Monthly Archives: September 2010

Fed planning trillion dollar Quantitative Easing. Fed official admits it won’t work.

The Fed is currently planning a one trillion dollar quantitative easing program. As Jonathon Trugman of the NY Post reports:

The Fed will likely undertake a very large quantitative easing program sooner rather than later, if the economic data doesn’t get markedly better in the very near future.

This QE2 will need to be far more aggressive than most expect, for there is not going to be a QE3. It is essentially the last chance the Fed has. It will want to eradicate any doubt about its ability to work; it is, in essence, the nuclear option.

The measure could be as much as $750 billion to $1.5 trillion. And expect far more aggressive purchases than in QE1.

Mortgage-backed securities, the root cause of the economic collapse, will be the cornerstone of the purchases, thereby allowing a possible 10 percent to 15 percent increase in home prices, which would do wonders for the flat-lined economy.

Credit card-backed paper will be on the tab as well as some auto loans to keep the administration happy.

Sadly, with credit still unavailable to the “middle class” due primarily to poor fiscal policy and economic leadership, the Fed will have to dramatically increase the money supply in order to spur spending. It will work, but it’s going to be complicated.

So Mr. Trugman believes this quantitative easing will work, but that it has to be huge to spur spending. He fails to ask the simple question: will such an aggressive program be worth the benefit?

But others are arguing that the quantitative easing will have no effect at all. Marketwatch reports:

A new round of Federal Reserve purchases of bonds would have little impact on markets or the economy, Minneapolis Fed President Narayana Kocherlakota said in a speech on Wednesday.

Speaking in London, Kocherlakota on Wednesday outlined several reasons why buying government bonds wouldn’t make a major impact. For one, banks already have nearly $1 trillion in excess reserves. “QE gives them new licenses to create money, but I do not see why they would suddenly start to use the new ones if they weren’t using the old ones,” he said, according to a copy of the text he was due to deliver.

As to the first round of quantitative easing by the Fed, Kocherlakota cited an academic study showing that the $1.5 trillion purchase of agency debt, agency mortgage-backed securities and Treasuries by the Fed between Jan. 2009 and March 2010 reduced the term premium on 10-year Treasurys relative to 2-year Treasurys by about 40 to 80 basis points, which in turn led to a slightly smaller fall in the term premia of corporate bonds.

Kocherlakota estimates a new round of QE would have a more muted effect, because financial markets are functioning much better than they were in early 2009. “As a result, the relevant spreads are lower, and I suspect that it will be somewhat more challenging for the Fed to impact them,” he said.

So Trugman says this aggressive quantitative easing will work, but Kocherlakota says it won’t. In reality, who knows? The real problem is that there is so little discussion of the risks and costs involed. Marketwatch explains the risk in one sentence:

Kocherlakota also said that the impact of quantitative easing is to shift the interest rate risk on bonds from investors to taxpayers.

So the real impact of this quantitative easing will be to socialize risk. The Fed risks creating further moral hazard. The Fed risks producing interest rates that are too low, which will create more bubbles. The Fed is going to create distortions in the market system. But despite these risks, there is no guarantee of success.

I applaud Minneapolis Fed President Narayana Kocherlakota’s efforts to restore reason and common sense to our ineffective and inefficient monetary policy.

Stimulus spending: the new perpetual motion machine.

Stimulus spending is like a perpetual motion machine. Sounds great in theory, but it doesn’t work. Just as machines must use up more power than they output, so too stimulus costs more than it produces.

If stimulus spending really creates jobs and improves the economy, the government could just stimulate the economy all the time and we’ll never have recessions or unemployment. We can achieve perpetual motion through big government! Or so they tell us.

Eighty years ago, Ludwig von Mises wrote:

It is obviously futile to attempt to eliminate unemployment by embarking upon a program of public works that would otherwise not have been undertaken. The necessary resources for such projects must be withdrawn by taxes or loans from the application they would otherwise have found. Unemployment in one industry can, in this way, be mitigated only to the extent that it is increased in another. From whichever side we consider interventionism, it becomes evident that this system leads to a result that its originators and advocates did not intend and that, even from their standpoint, it must appear as a senseless, self-defeating, absurd policy.

It is not just economists like Mises that predict the failure of stimulus projects. History predicts it as well.

Stimulus spending didn’t prevent the Great Depression. It didn’t prevent any recession since then. And I have yet to see proof that stimulus spending produced a net economic benefit when the costs of the government programs were weighed against the economic gains, if there were any at all. Which leads us to one of two conclusions: either (1) stimulus spending cannot work or (2) it can work in theory but government is simply incapable of applying the correct amount of stimulus at the correct time.

In reality, stimulus does have some short-term effect. The “cash for clunkers” program boosted auto sales briefly. The tax credit for home purchases boosted home sales briefly. Construction spending from the Recovery Act did help the economy slightly. The census lifted employment for a few months. But all these programs do is borrow from the future. In the case of “cash for clunkers” and home tax credit, it brought future sales into the present. In the cases of jobs programs and construction projects, the government takes money from the future (debt) and spends it today. That leaves the government with less money in the future and it will either need to reduce future spending or raise taxes, either way harming our economic future.

The Keynesian argument is that this stimulus spending during a recession and cutting back in the future will smooth out the volatility of the economy. First, the government is great at the spending during the recession part, but terrible at cutting back during the recovery. Keynes’ idea was to run a budget deficit during recessions and a surplus during booms. Instead, government runs a deficit during booms and an even larger deficit during recessions. Second, the government has no idea how much to spend on stimulus during a recession and when to cut back on that spending. The government can only guess at how deep the recession will be, when it will start, when it will end, and how strong the recovery will be.

But the government will not let economics or history stand in the way of its grandiose ideas. As Stalin used to say, “We are bound by no laws. There are no fortresses which Bolsheviks cannot storm.”

History has proven that stimulus spending does not work, just as the great economists explained. Yet, time and again voters fall for the same trick and beg our “benevolent leaders” in Washington to take our hard-earned money from us to spend for us.

God willing, voters this November will learn to say NO to Washington and the politicians. “Fool me once, shame on you. Fool me twice, shame on me!” As those great political thinkers from The Who sang, “Won’t Get Fooled Again.”

The sovereign debt crisis is far from over. In fact, it is just beginning.

Anybody who thought the sovereign debt crisis was over, it is now time to wake up. Irish credit default swaps hit a new record today!

Irish government bond yields rose and the cost of insuring sovereign debt against default jumped Friday due to ongoing jitters over the cost of bailing out Ireland’s troubled banking sector.

Analysts tied the weakness in part to a research note published Thursday by Barclays Capital warning that the Irish government could eventually be forced to seek outside help from the International Monetary Fund and European Union if the fiscal situation proves worse than expected.

The spread on five-year Irish sovereign credit default swaps hit 433 basis points, up from 387 basis points on Thursday — soaring to the widest level on record, according to data provider Markit. That means it would now cost $433,000 a year to insure $10 million of government debt against default, up $36,000 from Thursday.

For months, the various world governments and mainstream media told us that the debt crisis was over. Why? Because countries such as Greece, Spain, Portugal, and Ireland would reduce their budget deficits. Not eliminate them, just reduce them.

For example, Portugal:

Portugal posted a deficit of 9.3 percent of gross domestic product in 2009, the fourth-highest in the 16-country euro region. The government aims to narrow the deficit to 7.3 percent this year and intends to meet the EU’s 3 percent limit in 2012.

Yes, a 3 percent deficit is preferable to a 9.3 percent deficit, but with debt of 75 percent of GDP as of 2009 (much higher now), they are only switching from a quick death to a slow one. Besides, their deficit target is based on assumptions of a growing economy. What if the economy does not grow? The deficit will be wider than expected and their debt problem will get even worse.

Or Spain:

Zapatero has imposed tough austerity programmes, aiming to slash the budget deficit to 3 percent of gross domestic product by 2013 from 11.2 percent last year.

Again, 3 percent is better than 11.2 percent, but the slow bleed continues. They are simply putting a band-aid on a broken arm.

And in Greece:

The government plans to cut the budget deficit to 8.1 percent of gross domestic product this year from 13.6 percent last year.

Again, I’m unimpressed. Greece’s debt is already 113 percent of GDP. Is there any way to recover from that besides running budget surpluses, which would require sharp cutback in government services?

And what is the situation like in Ireland, Europe’s new bogeyman?

Analysts say this year’s budget deficit could reach around 25 percent of gross domestic product (GDP) including the one-off costs associated with bank bailouts.

Even without the one-off bank bill, the shortfall is still expected to be around 10 percent next year on an underlying basis, over three times an EU limit of 3 percent, according to the latest Reuters poll.

Are you serious? A 25 percent deficit is possible this year? And an “improvement” to 10 percent next year?

By the way, the situation in the United States is not much better. This year’s deficit is expected to be 10.6 percent of GDP. Next year’s: 8.3 percent. Eventually, if all things go according to plan, which they never do, the deficit will fall to 3.9 percent of GDP. Not much better than those failing European countries.

And the government/mainstream media is trying to convince us that there is nothing to worry about. Gold is looking more and more attractive every day.

Possible new gold disclosure rules. Hurting you in the name of consumer protection.

With gold hitting record highs, it is obviously time for Congress to do something stupid. Seeking Alpha reports:

A press release from Rep. Anthony Weiner, Democrat of New York, not yet (as of this instant) posted on Mr. Weiner’s Web site, announces that a September 23 hearing of the Subcommittee on Commerce, Trade, and Consumer Protection (a subcommittee of Rep. Henry Waxman’s Commerce Committee) will focus on “legislation that would regulate gold-selling companies, an industry who’s [sic] relentless advertising is now staple of cable television.”

From the press release: “Under Rep. Weiner’s bill, companies like Goldline would be required to disclose the reasonable resale value of items being sold.” That’s great. Are Mr. Weiner and Chairman Bernanke also going to agree to print on every dollar the reasonable expectation that its value will be eroded by inflation?

Why don’t they require all companies selling goods to disclose the resale value? The second you drive off the lot with a new car, the value drops by about 20 percent. Why isn’t that disclosed? Of course, the goal here is not disclosure. It’s to put these companies out of business. It would be impossible for a company like Goldline to disclose the resale value in its commercial because the value is constantly changing. Is Congress too stupid to know that or so manipulative as to pretend they are looking out for consumers?

Time to support the independents. Time to support the Constitution!

For years we’ve heard anger directed at the two-party system. “The parties don’t represent us.” “They are all just a bunch of crooks.” Even I have said on many occasions, “There is only one thing I hate more than a Republican; and that’s a Democrat!”

Now American’s will have to put up or shut up. After the remarkable success of tea party candidates in the primaries, let’s see how these naysayers vote. We now have candidates who are well-educated in American values, whose stated goal is to uphold the Constitution, and are not beholden to either party. Yes, these candidates are all nominally Republicans, but so many of them were opposed by the party and, therefore, they have no allegiance to the party leadership.

The main argument against these candidates is that they are “too far to the right.” Right and left is not the issue here. The issue today is constitutional republicanism or collectivist tyranny. I know how the tea party candidates and supporters stand on these issues. And I know what those on the extreme left believe.

How about you Mr. Moderate and Mrs. Independent? Do you stand for law, order, justice, and liberty? Or do you stand for rule by men, corruption, party loyalty, and government handouts?

For the first time in many years, you will show us in November what you really believe. I urge you to vote for the tea party candidates whose loyalties belong to the Constitution and not to the Republican or Democratic Party.

Did World War II lift us out of the Great Depression?

We are constantly told that the economy was lifted out of its Great Depression because of World War II. While it is certainly true that the economic production recovered thanks to war production, I do not believe that the economy actually “recovered” during the war. Of course, it all depends on how you define an economic recovery. The statistical method of doing so is to look at Gross Domestic Product (GDP) or industrial production. However, looking at those figures, even adjusting for inflation, ignores things such as changes in population and demographics.

When World War II began, millions joined or were drafted into the armed forces. Their production was lost as they fought overseas. To make up for that loss, women entered the workforce and men worked longer hours. Yes, economic production rose, but the number of hours worked rose even more so. Americans were forced to work instead of spending their time in leisure or raising their families. This was of course good for the many who had previously been unemployed, but bad for those who had already had jobs, housewives who were caring for their children, the elderly who held off on retirement, and the young who skipped college to enter the army.

While hours worked were up, most of the increase in production went to war manufacturing. The United States churned out planes, ships, tanks, guns, and bullets. Japan and Germany had a ten-year head start in military production, but the United States quickly caught up once its economic wheels moved forward. Furthermore, much of the food, clothing, and other staples required for day-to-day living were shipped to troops overseas instead of staying within the country’s borders. The domestic economy of the United States was dominated by rations and shortages. This was not your typical economic recovery with new products available to consumers and increasing wealth. Instead, it was economic production designed to destroy (though for a good cause) instead of create. The billions of dollars spent on bombs, downed planes, sunk ships, shattered tanks, and bullets was capital forever lost to mankind.

With longer work hours, families separated for years, hundreds of thousands of killed soldiers, and production devoted to the military instead of consumers, the standard of living of the average American was no better during World War II than it was during the Great Depression and worse than it was in the 1920s.

But what about unemployment which went from 25% down to 1%? Gene Smiley writes, “The number of unemployed workers declined by 7,050,000 between 1940 and 1943, but the number in military service rose by 8,590,000. The reduction in unemployment can be explained by the draft, not by the economic recovery.” He continues, “Most estimates show declines in real consumption spending, which means that consumers were worse off during the war. Business investment fell during the war. Government spending on the war effort exceeded the expansion in real GNP.” Smiley does admit that economic measurement during this time was exceedingly difficult, asking “How can we establish a consistent price index when government mandates eliminated the production of most consumer durable goods?” Smiley concludes, “For consumers, the recovery came with the war’s end, when they could again buy products that were unavailable during the war and unaffordable during the 1930s.”

* All this says nothing about the need to enter the war against the Japanese and Germans. However, the idea that a war could lift an economy out of depression is tenuous. The economic recovery following World War II was the result of the newfound economic freedom in the United States but even more so overseas where countries such as Germany, Italy, and Japan experienced true freedom for the first time in many years.

UPDATED: Germany and Italy also “boosted” their economies with military production and conscription. Few would argue that their “economic recoveries” were sustainable or good.