The Fed is in a bind. The economy is clearly slowing down again. Unemployment will soon follow. According to the Fed’s Dual Mandate they should be doing something about that.
They have few options. They can’t do more Large Scale Asset Purchases (“LSAP”). What has become referred to as “QE”, has not worked. It was also very unpopular (both in and out of the country). LSAPs may come back sometime, but they are on the shelf for at least a year. What could the Fed do in the near future?
I) They could increase the inflation target (core CPI) from “A little under 2%” to “A tad over 3%”.
II) They could alter the ZIRP (zero interest rates) language from: “For the foreseeable future” to: “Until such time as the Fed’s new inflation target has been achieved but not less than one year”.
These relatively minor changes would have very dramatic effects.
-Inflationary expectations would jump. Actual inflation would follow.
-The dollar would crap out. Exports would increase.
-This would result in wage pressure. Exactly what the Fed wants.
-The resulting inflation in all commodities would roll into new home construction costs and therefore be a boost to existing values. (Soft bailout to housing/lenders)
-It is (short-term) supportive of equities. Exactly what the Fed wants.
-Debt costs can’t rise too fast as ZIRP keeps the belly of the curve cheap. This has to happen. Without LSAPs, this is the only way to achieve it.
Are you scared yet? Now consider where the politicians are on the inflation story.
Republicans have drawn a line in the sand on the debt limit with their position of “No New Taxes”. The Democrats have said pretty much the opposite with, “No spending cuts”.
Neither side appears to be giving an inch. There is no common ground. Yet, to go to August 2 without a resolution is just a dumb move. Both sides of this big debate know that the next presidential election is riding on the outcome. If the US is to default; one side or the other will shoulder the blame. The “side” that gets the blame will lose the election. And both sides understand this. So where’s the compromise?
The solution is inflation. The government has got to get out of its inflation indexed obligations. You don’t have to raise tax brackets to raise revenues or cut expenses. You can mess with inflation adjustments to achieve these ends. Both sides can appear to win if this is accomplished.
Consider the words last week of Brian Graff of ASPPA (Lobby for pensions and actuaries) (The conference was sponsored by the IRS!!)
"Eliminating indexing is one of the proposals receiving serious consideration as Congress enters “uncharted territory” with legislation to raise the debt ceiling, If Congress were to stop indexing for a period of time, which would affect tax brackets, individual retirement account contributions, and contribution limits under tax code Section 415, “you could raise a lot of money, and those are the kinds of things they are talking about.”
On the expense side of the equation a great deal of fat can be cut by eliminating/cutting COLA increases in a variety of programs. The most important of which would be Social Security. Depending on how the cuts in COLA are defined and how they are applied a huge amount of money would be saved over an extended period.
If all social obligations had their COLA increases cut in half it would (on paper) put the US on a much more solid long-term footing. It is a very appealing “kick the can down the road” approach. No cuts in programs (just smaller increases) and no new taxes (but higher revenue as the inflation adjustments for AMT and other tax issues kick in).
If you buy into this thinking this is they way it could play out:
We DO go to the 11th hour on the debt limit. But a compromised is reached. Central to the deal is a broad restructuring of the way inflation impacts both revenue and expenses at the federal level. Both sides claim victory.
Two months later Bernanke will announce what will be called QE3. He will make a long-term commitment (at least one year) to maintaining interest rates at near zero levels. And he will raise the inflation target that the Fed is hoping to achieve by 35% ('smidge' over 3% core CPI)
Should things play out along these lines it will be sea change series of events. If anything like this were to be in our future the very worst financial position would be short gold and long bonds. Being short volatility in any market would also be a mistake. Outside of that, I’m not sure where/how to position for this.
My thoughts:
Deflation is scaring us to death. But inflation will kill us. And that is exactly what the ‘Deciders’ have in store for us.
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Well put, Bruce. A little bit of currency debasement is exactly what the government needs. The problem is keeping it to a little bit. But you are spot on in saying that this is the most attractive way out for the politicians once they stop thinking that they are scoring points by arguing. . .
ReplyDeleteMore financial repression, please; all bow to Keynes! Best article in weeks -- bravo, Bruce
ReplyDeleteBig O and the Congress will announce a deal: a trillion or so will be cut over the next 30 years beginning in 2025, everyone declares victory, and the next generation is sent another mile down the Road to Serfdom. Voila
ReplyDelete""The resulting inflation in all commodities would roll into new home construction costs and therefore be a boost to existing values.""
ReplyDeleteWell except that commodity price increases since 2009 havent had any impact on home values.
I dont think indexing will be repealed. Not in a GOP House anyways. I dont think your source is reliable.
Anon at 3:23
ReplyDeleteI never suggested I had a "source" for this. This is just me looking at the tea leaves and concluding that there are no other options.
We shall see.
Yep, this is why I am 50% gold and 30% oil. Now, what to do with the pesky 20% remaining? Yee-haw!
ReplyDeleteTrue journalism requires analysis as to what is truth which this blog seeks to do. I thank you for this blog giving a forum for all to think of truth. Bad journalism is when you present both sides 50% equally when the matter is not equal, presenting news without any thinking but being a robot. That is why Wikipedia is a sham on a lot of its pages, to give very distorted information about people and events.
ReplyDeleteBruce your wrong. With U6 unemployment at 21% even if inflation increased there would be increase in wages. Oil would go to 150 gas 4 and change no more money for anything besides food and gas and welcome to your next recession without solving anything.
ReplyDeleteSince the empty heads in DC have no common sense, no financial sense, no economic sense and no good sense at all, your guess is as good as anyone's as to what nonsense they will try next. But as to your housing guess, I don't agree.
ReplyDeleteNot only have high commodities done nothing to home prices thus far, as anonymous said, but you miss the point that no matter how much something may cost to build, if you have no jobs, who is going to buy? There simply are no buyers out there and banks are not lending anyway. We hear that cash buyers of homes are making up 30% of purchases now, but who exactly is that? Foreigners, sadly. And REIT's and syndicates who are thinking that they can flip these houses in the near future.
I think housing is its own complicated mess.
I understand Bruce is basically spit balling here. Also, I admit that I am not the smartest guy in the room. That said, there are points he raises and a point raised by another commenter that I just don't follow.
ReplyDeleteIt is hard to believe that GOP members of the House will go along with these sorts of "tweaks" that are really tax increases. Gone are the days when President Reagan and Speaker Tip O'Neill can sit in a room and hammer out a deal. I suspect that if Speaker Boehner does this and includes tax increases, there will be a mutiny in the House. Whether or not that is a good thing depends on your perspective.
One commenter said that "a bit of currency debasement is exactly what the government needs." If that were true, we would now be in good shape because of the significant currency debasement that has already happened and continues, wouldn't we?
Finally, I must say that a forthright discussion that is based on a forthright opinion piece like this one is "...exactly what the government needs." Sadly, I doubt that is happening or is likely to happen.
The GOP would go along with these tweeks to COLA since they are "tax increases" on the poor and lower middle class who rely most on SS.
ReplyDeleteA COLA-cut exemption to certain programs for which the upper middle class and rich benefit most could be included.
My question is why would the Democrat agree... but then, they have no spine so of course they would agree...
Great thinking Bruce. It is very hard to see any other outcome. Unemployment have to be solved, otherwise Obama will be at one turn president. It will have worldwide implications for the economy of the whole world. Nowhere to hide!
ReplyDelete"Republicans have drawn a line in the sand on the debt limit with their position of “No New Taxes”. The Democrats have said pretty much the opposite with, “No spending cuts”."
ReplyDeleteBang on about the Republicans, the Democrats, not so much. The Dems know that the US has a spending problem. But they don't think this is the only piece of the puzzle (and they are right - a cursory glance at a chart of tax revenue as a % of GDP over the last 100 years is all you need).
Nonetheless, those Republican ideologues are so unwilling to compromise that I don't see a deal getting done before the 11th hour (and a lot of rate volatilty). To watch somebody grandstand with such a toxic combination self-assurance and ignorance is truly worrying.
Just when Republicans found the courage to say spending cuts, you write them off.
ReplyDeleteThe political class is still peddling the self-serving "austerity" bloody shirt,but not all of us are fooled. Get rid of one federal employee who produces nothing but headaches for the rest of us; the same money left in capital markets generates TWO jobs and real wealth. This is the opposite of austerity.
The US has had a fundamental shift. Jobs have disappeared. They aren't coming back.
ReplyDeleteWhat's the biggest investment most people make in their lifetime ? A home. Nearly everything else flows from that. Houses drive the economy, like it or not. But as the GFC showed us you cannot sell houses to people without a job.
So until you can address the problem of how to fix an unemployment rate of 20% you cannot fix the housing problem and you cannot fix your economy.
Have you guys never played Monopoly ?
From an engineering viewpoint the only other solution is to rid yourself of excessive people.
What a mess. I have been watching this since around 1995. This was when the US balance of trade went negative to the tune of 600 million per annum. The Us became a net debtor as opposed to a net creditor nation. The structural problem began. The US has been living beyond it's means since then.
ReplyDeleteApart from anything else, the major wars have added trillions to the problem of vast military expenditures.
The structural problems are added to by the progressive loss of manufacturing and other basic wealth producing jobs. There is less wiggle room with taxes and cuts. The can has been kicked down the road as far as it can go. Now the time has arrived to pay the piper. Whether by the methods mentioned in this article or not. Now the tottering structure is creaking on the point of collapse. These may only be a part of what is necessary.
Has anybody out there read Michael Grant's The Climax of Rome, chapter 3? Rome did exactly the same thing during the fourth century. It devalued the coinage from 100% to .5% to finance military adventures. The military was given priority overr everything. In our case it is the banksters too, who get huge bonuses for destroying the world economy. Oh, by the way, here is something you didn't learn in history class. After Rome fell, within a relatively brief period of time Persia, the Gupta Empire of India, China (conquered by the Mongols) and the Arabic culture (which was one of the most progressive cultures of the time) collapsed - economically, politically and socially. Know what followed? THE MIDDLE AGES over this entire area. China did not emerge from its middle age until Deng Shao Ping took over after Mao's death, and the Arabic countries are just now trying to emerge from theirs. So what happened to the Byzantine Empire? When they saw things were getting bad, they switched back to the gold standard, and they survived until conquered by the Turks in 1450, which whisked them right into the middle ages. By that time the West was beginning to recover.
ReplyDeleteNOW, TELL ME HISTORY IS IRRELEVANT!!!!!! (It is, the way the college profs di it. You gotta get in there and dig it out for yourself. Remember, PROFESSors can only PROFESS to know anything, but often they don't. (Voice of experience)
Has anybody out there read Michael Grant's The Climax of Rome, chapter 3? Rome did exactly the same thing during the fourth century. It devalued the coinage from 100% to .5% to finance military adventures. The military was given priority over everything. In our case it is the banksters too, who get huge bonuses for destroying the world economy. We are not far behind Rome at 4%. Check the figures. Since 1920 the dollar has lost 96% of its purchasing power.
ReplyDeleteOh, by the way, here is something you didn't learn in history class. After Rome fell, within a relatively brief period of time Persia, the Gupta Empire of India, China (conquered by the Mongols) and the Arabic culture (which was one of the most progressive cultures of the time) collapsed - economically, politically and socially. Know what followed? THE MIDDLE AGES over this entire area. China did not emerge from its middle age until Deng Shao Ping took over after Mao's death, and the Arabic countries are just now trying to emerge from theirs. So what happened to the Byzantine Empire? When they saw things were getting bad, they switched back to the gold standard, and they survived until conquered by the Turks in 1450, which whisked them right into the middle ages. By that time the West was beginning to recover.
NOW, TELL ME HISTORY IS IRRELEVANT!!!!!! (It is, the way the college profs teach it. You gotta get in there and dig it out for yourself. Remember, PROFESSors can only PROFESS to know anything, but often they don't. (Voice of experience)
S.I. Fishgal wrote in "KOSHER HOOKS" (http://stores.lulu.com/fishgal):
ReplyDelete"...Amerikakers believe to and cram all, but understand zilch. The unabated consumerisms, incompetence, currency debasing and keeping up appearances indebt their offspring, enrich their enemies and turn capitalism to kaput-alism. Amerikakers (In case that Russian, Yiddish or German languages are not your forte, kaka and kaker mean feces and its appropriate derivative.) are above Marx’s and Lenin’s teaching that such deeds ruined even Rome and will the US Empire of debt and “useful idiots” (Lenin’s term). They do not own their useless stuff. It owns them and is not loaded on a hearse anymore. It was quite liberating not to keep up appearances during the American Revolution. Then the troops lined worthless bills called shinplasters in the knee-length boots.
Amerikakers convert the capitalist society to the capital-less and vote for the like corrupted nobodies, bigots, cranks, hustlers and pulpit artists franchising race or faith into a fat living and political career. For the world revolution, Lenin, Trotsky, and, for the corrupted democracy, some US presidents ruined countries regardless of the people acceptance.
Since US universities develop one’s entire abilities, especially the idiocy, the educated idiots are most dangerous. An economist (let leave him nameless for his own sake) became a Nobel laureate for his mathematical exercises on options, applied that in his hedge fund and did not ruin the entire financial system just by accident. Of course, Sir Isaac Newton failed to gauge “the madness of the crowd” (his term) too, but he ruined fiscally only self and became famous not just for that.
God bless and help America, the country of best brightest politicians (i.e. masterly liars), incompetents, useful idiots, and great opportunities, especially for fraud! Welcome to Amerikaka, Comrades!
Amen!"
Even if some miracle happen and we get out of this mess the other BIG ONE will appear:
ReplyDeleteINFRASTRUCTURE...
Good luck.
I will put my money on the Communist getting their way ...someway somehow.
ReplyDeleteSpineless BONER will appease the Kenyan Bitch....and they will come out smiling to the ignorant public
When you’re doing what you’re supposed to be doing, it rests softly inside your being with no judgment, no guilt & no imbalance. You KNOW!
ReplyDeleteWhen you’re doing what you’re supposed to be doing, it rests softly inside your being with no judgment, no guilt & no imbalance. You KNOW!
ReplyDeleteThere is only one way out of this mess. Grow the economy, cut national spending, and pay off the debt. The big problem is how to grow the economy. The simple answer is increase potential profits to business. Start by doing away with corporate taxes and income taxes. Shift to a national sales tax. That way every player in our US market has to pay for government services, that means China and others. The tax shift has to have some permanency to encourage enterprise. As to cuts how about a 10% across the board cut for all government agencies, yes Social Security, Medicare, Medicaid, Defense government health and retirement programs etc. If and when things get back on an even keel adjustments can be reviewed. Most all solutions I see try to find solutions at someone else's expense.
ReplyDeletelike the tax and cut ideas.drawbacks?
ReplyDeleteVery well stated Anonymous June 28, 2011 6:09 PM.
ReplyDeleteDelighted by your perspective.
Come on, people! Raise the debt ceiling AGAIN and get back to work --then pretty soon we will be back needing to raise the new debt ceiling and so on --no one is serious about saving this Country for our kids sakes --it is all me, me, me, now, now, now, let someone else pay more tax, but not me!!! It's all about our refusing to face reality or move back to reality and keep spending our kids futures on ourselves and who cares about them, anyway!!!!! What a bunch of rotten adults we have today in this Country! I bet our Founding Fathers, if looking in here, wonder why they bothered to risk lives and sacred honors for this bunch!
ReplyDeletecome on: all we have is a GOD problem - the way up for all is down on your knees!!!
ReplyDelete