From: JJ LANDO
At: May 14 2013 07:41:14

Consider the following thought experiment. These are the scenarios:
A. The Treasury decides that it will fund itself 30% more in Overnight Bills and reduce issuance across the curve.
B. The Fed announces it will increase QE by 30% (it will remit the net income of this activity back to the Treasury like taxes)
C. Congress announces a new tax on all passive income from USTs, to holders both at home and abroad (ie Central Banks), for all new-issue USTs
D. Lew pre-announces that we will ‘selectively default’ and apply a haircut of on all future Treasury coupon payments of new issues.

Here’s what’s funny. Most intelligent market participants will say things like:
A. Stocks down a few percent on fear of downgrade. Economy slightly weaker or unchanged.
B. Stocks up 5-10% and economy grows another 1% for 1-2yrs; monetary stimulus.
C. Stocks down 5-10% on tax hike (like last year) that maybe corrects. Economy slows 1-2% for a year or so because it’s a tax hike (ie fiscal consolidation).
D. Stocks down 80% and we go into a great depression on steroids. All investment dollars flee the US. I can’t tell you what happens next because my Bloomberg account gets shut down. They might even declare an Internet Holiday.

Here’s what’s craziest: THESE ARE ALL THE SAME THING. The name and the process is different, the OPTICS is different, but the net is the same. There’s the government and there’s everyone else. The government either pays more out – in interest payments or transfer payments or vendor payments, or it takes back more in taxes or default or interest ‘savings.’ Everything the government net gets in ‘revenue’ the rest of the world loses in income. Everything the government dissaves (deficits) the rest of the world saves. Equal and opposite.

[You need to further get around the idea that reserves are overnight bills and there's no such thing as 'monetary base' - just interest rates; that lower discount rates are lower no matter how you get there; that rate cuts are taxes are austerity, even considering the benefit to risk assets from 'lower riskfree discount rates'... it's all basically true if you think abt it long and hard].

Here we are, almost 550 rate cuts into this thing, and inflation everywhere with QE is basically falling (see chart), and incomes are falling everywhere but in the top brackets (see page 9 here for a TRULY SOBERING CHART)… let us never forget that the goal is TO IMPROVE PEOPLE’S QUALITY OF LIFE NOT TO JUICE GDP . Thus economics as a whole also has some major shortcomings. Exporting your way to prosperity is the same as turning your entire population into servants to foreign masters. Disinflation due to lower input costs or better goods or technological gains are good things. HOWEVER if suddenly 20-somethings find social currency in free online friend status rather than cars and houses and weddings – if it makes them happy that’s great but it is also a downward shift in the demand curve that if isn’t replaced leads to someone somewhere being unemployed. These are different issues that shouldn’t all be swept under the ‘disinflation’ rug.

But I digress. Where am I going with all this?
Let’s pretend risk is now in the last 6m-18m phase where everything rallies, everyone in the pool, everyone chases any risk premium to sell, and the underlying income trends are irrelevant. Since I also will posit the Fed isn’t hiking in the next 18 months, I now believe the Fed will entirely miss this risk cycle. Which means they are on hold beyond any trading horizon. So what triggers the end of the cycle? Most would argue – the fear that they ‘tighten’ or ‘hike’ or ‘aren’t on hold anymore.’
To that I disagree…the income and earnings just isn’t there and QE is hurting…in fact the reason the consumer is now tracking +3-4% has been due to a decline in the savings rate (1-handle in q1 as tax hikes hit) that is prone to reverse…it’s MUCH more likely is what triggers the end is that the world starts to understand that QE is a lot like a tax (+ some ‘Richfare’) rather than a stimulus…and that lower rates do raise asset prices for the asset rich but lower incomes and the net to the median person is not what it appears…I see progress on this day every front…TBAC is starting to get it…the inflation markets are starting to get it… we’ll get there … low rates forever…buy blues..

My Two (Per)cents: How Are American Workers Dealing with the Payroll Tax Hike?

By Basit Zafar, Max Livingston, and Wilbert van der Klaauw

Overall, our analysis suggests that the payroll tax cut during 2011-12 led to a substantial increase in consumer spending and facilitated the consumer deleveraging process. Based on consumers responses to our recent survey, expiration of the tax cuts is likely to lead to a substantial reduction in spending as well as contribute to a slowdown or possibly a reversal in the paydown of consumer debt. These effects are also likely to be heterogeneous, with groups that are more credit and liquidity constrained more likely to be adversely affected. Such nuances may be lost in the aggregate macroeconomic statistics, but theyre important for policymakers to consider as they debate fiscal policy.

A number of people have inquired about this morning’s front page article in the WSJ by Jon Hilsenrath, “Fed Maps Exit from Stimulus.”

This seems constructed by Jon in a way that is very much reminiscent of the three-day inflation scare and talk of early exit he created last year. Note four points:

1. Jon does not have access to policy makers in the way the WSJ beat reporter once had. The days of Wessel and Ip are over. Bernanke was very reluctant to provide informal guidance to begin with, and the practice virtually ceased with the report of the Subcommittee on Communications at the beginning of last year. Essentially, they decided to speak authoritatively in FOMC statements and everyone was free to offer their own view in the public record after that, but not off camera.

2. The first two paragraphs are an extended, bloated, version of the single sentence in the statement that said “The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes.” Those paragraphs don’t say anything more than the Fed has a plan to do its job. This reminds me of the CNBC banner yesterday morning while Bernanke was giving his speech on financial stability. It said “BREAKING NEWS: THE FED IS MONITORING FINANCIAL STABILITY.” It would have been just as informative to run the banner “BREAKING NEWS: THE FED IS STILL IN BUSINESS.”

3. Note that the only two on-the-record, active voices are Charlie Plosser and Richard Fisher. Those two are probably last on the list of reliable co-conspirators for the core of the Committee that makes policy. But those quotes, plus the older Williams’ one, allows Jon to write “Fed officials” to make it sound like he has access to the second floor of the Board. It also lets him bring out the stale dealers survey.

4. Note the inconsistencies in the story. Fed officials want to put more volatility in the market by conveying that QE is a flexible, smoothly adjusting instrument. The problem is that this makes more sense if the effect of QE was on flows, not stocks, which they have studiously denied for four years. By the way, if those conspiring officials want to make clear it won’t be a slow, steady retreat of accommodation, than they better tell Janet Yellen to stop showing the optimal policy path. Good luck to that.

I believe the central message, which is what I have described in earlier notes: Fed officials want to put as much volatility as possible back into the market before starting to raise rates, provided financial conditions otherwise remain supportive to sustained expansion. They’ll take opportunities to do so on the back of an equity market rally. But Jon Hilsenrath is not the means they will do so.

Vincent

Karim writes:
RETAIL SALES

Mosler lays down tablets on the economy, stupid

By Peter McAllister

May 11 (Sydney Morning Herald) — Ask US economist Warren Mosler whether the national disability insurance scheme should be paid for by a new levy or by spending cuts, and you’ll get a jarring answer – neither.

He’ll also tell you the question shows both the government and the opposition don’t really understand how public services are funded in a modern economy.

”Julia Gillard’s DisabilityCare does not require a tax at all,” Mosler says. ”Despite what most of us think, no modern capitalist government ever taxes to raise money to spend. Their real motive, even if they don’t know it, is to reduce aggregate demand and slow the economy.”

That means Tony Abbott’s insistence on spending cuts to return the budget to surplus is wrong too. ”When the economy is at less than full employment, spending cuts can only make matters worse.”

What’s really needed, Mosler adds, is both a simultaneous cut in taxes and an increase in spending to cover NDIS costs. That will restore what ought to be an essential fixture of Australian, and world, economies: good, healthy, productivity-enhancing deficits.

Welcome to the strange world of Warren Mosler, creator of Modern Monetary Theory.

The fact that Mosler – a tall, spare and super-rich Connecticut Yankee – dresses in nondescript slacks and T-shirts, and speaks in soft, matter-of-fact tones, only adds to the mind trip. He was recently in Australia to lay that trip on Northern Territory Treasury officials at a seminar organised by Charles Darwin University’s Centre for Full Employment and Equity, COFFEE for short. What they made of his message that deficits, like their $867 million budget hole, should be bigger, not smaller, is anybody’s guess.

”Budget deficit” is still the phrase that dare not speak its name in Australian politics. Mosler, however, says this will change. The world economic crisis, which is highlighting the bankruptcy of austerity economics and our obsession with surpluses, will force a rethink on deficit financing in Australia too. ”Current economic thought has it exactly backwards,” he explains. ”Government surpluses are not an economic plus – they’re a drag on performance because they always represent monetary savings withdrawn from the economy.” Mosler claims that, in fact, most financial crises in the modern era were caused by a preceding run of surpluses.

If that seems hard to absorb, you’re not alone. The longer Mosler talks, the longer the list of big-name economists and public officials who he says are wallowing in similar economic confusion. The chairman of the US Federal Reserve, Ben Bernanke, for example ”didn’t understand how the Fed worked in the US economic crisis; he disrupted recovery for six months by failing to realise he could lend freely to US banks on an unsecured basis”. Similarly, Paul Krugman, Nobel prizewinning economist, ”still hasn’t realised that regulating the economy through interest rates doesn’t work because cheaper credit is inevitably cancelled out by lower interest income”.

Their real error, however – and one shared by RBA governor Glenn Stevens – is the exaggerated importance they place on government debt.

”They don’t fully understand that where a government issues its own currency it doesn’t matter how large its debt grows, it can always pay it.” By extension, Mosler says, that guarantees future generations can pay it too, meaning our fears of passing a debt burden to our children are misplaced.

”We’re all still behaving as if our currency were linked to the gold standard, as it was before 1971,” Mosler complains. ”We’ve yet to adjust to the government’s new role as the economy’s scorekeeper, with money as nothing more than the points.”

Yet the game, he points out, really has changed. ”Not only can the government no longer run out of money, it also can’t drive up interest rates through higher levels of debt because its own central bank necessarily sets those rates, not market forces,” he says.

Likewise, Mosler adds, there is nothing to fear from the legendary ”bond vigilantes”, who supposedly police rising government debt through refusal to buy it. ”Since the government doesn’t, in reality, ever borrow to obtain funds, but rather to support interest rates, private refusal to buy securities actually results in a benefit to the treasury.” No issuer of currency, Mosler insists, is ever at risk from bond vigilantes; only users of currency, such as state governments, are.

These are certainly radical views – the question is should the world accept them? What separates Mosler from the myriad crackpot bloggers filling the digital airwaves with wacked-out and ruinous economics prescriptions?

Well, the evidence, possibly.

Some empirical support for Mosler’s radical views is surfacing. The controversy over the Reinhart-Rogoff analysis of growth rates in high debt-to-GDP ratio countries, for example, has established that there is, apparently, no growth penalty for high government debt. (Where there is, says Mosler, it is not from the debt itself but from the misguided contractionary measures governments take to reduce it). Then there is Mosler’s 2006 prediction that the current euro crisis would be the certain result of the PIGS countries’ surrender of their ability to issue currency and finance through government deficit.

There is also the small matter of the multibillion-dollar Bush tax cuts and spending increases, the second tranche of which, Mosler casually reveals, were inspired by his 2003 meeting with Andy Card, White House chief of staff to then president George W. Bush.

Most persuasive, however, is the man himself. If only three people actually understand global finance, Mosler might well be the only one to also understand international bond markets. He has, after all, traded in them for more than 40 years, managing billions in funds and making millions in profit. It was during his most profitable trades – on Italian government bonds in the 1990s – Mosler says, that he had his epiphany.

”We made a lot of money by betting the Italian government wouldn’t default even though their debt-to GDP ratio had exceeded 110 per cent,” Mosler recalls. ”I knew no country that issued its own currency ever had defaulted, nor had they ever had to ‘print money’ to pay, but I didn’t know why. Eventually it hit me: buying securities from a country’s central bank or its treasury are both functionally the same.”

They’re supposed to be different, Mosler points out: central banks sell securities in order to drain reserves, while treasuries supposedly do it to raise expenditure. ”But the end result is exactly the same – a pile of money sitting in securities accounts at the country’s central bank,” he says. ”The inescapable conclusion is that treasury sales of government debt don’t actually raise funds: they too simply drain reserves. That means that it is government spending and taxing that actually impacts the economy, not managing the debt.”

To paraphrase Dick Cheney, deficits do matter, says Mosler. ”And your persistent unemployment in Australia is telling you yours are far too small and need to be much larger.”

Large enough, perchance, for the NDIS, Gonski and Abbott’s parental leave scheme combined? Now that would be the end of politics as we know it.

Dr Peter McAllister is a journalism lecturer on the Gold Coast campus of Griffith University.

As previously discussed, financial placebos like QE do cause market participants to alter behavior out of either a misunderstanding of the actual fundamentals, or in anticipation of reactions by others presumed to be misinformed. And while the effects of these activities get reversed, however sometimes the effects are more lasting.

And there are also first order and second order effects. For example, a QE announcement could unleash misinformed fears about ‘money printing’ and ‘currency debasement’ and subsequent portfolio shifting that drives down the currency in the fx markets and drives up the price of gold. And the same misguided fears could cause bond yields to go higher in anticipation of a stronger/inflationary economy, even with the Fed buying bonds in an attempt to take yields lower.

So right now the QE/’monetary policy works if large enough’ placebo is at least partially driving things in both Japan and the US, and today’s announcement of the possibility of the ECB buying asset backed securities is now also at work.

And along the same lines but with a different ‘sign’ is the ideologically driven idea that cutting govt spending in the face of a large output gap- the sequester- is a plus for output and employment. Same for the year end tax hikes.

The underlying fundamental I don’t see discussed is whether private sector credit expansion can continue to sufficiently ‘overcome’ the declining govt deficit spending and satisfy the ‘savings desires’/demand leakages.

The main sources of private sector credit expansion are housing, student loans ($9 billion increase in March), and cars. Since 2009, the private sector credit expansion has managed to stay far enough ahead of the declining govt deficit, which has fallen from about 9% of GDP to about a rate of 6% of GDP by year end (mainly via the ‘automatic fiscal stabilizers’ of higher tax receipts and moderating transfer payments) resulting in about 2% real growth.

The question now is whether the private sector credit expansion can survive the 1.25% of GDP shock of the FICA tax hike and sequesters- which reduce support from the govt deficit to only maybe 4.5% of GDP- and still continue to sufficiently feed the (ever growing) demand leakages enough to generate positive GDP growth.

The stock market is often the best leading indicator of the macro economy, but it has ‘paused’ for two double dips that didn’t happen over the last few years, and it is subject to influence from placebos. Additionally, valuations change as implied discount rates change, and so in this case P/E’s shifting upwards may be discounting interest rates staying low for longer, due to an economy too weak to trigger Fed rate hikes, but strong enough to keep sales and earnings at least flat.

Placebo Surgery Shows Surprising Results

By Kate Melville

Research by Doctor Cynthia McRae of the University of Denver’s College of Education provides strong evidence for a significant mind-body connection among patients who participated in a Parkinson’s surgical trial.

Forty persons from the United States and Canada participated to determine the effectiveness of transplantation of human embryonic dopamine neurons into the brains of persons with advanced Parkinson’s disease. Twenty patients received the transplant while 20 more were randomly assigned to a sham surgery condition. Dr. McRae reports that the “placebo effect” was strong among the 30 patients who participated in the quality of life portion of the study.

“Those who thought they received the transplant at 12 months reported better quality of life than those who thought they received the sham surgery, regardless of which surgery they actually received,” says Dr. McRae. More importantly, objective ratings of neurological functioning by medical personnel showed a similar effect. In the report, appearing in the Archives of General Psychiatry, Dr. McRae writes “medical staff, who did not know which treatment each patient received, also reported more differences and changes at 12 months based on patients’ perceived treatment than on actual treatment.”

One patient reported that she had not been physically active for several years before surgery, but in the year following surgery she resumed hiking and ice skating. When the double blind was lifted, she was surprised to find that she had received the sham surgery.

Although patient perceptions influenced their test scores, when the total sample of patients was grouped by the actual operation they received, patients who had the actual transplant surgery showed improvement in movement while, on average, patients who had sham surgery did not.

Professor Dan Russell at Iowa State, the study’s co-author, says the findings have both scientific and practical implications. “This study is extremely important in regard to the placebo effect because we know of no placebo studies that have effectively maintained the double-blind for at least 12 months. The average length of placebo studies is eight weeks,” according to Russell. Dr. McRae notes that similar results related to the placebo effect have been found in other studies with patients with Parkinson’s disease. She says that there is a need for placebo controls in studies evaluating treatment for Parkinson’s as the placebo effect seems to be very strong in this disease. Dr. McRae also reports that although the sham surgery research design is somewhat controversial and has raised some ethical concerns, the results of this study show “the importance of a double-blind design to distinguish the actual and perceived values of a treatment intervention.”

Knee Surgery Proves No Better Than Placebo

By Katrina Woznicki

July 10, 2002 (UPI) — For individuals suffering from osteoarthritis in their knees, a common type of knee surgery has been found to be no more beneficial than a placebo, a new study revealed Wednesday.

Researchers at the Houston VA Medical Center and at Baylor College of Medicine came to this surprising conclusion after comparing various knee treatments to placebo surgery on 180 patients with knee pain.

The patients were randomly divided into three groups. One group underwent debridement, in which the damaged or loose cartilage is the knee is surgically removed by an arthroscope, a pencil-thin tube that allows doctors to see inside the knee. The second group received arthoscopic lavage, which flushes out the bad cartilage from the healthier tissue. A third group underwent a placebo surgery. They were sedated by medication while surgeons simulated arthroscopic surgery on their knees by making small incisions on the leg, but not removing any tissue.

During a two-year follow-up, researchers found no differences among the three groups. All patients reported improvement in their symptoms of pain and ability to use their knees. Throughout the two years, patients were unaware whether they had received the “real” or placebo surgery.

However, patients who received actual surgical treatments did not report less pain or better functioning of their knees compared to the placebo group. In fact, periodically during the follow-up, the placebo group reported a better outcome compared to the patients who underwent debridement.

Good to see Ken, who I’ve never met, and Carmen who I do know, no doubt assisted by her husband Vince, beginning to come clean with this response. While not complete, it’s the beginning of an encouraging, epic reversal and a first step in the right direction!

My comments added below:

Austerity is not the only answer to a debt problem

By Kenneth Rogoff and Carmen Reinhart

May 1 (FT) — The recent debate about the global economy has taken a distressingly simplistic turn. Some now argue that just because one cannot definitely prove very high debt is bad for growth (though the weight of the results still say it is),

They could add here ‘though likely via the reaction functions of govts and not the high debt per se.’

then high debt is not a problem. Looking beyond the recent public debate about the literature on debt we have already discussed our results on debt and growth in that context the debate needs to be reconnected to the facts.

Let us start with one: the ratios of debt to gross domestic product are at historically high levels in many countries, many rising above previous wartime peaks. This is before adding in concerns over contingent liabilities on private sector balance sheets and underfunded old-age security and pension programmes. In the case of Germany, there is also the likely need to further cushion the debt loads of eurozone partners.

Adding here ‘as they are ‘users’ of the euro the way US states are ‘users’ of the dollar, and not the actual issuer of the currency like the ECB, the Fed, the BOE, the BOJ, and the rest of the world’s central banks.’

Some say not to worry, pointing to bursts of growth after the world wars. But todays debts,

Add ‘while they pose no solvency risk for the issuer of the currency.’

will not be dealt with by boosts to supply from postwar demobilisation and to demand from the lifting of wartime controls.

To be clear, no one should be arguing to stabilise debt, much less bring it down, until growth is more solidly entrenched if there remains a choice, that is.

BRAVO!!!! And add ‘as is always the case for the issuer of the currency.’

Faced with, at best, haphazard access to international capital markets and high borrowing costs, periphery countries in Europe face more limited alternatives.

Add ‘as is the case for ‘users’ of a currency in general, including the US states, for example’.

Nevertheless, given current debt levels, enhanced stimulus should only be taken selectively and with due caution. A higher borrowing trajectory is warranted, given weak demand

BRAVO!

and low interest rates,

Add ‘which are confirmation by the CB policy makers who set the rates low that they too believe demand is weak’.

where governments can identify high-return infrastructure projects. Borrowing to finance productive infrastructure raises long-run potential growth, ultimately pulling debt ratios lower. We have argued this consistently since the outset of the crisis.

BRAVO! And add ‘additionally, weak demand can be addressed by tax reductions, recognizing that counter cyclical fiscal policy of currency users, like the euro zone members, requires funding support from the issuer of the currency, which in this case is the ECB.’

Ultra-Keynesians would go further and abandon any pretense of concern about longer-term debt reduction.

Add ‘without a credible long term inflation concern, as for the issuer of the currency inflation is the only risk from excess demand.’

This position has been in the rhetorical ascendancy in recent months, with new signs of weaker growth. It throws caution to the wind on debt

Add ‘with regards to solvency, as is necessarily the case for the issuer of the currency.’

and, to quote Star Trek, pushes governments to go where no man has gone before

Add ‘apart from war time, when the importance of maximum output and employment takes center stage.’

The basic rationale

Add ‘of the mainstream deficit doves (not the ultra Keynesian MMT school of thought)’

is that low interest rates make borrowing a free lunch.

Unfortunately,

Add ‘the mainstream believes’

ultra-Keynesians are too dismissive of the risk of a rise in real interest rates. No one fully understands why rates have fallen so far so fast,

Add ‘apart from the Central Bankers who voted to lower them this far and this fast, and in some cases provide guarantees to other borrowers.’

and therefore no one can be sure for how long their current low level will be sustained.

Add ‘as it’s a matter of second guessing those central bankers.’

John Maynard Keynes himself wrote How to Pay for the War in 1940 precisely because he was not blas about large deficits even in support of a cause as noble as a war of survival. Debt is a slow-moving variable that cannot and in general should not be brought down too quickly. But interest rates can change rapidly.

Add ‘all it takes is a vote by central bankers.’

True, research has identified factors that might combine to explain the sharp decline in rates.

Add ‘in fact, all you have to do is research the votes at the central bank meetings.’

Greater concern

Add ‘by central bankers’

over potentially devastating future events such as fresh financial meltdowns may be depressing rates. Similarly, the negative correlation between returns on stocks and long-term bonds, while admittedly quite unstable, also makes bonds a better hedge. Emerging Asias central banks have been great customers for advanced economy debt, and now perhaps the Japanese will be once more. But can these same factors be relied on to keep yields low indefinitely?

Add ‘In the end, it’s all a matter of the central bank’s reaction function.’

Economists simply have little idea how long it will be until rates begin to rise. If one accepts that maybe, just maybe, a significant rise in interest rates in the next decade

Add ‘due to inflation concerns’

might be a possibility, then plans for an unlimited open-ended surge in debt should give one pause.

Add ‘if he does not see the merits of leaving risk free rates near 0 in any case, as there is no convincing central bank research that shows rate hikes reduce inflation rates, and even credible theory and evidence to be concerned that rate hikes instead exacerbate inflation.’

What, then, can be done? We must remember that the choice is not simply between tight-fisted austerity and freewheeling spending. Governments have used a wide range of options over the ages. It is time to return to the toolkit.

First and foremost,

Add ‘only’

governments

Add ‘who fail to recognize that these are merely matters of accounting that don’t themselves alter output and employment’

must be prepared to write down debts rather than continuing to absorb them. This principle applies to the senior debt of insolvent financial institutions, to peripheral eurozone debt and to mortgage debt in the US.

Add ‘Additionally’

For Europe, in particular, any reasonable endgame will require a large transfer

Add ‘of public goods production’

from Germany to the periphery.

Add ‘which in fact would be a real economic benefit for Germany.’

The sooner this implicit transfer becomes explicit, the sooner Europe will be able to find its way towards a stable growth path.

There are other tools. So-called financial repression, a non-transparent form of tax (primarily on savers), may be coming to an institution near you. In its simplest form, governments cram debt into domestic pension funds, insurance companies and banks

By removing governmental support of higher rates from their net issuance of debt instruments, particularly treasury securities.

Europe is there already and it has been there before, several times. How to Pay for the War was, in part, about creating captive audiences for government debt. Read the real Keynes, not rote Keynes, to understand our future.

One of us attracted considerable fire for suggesting moderately elevated inflation (say, 4-6 per cent for a few years) at the outset of the crisis. However, a once-in-75-year crisis is precisely the time when central banks should expend some credibility to take the edge off public and private debts, and to accelerate the process bringing down the real price of housing and real estate.

It is therefore imperative for the central bankers to make it clear to the politicians that there is no solvency risk, and that central bankers, and not markets, are necessarily in control of the entire term structure of risk free rates, and that their research shows that rate hikes are not the appropriate way to bring down inflation, should the question arise’

Structural reform always has to be part of the mix. In the US, for example, the bipartisan blueprint of the Simpson-Bowles commission had some very promising ideas for simplifying the tax codes.

There is a scholarly debate about the risks of high debt. We remain confident in the prevailing view in this field that high debt is associated with lower growth

Add ‘but must add that the risk is that of misguided policy response, and not the level of debt per se.’

Certainly, lets not fall into the trap of concluding that todays high debts are a non-issue.

Add ‘as we must be ever mindful of the possibility of excess demand using up our productive capacity’

Keynes was not dismissive of debt. Why should we be?

The writers are professors at Harvard University. They have written further on carmenreinhart.com

This is my overall view of the economy.

The US was on the move by Q4 last year. A housing and cars (and student loans) driven expansion was happening, with slowing transfer payments and rising tax revenues bringing the deficit down as the automatic stabilizers were doing their countercyclical thing that would eventually reverse the growth. But that could take years. Look at it this way. Someone making 50,000 per year borrowed 150,000 to buy a house. The loan created the deposit that paid for the house. The seller of the house got that much new income, with a bit going to pay taxes and the rest there to be spent. Maybe a bit of furniture etc. was bought on credit as well, again adding income and (gross) financial assets to the recipients of the borrowers spending. And increasing sales added employment as well as output, albeit not enough to keep up with population growth etc.

I was very hopeful. Back in November, after the ‘Obama is a socialist’ sell off, I wrote that it was time to buy stocks and go play golf for three years, as, left alone, the credit accelerator in progress could go on for a long time.

But it wasn’t left along. Only a few weeks later the cliff drama began to intensify, with lots of fear of going over the ‘full cliff’. While that didn’t happen, we did go over about 1/3 cliff when both sides let the FICA reduction expire, thus removing some $170 billion from 2013, along with strong prospects of an $85 billion (annualized) sequester at quarter end. This moved me ‘to the sidelines’. Seemed to me taking that many dollars out of the economy was a serious enough negative for me to get out of the way.

But the Jan and then Feb numbers showed I was wrong, and that the consumer had continued to grow his spending as before via housing and cars, etc. Even the cliff constrained -.1 GDP of Q4 was soon revised up to .4. Stocks kept moving up and bonds moved higher in yield, even as the sequester kicked in, with the market view being the FICA hike fears were bogus and same for the sequester fears. Balancing the budget and getting the govt out of the way does indeed work to support the private sector. The UK, Eurozone, and Japan were exceptions. Austerity inherently does work. And markets were discounting all that, as it’s what market participants believed and the data supported.

Then, it all changed. April releases of March numbers showed not only suddenly weak March numbers, but Jan and Feb numbers revised lower as well. The slope of things post FICA hike went from positive to negative all at once. The FICA hike did seem to have an effect after all. And with the sequesters kicking in April 1, the prospects for Q2 were/are looking worse by the day.

My fear is that the FICA hikes and sequesters didn’t just take 1.5% of GDP ‘off the top’ as forecasters suggest, leaving future gains from the domestic credit expansion there to add to GDP as they had been. That is, the mainstream forecasts are saying when someone’s paycheck goes down by $100 per month from the FICA hike, or loses his job from the sequester, he slows his spending, but he still borrows to buy a car and/or a house as if nothing bad had happened, and so GDP is reduced by approximately the amount of the tax hikes and spending cuts, with a bit of adjustment for the ‘savings multipliers’. I say he may not borrow to buy the house or the car. Which both removes general spending and also slows the credit accelerator, shifting the always pro cyclical private sector from forward to reverse. And the ‘new’ negative data slopes have me concerned it’s already happening. Before the sequesters kicked in.

Looking at Japan, theory and evidence tells me the lesson is that lower interest rates require higher govt deficits for the same level of output and employment. More specifically, it looks to me like 0 rates may require 7-8% or even higher deficits for desired levels of output and employment vs maybe 3-4% deficits when the central bank sets rates at maybe 5% or so, etc. And US history could now be telling much the same.

And another lesson from Japan we should have learned long ago is that QE is a tax that does nothing good for output or employment and is, if anything, ‘deflationary’ via the same interest income channels we have here. Note that the $90 billion of profits the Fed turned over to the tsy would have been earned in the economy if the Fed hadn’t purchased any securities. So, as always in the past, watch for Japan’s QE to again ‘fail’ to add to output, employment, or inflation. However, their increased deficit spending, if and when it materialize, will support output, employment, and prices as it’s done in the past.

Oil and gasoline prices are down some, which is dollar friendly and consumer friendly, but only back to sort of ‘neutral’ levels from elevated ‘problematic’ levels And there is risk that the Saudis decide to cut price for long enough to put the kibosh on the likes of North Dakota’s and other higher priced crude, wiping out the value of that investment and ending the output and employment and currency support from those sources. No way to tell what they may be up to.

So my overall view is negative, with serious deflationary risks looming.

And the solution is still fiscal- a tax cut and/or spending increase.
However, that seems further away then ever, as the President is now moving towards an additional 1.8 trillion of deficit reduction.

:(

Maybe they are beginning to confirm my ‘suspicion’ the mainstream has the rate thing backwards? Not that I agree with all their reasons, of course!

Subject: For The Economist in Us – Low FF rate and down shift of Labor Particpation

A short and interesting piece can be found on the St Louis Fed web site (and attached). Good chart on the second page showing the Federal Funds Rate and the Employment-to-Population Ratio. Towards the end of the report there is an interesting point about the current near zero rate and how it lifted, it could have have people re-enter the work force because it would increase the return to saving(s). I guess the labor force drop-outs view they’re not “leaving much on the table” . -Peter
—————————————————————————–
It is titled “Low Interest Rates Have Yet to Spur Job Growth”.

The study says that “low interest rates , of late, do not seem to be having much of the intended effect either on spending or on job growth.”

A serious concern in labor market has been the down shift of the labor participation rate which may be hiding the true level of unemployment as people drop out of the labor force.

The paper states “”Interest rates represent the return we get for waiting to consume. Low interest rates encourage more spending today, which the Fed intends, and more leisure today, which the Fed does not intend. Labor participation rates decline for many reasons, but low interest rates work in the direction of discouraging labor market participation.”

Apparently, the Fed has been chasing its own tail and the more it has lowered rates in order to produce higher demand for labor, it has generated lower participation rates.

The paper concludes, with great understatement, “After four years of low interest rates and stagnating growth around the world, a better understanding of low interest rate policies is needed.”

Maybe Chair Bernanke agrees and this explains his announced absence from Jackson Hole.

Doesn’t give the Fed much comfort
;)

Yet to find a single FOMC member who’s got it right, particularly with regard to QE:

Kocherlakota Says Low Fed Rates Create Financial Instability

By Joshua Zumbrun

April 18 (Bloomberg) — Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said the central banks low interest-rate policies, though necessary, will probably generate signs of financial instability.

‘Probably’ used here means they haven’t yet. And if you look at Japan after 20 years of this it’s quite the opposite.

Unusually low real interest rates should be expected to be linked with inflated asset prices, high asset return volatility and heightened merger activity, Kocherlakota said today

Any evidence of this in Japan, US?

in the prepared text of a speech in New York. All of these financial market outcomes are often interpreted

Yes, and just as often wrong.

as signifying financial market instability. He told reporters later he doesnt see financial instability as imminent.

Right, so where’s he coming from?

Fed Governor Jeremy Stein and Kansas City Fed President Esther George are among those who have voiced concerns that an extended period of low interest rates is heightening the risk of asset bubbles in markets such as junk bonds and farmland.

Based on what? Has new issuance of junk bonds exploded in Japan? US? Anywhere due to low rates?

While George has dissented from this years Federal Open Market Committee decisions because of this risk, Kocherlakota is among the strongest supporters of additional monetary stimulus on the committee.

That hasn’t been working as hoped for/expected/feared.

In speeches earlier this month, Kocherlakota said he sees an ongoing modest recovery with unemployment staying at 7 percent or more through late 2014. The slow recovery calls for more accommodation, he said in a speech, repeating his call to postpone consideration of any increase in interest rates. He doesnt vote on policy this year.

Not a word about interest income channels, or any other attempt to explain why low rates haven’t ‘worked’ here or in Japan or anywhere else. The best they can do is the counter factual ‘it would have been worse otherwise based on our models’

Please let him know the liability side of banking is not the place for market discipline, thanks:

Fed’s Tarullo says focused on big bank reliance on wholesale funding

April 18 (Reuters) —
WASHINGTON – Federal Reserve Board Governor Daniel Tarullo said on Thursday that U.S. banks were in better shape now than prior to the financial crisis, but he remained worried by the vulnerability of the very big firms to reliance on fickle market liquidity.

“My concern in particular is the intersection of ‘too big to fail’ with very large institutions, with very large wholesale funding markets that are subject to runs, and eventually then to liquidity freezes,” he told Bloomberg Television in an interview.

This is a new one. A new low, that is:

The “decision in or out of the labor force is affected by a whole bunch of things, like disability insurance, unemployment insurance benefits and the like,” he said. “I think that’s quantitatively taking a significant bite out of the labor force participation.”

He still thinks bond buying is stepping on the gas pedal, when it’s actually the brake pedal.

Latest Jobs Report Gives Me Pause, Says Fed’s Dudley

April 16 (Reuters) — An influential Federal Reserve official said on Tuesday the weak March jobs report made him more cautious on how far the economy has come, and underscores the need for the U.S. central bank to keep buying bonds apace.

In a breakfast address, New York Fed President William Dudley said he expects “sluggish” economic growth of 2 to 2.5 percent this year and only a modest decline in unemployment. The labor market, he said, has not yet shown the substantial improvement the Fed seeks.

A paltry 88,000 new jobs were created last month, well below expectations, while the jobless rate fell by a tenth to 7.6 percent because droves of Americans gave up the search for work.

“While I don’t want to read too much into a single month’s data, this underscores the need to wait and see how the economy develops before declaring victory prematurely,” said Dudley, a permanent voting member of the Fed’s monetary policy committee and a close ally of Fed Chairman Ben Bernanke.

“I’d note that we saw similar slowdowns in job creation in 2011 and 2012 after pickups in the job creation rate and this, along with the large amount of fiscal restraint hitting the economy now, makes me more cautious,” he told the Staten Island Chamber of Commerce.

Warren Mosler discusses the Fed and the economy

Comments and ramblings:

“Strong multiplier effects from construction jobs to broader economy.”

Good report!!!

I used to call this the ‘get a job, buy a car, get a job buy a house’ accelerator. And yes, it has happened in past business cycles and been a strong driver. But going back to the last Bush up leg, turns out it was supported to a reasonably large degree by the ‘subprime fraud’ dynamic of ‘make 30k/year, buy a 300k house’ with fraudulent appraisals and fraudulent income statements. And the Clinton up leg was supported by the funding of impossible .com business plans and y2k fear driven investment, and the Reagan years by the S&L up leg that resulted in 1T in bad loans, back when that was a lot of money. Japan, on the other hand, has carefully avoided, lets say, a credit boom based on something they would have regretted in hindsight, as was the case in the US.

The point is it takes a lot of deficit spending to overcome the demand leakages, and with the govt down to less than 6% of GDP this year, yes, ‘legit’ housing can add quite a bit, but can it add more than it did in Japan, for example? And, to the point of this report, will it be enough to move the Fed?

Also, looks to me like, at the macro level, credit is driven by/limited by income (real or imagined), and the proactive deficit reduction measures like the FICA hikes and the sequesters have directly removed income, as had QE and the rate cuts in general. So yes, debt is down as a % of income, but the level of income is being suppressed (call it income repression policy?) through pro active fiscal and the low number of people working and getting paid for it.

Domestic energy production adds another interesting dimension. It means dollar income is being earned by firms operating domestically that would have been earned by overseas agents. The question here is whether that adds to incomes that gets spent domestically. That is, did the dollars go to foreigners who spent it all on fighter jets, or did they just let them sit in financial assets vs the domestic oil company? Does it spend more of its dollar earnings domestically than the foreign agent did, or just build cash, etc? And either way its dollar friendly, which also means more non oil imports, particularly with portfolio managers ‘subsidizing’ exports from Japan with their currency shifting. That should be a ‘good thing’ for us, as it means taxes can be that much lower for a given size govt, but of course the politicians don’t have enough sense to do that. It all comes back to the question of whether the deficit is too small.

As for banking and lending, anecdotally , my direct experience with regulators is that they are ‘bad’ and vindictive people, much like many IRS agents I’ve come across, and right now they are engaging in what the Fed calls ‘regulatory over reach’, particularly at the small bank level, but also at the large bank level. This makes a bank supported credit boom highly problematic. And without bank support, the non bank sector is limited as well.

Lastly, there’s a difference between deficits coming down via automatic stabilizers and via proactive deficit reduction. The automatic stabilizers bring the deficit down when non govt credit growth is ‘already’ strong enough to bring it down, while proactive deficit reduction, aka ‘austerity’ does it ‘ahead of’ non govt credit growth, which means austerity can/does keep non govt credit growth from materializing (via income/savings reduction).

Conclusion- the Fed is correct in being concerned about our domestic dynamics. And they are right about being concerned about the rest of the global economy. Europe is still going backwards, as is China where they are cutting back on the growth of debt by local govts and state banks, all of which ‘counts’ as part of the deficit spending that drove prior levels of growth. And softer resource prices hit the resource exporters who growth is leveraged to the higher prices. I wrote a while back about what happens when the longer term commodity cycle peaks, supply tends to catch up and prices tend to fall back to marginal costs of production, etc.

And the Fed has to suspect, at least, the QE isn’t going to do anything for output and employment in Japan, any more than it’s actually done for the US.

Here’s how I remember it all.
I didn’t look anything up, with the idea that memories matter.

The ‘golden age’ from WWII was said to have ended around 1973. Inflation and employment was remembered as relatively low, productivity high, the American middle class thriving.

Why? Keynes was sort of followed. The Kennedy tax cuts come to mind. But also of consequence and ignored was the fact that the US had excess crude production capacity, with the Texas Railroad Commission setting quotas, etc. to support prices at maybe the $2.50-$3.00 price range. And stable crude prices, though maybe a bit higher than they ‘needed’ to be, meant reasonable price stability, as much was priced on a cost plus basis, and the price of oil was a cost of most everything, directly or indirectly.

But in the early 1970′s demand for crude exceeded the US’s capacity to produce it, and Saudi Arabia became the swing producer, replacing the Texas Railroad commission as price setter. And, of course, price stability wasn’t their prime objective, as they hiked price first to about $10 by maybe 1975, which caused a near panic globally, then after a too brief pause they hiked to $20, and finally $40 by maybe 1980.

With oil part of the cost structure, the consumer price index, aka ‘inflation’, soared to double digits by the late 70′s. Headline Keynesian proposals were largely the likes of price and wage controls, which Nixon actually tried for a while. But it turned out the voters preferred inflation to their government telling them what they could earn (wage controls on organized labor and others) and what they could charge. Arthur Burns had the Fed funds rate up to maybe 6%. Miller took over and quickly fell out of favor, followed by tall Paul in maybe 1979 who put on what might be the largest display of gross ignorance of monetary operations with his borrowed reserve targeting policy. However, a year or so after the price of oil broke as did inflation giving tall Paul the spin of being the man who courageously broke inflation. Overlooked was that Jimmy Carter had allowed the deregulation of natural gas in 1978, triggering a massive increase in supply, with our electric utilities shifting from oil to nat gas, and OPEC desperately cutting production by maybe 15 million barrels/day in what turned out to be an unsuccessful effort to hold price above $30, as the supply shock was too large for them and they drowned in the flood of no longer needed oil, with prices falling to maybe the $10 range where they stayed for almost 20 years, until climbing demand again put the Saudis in the catbird seat. Meanwhile, Greenspan got credit for that goldilocks period that again was the product of stable oil prices, not the Fed (at least in my story.)

So back to the 70′s, and continuous oil price hikes by a foreign monopolist. All nations experienced pretty much the same inflation. And it all ended at about the same time as well when the price of crude fell. The ‘heroes’ were coincidental. In fact, my take is they actually made it worse than it needed to be, but it did ‘get better’ and they of course were in the right place at the right time to get credit for that.

So back to the 70′s. With the price of oil being hiked by a foreign monopolist, I see two choices. The first is to try to let there be a relative value shift (as the Fed tries to do today) and not let those price hikes spill into the rest of the price level, which means wages, for the most part. This is another name for a decline in real terms of trade. It would have meant the Saudis would get more real goods and services for the oil. The other choice is to let all other price adjust upward to keep relative value the same, and try to keep real terms of trade from deteriorating. Interestingly, I never heard this argument then and I still don’t hear it now. But that’s how it is none the less. And, ultimately, the answer fell somewhere in between. Some price adjustment and some real terms of trade deterioration. But it all got very ugly along the way.

It was decided the inflation was caused by unions trying to keep up or stay ahead of things for their members, for example. It was forgotten that the power of unions was a derivative of price power of their companies, and as companies lost pricing power to foreign competition, unions lost bargaining power just as fast. And somehow a recession and high unemployment/lost output was the medicine needed for a foreign monopolist to stop hiking prices??? And there was Ford’s ‘whip inflation now’ buttons for his inflation fighting proposal, and Carter with his hostage thing adding to the feeling of vulnerability. And the nat gas dereg of 1978, the thing that actually did break the inflation two years later, hardly got a notice, before or after, and to this day.

As today, the problem back then was no one of political consequence understood the monetary system, including the mainstream Keynesians who had been the intellectual leadership for a long time. The monetarists came into vogue for real only after the failure of the Keynesians, who never did recover, and to this day I’ve heard those still alive push for price and wage controls, fixed exchange rates, etc. etc. in the name of price stability.

So in this context the rise of Thatcher types, including Reagan, makes perfect sense. And even today, those critical of Thatcher type policies have yet to propose any kind of comprehensive proposals that make any sense to me. They now all agree we have a long term deficit problem, and so put forth proposals accordingly, etc. as they are all destroying our civilization with their abject ignorance of the monetary system. Or, for some unknown reason, they are just plain subversive.

Thatcher?
It was the blind leading the blind then and it’s the same now.
And that’s how I remember it/her.
And i care a whole lot more about what happens next than about what happened then.

:(

Karim writes:

*LOCKHART SAYS `GENERALLY THE TONE IS UPBEAT’ IN HIS REGION *LOCKHART SAYS THERE COULD BE `UNINTENDED CONSEQUENCES’ OF QE *LOCKHART SAYS `I’D LOVE TO SEE 7 PERCENT’ ON JOBLESS *LOCKHART SAYS `CURTAIL’ GOOD WAY TO TALK OF QE OPTIONS *LOCKHART SAYS 3 OR 4 OPTIONS ON QE

The Man from Snowy River

By Banjo Paterson

So Clancy rode to wheel them — he was racing on the wing
Where the best and boldest riders take their place,
And he raced his stock-horse past them, and he made the ranges ring
With the stockwhip, as he met them face to face.
Then they halted for a moment, while he swung the dreaded lash,
But they saw their well-loved mountain full in view,
And they charged beneath the stockwhip with a sharp and sudden dash,
And off into the mountain scrub they flew.

Unemployment is everywhere and always a monetary phenomenon, and necessarily a government imposed crime against humanity. The currency is a simple public monopoly.

The dollars to pay taxes, ultimately come from government spending or lending (or counterfeiting…)

Unemployment can only happen when a govt fails to spend enough to cover the tax liabilities it imposed, and any residual desire to save financial assets that are created by the tax and by other govt policy.

Said another way, for any given size government, unemployment is the evidence of over taxation.

Motivation not withstanding, David Stockman has long been aggressively promoting policy that creates and sustains unemployment.

Comments below:

State-Wrecked: The Corruption of Capitalism in America

By David Stockman

March 30 (NYT) — The Dow Jones and Standard & Poors 500 indexes reached record highs on Thursday, having completely erased the losses since the stock markets last peak, in 2007. But instead of cheering, we should be very afraid.

Over the last 13 years, the stock market has twice crashed and touched off a recession: American households lost $5 trillion in the 2000 dot-com bust and more than $7 trillion in the 2007 housing crash. Sooner or later within a few years, I predict this latest Wall Street bubble, inflated by an egregious flood of phony money from the Federal Reserve rather than real economic gains, will explode, too.

Phony money? What else are $US other than credit balances at the Fed or actual cash in circulation? Of course he fails to realize US treasury securities, also known as ‘securities accounts’ by Fed insiders, are likewise nothing more than dollar balances at the Fed, and that QE merely shifts dollar balances at the Fed from securities accounts to reserve accounts. It’s ‘money printing’ only under a narrow enough definition of ‘money’ to not include treasury securities as ‘money’. Additionally, of course, QE removes interest income from the economy, but that’s another story…

Since the S.&P. 500 first reached its current level, in March 2000, the mad money printers at the Federal Reserve have expanded their balance sheet sixfold (to $3.2 trillion from $500 billion).

And also debited/reduced/removed an equal amount of $US from Fed securities accounts. The net ‘dollar printing’ is 0.

Yet during that stretch, economic output has grown by an average of 1.7 percent a year (the slowest since the Civil War); real business investment has crawled forward at only 0.8 percent per year; and the payroll job count has crept up at a negligible 0.1 percent annually. Real median family income growth has dropped 8 percent, and the number of full-time middle class jobs, 6 percent. The real net worth of the bottom 90 percent has dropped by one-fourth. The number of food stamp and disability aid recipients has more than doubled, to 59 million, about one in five Americans.

Yes, and anyone who understood monetary operations knows exactly why QE did not add to sales/output/employment, as explained above.

So the Main Street economy is failing while Washington is piling a soaring debt burden on our descendants,

‘Paying off the debt’ is simply a matter of debiting securities accounts at the Fed and crediting reserve accounts at the Fed. There are no grandchildren or taxpayers involved, except maybe a few to program the computers and polish the floors and do the accounting, etc.

unable to rein in either the warfare state or the welfare state or raise the taxes needed to pay the nations bills.

The nations bills are paid via the Fed crediting member bank accounts on its books. Today’s excess capacity and unemployment means that for the size govt we have we are grossly over taxed, not under taxed.

By default, the Fed has resorted to a radical, uncharted spree of money printing.

As above, ‘money printing’ only under a narrow definition of ‘money’.

But the flood of liquidity, instead of spurring banks to lend and corporations to spend, has stayed trapped in the canyons of Wall Street, where it is inflating yet another unsustainable bubble.

With floating exchange rates, bank liquidity, for all practical purposes, is always unlimited. Banks are constrained by capital and asset regulation, not liquidity.

When it bursts, there will be no new round of bailouts like the ones the banks got in 2008.

There is nothing to ‘burst’ as for all practical purposes liquidity is never a constraint.

Instead, America will descend into an era of zero-sum austerity and virulent political conflict, extinguishing even todays feeble remnants of economic growth.

This dyspeptic prospect results from the fact that we are now state-wrecked. With only brief interruptions, weve had eight decades of increasingly frenetic fiscal and monetary policy activism intended to counter the cyclical bumps and grinds of the free market and its purported tendency to underproduce jobs and economic output. The toll has been heavy.

The currency itself is a simply public monopoly, and the restriction of supply by a monopolist as previously described, is, in this case the cause of unemployment and excess capacity in general.

As the federal government and its central-bank sidekick, the Fed, have groped for one goal after another smoothing out the business cycle, minimizing inflation and unemployment at the same time, rolling out a giant social insurance blanket, promoting homeownership, subsidizing medical care, propping up old industries (agriculture, automobiles) and fostering new ones (clean energy, biotechnology) and, above all, bailing out Wall Street they have now succumbed to overload, overreach and outside capture by powerful interests.

He may have something there!

The modern Keynesian state is broke,

Not applicable. Congress spends simply by having its agent, the tsy, instruct the Fed to credit a member bank’s reserve account.

paralyzed and mired in empty ritual incantations about stimulating demand, even as it fosters a mutant crony capitalism that periodically lavishes the top 1 percent with speculative windfalls.

Some truth there as well!

The culprits are bipartisan, though youd never guess that from the blather that passes for political discourse these days. The state-wreck originated in 1933, when Franklin D. Roosevelt opted for fiat money (currency not fundamentally backed by gold), economic nationalism and capitalist cartels in agriculture and industry.

Under the exigencies of World War II (which did far more to end the Depression than the New Deal did), the state got hugely bloated, but remarkably, the bloat was put into brief remission during a midcentury golden era of sound money and fiscal rectitude with Dwight D. Eisenhower in the White House and William McChesney Martin Jr. at the Fed.

Actually it was the Texas railroad commission pretty much fixing the price of oil at about $3 that did the trick, until the early 1970′s when domestic capacity fell short, and pricing power shifted to the saudis who had other ideas about ‘public purpose’ as they jacked the price up to $40 by 1980.

Then came Lyndon B. Johnsons guns and butter excesses, which were intensified over one perfidious weekend at Camp David, Md., in 1971, when Richard M. Nixon essentially defaulted on the nations debt obligations by finally ending the convertibility of gold to the dollar. That one act arguably a sin graver than Watergate meant the end of national financial discipline and the start of a four-decade spree during which we have lived high on the hog, running a cumulative $8 trillion current-account deficit. In effect, America underwent an internal leveraged buyout, raising our ratio of total debt (public and private) to economic output to about 3.6 from its historic level of about 1.6. Hence the $30 trillion in excess debt (more than half the total debt, $56 trillion) that hangs over the American economy today.

It also happens to equal the ‘savings’ of financial assets of the global economy, with the approximately $16 trillion of treasury securities- $US in ‘savings accounts’ at the Fed- constituting the net savings of $US financial assets of the global economy. And the current low levels of output and high unemployment tell us the ‘debt’ is far below our actual desire to save these financial assets. In other words, for the size government we have, we are grossly over taxed. The deficit needs to be larger, not smaller. We need to either increase spending and/or cut taxes, depending on one’s politics.

This explosion of borrowing was the stepchild of the floating-money contraption deposited in the Nixon White House by Milton Friedman, the supposed hero of free-market economics who in fact sowed the seed for a never-ending expansion of the money supply.

And the never ending expansion of $US global savings desires, including trillions of accumulations in pension funds, IRA’s, etc. Where there are tax advantages to save, as well as trillions in corporate reserves, foreign central bank reserves, etc. etc.

As everyone at the CBO knows, the US govt deficit = global $US net savings of financial assets, to the penny.

The Fed, which celebrates its centenary this year, fueled a roaring inflation in goods and commodities during the 1970s that was brought under control only by the iron resolve of Paul A. Volcker, its chairman from 1979 to 1987.

It was the Saudis hiking price, not the Fed. Note that similar ‘inflation’ hit every nation in the world, regardless of ‘monetary policy’. And it ended a few years after president Carter deregulated natural gas in 1978, which resulted in electric utilities switching out of oil to natural gas, and even OPEC’s cutting of 15 million barrels per day of production failing to stop the collapse of oil prices.

Under his successor, the lapsed hero Alan Greenspan, the Fed dropped Friedmans penurious rules for monetary expansion, keeping interest rates too low for too long and flooding Wall Street with freshly minted cash. What became known as the Greenspan put the implicit assumption that the Fed would step in if asset prices dropped, as they did after the 1987 stock-market crash was reinforced by the Feds unforgivable 1998 bailout of the hedge fund Long-Term Capital Management.

The Fed didn’t bail out LTCM. They hosted a meeting of creditors who took over the positions at prices that generated 25% types of annual returns for themselves.

That Mr. Greenspans loose monetary policies didnt set off inflation was only because domestic prices for goods and labor were crushed by the huge flow of imports from the factories of Asia.

No, because oil prices didn’t go up due to the glut from the deregulation of natural gas .

By offshoring Americas tradable-goods sector, the Fed kept the Consumer Price Index contained, but also permitted the excess liquidity to foster a roaring inflation in financial assets. Mr. Greenspans pandering incited the greatest equity boom in history, with the stock market rising fivefold between the 1987 crash and the 2000 dot-com bust.

No, it wasn’t about Greenspan, it was about the private sector and banking necessarily being pro cyclical. And the severity of the bust was a consequence of the Clinton budget surpluses ‘draining’ net financial assets from the economy, thereby removing the equity that supports the macro credit structure.

Soon Americans stopped saving and consumed everything they earned and all they could borrow. The Asians, burned by their own 1997 financial crisis, were happy to oblige us. They China and Japan above all accumulated huge dollar reserves, transforming their central banks into a string of monetary roach motels where sovereign debt goes in but never comes out. Weve been living on borrowed time and spending Asians borrowed dimes.

Yes, the trade deficit is a benefit that allows us to consume more than we produce for as long as the rest of the world continues to desire to net export to us.

This dynamic reinforced the Reaganite shibboleth that deficits dont matter and the fact that nearly $5 trillion of the nations $12 trillion in publicly held debt is actually sequestered in the vaults of central banks. The destruction of fiscal rectitude under Ronald Reagan one reason I resigned as his budget chief in 1985

I wonder if he’ll ever discover how wrong he’s been, and for a very long time.

was the greatest of his many dramatic acts. It created a template for the Republicans utter abandonment of the balanced-budget policies of Calvin Coolidge and allowed George W. Bush to dive into the deep end, bankrupting the nation

Hadn’t heard about an US bankruptcy filing? Am I missing something?

through two misbegotten and unfinanced wars, a giant expansion of Medicare and a tax-cutting spree for the wealthy that turned K Street lobbyists into the de facto office of national tax policy. In effect, the G.O.P. embraced Keynesianism for the wealthy.

He’s almost convinced me deep down he’s a populist…

The explosion of the housing market, abetted by phony credit ratings, securitization shenanigans and willful malpractice by mortgage lenders, originators and brokers, has been well documented. Less known is the balance-sheet explosion among the top 10 Wall Street banks during the eight years ending in 2008. Though their tiny sliver of equity capital hardly grew, their dependence on unstable hot money soared as the regulatory harness the Glass-Steagall Act had wisely imposed during the Depression was totally dismantled.

Can’t argue with that!

Within weeks of the Lehman Brothers bankruptcy in September 2008, Washington, with Wall Streets gun to its head, propped up the remnants of this financial mess in a panic-stricken melee of bailouts and money-printing that is the single most shameful chapter in American financial history.

The shameful part was not making a fiscal adjustment when it all started falling apart. I was calling for a full ‘payroll tax holiday’ back then, for example.

There was never a remote threat of a Great Depression 2.0 or of a financial nuclear winter, contrary to the dire warnings of Ben S. Bernanke, the Fed chairman since 2006. The Great Fear manifested by the stock market plunge when the House voted down the TARP bailout before caving and passing it was purely another Wall Street concoction. Had President Bush and his Goldman Sachs adviser (a k a Treasury Secretary) Henry M. Paulson Jr. stood firm, the crisis would have burned out on its own and meted out to speculators the losses they so richly deserved. The Main Street banking system was never in serious jeopardy, ATMs were not going dark and the money market industry was not imploding.

While the actual policies implemented were far from my first choice, they did keep it from getting a lot worse. Yes, it would have ‘burned out’ as it always has, but via the automatic fiscal stabilizers working to get the deficit high enough to catch the fall. I would argue it would have gotten a lot worse by doing nothing. And, of course, a full payroll tax holiday early on would likely have sustained sales/output/employment as the near ‘normal’ levels of the year before. In other words, Wall Street didn’t have to spill over to Main Street. Wall Street Investors could have taken their lumps without causing main street unemployment to rise.

Instead, the White House, Congress and the Fed, under Mr. Bush and then President Obama, made a series of desperate, reckless maneuvers that were not only unnecessary but ruinous. The auto bailouts, for example, simply shifted jobs around particularly to the aging, electorally vital Rust Belt rather than saving them. The green energy component of Mr. Obamas stimulus was mainly a nearly $1 billion giveaway to crony capitalists, like the venture capitalist John Doerr and the self-proclaimed outer-space visionary Elon Musk, to make new toys for the affluent.

Some good points there. But misses the point that capitalism is about business competing for consumer dollars, with consumer choice deciding who wins and who loses. ‘Creative destruction’ is not about a collapse in aggregate demand that causes sales in general to collapse, with survival going to those with enough capital to survive, as happened in 2008 when even Toyota, who had the most desired cars, losing billions when 8 million people lost their jobs all at once and sales in general collapsed.

Less than 5 percent of the $800 billion Obama stimulus went to the truly needy for food stamps, earned-income tax credits and other forms of poverty relief. The preponderant share ended up in money dumps to state and local governments, pork-barrel infrastructure projects, business tax loopholes and indiscriminate middle-class tax cuts. The Democratic Keynesians, as intellectually bankrupt as their Republican counterparts (though less hypocritical), had no solution beyond handing out borrowed money to consumers, hoping they would buy a lawn mower, a flat-screen TV or, at least, dinner at Red Lobster.

Ok, apart from the ‘borrowed money’ part. Congressional spending is via the Fed crediting a member bank reserve account. They call it borrowing when they shift those funds from reserve accounts at the Fed to security accounts at the Fed. The word ‘borrowed’ is highly misleading, at best.

But even Mr. Obamas hopelessly glib policies could not match the audacity of the Fed, which dropped interest rates to zero and then digitally printed new money at the astounding rate of $600 million per hour.

And ‘unprinted’ securities accounts/treasury securities at exactly the same pace, to the penny.

Fast-money speculators have been purchasing giant piles of Treasury debt and mortgage-backed securities, almost entirely by using short-term overnight money borrowed at essentially zero cost, thanks to the Fed. Uncle Ben has lined their pockets.

Probably true, though quite a few ‘headline’ fund managers and speculators have apparently been going short…

If and when the Fed which now promises to get unemployment below 6.5 percent as long as inflation doesnt exceed 2.5 percent even hints at shrinking its balance sheet, it will elicit a tidal wave of sell orders, because even a modest drop in bond prices would destroy the arbitrageurs profits. Notwithstanding Mr. Bernankes assurances about eventually, gradually making a smooth exit, the Fed is domiciled in a monetary prison of its own making.

It’s about setting a policy rate. The notion of prison isn’t applicable.

While the Fed fiddles, Congress burns. Self-titled fiscal hawks like Paul D. Ryan, the chairman of the House Budget Committee, are terrified of telling the truth: that the 10-year deficit is actually $15 trillion to $20 trillion, far larger than the Congressional Budget Offices estimate of $7 trillion. Its latest forecast, which imagines 16.4 million new jobs in the next decade, compared with only 2.5 million in the last 10 years, is only one of the more extreme examples of Washingtons delusions.

And with no long term inflation problem forecast by anyone, the savings desires over that time period are at least that high.

Even a supposedly bold measure linking the cost-of-living adjustment for Social Security payments to a different kind of inflation index would save just $200 billion over a decade, amounting to hardly 1 percent of the problem.

Thank goodness, as the problem is the deficit is too low, as evidenced by unemployment.

Mr. Ryans latest budget shamelessly gives Social Security and Medicare a 10-year pass, notwithstanding that a fair portion of their nearly $19 trillion cost over that decade would go to the affluent elderly. At the same time, his proposal for draconian 30 percent cuts over a decade on the $7 trillion safety net Medicaid, food stamps and the earned-income tax credit is another front in the G.O.P.s war against the 99 percent.

Never seen him play the class warfare card like this?

Without any changes, over the next decade or so, the gross federal debt, now nearly $17 trillion, will hurtle toward $30 trillion and soar to 150 percent of gross domestic product from around 105 percent today.

Not that it will, but if it does and inflation remains low it just means savings desires are that high.

Since our constitutional stasis rules out any prospect of a grand bargain, the nations fiscal collapse will play out incrementally, like a Greek/Cypriot tragedy, in carefully choreographed crises over debt ceilings, continuing resolutions and temporary budgetary patches.

No description of what ‘fiscal collapse’ might look like. Because there is no such thing.

The future is bleak. The greatest construction boom in recorded history Chinas money dump on infrastructure over the last 15 years is slowing. Brazil, India, Russia, Turkey, South Africa and all the other growing middle-income nations cannot make up for the shortfall in demand.

Agreed.

The American machinery of monetary and fiscal stimulus has reached its limits.

Do not agree. In fact, there are no numerical limits.

Japan is sinking into old-age bankruptcy and Europe into welfare-state senescence. The new rulers enthroned in Beijing last year know that after two decades of wild lending, speculation and building, even they will face a day of reckoning, too.

The state-wreck ahead is a far cry from the Great Moderation proclaimed in 2004 by Mr. Bernanke, who predicted that prosperity would be everlasting because the Fed had tamed the business cycle and, as late as March 2007, testified that the impact of the subprime meltdown seems likely to be contained. Instead of moderation, whats at hand is a Great Deformation, arising from a rogue central bank that has abetted the Wall Street casino, crucified savers on a cross of zero interest rates and fueled a global commodity bubble that erodes Main Street living standards through rising food and energy prices a form of inflation that the Fed fecklessly disregards in calculating inflation.

It’s not at all disregarded. And the Fed has only done ‘pretend money printing’ since they ‘unprint’ treasury securities as they ‘print’ reserve balances.

These policies have brought America to an end-stage metastasis. The way out would be so radical it cant happen.

How about a full payroll tax holiday? Too radical to happen???

It would necessitate a sweeping divorce of the state and the market economy. It would require a renunciation of crony capitalism and its first cousin: Keynesian economics in all its forms. The state would need to get out of the business of imperial hubris, economic uplift and social insurance and shift its focus to managing and financing an effective, affordable, means-tested safety net.

These are the conclusions of his way out of paradigm conceptualizing.

All this would require drastic deflation of the realm of politics and the abolition of incumbency itself, because the machinery of the state and the machinery of re-election have become conterminous. Prying them apart would entail sweeping constitutional surgery: amendments to give the president and members of Congress a single six-year term, with no re-election; providing 100 percent public financing for candidates; strictly limiting the duration of campaigns (say, to eight weeks); and prohibiting, for life, lobbying by anyone who has been on a legislative or executive payroll. It would also require overturning Citizens United and mandating that Congress pass a balanced budget, or face an automatic sequester of spending.

Whatever…

It would also require purging the corrosive financialization that has turned the economy into a giant casino since the 1970s. This would mean putting the great Wall Street banks out in the cold to compete as at-risk free enterprises, without access to cheap Fed loans or deposit insurance. Banks would be able to take deposits and make commercial loans, but be banned from trading, underwriting and money management in all its forms.

I happen to fully agree with narrow banking, as per my proposals.

It would require, finally, benching the Feds central planners, and restoring the central banks original mission: to provide liquidity in times of crisis but never to buy government debt or try to micromanage the economy. Getting the Fed out of the financial markets is the only way to put free markets and genuine wealth creation back into capitalism.

Rhetoric that shows his total lack of understanding of monetary operations.

That, of course, will never happen because there are trillions of dollars of assets, from Shanghai skyscrapers to Fortune 1000 stocks to the latest housing market recovery, artificially propped up by the Feds interest-rate repression.

No govt policy necessarily supports rates. Without the issuance of treasury securities, paying interest on reserves, and other ‘interest rate support’ policy rates fall to 0%. He’s got the repression thing backwards.

The United States is broke fiscally, morally, intellectually and the Fed has incited a global currency war (Japan just signed up, the Brazilians and Chinese are angry, and the German-dominated euro zone is crumbling) that will soon overwhelm it. When the latest bubble pops, there will be nothing to stop the collapse.

How about a full payroll tax holiday???

If this sounds like advice to get out of the markets and hide out in cash, it is.

I tend to agree but for the opposite reason.

The deficit may have gotten too small with the latest tax hikes and spending cuts.

(feel free to distribute)

Karim writes:

It looks like the inventory rebuild has peaked,

Agreed, pay back from Q4 caution might have masked underlying weakness from tightening fiscal which intensifies some into Q2 as sequesters kick in, driving the deficit down to maybe 5% of GDP. The lesson of Japan may be that with 0 rates and QE, 5% might not be enough for anything more than stagnation.

but demand related indicators (employment, exports, imports) holding up.
The employment index is now at a 9mth high.

MMT to Washington: There Is No Long-term Deficit Problem!

By Warren Mosler