Inflation Watch: Early 2010

It is kind of interesting now. Aside from the very important fight to prevent the federal government from expanding their control over medicine, not much is happening. It is a lull. It is the eye of the storm. It is waiting for the other shoe to drop (and it could be a big shoe). It is the calm before…..well you get it.


If this were nearly any other time after WW2, we would be seeing business activity picking up, profits being made, people being hired. Instead, people are waiting. Sure the equity markets have moved up some. Obama has spent a lot, okay, he has spent a lot of a lot. He is going to be spending even more, even if the healthcare bill fails. But, banks are still not making loans. The last report on consumer credit showed a decline. The money supply quantity has been level for a while – it is a reverse hockey stick. The dollar, the price of gold, oil prices, and house prices are staying in a pretty narrow range. Of course, when the supports of house prices disappear, we may see something different. The Fed keeps talking about having to soak up all of the excess reserves they created, but a lot of people don’t think that they have the backbone, let alone the ability, to do it. What we are all doing is waiting. Waiting for the shoe to drop. We’re afraid that it will hit us on the head, hard.

There is some talk about production beginning to come back on line, about corporate profits growing and banks regaining their strength. Then, following FDR’s example, Obama says something that scares everyone (like the tax on banks to “recover” the TARP junk money), except his loyal followers, and decision makers, the wise ones, sit on their hands again. So, this period is one of uncertainty and pause.
We can be certain that everything that Obama has done and wants to do and what the Fed has done and will probably do are bad for us. The corrections that are needed because of the house price bubble have only partially occurred, at best. There is still a lot that could happen besides a house price decline. We could easily see more unemployment, and certainly see more non-employment, as Obama continues to take money out of the economy to fund non-productive, make-work jobs. It would take a lot of study to determine which was worse, unemployment insurance or Obama make work jobs. Not only are these people not producing which would move our economy toward prosperity, but money is being taken out of the economy to pay the unemployed not to produce. At least with unemployment insurance there is no pretense.

Even though the money supply numbers are coming up flat for the last several months, since production has fallen off, but prices have not, we are experiencing price inflation, at least enough to maintain prices. There may be some asset boom in the price level of stocks and gold, but not a lot. There is a lot of money sitting on the sidelines. There is talk of the “carry trade” in international asset markets. I am sure that there is something happening there. How big it is I don’t think anyone knows.
Since banks aren’t lending, added money is coming from direct government spending. Obama’s spending feeds directly into the consumer markets, therefore, to the extent that the money is being pumped, we will see pressure on prices. The direct spending is coming through the increased government payroll and things like non-employment programs and mortgage support. This spending is money that winds up in individual’s pockets and does not impact any specific set of prices. As general government spending continues to ramp up, the result will be more like “stagflation”, much like the 70’s where we had a stalled economy and rising prices. This will confound the “economists”, especially the Fed’s people. They are depending upon businesses being able to ramp up their production to meet the levels of money wondering around the economy. Businesses aren’t ramping. Banks aren’t lending, which is a really reasonable, business wise, good decision.

The Fed will be amazed that their magic wand, really low interest rates, doesn’t provide the wonderful result their models predict. We will be back in 30’s, or the 70’s take your unhappy pick.  (When you hear "low interest rates" from the Fed, always think: creating made-up money.)
The money for the government spending is coming from some U.S. “investors” who are frightened and think that federal bonds are safe. A lot is coming from foreigners, mainly central banks, who have trillions of dollars sitting there with nowhere to go except U.S. government debt. If the Fed does start mopping up money out of bank reserves, we will see short-term interest rates rise, which may affect the long-term bond rates. It depends on the conclusions reached by investors. If they think that the Fed is acting with some determination and will finish the task of taking nearly a $ T out of member bank deposits (this is the money that banks are forced to have on deposit with the Fed;  in government speak, it is called a reserve, but it isn't), then long-term bond rates may stay fairly flat, with the inflation premium pretty small. If investors think that the Fed is not serious or lacks the will to do the job, long-term rates will rise, and today’s buyers will suffer.

Maybe it would be worthwhile to talk about what makes up interest rates. As von Mises would say, the basic decision a person has to make is his preference for current consumption or future consumption, today’s goods vs. future goods. What does it take to get you to put off consumption? The classical answer that I have seen is something like 1 ½ to 2 %, that is, you would want an interest rate of return of say 2% a year to put off consumption, all things being equal. That is a wonderful saying by economists, isn’t it? “All things being equal”, because all things aren’t equal in a mixed economy. There are two added factors: inflation and taxes. (This is why government bonds have always been a bad deal, because after inflation and taxes they generate a net loss, guaranteed.)

What is your expectation for inflation? Up until 2007, the average for 10 to 15 years had been around 2%, using the CPI (don’t shout at me, this is only an example). Let’s say that your tax rate (federal only) is 33%. Using the basic, “natural” interest rate of 2%, you would want a nominal rate of return of 6% on your bond, i.e., after the tax of 33%, you had 4%, then minus the rate of inflation, you had 2% left. Today the 10-year bond is under 4%. In 2008, the social security people decided seniors should get an indexed increase of 5.6%. That tells you where things were headed, doesn’t it.

What is your inflation expectation of 2011 and beyond? More than 2%? Mine is. Taxes aren’t going down either (I will pause while you laugh.)………

If long-term bond prices go up, BO will have to spend more money financing his spending (doesn’t that make sense?), and he won’t be happy. He will point his finger at the Fed. Our hero, Bernanke, will…. And the story continues.

Back to my inflation watch, I am trying to avoid guessing or jumping to conclusions, here. I don’t see much hope. I think the question is how severe will things get. If they get more severe, will people demand that the government and the Fed do something different, like get there hands off the economy and also stop making money? We shall see.



To let you know that I am keeping my eyes as open as possible, I want to report that one of the standard indicators of the 20C suggests that we will not see more downturn. Hemlines have pretty much stayed where they were. Yes, for most of the 20C, when recession or depression hit, hemlines went down, adding to the personal sense of depression. However, either this indicator has lost its connection to the economy, or things will be fine, or at least the level of depression in the population will be a little lighter.



(Please give me some feedback if any part of this was not as clear as you want. I want to be sure that I am deciding to publish what an intelligent person will understand. Thank you. C.W.)

Their Plans for You

Courtesy of Lisa Doby, on Facebook, where she referred to this article. 

The government has plans for you, your money, your retirement plan.  You know that Obama and his gang are looking out for you, don't you?  So everything will be okay, right? 

Seriously, keep your eyes open, and be prepared to act.

http://market-ticker.org/archives/1830-401kIRA-Screw-Job-Coming.html

Speech by Ben S. Bernanke, Commentary

Monetary Policy and the Housing Bubble
At the Annual Meeting of the American Economic Association

January 2, 2010

This is a speech in front of an association of economists, and, consequently, Bernanke can talk freely in his “native language”. He can use the reasoning and terms with which he is most comfortable, keeping in mind that it is in public and the speech will be reported. This speech is his personal, professional statement of what he considers to be the consequences of his actions as a government official.

First, Bernanke’s comments make clear that in his opinion, the range of options that he faced or would not consider appropriate do not extend to letting interest rates rise to the market level. Those who argue the rates were too low, he says, meant that he should have done something different, not leave his hands off. As he was reported to have said in the book In Fed We Trust (p. 21), he was unpersuaded by arguments that the market can be effective by itself. In addition, he says that he was afraid of an unwelcomed decline in inflation. He was afraid of deflation, referring to Japan as an example of what can happen if prices fall.

“…the FOMC’s policy response also reflected concerns about a possible unwelcome decline in inflation. Taking note of the painful experience of Japan, policymakers worried that the United States might sink into deflation and that, as one consequence, the FOMC’s target interest rate might hit its zero lower bound, limiting the scope for further monetary accommodation.”

That he has no evidence that deflation in the U.S. was happening, or that it would have been bad is not considered. What he is actually saying is that falling prices is a bad thing for any economy. Falling prices are to be avoided at all costs. Falling prices, plus the potential for large scale problems in the financial sector world wide meant probable depression.

Bernanke has established himself as an expert on the Great Depression. His take on the depression is that it could have been avoided if the Fed had flooded the market with money in 1931 and 1932. This is his perspective. If something goes wrong in the economy, lower the interest rates.

Bernanke’s speech begins with discussion of the level of the overnight federal funds interest rate between 2002 and 2006. The question is whether it was appropriate in the face of the critics. He thus says that he will begin with a discussion of “simple rules” that have been offered to determine the proper rate, and talks about one, only one. And with the conclusion of this discussion, he simply dismisses the issue of the interest rate levels by saying that it appears that the Fed followed the correct policy.

The “simple rule” is a formula suggested by an academic that includes the actual rate of inflation, the desired rate of inflation, and the deviation from the optimum level of production. Bernanke quibbles about some of these terms, and ends by declaring that, even if the final result, after he has tinkered with the terms, is close to what the short-term interest rate goals that the Fed actually achieved, it is still too restrictive to be used. Sound strange? It is. I don’t recommend reading that section (or any of them, really; what’s that fun saying that some media types are using, “I read it so that you don’t have to”). (I am sorry. This section of the speech, about 25% of the text, is just not easily translated.)

He also uses only the level of prices, consumer prices as the subject matter of inflation. If prices rise there is inflation. If prices fall there is deflation. He is not willing to suggest that there is any other set of issues. Money supply is not an issue. It is not mentioned during the speech. Other causes for price rises, such as restrictions on oil production and thus higher oil prices, which tend to make other prices are not considered, at least in this speech. (He would probably like this suggestion, since it would be yet another explanation of “inflation” in which the central bank played no part.)

As you would expect, the concrete-bound detail and triviality of his remarks make this extremely tedious to read, as, I am sure, to hear by his listeners. Of course, they were mostly mainstream economists and government people and are used to hearing this kind of speech.

He then asks “can monetary policy have made an impact on housing prices?”

“With respect to the magnitude of house-price increases: Economists who have investigated the issue have generally found that, based on historical relationships, only a small portion of the increase in house prices earlier this decade can be attributed to the stance of U.S. monetary policy. This conclusion has been reached using both econometric models and purely statistical analyses that make no use of economic theory.”

Bernanke’s answer is founded in statistical analysis. He doesn’t use cause and effect, but looks for correlations. These techniques also depends upon focusing on the interest rate at the time and price inflation. What they ignore entirely is how low interest rates are achieved. He pretends that the fed declares low interest rates and they come about. But what happens is that to keep interest rates low, even the short-term rates, the Fed must supply funds. It must make up money. It must keep making money (this is electronic money) as long as it wants to keep the interest rates below what the market would set. Every time there is a move upward, the Fed makes up more money. Where does this money go? In the period in question, much of it went into mortgages. But Bernanke does not think that looking at this money makes any sense. He ignores it as if it doesn’t exist. But it does, or did until the liquidation of mortgage-backed securities became necessary because of so many defaults, which was the liquidation of the mortgages.

His entire speech demonstrates that the epistemological methods used in today’s mainstream economics is designed to avoid looking at reality and to obfuscate cause and effect.

He slips in the suggestion that the availability of ARMs and other special mortgage types is a “key” explanation of the rise in house prices.

“Clearly, for lenders and borrowers focused on minimizing the initial payment, the choice of mortgage type was far more important than the level of short- term interest rates. The availability of these alternative mortgage products proved to be quite important and, as many have recognized, is likely a key explanation of the housing bubble.”

At this point the level of evasion of responsibility becomes obvious, since the Fed, as well as every other imaginable government agency had pushed home ownership and the lowering of credit standards for years. (see Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse by Thomas Woods, p. 15ff)

“As you can see, the use of these nonstandard features increased rapidly from early in the decade through 2005 or 2006. Because such features are presumably not appropriate for many borrowers, Slide 8 is evidence of a protracted deterioration in mortgage underwriting standards, which was further exacerbated by practices such as the use of no-documentation loans. The picture that emerges is consistent with many accounts of the period: At some point, both lenders and borrowers became convinced that house prices would only go up. Borrowers chose, and were extended, mortgages that they could not be expected to service in the longer term. They were provided these loans on the expectation that accumulating home equity would soon allow refinancing into more sustainable mortgages. For a time, rising house prices became a self-fulfilling prophecy, but ultimately, further appreciation could not be sustained and house prices collapsed.”

To further support his position that the Fed is blameless, he considers the rise of house prices internationally. Bernanke uses the same statistical method of comparing monetary policy, as represented by a statistical analysis of the central bank short-term rates compared to the rise of house prices in separate countries. He finds no correlation. So the central bank of the U.S., the Fed, did not cause the rise in house prices. QED! The guy is a wizard! And, it is entirely nonsense. He has no concept of the role of cause and effect in economics. That is where we are, and why he and his brothers are completely mystified as to why people want to shut them down.

So what explains it, in Bernanke’s opinion: savings glut, especially in developing countries. It seems that the people who feed off of money loaned or “invested” in developing countries turn around and put the money in the U.S. Since this money is usually dollars and it isn’t actually U.S. savings, but made-up money, it is U.S. inflation anyway. But that is far too long of a chain for Bernanke to accept or even consider. Yet, here we are, foreign savings sent to the U.S. has driven up American house prices.

Step back and consider our house prices dependency on foreign money for a second. With Bernanke is keeping American interest rates low, why would anyone send us money. Well maybe, if your own country’s currency is even less stable, the U.S. is a fine place to put your money, or maybe you have so many dollars you need someplace to put them.

Somehow Bernanke can keep track of the money coming into the U.S., he says (actually, he is suggesting it, cause and effect is something that he is avoiding), but he can’t or won’t consider what is being done with the money the Fed is creating to keep the interest rates low in the first place. There is a parallel, Bernanke admitted in front of Congress that he doesn’t know what happened to the money that he loaned/gave to foreign central banks as part of the stabilization after September, 2008. He doesn’t watch it, except for that money that came from developing countries that drove up house prices in the U.S.

“In previous remarks I have pointed out that capital inflows from emerging markets to industrial countries can help to explain asset price appreciation and low long-term real interest rates in the countries receiving the funds -- the so-called global savings glut hypothesis (Bernanke, 2005, 2007).”

In his argument that central bank short-term interest rate policies are not responsible for the increase in house prices, Bernanke’s approach shows that there is a very significant methodological issue here. Bernanke felt that all he needed to do was create charts comparing the central bank interest rates with the house prices. He didn’t feel it was important to consider the actual money market in each country, or credit standards, if credit is used, type of mortgages, income levels of house purchasers, laws, or any feature that might or might not make each county a relevant candidate for comparison with the U.S. situation. No, all that is needed in Bernanke’s world is a look for the correlation. I have watched reactions to Bernanke’s speech and I have seen no reaction at all to his analytical methods. I suspect that the standard journalist is intimidated by what passes as Bernanke’s science. I saw one comment on a critic’s article saying that he thought Bernanke was smarter than the author of the article and so would continue to believe Bernanke. That is part of the problem, a lack of understanding of simple methodology.

And, therefore, after his analysis of the appropriateness of his low short-term interest rate policy and the possibility of Fed responsibility for the rise in house prices, both of which Bernanke resolved in his own favor, the cash payout, the conclusion, the recommendation is, wait for it, what do you think, you get three answers and the first two don’t count, what do you think it could be….(consider this all said in a high voice with a drum roll)…… it is, to da, MORE REGULATON!!!! SURPRISE!!!

Sorry, I couldn’t resist.

“What policy implications should we draw? I noted earlier that the most important source of lower initial monthly payments, which allowed more people to enter the housing market and bid for properties, was not the general level of short-term interest rates, but the increasing use of more exotic types of mortgages and the associated decline of underwriting standards. That conclusion suggests that the best response to the housing bubble would have been regulatory, not monetary. Stronger regulation and supervision aimed at problems with underwriting practices and lenders’ risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates. Moreover, regulators, supervisors, and the private sector could have more effectively addressed building risk concentrations and inadequate risk- management practices without necessarily having had to make a judgment about the sustainability of house price increases.

“The Federal Reserve and other agencies did make efforts to address poor mortgage underwriting practices. In 2005, we worked with other banking regulators to develop guidance for banks on nontraditional mortgages, notably interest-only and option-ARM products. In March 2007, we issued interagency guidance on subprime lending, which was finalized in June. After a series of hearings that began in June 2006, we used authority granted us under the Truth in Lending Act to issue rules that apply to all high-cost mortgage lenders, not just banks. However, these efforts came too late or were insufficient to stop the decline in underwriting standards and effectively constrain the housing bubble.

“The lesson I take from this experience is not that financial regulation and supervision are ineffective for controlling emerging risks, but that their execution must be better and smarter. The Federal Reserve is working not only to improve our ability to identify and correct problems in financial institutions, but also to move from an institution-by- institution supervisory approach to one that is attentive to the stability of the financial system as a whole. Toward that end, we are supplementing reviews of individual firms with comparative evaluations across firms and with analyses of the interactions among firms and markets. We have further strengthened our commitment to consumer protection. And we have strongly advocated financial regulatory reforms, such as the creation of a systemic risk council, that will reorient the country’s overall regulatory structure toward a more systemic approach. The crisis has shown us that indicators such as leverage and liquidity must be evaluated from a systemwide perspective as well as at the level of individual firms.”

The nicest thing that can be said is the he must be well insulated. The push to expand home ownership and lower credit standards by the government was a very big effort. To ignore that takes a heap of mental effort. The other problems I have touched upon.

But, the basic modus operandi of a government regulator is well established by excellent writers, Ayn Rand, Ludwig von Mises, and many more. When something goes wrong in the economy you are regulating always blame it on free enterprise and never yourself. And demand, loudly and often, more controls and power and less freedom.

(Bernanke's speech    http://www.federalreserve.gov/newsevents/speech/bernanke20100103a.htm)

Meltdown by Thomas Woods, Review

Over the last two years or so, we, the citizens of the civilized world, have gone through a horrendous period in our economy. We have seen a towering boom in residential real estate turn into a collapse in that area followed by a collapse in the financial industry accompanied by a collapse in the stock market, with high unemployment, high foreclosures of homes, business failures, and amazingly high government spending, debt, money creation, and rhetoric.

What happened? The government talks about greed and risk-taking. They, the Fed and the Treasury, are the heroes.

But if you really want to know what happened and what the consequences of the current “recovery” actions are, read Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse by Thomas Woods..

As opposed to most discussions of the meltdown, this one begins years ahead of the September, 2008 Lehman Brothers bankruptcy. The roots of the bust are in the boom. In fact, as Woods explains, the damage to our economy is done during the boom. The damage starts with the Federal Reserve Board and its policy of low interest rates.

This specific cycle also is rooted in the appeal of home ownership for all. The liberals take this goal as a government policy, without regard to the economic consequences to the country or the individual buyers. Woods recounts the many and varied steps the government took to push home ownership without regard and in spite of the credit worthiness or ability to repay a loan.

Very important to anyone interested in how our economy works is Woods’ discussion of the Fed’s policy of low interest rates and credit expansion and the consequences in the 2008 panic. Woods points out that these activities have consequences, and not the ones that the Fed or either the Democrats or Republicans think. The consequences turn out to be the bust. The Fed’s policies create misallocations of savings and resources into investments that the economy can’t support. When he says “the economy” he means people who have produced and earned income and want to spend their income on their values. The Fed’s policies divert savings from what consumers want. Misallocated resources need to be put to productive uses, and that reallocation occurs during the bust. You get the fake boom and then you get to pay for it in the bust.

But for the bust to work, the assets have to be reallocated, which happens through business failures, lower prices, and movement of employees from bad investments to good ones, i.e., unemployment. These are all viewed as bad by the government and the Fed and they try hard (i.e., they spend money and make regulations) to keep businesses from failing, prices from lowering, and unemployment from rising. The things that need to happen to return the economy to productivity and prosperity are stopped, or at least they try to stop it. Woods points out that the result of stopping the process of reallocation can only be continued recession, as we are seeing, and will probably continue to see.

If you have read my recent blog post you know that I want to encourage people to learn how capitalism works. Reading this book would be a good beginning. It will also give you a good idea as to why government intervention and money manipulation is bad for us. It will help with your understanding of inflation. It will help you understand your own predicament.

Having said that, I must, unfortunately voice my one significant complaint about the book. As clear as he is about the causes of our economy’s current mess and the wrong headedness of the government’s actions today, Woods falls down on his explanation of the Fed’s creation of money and inflation. It isn’t that he is wrong so much as he leaves it muddled. You may come away with a confusion regarding inflation, price inflation, credit expansion, and how it all fits together. He talks about the expansion of credit to business being important in the boom/bust cycles, and then talks entirely about price inflation when explaining the Fed’s manipulation of the money supply. I hope that you can make the connection. [If not you can always ask me. I think that I can show the connections clearly enough for you. (Some of my earlier blog posts may help.)]
I found this book because a friend mentioned that Yaron Brook of The Ayn Rand Institute had recommended it. It was a good suggestion. Allow me to add my modest recommendation. In fact, please allow me to say that if you want to understand the economic world you live in, you will read it.

Learn About Capitalism

Capitalism is a major value for a rational person. It is the political system of freedom. It requires property rights and thus the individual rights that are necessary for man to live as a man and pursue happiness. Without rights and capitalism, man is a miserable, sacrificial animal.

Not known until the last century, and the writings of Ayn Rand, capitalism is the only moral economic/political system. It is the only such system that is consistent with man’s need to make decisions based upon his own judgment and create values. In our current world that is flooded with pleas, demands, and commands to be altruistic, to be a human sacrifice, the morality of capitalism is truly unknown. This knowledge, the reality of the moral purity of capitalism, needs to be broadcast loudly and constantly.

Yet, I have found that those who know of the moral stature of capitalism often have less knowledge of how capitalism works. They do not know the issues of trade, finance, money, and business. They do not know how the nuts and bolts fit together.

I think that it is vital that the supporters of capitalism know the economics of capitalism, for the same reasons.

You see, unfortunately, the rest of the population doesn’t know either.

The effort to deny the moral stature of capitalism also has succeeded in hiding the efficaciousness of capitalism as well.

People in general do not know that capitalism works.

People in general believe that capitalism leads to boom and bust, to keeping the poor poor, to the exploitation of the under privileged, to overproduction, to producing things that will fall apart, to destroying the Earth. They do not know anything, or at least very little, about what capitalism actually does for mankind.

I think that this lack of knowledge extends to just about everyone, including “economics professor”. Certainly, almost no journalist, few blogger, no commentator, and few TV talking heads have an idea of how capitalism works. I wouldn’t put the “pro-business” conservative or Republican in the category of the pro-capitalist, since most of them would be terrified of the idea of doing away with any of the New Deal restrictions on business. Capitalism is fine, they think, as long as it isn’t allowed to go full bore.

It isn’t just that capitalism is the unknown ideal, capitalism as a system is literally unknown, too (even among many who support it). If you sit down and argue capitalism’s moral worth, you could easily get the answer, “Okay, it may be moral, but it doesn’t work!”

I have read and heard surprise that people are ready to discard this wonderful system that has brought about our unprecedented standard of living. But people do not know that capitalism is responsible. They see the health care industry failing, for example. It seems that the market is failing. They do not know that capital is required for production. They do not actually know what capital is. They do not know how money works, or finance, or markets. Their ignorance is amazing until you realize that there is no source in our educational system to learn about capitalism.

So, if you want to argue for capitalism, you need to be able to explain what it is, that it is moral, that it works (and how), and, I am sorry to say, how and why what is currently going on is so bad for America. This last point is like having to look deeply into very shameful, evil, and often, boring issues. But it is necessary. I do mean necessary. If we are going to beat this thing, we need to root it out and kill it. And we have got to know our enemy to succeed.

Our biggest enemy today, the one with the most impact on our daily lives and that undercuts our prosperity is the Federal Reserve Board. There are very few who have a clue as to what it is and how it works. Start there. Read Meltdown by Thomas Woods. (I just finished it and will have a review here shortly.)

Read the business section of your newspaper. Read The Capitalist Manifesto. Read Ludwig von Mises. Read the Fed website. Read the few blogs dedicated to capitalist economics.

Learn how the Fed manipulates the money supply and how much it has done. Pick an industry and learn how it is manipulated and regulated. Learn how pervasive federal, state, and local governments are in every area of our daily lives. You will become a fountain of knowledge and moral condemnation.

I know that this sounds like a lot to do. Economics texts tend to be big and filled with jargon. If you took economics in college you may be scared for life! But knowing how capitalism works is important. You know, if you actually lived in a capitalist economy, you would want and need that knowledge. The more you knew about the rational world you lived in, the better off you would be. The same is true in this context. Speaking about your personal situation, the more you know about what is happening, especially when it is bad, the better off you will be. So there are two excellent reasons to follow up.

Green Jobs; Obama’s Jobs Program and Inflation

This idiot program has been discussed in other places regarding its failings as a stimulas, as a provider of real jobs, as a wealth producer, and as a drag on the economy. I want to talk about it regarding its impact on inflation.

This is a direct price inflation input into the economy.

As we know from economists, inflation affects industries and people unevenly. Its first impact is where the new money enters the economy. There are at least two sectors in our economy that have been receiving made up money for decades which are major distributors of consumer level price inflation. They are very obvious: health care and higher education (the costs of which have been raising at over 7% a year for decades).

Most of the rest of the inflation has been coming in via the expansion of bank credit, i.e., exported inflation by way of the trade deficit, and asset balloons like the tech stock bubble and the residential real estate bubble.

Here we have money to be pumped directly into the consumer economy by way of unproductive jobs. The good news is that this entry point into the economy will not cause asset bubbles or significantly increase our trade deficit. The bad news is that it will feed directly into consumer prices.

A major technical hurtle in understanding how newly made money filters through our economy is understanding why prices haven’t risen more over the past twenty years. Don’t yell at me that the government CPI under measures inflation, it doesn’t matter. My standard is real, corporate profits, which is to say, their real, ongoing costs of production. If we had significant price inflation, those costs would be causing ongoing corporate profit problems because the cost of replacing materials would be higher each cycle, and you would see problems. We don’t see cost problems to speak of. The inflation is going elsewhere.

We do have other consequences of inflation: the trade deficit, or actually, the money that leaves and doesn’t come back (yet) and asset bubbles. Some suggest that our rising productivity soaks up made up money, and thus prices don’t drop as they normally would. I don’t disagree with this suggestion. I don’t think that it’s large enough to make up the difference between the actual amount of inflation and the experienced level of price inflation. I admit that I don’t have figures (if it is actually possible to have “figures”).

We do see in front of us on a daily basis the method that made up money makes it into the economy: the federal payroll and federal retirement benefits, plus social security. To the extent that the government finances itself via inflation, the federal payroll, etc., is a dispenser of money that goes directly into consumer prices. How does the federal government do that? I mean that I am on record as saying that as long as the deficit is funded by selling bonds, then there is no inflation stemming from the deficit. No body called me on that. You see, a significant portion of the annual federal deficit is funded by foreign central banks and other foreigners buying federal bonds. All of the money coming from foreign central banks is made up money. Plus, some of the federal debt is purchased by the Fed, though not much. Therefore, a lot of the federal spending each year is in made up money, which goes directly into the consumer markets, and is a source of the rise of prices and price inflation. It’s nice to figure these things out.
So, the conclusion about Obama’s grand unproductive jobs program is that he will be adding yet another source for inflating the prices we see when we go out to the market. Thank you B.O.

The Gold Market: Update on Central Bank Activity and More

People get excited about central banks because they have lots of money (called inflation) and they tend to make big moves. The central banks do not move as a group. Some may be buying while others are selling. You also have to factor in the IMF, which has a lot of gold and is selling to support its activities. When the IMF sells and some central bank is buying, they tend to set the transaction between them, so there is no impact on the gold market. The IMF has been selling around 400 metric tons a year. There is an agreement among the major central banks called the Central Bank Gold Agreement in which they voluntarily limit the amount of gold they sell a year, currently 400 metric tons. That doesn’t mean that they are selling that amount, just that they won’t as a group sell more than that. It is suggested that they aren’t selling at all. Who can know? We won’t know for some time. There is reason to think that some central banks, small countries, are buying, probably from the IMF.

One writer suggested that central banks do not pay attention to price, once they decide that they want to buy. On the other hand, a spokesman for the Chinese Central Bank said that they would not buy when the price was “high”. I think that belittling the bankers is reasonable when writing about them, but when devising a gold purchase strategy, it is risky. Overestimating the reasoning power of other market players is a better approach to risk management, keeping in mind their motivations and perspectives.

An article I came across recently reminded me that over the last two decades the central bankers have been selling gold. Even last year, on balance, they sold. I think that period has ended. It ended primarily because of the realization of the weakness of the dollar and, more importantly, the U.S. financial system and economy. They might have the wrong idea as to why the U.S. financial system is weak, blaming the banks rather than the Fed, but they do understand that the recent worldwide recession began in the U.S. financial system. What has happened since has done nothing to reassure anyone.




From a wider perspective, the relation between gold and inflation is not direct. The effect, the ability of gold to keep pace with the drop in value of the dollar is in the long term, over years, sometimes decades. This is the result of the activities of the different elements of the market. The big drop had to do with the waining of the U.S. price inflation and gold selling by the central banks. The movement of gold upward now is due to fears and uncertainty, not a response to specific changes in the purchasing power of the dollar or other currencies, but expectations of deteriorating conditions. If conditions do not deteriorate within a certain time, the attention in gold will be reduced and the price will flatten, at best, maybe drop.

With the certainty that the Fed will be expanding the money supply by expanding credit as forcefully as it can, as it has been doing for the last year, we will see something happen. It could be another asset bubble, it could be a huge increase in our trade deficit, a significant drop in the value of the dollar, or, because of Obama’s spending, it could be real price inflation. We do not know where all that money will pop up, maybe many places at once. Just keep your eyes open.