The Fallacy of Money Mania
It's been a grueling Fall 2007, with the continued shocks from the housing mess, the market sell-off, oil still sky high, the dollar hitting new lows, and the rising gold price giving that ever-ominous sign of trouble ahead. Business conditions have deteriorated dramatically.
And the gold price reflects a general trend: the consumer and producer price indexes are continuing an uptrend that compares to the steep levels of the mid and late 1970s. And if you really want to wince, take a look at federal spending and debt. It's unreal: $8.2 trillion in debt, with nearly $5 trillion of it held by the public as an investment .
Ah, but wait! One day in November, the stock market soars and traders are wild with glee. The storm clouds are gone and the sun is out. What happened? No fundamentals changed. No new reports came in. No numbers were revised. What happened was but a few words from the vice chairman of the Federal Reserve, spoken at a roundtable at the Council on Foreign Relations.
He said the Fed would follow "flexible and pragmatic policy making" and "act as needed."
Woo hoo! You see, to markets that are worried about the future, this was interpreted as pledge to lower interest rates and flood the economy with more credit. FULL ARTICLE
Comments (23)
There has clearly been strong inflation of the money supply these last years. As for the recent months it is less clear. How should one interpret Frank Shostak's numbers?
Shostak Weekly Overview
Published: November 30, 2007 9:18 AM
Stephanie: "How should one interpret Frank Shostak's numbers?"
I hope Frank will respond to your question. Meanwhile, here's my two bits: The Fed is pushing on a string. Japan experienced this in the 1980's. When the malinvestment caused by the previous inflation becomes clear, business people quit borrowing and banks quit lending, and the money supply shrinks, regardless of how low the Fed takes the interest rate and tries to inflate.
The Fed isn't all-powerful. It's efforts at inflation work only when the economy has recovered from previous malinvestments. But monetary inflation causes malinvestments that don't appear for a while. When they appear, they have to be liquidated and the Fed is powerless to stop it. That liquidation of malinvestments causes the money supply to shrink.
Published: November 30, 2007 10:41 AM
It always amuses me when people talk about how bad welfare is and how we should stop giving it to people. Most of the people saying that will also say that they support the Fed cutting interest rates. I guess only welfare to poor people is bad. People only see their money going to the poor, they don't see their *wealth* going to the rich. Either way the middle class gets screwed.
What really annoys me is when I try to inform party-line Republicans about this "corporate welfare" they automatically thinking I'm a leftist because of the left's bastardization of that term. But party-liners are usually incapable of original thought, so there is no hope anyway.
Published: November 30, 2007 12:09 PM
Actually, the PPI rose only by .1 percent in October, which is a drop compared to the 1.1 it was in September. This is all according to the latest data from the BLS.
Published: November 30, 2007 12:36 PM
Jack, That's an indication that the money supply has been falling in spite of the Fed's efforts to pump it up. Remember that Hayek wrote that manipulations of the money supply automatically reverse themselves. If monetary pumping swells the money supply and spurs the economy to excessive growth, the malinvestment that takes place will cause businesses to fail and the money supply to contract, regardless of what the Fed does.
Published: November 30, 2007 1:35 PM
"...business people quit borrowing and banks quit lending..."
Could it be that the consumer also needs to accept some of the responsibility???
There was a time when credit was used as a last resort or invoices were paid within the first billing cycle to avoid interest.
Now, purchases are no longer based solely upon quality and/or price, but on some outlandish credit scheme that encourages you to avoid making payments for three years.
Credit may increase purchasing power, but it's as though we're incapable of having a nice meal at the table where we know enough to put down our fork when we're full. Instead, it's more like we're feeding at a trough, and we no longer find ourselves capable of appreciating what we're consuming, nor are we able to figure out when we're full.
Or am I too naive about the ability of the consumer to control his/her appetite?
Published: November 30, 2007 2:33 PM
Stepane, Gary North has been on about this same thing.The
indicator he likes to use is here.
http://research.stlouisfed.org/fred2/fredgraph?s[1][id]=BASE
Published: November 30, 2007 2:35 PM
IMHO: "Or am I too naive about the ability of the consumer to control his/her appetite?"
You're right, especially where the house debacle is concerned.
Published: November 30, 2007 3:42 PM
I agree that the consumer shares an equal portion of the blame. Personal responsibility dictates that one must do due diligence before entering into a contract, understanding the terms of the agreement before signing on the dotted line. Too often, however, the consequences of bad decisions on the part of consumers are mitigated by government...spread out amongst the mass of taxpayers, rather than borne by the individual him/herself. The lack of consequences fosters irresponsible behavior.
Still, businesses and banks aren't required to bear the consequences of over-borrowing or -lending, either, so they're essentially behaving in the same manner as individual consumers. Why exercise restraint if you're fairly certain you won't have to pay the piper?
Published: November 30, 2007 4:03 PM
@Robert M:
What you pointed out is irrational from a budget-cutter's perspective. Eliuminating handouts to welfare recipients wouldn't shrink the government's budget that much - and it certainly wouldn't shrink the tax burden that much.
So, we're dealing with another value. I suggest that it's a "Statecraft as Soulcraft" bit: what are de facto welfare handouts are quite fine as long as the recipient is engaged in working away at something. In other words, make-work is okay as long as it's work.
Economically, it's ersatz work. In terms of effort, though, it's "work like any other." Implication: what passes for the "merit system" nowadays focuses on input, not output. The latter, after all, is too fraught with uncertainty....
Published: November 30, 2007 4:36 PM
Hi Lew,
Just last fall, I was taking a graduate finance course (taught by a keynesian guy with a Ph.D. in Economics who literally loves input-output models) and all he and the other finance professors were just gushing about "how great things were and how there were never-before-seen amounts of liquidity available for companies to anything and everything". It is hopeless to talk economic sense with people like that, but I do laugh at the current, bitter opposite tale they now tell. Knowing them well, though, they are now indoctrinating (mostly) MBA students by blaming the whole mess on "ethical lapses of unscrupulous businessmen". In a way they can't bring themselves to understand, of course, I suppose they are partially correct.
Published: November 30, 2007 11:50 PM
*liquidity to spend on anything and everything*
Published: November 30, 2007 11:51 PM
IMHO: We cannot blame the consumer for taking credit and overspending. Financially it is in the consumer's best interest to behave this way when the fed is pumping easy money and destroying the currency. You see, saving when real interest rates are close to or are negative makes no economic sense. So consumers have to spend, forced by the Fed. Plus, when money is dropping in value it is better to use the bank's money (OPM). So using credit when money is losing it's value makes perfect sense. Not only because real interest rates might be negative (or close to) but also because the dollar is falling faster than the interest rate the bank charges, thus, a $10,000 debt in 2007 will be worth far less than $9,500 in 2008 devalued dollars. If the real interest rate is very low, you gain by using credit, because you would be paying less for goods and services and the bank would take the loss in value of money.
So the consumer destroying savings and engaging in credit and overconsumption is a direct consequence from the wreckless fed actions. Do not blame the consumer for acting rationally in lure of the Fed's irresponsible actions.
Published: December 1, 2007 12:53 PM
I'm probably too optimistic, but I think you are misreading the market's response. The market has no choice but go up as interest rates go down - the market is one of the first places new money goes. Thus traders have no choice but to push the market up. The market is just making a rational adjustment for the probability of new money. The fact that the money is illegitimately created has no bearing on the market which has to deal with what is, not what should be.
Published: December 1, 2007 6:21 PM
There might be a reason for the FED to behave this weird: When you study the FED's flow of funds sheet (http://www.federalreserve.gov/releases/z1/current/accessible/d3.htm) and you add up all the debt then you find a staggering number:
46 trillion US$.
That is the combined debt of the US economy, yet when you apply a normal level of interest, say 5%, you calculate that every year 2.4 trillion US$ is needed to cover the interest...
So, since 2.4 trillion is 15 to 16% of the gross domestic product, we see that the interest payments a larger then the whole after taxes profit of the US economy.
Hence, the USA is broke & all the FED can do is preventing this knowlegde to spread by making strange statements.
With thanks to Allen Greenspan: 15 to 16% of the GDP is needed to cover just the interest...
Oh oh, what to do with the fool Allan?
Published: December 2, 2007 8:06 AM
ron "Still, businesses and banks aren't required to bear the consequences of over-borrowing or -lending, either, so they're essentially behaving in the same manner as individual consumers. Why exercise restraint if you're fairly certain you won't have to pay the piper?"
and david "We cannot blame the consumer for taking credit and overspending. Financially it is in the consumer's best interest to behave this way when the fed is pumping easy money and destroying the currency. You see, saving when real interest rates are close to or are negative makes no economic sense. "
nothing to add just good comments
Published: December 2, 2007 9:58 AM
"You see, saving when real interest rates are close to or are negative makes no economic sense.
And putting oneself deeply in debt does make economic sense? What if you lose your job? What if you become disabled?
Published: December 3, 2007 9:43 AM
"...when real interest rates are close to or are negative makes no economic sense."
Is it possible for real interest rates to be zero? Time preference determines interest rates. So is it possible that people will have no interest in providing for the future at all?
Published: December 3, 2007 9:58 AM
Is it possible for real interest rates to be zero? Time preference determines interest rates.
Not really - what people see however is the distorted picture created by the perverse effect of the Fed's manipulations. The real interest rate cannot be known unless these distorsions dissapear.
So is it possible that people will have no interest in providing for the future at all?
It is entirely possible if people are manipulated into thinking that the State will provide.
Published: December 3, 2007 7:12 PM
"If credit expansion, protectionism, and government spending were a path to prosperity, mankind would have long ago created heaven on earth. But the politicians engaged in these activities have to contend with reality, and the reality is that economic forces in society must be mutually sustaining. To have production and borrowing, there must be savings, which only occur when people forgo consumption today to prepare for tomorrow, and when investment pans out in the form of consumption. Absent such conditions, economic growth lacks a foundation in reality and turns to dust when economic conditions change."
Speaking of Liberty, pp.23
Published: December 4, 2007 10:18 AM
I've heard - and believed - a lot of nasty actual reasons for the creation of the Fed, but the assertion that this was done to fund the conduct of World War I (presumably by the Entente in general, and not just the US) is a new one on me.
If anyone (Lew?) could point me to sources supporting this view, I'd love to review them, and perhaps add a reason to the list that's even nastier (by far) than the ones already there.
Published: December 4, 2007 5:46 PM
Does anyone remember the show "Good Times" one of the lines in the themes song
"EEEASY credit rip off!!"
Published: December 5, 2007 9:43 AM
"Not really - what people see however is the distorted picture created by the perverse effect of the Fed's manipulations. The real interest rate cannot be known unless these distorsions dissapear."
I think he was referring to nominal interest rates minus inflation, roughly speaking at least. I think what you are referring to is the free market interest rate, though I'm not sure what the actual term for it is.
"Is it possible for real interest rates to be zero? Time preference determines interest rates. So is it possible that people will have no interest in providing for the future at all?"
Doesn't an interest rate of zero imply that we are producing a surplus of present goods in order to run a deficit in future goods? If this is the case, then today we are giving up consumption for the benefit of future consumption.
Published: December 7, 2007 3:30 PM