Reality Disconnect, Again

So many news headlines these days take my breath away because they are just so intent on pushing liberal/progressive views. Today offered one of the worst: “Last Bernanke Years Shows No Sign of Buyer’s Remorse” online at Bloomberg. The article is congratulating Bernanke for navigating the last six years without seeing high rates of consumer price increases. I know that many people disagree with the government’s claim that prices have not been climbing more rapidly, but for the issue in the article, it doesn’t matter. What matters is the underlying, widely accepted view of the article. That view holds that it is okay to focus very narrowly on an isolated, micro point, and assert that it means something. Using Dr. Leonard Peikoff’s DIM nomenclature, this is at best D1, possibly D2.

A knee-jerk, but nevertheless appropriate, response to this article would be to observe that there is less upward price pressure during a recession/depression. As Bernanke has responsibility for the recession, which he shares with some other esteemed governmental and legislative fools, it is morally outrageous to give him credit for the accidental consequence that consumer prices aren’t raising fast enough for people to be angry. Supposedly, Bernanke meant for prices to remain stable. But that is not true. Bernanke has been trying for a 2.5% rate of increase, and he hasn’t been able to get there, regardless of the amount of made-up money he has pushed toward the economy. Bernanke is being given credit for something he didn’t want and really thinks is bad.

Furthermore, focusing on the period of the last few years fails to observe that the consequences of his policies are going to be disasters for many more years into the future. This is another sign of the D mentality: the future isn’t real to them. What happens tomorrow is always a complete surprise. When you discard causality, the future has no relation to the present. This is especially true of government actions. They say that their new law or control will eliminate some perceived error in economic activity. They never check to see if the law or regulation had any effect on that problem, never. They do apparently assume that merely making the law is a sufficient “cause” for the problem to go away. But they do not actually realize that their action might cause some other, unwanted effect, in spite of the current wave of the hand at “unintended consequences.” The possibility is not part of their view of the world because they don’t understand cause and effect.

Bernanke is such an eloquent example. He was surprised by every turn of the economy from the day he took office until today. He has denied that his actions have had any negative consequence. He just won’t believe it (see my blog on his speech about the cause of the housing price boom). He has one response for any kind of economic situation: put more, lots more, money into the economy. More money is always good. And if wonderful things don’t happen, it is because really bad things were happening, which were staved off by the money he did put in. “Just think,” he might say, “how bad things would have been if I hadn’t acted.” Thus he proclaimed himself hero of the universe when he pushed a trillion of so into the economy during the beginning of the recession. Never mind that he has had to do the same thing repeatedly since. In his view that is because capitalism had let us down drastically in 2007.

This is another aspect of the D1 (he is a D1 because he does have a theory, an integration, which he thinks is founded in science). The theory is true, and thus must be applied, regardless of the actual results. He is not capable of reevaluating the theory.

All of this underscores the vital nature of philosophy in our battle to change the culture. We can’t argue or collaborate with a D. There is no common ground, actually no ground at all for him. We have to just replace him. In general, the same is true with the M. In the sense of using their theory, the M holds his ideas in much the same way as the D: the theory cannot be touched by reason or consequences.

We have to address ourselves to those people who aren’t contorted into either anti-reason methodology. That means the young and those individuals who somehow survived today’s schooling with some of their brains intact. It isn’t easy.

My Predictions

Although I originally began this blog with the idea of keeping track of inflation and potential results for prices and prosperity in general, I haven’t engaged in prediction. My focus has been on commentary. We are, however, at a point that offers some interesting prospects for the future and I though it might be interesting and possibly helpful to suggest a possible set of outcomes.

Specifically, at this point in late 2012 the governments in the major economies have either implemented or are poised to implement some massive monetary flooding, which they call “easing.” The U.S. Federal Reserve officials have announced an open ended $40B a month scheme that will continue until either employment begins increasing or the end of time, whichever comes first. In Europe, the European Central Bank is ready to create unlimited amounts of money, claiming that it has to reduce the spread in government bond prices (between Spain and Italy, who have had to pay high interest rates, and Germany’s very low rates). China is expected to begin more “easing” in that it is currently seeing a much deeper and more significant drop in economic activity than the government seemed to expect. Apparently they thought that they were a separate, insulated entity. In response, just as any Western mixed economy government would do, the Chinese are moving toward spending newly made-up money. Japan has just begun its own easing program and England began theirs a few months ago. There is a great orgy of money creation in progress.

Those countries with “strong” currencies are also involved. They really don’t want to see their competitive position undercut by having other currencies diving in comparative cost, making their own products much more expensive on the world market. One example is that Switzerland’s central bank been buying euros for several months to keep their currency in line. As has been said by others, there is something akin to the arms race growing where every country inflates their currency in competition with the others. This process could also lead to protectionism, with higher tariffs and import controls.

As long as our economic problems are seen as the consequences of low consumption or low demand (and demand is seen as just money and not production related), we can always expect that the government response will be to create more money. There is some fear of the new money increasing consumer prices beyond a certain level (generally at an annual rate of 2% - some poison is good for you apparently). This concern is an interesting hold over from a point where government economists had a closer contact with reality. But there is little concern about the prospects for unacceptable levels of price inflation. It is the case that the upward pressure on prices from constant increases in the money supply tends to be less when production levels are low.

Consequently, we can expect that we will soon see a lot more money being created and put into the larger, more industrialized economies and interest rate will remain extremely low.

The amount of money that actually comes into the U.S. economy is a question for which I have no good answer. There is certainly some, but not as much as you might think when you hear the Fed brag about its easing. The money created by the Fed for QE1 and QE2 is mostly still sitting at the Fed in the deposit accounts for member banks receiving 0.25% a year.

 

The money supply has continued to grow, but the pace is not as fast as one might expect.

 

You can see in the graph that the average dollar amount of growth every year has been somewhat consistent. That means that the percentage rate of growth is falling. To just keep the constant percentage rate, this graph would need to show a much larger constantly increasing dollar amount, as the total grew each year.

As a result, consumer prices have moved upward modestly in the last few years (by comparison) and asset prices are mixed (housing downward and equities upward, but less than the CPI). Only bond prices have moved upward, as the Fed has moved to force down long-term interest rates as well as short-term. Long-term rates are very low, especially considering the need for capital in our economy. There is no connection today between savings, investment, interest rates, and the capital markets.

In these conditions, I wonder what the Fed believes that more “quantitative easing” or lower interest rates, could achieve. They talk about lowering unemployment as if the problem is that jobs are not being created for of financial reasons. Here we have an excellent example of theoretical, rationalist thinking that doesn’t consider even the possibility of looking at the real world. At present, there is no connection between the interest rate (including the supply of money) and investment/growth decisions. For a business, the difference between 3% and 2.5% on a long-term, profitable investment is insignificant. The real question for businesses is whether the project could be profitable. Some companies have invested when they have cash on hand. Many are considering a merger or acquisition, which doesn’t add to our productive capacity (although it might improve efficiency). But U.S. companies see no justification in future profitability to make the investment needed to put over two million people to work. The Fed and the Government, and Romney and the Republicans just don’t see that.

Another upcoming set of events in the U.S that could have a negative impact on our economy is the end of the Bush tax cuts and the spending cuts required by law. These events, both scheduled for January 1, 2013, won’t improve the capital and investment situation, although the rate of growth of government debt will slow some. At least in the short-term, if the tax cuts do end and the rate of spending slows, the immediate result will be a drag on the U.S. economy.

I am not convinced that the supposed mandatory cuts in spending are particularly important economically. Some people try to make this situation seem cataclysmic by quoting a cut of over a trillion dollars. That is fraud, since that is a ten-year number. As is always the case with government cuts, they are loaded mostly into the latter years. I think that the 2013 number is closer to $69B, which is for the full year. When you are talking about a multi-trillion budget and a deficit of over a trillion dollars, sixty-nine billion is an accounting error.

But saying “cuts” is intended to be misleading. The Congress didn’t pass a cut in spending. They authorized a reduction in the expected growth of spending. It was a cut from what they thought current laws would require the government would spend. There is not going to be a cut in spending. Let me repeat: These are not cuts in spending but small reductions in the growth of spending. Even so, there may be some companies that will feel an impact in their expected revenue from government contracts. But, economically, compared to the total level of spending and the prospect of more “easing”, big deal.

Combined, the tax cut, possible cuts in the growth of spending, and the Fed’s money flood, mean that there will be less money in people’s pocketbooks, but more, potentially, in the banking system. Remember that the way the Fed’s money gets into the economy is via bank loans. If the banks continue to maintain their stricter standards there is not going to be a significant increase in bank loans. In fact, the current trend is for lower corporate profits, meaning that businesses will be less credit worthy than before (and stock prices should decline, instead of booming). In addition, ever since the beginning of the “Great Recession,” bank regulators have been constantly checking on the “quality” of bank loans. Unless regulators are willing to loosen the strings, banks aren’t taking any riskier loans. I don’t see much of the Fed’s new money getting into the economy. That is not to say that there won’t be an effect. As in the past, there is a tendency to some money to find its way into assets.

In addition, the final Dodd-Frank regulations have yet to appear and the costly ObamaCare provisions are coming into effect. All businesses, but especially banks, are legitimately confident that their costs will increase significantly and their range of action considerably curtailed. Startup businesses have declined. dramatically. For the economic/cultural pessimist, there is much support in the U.S.

In Europe, the central bank is being pushed into acting because the market for Spanish and Italian government bonds demands much higher returns to compensate for higher risk. Personally, I think that there is no uncertainty. Neither Spain nor Italy will be able to repay their bonds in the coming years. (I equate being given worthless money with not being paid.). So the higher rates are certainly justified. But enough of the euro country governments don’t like that. The higher rates mean that Spain and Italy would have to face their insolvency soon, which would be a big problem for the other euro government countries. So the euro block is pushing the central bank to create money to avoid reality. In this case the money will go directly into government spending and will have very negative consequences. Not the least consequence will be a lessening of the pressure on Spain and Italy to solve their problems. (Spain is expected to need the euro bank bailout. No one is currently talking about Italy, but its economy is heading the same direction.) By creating money to buy government bonds the European Central Bank is defaulting on the loans by directly creating inflation and thus reducing the purchasing power of the money that bought the bonds. Everyone in Europe is ignoring that fact. In addition, there will be a lot of upward pressure on prices and everyone will feel the cost. But, most of all, the importance of freeing their economies and being fiscally responsible can be evaded. The ultimate result will be greater disasters.

I expect that China’s new money will be similar to earlier efforts, which went primarily into government owned and controlled businesses, shrinking the portion of the economy that is private. It may also be more of a “consumption” orientation, which will mean less of a push in industrialization, and a move toward Western ideas of a consumer driven economy. That government decision would necessarily reduce the growth rate even without the normal consequences of asset booms and busts.

If more “easing” won’t help solve the unemployment problem (who cares about actual production?) and thus won’t help with economic activity, what will it do?

Well, the U.S. economy isn’t going to grow much, if at all. In fact, it could contract. If the new money just sits at the Fed as before, we needn’t worry about hyperinflation. The money supply will grow, but not significantly faster than before, although those numbers should be watched carefully.

I heard someone point out that since the first “easing” the Dow has risen 4000 points and since the second “easing” nearly 3000. I am sure that the Dow and other indexes will raise some more. The Dow has already gone up a few hundred points since the Fed announcement. What would a push by the Fed be without a serious increase in asset prices? Commodity prices could also rise. Some are saying that industrial commodities, such as copper, will not because industrial production is tending to fall. But the money being created will go somewhere. You just need to keep an eye out to see where that is.

So, if you want to put your money somewhere, based upon recent history, there you are! Just be careful about your timing and don’t lose perspective about the causes of the asset price rise and its duration. Be ready to short.

Of course, economic events are really harder to predict than that, especially in a controlled economy. Something will happen that we don’t foresee and things will happen differently than we expect. One thing we do know, whatever happens, it’s unlikely to be good.

Long-term, the consequence of all of this “easing” is to probably bring the day of reckoning closer, possibly by years. With unemployment staying down, Social Security and Medicare spending will continue to widen the gap between tax income and spending. The demands upon the Treasury will increase, meaning more debt. The low levels of production will mean that wealth is not being created and our personal wealth and standard of living will continue to fall.

I think that money can be made from the chaos and misallocation of resources. You just have to pick your method based upon the circumstances and pay attention to the situation.


P.S. I just listened to Yaron Brook on the Mike Slater show (via a notification from Lassiez-Faire). He says so much of what I just mentioned. I really did work it out before. But he says it well.

Uncle Ben Spoke, and a couple Economics Lessons

Uncle Ben had a press conference a couple weeks ago – a first for a Fed Chairman.  (Uncle Ben Bernanke, Chairman of the Federal Reserve Board.)

And didn’t really say anything. Transparent! Transparent = Nothing! Fits.

So, Ben said that inflation expectations are low and that core inflation is low and the Fed isn’t responsible for anything that might be bad and everything that the Fed is responsible for is good and coming along, perhaps slowly, but coming along. Notice that when he discusses his policies he refers to the models and intellectual justifications, not to the results and consequences, not to the facts of reality.

Bernanke’s history at the Fed has shown that he does not believe that any of the problems that the economy has experienced are the result of the Fed’s policies. The Fed does the right thing and somehow, some other source of economic action causes things to go wrong. The Fed, Bernanke, is always right. He knows that he is right. He doesn’t know why things go bad.

More fundamentally, no result could cause Bernanke to question his beliefs. He is not reality oriented. He also hasn’t seen anything bad that was coming. In 2004, 2005, 2006, and 2007 he kept saying that everything was just fine. Then, in 2008, he said things weren’t doing so badly. Then, in 2009, he said that his actions had saved us all.

He does have the power, by being the Federal Reserve Board Chairman, to manipulate the economy. And he is intent on doing so. We are at his mercy, at the mercy of his mistaken views, at the mercy of his lack of contact with reality. We, the American people and the world, will continue to suffer.

But here is where I get very upset with the people who are criticizing him, those who post blogs and comments, etc. I include many Objectivists. The only thing they apparently see is inflation. Apparently, if commodity, food, and oil prices weren’t rising, they would have no problem with Bernanke. Well, they would probably howl that Bernanke’s policies would lead to inflation, but it would always be inflation, inflation, inflation. One note Johnnys.

It is certainly the case that the Fed’s only purview is monetary policy, i.e., pumping money. But controlling the money supply has other consequences, and to ignore those consequences is to leave Bernanke and his fellow government manipulators a free area of activity, damaging activity, deadly activity, immoral activity.

For example, one of the actions of the Fed is aimed at keeping interest rates low (the activity they have some direct control over, as opposed to the money supply, which is controlled indirectly) completely distorts a basic, key price in the economy. Interest rates are important in an economy and impact many decisions and other prices. People are just not able to make rational decisions in such an environment. I mean, since rationality consists of observing reality and acting accordingly, without basic, accurate information about the economic situation, rational decision-making is not possible.

I know that some argue that businessmen are smart and know that the interest rates do not reflect reality and adjust their thinking. I am sure that they do. But how much do they adjust? What can they think is the reality of the situation? I mean, without the facts, the businessman is only guessing. It might be a smart, experienced, wise guess. But it is still a guess, not knowledge. As a guess, it could still be way off. It could still be damaging. Further, since it has been literally decades since a market for capital has existed, any guess cannot be based on any actual market experience. A businessman’s wisdom is not an argument that changes the significance or the damage done by the manipulation of interest rates by the Fed.

The impact of the Fed is much wider than real or potential rising prices. People need to stop thinking that inflation is the only or even the major issue in every situation.

By the way, I was looking at copper and corn, two of the “commodities” that people are referring to when they say that “commodity” prices are rising. It may not be significant (you can’t really tell until sometime later), but both have backed off their recent high prices. I don’t know why yet, that is, I don’t know if it is a lowering of demand or if new production has come into the market, but if this trend continues, or if they just don’t keep going up, the contention that the Fed causes every bad economic consequence in the world will be even more questionable. Then the problem of being unscientific, i.e., not looking for causes, will have bigger consequences because it will make all criticism of the Fed look unsupported.

There is another error in the thinking of many about the economy. It is thinking that by knowing at least some of the consequences of the actions of government in the economy that one knows something about economics. Recently I have seen people dismiss comments I have made merely because I didn’t attribute what they viewed as negative economic consequences to a government. It is as if the only economic actor who has any efficacy is the government. Certainly, they conclude, that if anything happens that they don’t like it must be the fault of the government. There are several fallacies involved in such thinking, e.g., affirming the consequence, but the most basic fallacy is just not having taken the effort to learning the subject.

As a reader of Ayn Rand, we have learned that one must use one’s own judgment. This is important for many different, fundamental reasons, including moral ones. There is, however, an important context: a judgment without knowledge is not rational. That is, in order to decide, judge, conclude, make any kind of rational decision, one has to have knowledge of reality. Making a statement, declaring a judgment about an economic subject means you have to know economics, the fundamentals, and not marginally.

The fundamentals of economics involve the actions of individuals, people, acting as producers and consumers. It involves markets, prices, costs, production, and making economic choices. The actions of government overlay the reality of production and consumption. The actions of government affect what people do, the prices resulting from market actions, what people ultimately produce and consume. But the governmental actions are not fundamental to an economy, or its study. The fundamentals are the reason for the existence of markets, prices, and the creation of wealth. People acting for their own benefit are efficacious. Government action only corrupts.

It is often next to impossible to foretell what the results of government action is going to be because of the complexity of an economy, of the large number of actors, of differing interests and motives. In that government action is intended to get people to act differently than they would normally, the results cannot be good. But to identify and understand those results, you have to include the primary market participants. To ignore them is to drop the context. The primary actors are the individuals.

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.