one of the fundamental tools of Federal Reserve open market operations, and Bernanke is in violation of his fundamental duties as a central banker to arbitrarily take it off the table as a tool to use for re-inflating the money supply.

    In short, I believe Bernanke is allowing political considerations to override his duties as a central banker the most important of which is to prevent deflation and print sufficient money as necessary in order to have the small amount of inflation needed for capitalism to properly function (since only a small amount of inflation can get money out from mattresses and put it to use creating economic activity), and this is not good. Not good at all. Add Bernanke to the list of Neros fiddling. Sigh.

    - Badtux the Monetary Penguin

  3. is that the banks just wont lend because of deflation or fear that they wont get paid back (or paid back in less valued dollars)

    or is there just no demand for anything - people are not spending at all - i know i am not


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