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The Inflation Risk:

One issue that people have kicked around a bit is the risk of inflation embedded in the current fiscal and monetary policy being used to fight the recession and credit squeeze.

With respect to fiscal policy, the concern is probabilistic--will it be possible to fund the massive budget deficits, and now creation and expansion of new government policies, without at some point resorting to monetizing the debt. It is hard to see how, especially if heavier regulation and slower-growth policies are adopted.

Perhaps less-known but more frightening is the incredible growth in the money supply over the past year or so. I first found out about this a few weeks ago in this post by Peter Robinson which links to this extraordinary graph from the St. Louis Fed. Note the 2009 figures (and below the chart you can click on it to see different benchmark comparisons).

Why has this incredible boost in the money supply had no impact? Presumably because the "velocity" of money has remained low--people and banks are hoarding money, rather than spending, borrowing, and lending it. Assuming velocity rises again, however, we may be looking at an inflationary spiral like we've never seen before in this country.

Peter says it well, "We've Never Been Here Before."

lonetown (mail):
More rightly called the inflation certainty.
3.2.2009 11:22am
Linda F (mail) (www):
Yeah, that was the intent. To take money from those that have it, and give it to the spend-happy, the young, and the never-had-its.

Just like the old days. In Sherwood Forest.

Obama - the New, Improved Robin Hood.
3.2.2009 11:36am
Sarcastro (www):
lonetown sure does know his social science!
3.2.2009 11:37am
Sammy Finkelman (mail):
The real reason there has been no inflstion is that inflstion is not caused by an increase in the money, but ratehr the reverse, inflation causes an increase in the money supply. You can very well have inflastion without an increase in the money supply. To take the striongest example, in 1923 in Germany, the printers went on strike and theer was no money - but that didn't stop inflation (which was caused by the decline of the value of the mark in foreign exchange trading. You could aoso say there that even then it was already bank accounts)

Others would say this is not causing inflation because there is more supply than is being bought. The problem with that answser is that supply adjusts to demand - in both directions.
3.2.2009 11:39am
pireader (mail):
The money supply expanded because the Federal Reserve injected more funds. Fpr obvious reasons, people want to hold ("hoard") money right now and the Fed is giving them enough money stock to do so. The alternative would be catastrophic deflation.

When the crisis eases and people are less-inclined to hoard money, then the Fed can put the machine into reverse, gradually sucking money out of the system.

Is there some reason that you believe the Fed won't (or can't) do the latter as easily as the former?
3.2.2009 11:44am
Pro Natura (mail):
The analogies between the Nixon-Ford-Carter years and the Bush-Obama years are striking enough that I'm surprised no one has yet editorialized about them. The end result of the Nixon-Ford-Carter years was an annual inflation rate and an unemployment rate that added together exceeded twenty percent and an economy that some thought would never recover. Reagan saved us. I expect that by the end of Obama's first four years what Reagan called the misery index may beat the Carter record. At that point the country may be beyond salvation.
3.2.2009 11:45am
A. Zarkov (mail):
pireader:

"Is there some reason that you believe the Fed won't (or can't) do the latter as easily as the former?"

You bet there is. Go look at the Fed's balance sheet. It has been sucking massive amounts of junk. In a few months the balance sheet increased by a factor of 40 or 80 depending on whether you look at the weekly or monthly series.

Holding so much junk means the Fed has put a ratchet in the printing press. It won't run backward, or won't run backward at any kind rapid rate. There's a good reason the Fed won't reveal what it's buying and who it's buying from. The usual excuse won't wash.
3.2.2009 11:52am
Joseph Slater (mail):
It's like that great economist, Michael Steele said on Fox the other day: "But, you know, this new spend is just an amazing amount of cash, and the inflationary effect, the deflationary effect, all of those things are going to come to head at some point, Neil."

So yeah, it will be inflation or deflation, but the point is it will be something really bad, right?

And I love the idea of referring to "the Bush-Obama" years, not just because they are so incredibly different, but because this line was used when there haven't even been two whole "Obama months" yet.
3.2.2009 11:57am
Some Dude:
From what I understand, what has increased is actual paper money while M2 has not yet spiked upwards. What would be really cool would be if, once the economy gets humming along again, the Fed raised reserve requirements. The effect would be that M0 would be a larger percentage of M2 but M2 not increasing more than your normal currency devaluation.

The Fed won't do that of course.

Shut down the Fed!
3.2.2009 12:00pm
expat lumberjack (mail):
The last datapoints on that graph:

2008-09-01 36.138
2008-10-01 1135.820
2008-11-01 1481.943
2008-12-01 1692.511
2009-01-01 1735.316

But it's still all Obama's fault, I'm sure. Somehow.
3.2.2009 12:04pm
von Neumann (mail):
The problem of monetary velocity seems to me to be a result of the collapse of the CDO and CMO market and the all too late discovery that the rating agencies were shills of the issuers. It used to be that masters of the universe could place massive amounts of funds before lunch just by looking at the rating and determining the risk allocation based on that rating. Since no one believes the agencies any more, it takes individual thought, which is time consuming and slow.

We need a replacement for CMOs and CDOs in order to create more velocity. I think the issuance of new, quick, small bank certifications might be in order. Why can't the government protect investor deposits only up to $25 k or $50 k? And why can't these banks specialize i making loans to small business. Sometimes when the pipes are broke, you need new pipes.
3.2.2009 12:07pm
A. Zarkov (mail):
I recommend reading The Roving Cavaliers of Credit by Steve Keen. Put aside a good block of time because this is a long one. Keen points out the M0 (base money) is reactive to increases in M2 and M3. In other words the Fed reacts to the credit markets, it doesn't drive them.

On a lighter note, be sure to watch the video F**K the Fed. Great stuff.
3.2.2009 12:14pm
Strict:
And stocks are going down again - because of Obama.

Not because, like I said last week, that AIG would announce massive losses and the markets would respond negatively to such news.

It's too bad AIG is "too big to fail," but if a company with $1+ trillion in assets goes under, we'd see the DJ hit 4,000 in no time...
3.2.2009 12:18pm
pireader (mail):
A Zarkov wrote -- "Go look at the Fed's balance sheet. It has been sucking massive amounts of junk ... Holding so much junk means the Fed has put a ratchet in the printing press. It won't run backward, or won't run backward at any kind rapid rate."

You're right that the Fed is buying lots of non-traditional assets. That's how they're accomodating the public's desire to hoard money ... it's the key role of a central bank in times like these.

But I'm not sure why you say "it won't run backward". Some day--hopefully soon--when conditions improve and the public's desire to hoard eases, the Fed can sell assets just as easily as it's buying them today. Or they raise the reserve requirements--as Some Dude suggested above. Either way, they'll suck money out of the economy. Which was my point.
3.2.2009 12:22pm
PC:
And stocks are going down again - because of Obama.

Obama is so incompetent he forced HSBC to halt trading of their shares.
3.2.2009 12:23pm
frankcross (mail):
I think one big point is being missed in the looking forward. How bad would things be today if this had not happened?
3.2.2009 12:27pm
A. Zarkov (mail):
pireader:

"You're right that the Fed is buying lots of non-traditional assets. That's how they're accomodating the public's desire to hoard money ... it's the key role of a central bank in times like these."


"Non-traditional" is another word for junk. The Fed has never before bought what might be worthless assets. If it's only a matter of trying to compensate for money hoarding, then fiscal policy will do that better. In effect the Fed is replacing worthless or at least depreciated assets with base money-- the most liquid form of money-- the real thing so to speak. Or to put it another way, the Fed can't cure an insolvency by printing money. One way or another the insolvency exists. When it comes time to sell who will buy those depreciated assets at full value? No one. That why the printing press is not going to run backwards when we need it to.
3.2.2009 12:32pm
Strict:

Obama is so incompetent he forced HSBC to halt trading of their shares.


Lol. Yeah, and Obama forced HSBC to request the Hong Kong market to halt trading HSBC shares.

And Obama forced HSBC to halt all personal loans to US citizens and mortgages in the US.

HSBC just announced disastrous quarterly results. No doubt because of Obama.
3.2.2009 12:32pm
a grouch:
Why are you equating monetary base and momney supply? Monetary base is a pretty terrible measure of the money supply and leads to pretty erroneous conclusions when you have weird situations like the one we are in.

You should look at a much broader measure of the money supply, like M2. Your conclusions would not be as drastic if you used a more reasonable measure.
3.2.2009 12:43pm
pireader (mail):
A Zarkov wrote --"When it comes time to sell who will buy those depreciated assets at full value? No one. That why the printing press is not going to run backwards when we need it to."

Of course, the assets may sell at depreciated prices ... nonetheless, the Fed can sell them at some price and suck money out of the private sector. Or sell Treasury notes (bonds). Or raise bank reserve requirements. In the extreme, the Treasury could print more notes and sell them. Through any or all those means, the Federal government can certainly draw down the supply of money.
3.2.2009 12:44pm
Soronel Haetir (mail):

I think one big point is being missed in the looking forward. How bad would things be today if this had not happened?



The difference would be that the path ahead would be clear, people would know who was in good shape and who was going to the cleaners. The policies we've got going right now are just perpetuating the hurt and making the final collapse all the worse.
3.2.2009 12:45pm
AlanW (mail):
"Reagan saved us."

Um, no. Paul Volcker saved us, although it took a nasty recession to do so. To Reagan's credit, he let the economy take its lumps and work through it.
3.2.2009 12:50pm
A. Zarkov (mail):
"Why are you equating monetary base and momney supply?"

We need to distinguish between credit money and base money. Markets create credit money. If you lend me $1,000 we have created credit money. But if my checking account gets a credit, yours get a debit, so the amount base money is unaffected. Only the Fed can create and destroy base money with its magic checkbook. That's why its important to look at base money. Of course that's not the only thing you look at.

Anyone who has studied the creation and history of the Fed, basically a private organization of member banks can't help but be suspicious.

Recommended Reading.

*The Case Against the Fed, Murray Rothbard
A History of the Federal Reserve, Melzer
*The Creature from Jeykll Island, Griffin
The Assent of Money, Ferguson
Financial Markets and Institutions (6th Edition), Miskin

*= Available online for free.
3.2.2009 12:59pm
PC:
Um, no. Paul Volcker saved us, although it took a nasty recession to do so. To Reagan's credit, he let the economy take its lumps and work through it.

Obama needs to dump TurboTimmy and put Volcker in charge. This lumbering along, injecting cash into insolvent companies is just going to prolong the pain.
3.2.2009 1:08pm
A. Zarkov (mail):
pireader:

"Of course, the assets may sell at depreciated prices ... nonetheless, the Fed can sell them at some price and suck money out of the private sector..."

It can but that still leaves excess money created to buy the assets at full value in the first place. If the Fed buys a $100 million CDO from a bank at face value and later sells it for $10 million, that still leaves $90 million of base money in the economy.

"In the extreme, the Treasury could print more notes and sell them."

That still leaves M0 unchanged. The buyers of the notes get their accounts debited, but now the Treasury has a credit. What do you think politicians do with Treasury money-- burn it?

Of course the Fed can sell high quality government paper it carries on its balance sheet and un-create money. But if it doesn't have enough high quality stuff to offset the junk, it won't be able to rein in inflation.

I would remind you that other countries with Central Banks have suffered extreme inflation. The US suffered inflation in the 1970s. The Central Bank cannot in itself make a country wealthy by printing money. Otherwise Zimbabe would be a rich country.
3.2.2009 1:12pm
guy in the veal calf office (mail) (www):
And I love the idea of referring to "the Bush-Obama" years, not just because they are so incredibly different, but because this line was used when there haven't even been two whole "Obama months" yet.

In 8 years, Bush budgets featured $1.5 trillion aggregate deficits. Obama is 2/3ds of the way there in two whole months, and promising more (expanding welfare, universal coverage and the "regulatory" taxes that make life more expensive. Its fair to call it Bush-Obama era, just like the Hoover-FDR era, and the Nixon-Ford-Carter era.
3.2.2009 1:31pm
pireader (mail):
A Zarkov --"That still leaves M0 unchanged. The buyers of the notes get their accounts debited, but now the Treasury has a credit. What do you think politicians do with Treasury money-- burn it?"

The monetary effect of the Treasury selling a note is the same as the Fed selling an identical note -- to shrink the monetary supply (assuming that the selling agency impounds the proceeds). Generally, the Treasury sells notes to fund government operations, so they don't normally impound the proceeds; but there's no reason they can't do so to sop up money.

A Zarkov--"other countries with Central Banks have suffered extreme inflation. The US suffered inflation in the 1970s. The Central Bank cannot in itself make a country wealthy by printing money."

True enough, but a country without a central bank can suffer inflation too. It happened in the US during the Revolutionary War. And a central bank can do a hella job of impoverishing a country by not-printing money. That's more-or-less Milton's Friedman's version of what happened during the early 1930s, in the US and elsewhere.

BTW -- Must go off to a meeting soon. Thanks for the conversation
3.2.2009 1:41pm
TomHuff (mail):
Here's another chart -- also from the St. Louis fed -- which covers the last year and a half or so:

http://research.stlouisfed.org/publications/usfd/page3.pdf

Might be a bit more illustrative and meaningful than the one Robinson links to (which was a linear chart spanning the last 100 years).

Regardless, I think the biggest crisis is yet to come. As our economy weakens, I think it's inevitable that foreign central banks will start demanding higher interest payments to buy our treasuries.

This will put us in a quite a bind. We currently finance much of our debt with short-term treasuries, which makes our national debt somewhat akin to an adjustable-rate mortgage (we are constantly 'refinancing' our debt by selling more short-term treasuries to replace the ones that have matured). When interest rates on treasuries rise, our interest payments will suddenly become a very significant portion of GDP -- much more than we can collect in taxes. Unfortunately, I think we'll have no choice but to monetize (i.e. print) the difference, which will have a devastating effect on the value of our dollar.

I, for one, am gradually getting rid of almost all of my exposure to US dollars.
3.2.2009 1:45pm
ef (mail):
And I love the idea of referring to "the Bush-Obama" years, not just because they are so incredibly different,

The idea that their policies are at odds because their party affiliation is different is plainly false. Bush was no fiscal conservative, free-market, capitalist. The shame of this is that Obama continuously hammers on the "last 8 years of failed policies" line as an argument for adopting his ideas, but the new economic policies differ from the "failed" ones, not in direction, but degree.
3.2.2009 1:51pm
Dilan Esper (mail) (www):
Nobody should care about inflation in the middle of a recession. When choosing between no jobs and higher prices, I'll take higher prices any day of the year. We can always impose contractionary measures later to control inflation.
3.2.2009 2:06pm
Strict:

The idea that their policies are at odds because their party affiliation is different is plainly false.


This must be a joke. There are some big differences

Take taxation:

1. Obama wants to expand the business loss carry-backs, so businesses with current losses will be able to apply them against past profits - meaning that the business' now are considered to have overpaid taxes on those past profits, so they become eligible for a tax refund.

2. Obama wants to increase the tax rate on capital gains and dividends from 15% to 20%.

3. Obama wants to tax hedge fund managers at ordinary rates instead of capital gains rates.

4. Obama wants to increase the top income rates for high earners.

5. Obama wants to decrease the income tax rates for lower earners.
——————————-

There is a new Capital Assistance Program. You can read about it here and here.

etc. etc.

Some things stay the same, some things change...
3.2.2009 2:13pm
Thales (mail) (www):
"The idea that their policies are at odds because their party affiliation is different is plainly false. Bush was no fiscal conservative, free-market, capitalist. The shame of this is that Obama continuously hammers on the "last 8 years of failed policies" line as an argument for adopting his ideas, but the new economic policies differ from the "failed" ones, not in direction, but degree."

I think the difference is that Obama wants to actually pay for the things we spend money on with taxes rather than issuing more debt (long term, post recovery, obviously) and restore PAYG budgeting, whereas Bush and the Congressional Republicans from 2001-2008 completely discarded that idea, lowering taxes and at the same time raising spending.

Being a fiscal conservative or deficit hawk has no necessary connection to how regulated one wants the market to be or how much and on what the government should spend. That said, the professed connection between GOP libertarian(ish) market ideals and fiscal prudence has been blown out of the water by the actual behavior of the GOP. If they have now lately found their fiscal backbone, forgive me if I simply laugh and instead look to Obama to responsibly refine his plans so that we can and do pay for them.
3.2.2009 2:21pm
Allan Walstad (mail):

We can always impose contractionary measures later to control inflation.

Sure--and bring back the recession. Inflationary policies beget more inflationary policies, because as soon as the money-gusher slows down, all the capital projects that could only survive on easy money have to be liquidated. Why should we set ourselves up to have to go through another massive recession in order to get the economy back onto a sustainable track? The "stimulus" is roughly parallel to curing the sick by bleeding them. It's mostly quackery. Government meddling in the economy is what caused the meltdown, and more government meddling is not going to fix things.
3.2.2009 2:21pm
LN (mail):
Everyone knows that the Great Depression ended when World War II happened and the private sector really took over. Really, it's just common sense.
3.2.2009 2:25pm
CC1 (mail):
Excuse my ignorance of Economics, but I went to site Federal Reserve site and looked at the current "Money Stock Measures"

http://www.federalreserve.gov/releases/h6/current/

Based on this data, neither M1 nor M2 have appreciated astronomically. In fact, in January, M1 decreased.

How does this fit in with the St. Louis data?
3.2.2009 2:41pm
A. Zarkov (mail):
pireader:

"The monetary effect of the Treasury selling a note is the same as the Fed selling an identical note -- to shrink the monetary supply (assuming that the selling agency impounds the proceeds)."

"... assuming that the selling agency impounds the proceeds.." is the key phrase here. If people converted their checking accounts cash and buried the money that would work too. Do you really think the Obama Treasury is ever going to impound the money in its accounts?
3.2.2009 2:46pm
guy in the veal calf office (mail) (www):
Here is a pretty good look at these matters. Good reading.
3.2.2009 2:54pm
guy in the veal calf office (mail) (www):
Obama wants to decrease the income tax rates for lower earners.

Not true, he wants to continue the Bush tax cut on all but the 2 highest marginal rates. So he agrees with the Bush tax cuts, except for 2 of the rate changes.

Also, President Obama's second act was to raise taxes on the poor so the wealthier could access the SCHIP program; a tax on tabacco is a tax on the poor because its regressive and because the poor use tabacco at higher rates than the wealthy.
3.2.2009 3:01pm
Joseph Slater (mail):
Guy in the veal calf office:

Yeah, why wait to see how things work out under Obama?

And by the way, I don't think many people talk about the "Hoover-FDR era" of economic policy as if it were one thing.
3.2.2009 3:03pm
Dilan Esper (mail) (www):
Inflationary policies beget more inflationary policies

People who are obssessed with the gold standard and taking away power from the Fed always say this, but it isn't true. Most of the time, inflation is an easily controllable aspect of the economic system. It is true that the type of profligate spending in excess of capacity through devaluation of the currency that has occurred in some third world countries can lead to hyperinflation, but the deficit would need to be several orders of magnitude higher (i.e., tens or hundreds of trillions of dollars) for that to be an issue.
3.2.2009 3:06pm
Thales (mail) (www):
"Also, President Obama's second act was to raise taxes on the poor so the wealthier could access the SCHIP program; a tax on tabacco is a tax on the poor because its regressive and because the poor use tabacco at higher rates than the wealthy."

Hmm. No, it's a tax on the consumption of tobacco, whose consumers are disproportionately poor. Do you want to defend the "so the wealthier could access the SCHIP program" part of your assertion?
3.2.2009 3:07pm
A. Zarkov (mail):
"... true that the type of profligate spending in excess of capacity through devaluation of the currency that has occurred in some third world countries can lead to hyperinflation, but the deficit would need to be several orders of magnitude higher..."

Let's say the velocity of money stays constant, and M0 doubles (which it has done), then explain why this would not lead to inflation. Where does your order of magnitude theory of inflation come from? I have never heard anyone else assert that we would need to have hundreds of trillions of dollars as a budget deficit to cause inflation. Suppose the deficit (not the total national debt) were $20 trillion. Where would the money come from to finance such a debt as it exceeds all the tax revenues and borrowing capacity?

There is another problem. Approximately 70% of M0 circulates abroad. If for some reason foreigners decided to dump their dollars, then even a constant M0 could lead to inflation.

It seems to me that you are in denial about the danger of inflation. Germany, Hungary, Yugoslavia, Israel, Argentina etc have all experienced very severe inflation. Tell me why you think the US is immune where all these other countries weren't. Exactly how are we different?
3.2.2009 3:47pm
Strict:

Also, President Obama's second act was to raise taxes on the poor so the wealthier could access the SCHIP program; a tax on tabacco is a tax on the poor because its regressive and because the poor use tabacco at higher rates than the wealthy.


If raising income taxes is going to make people quit their jobs or drop to part time, wouldn't raising taxes on tobacco cause people to quit smoking or smoke less?

Sounds like a win-win: more money for the government, yet less smoking (and less costs caused by smoking-related illnesses.)

By "the wealthier," you are referring to CHILDREN WITHOUT HEALTH INSURANCE. I love this - people with a $300k annual income aren't "rich," but children without health insurance are the "wealthy."
3.2.2009 3:57pm
Dilan Esper (mail) (www):
Let's say the velocity of money stays constant, and M0 doubles (which it has done), then explain why this would not lead to inflation. Where does your order of magnitude theory of inflation come from? I have never heard anyone else assert that we would need to have hundreds of trillions of dollars as a budget deficit to cause inflation. Suppose the deficit (not the total national debt) were $20 trillion. Where would the money come from to finance such a debt as it exceeds all the tax revenues and borrowing capacity?

We've run huge deficits before in this country. They did not lead to hyperinflation.

The hyperinflation of Brazil, Argentina, etc., was caused by government spending financed by simple currency devaluation and debt default (i.e., "printing money"). We are not doing that-- we still have creditors and we still intend to pay every dollar we borrow.

If hyperinflationary spirals were so common and simply caused by moderate short-term deficit spending, we'd see them all the time. But we don't. The vast, vast majority of inflation never leads to hyperinflation. It's a nonexistent concern. And certainly not a reason to stop government spending that will put people to work.
3.2.2009 4:12pm
A. Zarkov (mail):
Dilan Esper:

Except for periods of war, the US has never run deficits anything like we face now. Not only that, total debt both public and private is at an all time high, more than 4 times GDP. Moreover, we are printing money, tons of it. Go to FRED and look at the graphs of base money. It more than doubled in two months. It has never done that before in the entire history of the Fed.
3.2.2009 4:19pm
PC:
It seems to me that you are in denial about the danger of inflation. Germany, Hungary, Yugoslavia, Israel, Argentina etc have all experienced very severe inflation. Tell me why you think the US is immune where all these other countries weren't. Exactly how are we different?

None of those countries acted as the reserve currency for the world. Right now the US dollar is the worst currency to be in, except every other currency.

I agree that there is a danger of inflation, but we are experiencing deflation right now which is a lot more dangerous and more immediate.
3.2.2009 4:32pm
Dilan Esper (mail) (www):
Go to FRED and look at the graphs of base money. It more than doubled in two months. It has never done that before in the entire history of the Fed.

And if base money meant anything, you'd have a point.

Seriously, this whining about inflation is worse than pernicious. We have 99 problems and inflation ain't one. Every time we expand the money supply for any reason, the gold standard and anti-Fed obsessives predict hyperinflation. And it never happens. Why? Because we aren't a third world country that defaults on its national debt after running it up paying for programs that are well beyond the nation's productive capacities. Rather, we are a wealthy country that can experience short term inflation but, thanks to our great Central Banking system and the willingness of other nations to see us as a reliable investment and an outstanding credit risk, doesn't really have to worry about inflationary spirals.

Further, the result of this worrying about inflation is to put people out of work. Period. If you and Prof. Zywicki got your way, we'd have bread lines and soup kitchens again. But at least prices wouldn't be going up.

There's going to be some inflation while we recover. We'll get it under control later. The United States correctly rejects libertarian economics. Deal with it.
3.2.2009 4:37pm
Splunge:
Most of the time, inflation is an easily controllable aspect of the economic system.

You know, I stopped reading everything you said after this line, which established beyond cavil that either (1) you're a clueless bullshitter, or (2) you never lived through -- nor studied -- the early 80s.
3.2.2009 4:54pm
William - liberalmorality (mail) (www):
Everyone knows that the Great Depression ended when World War II happened and the private sector really took over. Really, it's just common sense.

Robert Higgs has demonstrated quite convincingly that only the latter part of your statement is true—prosperity didn't return to the US until 1946, when government spending dramatically declined after the end of WWII. People who argue that World War II stimulated the economy fall prey to Bastiat's Broken Window Fallacy.
3.2.2009 4:59pm
A. Zarkov (mail):
"And if base money meant anything, you'd have a point."

If you can say that, then the conversation is hopeless. I can't deal with faith-based economic reasoning. I guess the FRED tracks base money for the fun of doing graphs.
3.2.2009 5:09pm
PC:
I don't know from eldritch tongues, but I'm not sure that's such a good idea.

Given the reasons behind ending the tracking of M3 you might not be too far off.
3.2.2009 5:18pm
Strict:

And stocks are going down again - because of Obama.

Not because, like I said last week, that AIG would announce massive losses and the markets would respond negatively to such news.

It's too bad AIG is "too big to fail," but if a company with $1+ trillion in assets goes under, we'd see the DJ hit 4,000 in no time...


Actually, I take this all back. The stocks didn't drop because of AIG. They dropped because Obama nominated Kathleen Sebelius to Secretary of HHS. She's a lady, and a legacy/limousine liberal. She's like the Kathleen Kennedy of Kansas.
3.2.2009 5:22pm
Steve H (mail):

In 8 years, Bush budgets featured $1.5 trillion aggregate deficits.


Do you have the stats to back this up?

According to the Treasury Dept, the debt for FY 2008 (ending September 2008) was $455 billion.

For your statement to be correct, that would mean that the deficit for the other seven years of the Bush Presidency averaged less than $150 billion per year. This doesn't sound right to me.

(Or are you using "Bush budgets" to highlight the dishonesty of never including the AMT fix and the Iraq-Afghanistan wars in the annual budgets?)
3.2.2009 5:29pm
Steve H (mail):
To follow up, Wikipedia (always accurate, of course) says that as of September 28, 2001, the US public debt was $5.8 trillion.

Seven years later (September 30, 2008), it was $10.0 trillion.

That's $4.2 trillion dollars over 7 years, or average deficits of $600 billion per year.

(If I am missing something here regarding the translation between budget deficits and public debt, someone please correct me.)
3.2.2009 5:35pm
PC:
Actually, I take this all back. The stocks didn't drop because of AIG. They dropped because Obama nominated Kathleen Sebelius to Secretary of HHS. She's a lady, and a legacy/limousine liberal. She's like the Kathleen Kennedy of Kansas.

I thought it was because CPAC was over and the markets are depressed because of it.
3.2.2009 5:42pm
A. Zarkov (mail):
Some readers here might find this crash course in inflation informative or at least entertaining. A lot of people seem to believe that fiat money is necessary for prosperity. Yet the US had centuries of sustained economic growth without fiat money or even a central bank. To mask the inflation effects from monetary policy over the last 30 years, the BLS has revised their method for calculating the CPI twice. To compare the old with the revised CPI see this graph. I have spoken with statisticians over at BLS, and they won't give me the unrevised series for CPI. This is pretty suspicious as far as I'm concerned. How does one study long term economic trends without using the same method for the whole series?
3.2.2009 5:45pm
Strict:

A lot of people seem to believe that fiat money is necessary for prosperity. Yet the US had centuries of sustained economic growth without fiat money or even a central bank.


Lol. And the US had years of prosperity and sustained economic growth with slavery, too!

"I want to assure you that in making this change from the 18th century we have no idea of returning to it. We are going to keep our eyes on the stars and our feet on the ground."
LBJ, concluding remarks upon signing the Coinage Act of 1965.

Since we're not going back, it's probably a good idea to engage with reality instead.
3.2.2009 6:14pm
Dilan Esper (mail) (www):
You know, I stopped reading everything you said after this line, which established beyond cavil that either (1) you're a clueless bullshitter, or (2) you never lived through -- nor studied -- the early 80s.

Splunge, the early '80's certainly featured double digit inflation, but they didn't feature hyperinflation (despite the fact that every anti-Fed goldbug, economic libertarian, and Friedman acolyte was going around predicting that it was right around the corner). Indeed, the early '80's prove my point-- the Fed decided eventually that a contraction was needed, we contracted and had a recession, and then we had 6 years of low inflation economic growth.

In other words, if we feel we need to control the inflation rate, we will be able to. It's just pretty unimportant right now.
3.2.2009 6:20pm
Dilan Esper (mail) (www):
If you can say that, then the conversation is hopeless. I can't deal with faith-based economic reasoning. I guess the FRED tracks base money for the fun of doing graphs.

The size of the money supply (including base money, M2, and other measures) is tracked by the Fed because the Fed needs to know how to set its targets to achieve its twin goals of full employment and low inflation.

That doesn't, however, mean that an increase in base money is actually some sort of indicator of economic catastrophe. Money supplies, after all, should expand. Moderate inflation is absolutely necessary for the economy over the long term.
3.2.2009 6:22pm
Dilan Esper (mail) (www):
Yet the US had centuries of sustained economic growth without fiat money or even a central bank.

We've only been around for just over 2 centuries, and for most of one and part of the other we had a central bank.

That said, we had deeper, longer, more severe panics (that's what they called them in those days) when we didn't have fiat money. Fiat money is absolutely necessary to avoid deflation and ensure that the velocity of money doesn't slow down. Without it, people will hoard, because their money is more valuable tommorrow than it is today, and the result is periodic panics.

As I said, though, this really doesn't matter. In the end, no important economic policymaker is going to adopt the discredited ideas of a few cranks on the internet on a matter as important as monetary policy. So sputter on about the evils of fiat money all you want. You'll still have federal reserve notes in your wallet for a long time to come.
3.2.2009 6:26pm
Perseus (mail):
Is there some reason that you believe the Fed won't (or can't) do the latter as easily as the former?

In order for the Fed to contract the money supply, it will have to sell public securities. But if the federal government has huge deficits that it's trying to finance (by also selling public securities), the Fed's job will be much more difficult. The job will be more difficult still to the extent that the dollar becomes relatively less attractive and if Americans do not save a lot more (e.g., Japan can afford relatively large budget deficits because the Japanese save a lot).
3.2.2009 7:01pm
LN (mail):
The dollar has been rising against other currencies for most of the past 6 months, and the government is currently borrowing money virtually interest-free.

Hardly conclusive facts, but facts nonetheless.
3.2.2009 7:07pm
Strict:
In other news, the Republicans are pushing the Fair Tax Act, which calls for, among other things, the abolishment of estate taxes in the name of "fairness."

I love this jumping on the "Fairness" bandwagon! It's almost as funny as McCain jumping on the "Change" bandwagon.

Right now, the exclusion is $3.5 million. So you can inherit an estate worth up to $3.5 million completely tax free. If you inherit any more than that, you'll get taxed on that overage. That's so unfair!

Of course, each "Congressional Finding" on this issue refers to family farms. Even though the Revenue Code already allows a $800+k deduction from the value of family farms in computing estate taxes, in addition to the above-mentioned exclusions.

lol
3.2.2009 7:11pm
Perseus (mail):
The dollar has been rising against other currencies for most of the past 6 months, and the government is currently borrowing money virtually interest-free. Hardly conclusive facts, but facts nonetheless.

Time will tell how long that path is sustainable.
3.2.2009 7:14pm
A. Zarkov (mail):
Dilan Esper:

"The size of the money supply (including base money, M2, and other measures) is tracked by the Fed because the Fed needs to know how to set its targets to achieve its twin goals of full employment and low inflation."

In the 1970s and the early 1980s we had both high inflation and and high unemployment.

"That said, we had deeper, longer, more severe panics (that's what they called them in those days) when we didn't have fiat money."

We had panics, but they were shorted lived. We went off the internal gold standard in 1933 and onto a quasi-fiat money regime after 1933 and had almost a decade of depression.

"Without it, people will hoard, because their money is more valuable tommorrow than it is today, and the result is periodic panics."


Why do you need fiat money to maintain aggregate demand? If people go into a panic and hoard money, the federal government can borrow money by selling bills and bonds and spending it to maintain demand. Why is fiat money necessary to do this?

"You'll still have federal reserve notes in your wallet for a long time to come."

Only because I'm forced to, not because fiat money is wise. If we do have serious inflation, you will see people abandon US dollars for something else abroad.
3.2.2009 7:39pm
tsotha:
In order for the Fed to contract the money supply, it will have to sell public securities.

Or it can raise interest rates. The whole point of having a fractional reserve system is you can take money out of circulation as easily as you put it in. Every time a debt is incurred money is added to the system, and every time a debt is paid back money is destroyed.

The problem we've been having for almost a year now is sustained deflation, as companies and individuals are refusing to incur more debt. The problem with pumping up the base money supply is when people start borrowing again you can end up with (in theory) nine dollars in the economy for every additional base dollar. So the only way we're going to avoid big, big inflation when things turn around is to have crippling interest rates. Borrowing is going to get very, very expensive.
3.2.2009 7:45pm
jukeboxgrad (mail):
veal:

In 8 years, Bush budgets featured $1.5 trillion aggregate deficits.


As steve pointed out, your numbers are wacky. Under Bush, the national debt grew 86%, an increase of about $5 trillion. 77% of our national debt was accumulated under three presidents: Reagan, Bush and Bush. Under Reagan, the national debt almost tripled. The debt is now 11 times higher than it was when Reagan took over. Cheney told us "deficits don't matter." Obviously the GOP motto is 'do as I say, not as I do.'
3.2.2009 7:47pm
LN (mail):
Perseus wrote:

Time will tell how long that path is sustainable.


Sure. But it seems odd to get into a "sky is falling" mentality about the dollar when it seems that there has been a ridiculous amount of demand for lending money cheaply to the US government. People have been worrying about this stuff for a couple of decades now; oddly enough, when the financial crisis finally came, things got even more ridiculous. In other words, something is obviously missing from the "common-sense" analysis being proposed in this comment thread.

And of course a stronger or weaker dollar is not a good in and of itself.
3.2.2009 7:51pm
A. Zarkov (mail):
"That doesn't, however, mean that an increase in base money is actually some sort of indicator of economic catastrophe. Money supplies, after all, should expand. Moderate inflation is absolutely necessary for the economy over the long term."

We don't know that the recent increase in base money is harmless as there is no precedent in the history of the Fed for such a rapid and large build up in M0. I don't understand why you are so confident. Money supplies-- credit money-- can expand without fiat money, that's what fractional reserve banking is all about. As for mild inflation being necessary for an economy for the long term the historical data does not bear you out. We have 300 years of price data starting in 1665. We had price stability (except for war periods) and economic growth an prosperity for 200 years until the civil war. Then we returned to price stability. Thus we had economic growth for 250 years without fiat money and without inflation (except for war time). After WWII we lost price stability and have suffered persistent inflation ever since. In real dollars people's incomes are not much higher than they were 30 years ago. That's not prosperity.
3.2.2009 7:56pm
PC:
We had panics, but they were shorted lived.

lol wut

Only because I'm forced to, not because fiat money is wise. If we do have serious inflation, you will see people abandon US dollars for something else abroad.

The only non-fiat currency I'm aware of is the one the Arab nations are talking about starting. What currency are you thinking of?
3.2.2009 8:04pm
LN (mail):
Bush was no fiscal conservative, free-market, capitalist.


Ronald Reagan actually raised taxes at some point, and did little overall to curtail increasing government spending. But conservatives still love him, because he was still popular when he left office, unlike He Whom Must Not Be Named.
3.2.2009 8:47pm
Allan Walstad (mail):
Going over the recent posts, I'm struck once again by the common substitute for rational argument typically employed by fans of Leviathan: "The powers that be line up behind what I want and against what you want, so shut up." Well, I for one don't apologize for arguing issues on their merits. The present crisis results from government interference in the market economy and will not be cured by more such meddling. This is the lesson of sound economic worked out long ago. When government pumps money into the economy it stimulates investments that can't be maintained without the easy money. When the money pump slows down, the necessary painful sorting out process is called a "recession." The idea that the feds will bring prosperity by printing greenbacks as fast as they can or by going trillions deeper into debt is a pipe dream. Yet the market economy is so productive and resilient that it may nevertheless recover--for which political and economic quacks may be sure to take credit.
3.2.2009 8:52pm
A. Zarkov (mail):
PC:

From your link
Some commentators suggest that the depression actually lasted into the 1890s, and was a price depression, not a production depression. According to some economic historians, this was not really a Depression if production and GDP grew throughout the period (see table below).
One should also note that historians call the period from 1865 to 1900 the Gilded Age.
This period also witnessed the creation of a modern industrial economy. A national transportation and communication network was created, the corporation became the dominant form of business organization, and a managerial revolution transformed business operations. By the beginning of the twentieth century, per capita income and industrial production in the United States exceeded that of any other country except Britain.
Thus for the US the period of the so-called long depression was hardly one of economic stagnation.

"The only non-fiat currency I'm aware of is the one the Arab nations are talking about starting. What currency are you thinking of?"

If the world's fiat currencies should falter something will replace them. I suspect that individual countries will simply abandon their fiat currencies and issue new currencies with some kind of backing.
3.2.2009 9:11pm
Strict:

The only non-fiat currency I'm aware of is the one the Arab nations are talking about starting. What currency are you thinking of?


Come 2010, there will be a new pan-Arab currency on the foreign exchange market. [This currency will not be non-fiat. If it's attached to gold, it will only be nominally so.] And the Chinese yuan is becoming fully convertible. Will these two currencies replace the USD? We don't know how they'll do!

Obama's going to have a lot on his platter, huh?



The present crisis results from government interference in the market economy


Lol. Very astute. It results from the Obamination, no doubt.
3.2.2009 9:24pm
jukeboxgrad (mail):
ln:

Reagan actually raised taxes at some point


He raised taxes repeatedly. It's not clear that he initiated the increases, but he signed them into law. Bruce Bartlett:

Reagan may have resisted calls for tax increases, but he ultimately supported them. In 1982 alone, he signed into law not one but two major tax increases. … TEFRA alone raised taxes by almost 1 percent of the gross domestic product, making it the largest peacetime tax increase in American history. … In 1983, Reagan signed legislation raising the Social Security tax rate. … In 1984, Reagan signed another big tax increase in the Deficit Reduction Act. … The Consolidated Omnibus Budget Reconciliation Act of 1985 raised taxes yet again. Even the Tax Reform Act of 1986, which was designed to be revenue-neutral, contained a net tax increase in its first 2 years. And the Omnibus Budget Reconciliation Act of 1987 raised taxes still more. … The year 1988 appears to be the only year of the Reagan presidency, other than the first, in which taxes were not raised legislatively.


And as I said above, he tripled the national debt. A great Republican!
3.2.2009 9:34pm
ATM (mail):
And as I said above, he tripled the national debt. A great Republican!


Why blame the deficits on Reagan, when its Congress says what money will be spent on? Democrats controlled at least one house of Congress the entire Reagan administration. They controlled at least one house of Congress for essentially half of GWB's admistration as well.
3.3.2009 12:37am
jukeboxgrad (mail):
Why blame the deficits on Reagan, when its Congress says what money will be spent on?


Please don't pretend that the president doesn't have a great deal of influence over tax and spending policy. He does. The federal budget process begins with a budget request created by the president.

Democrats controlled at least one house of Congress the entire Reagan administration.


For six of Reagan's eight years, Congress was split. So there's no particular reason to put a great deal of blame on the Dems during that period.

They controlled at least one house of Congress for essentially half of GWB's admistration as well.


For four of Bush's eight years, the GOP controlled both houses of Congress. And for the first two years, the GOP controlled the House, while the Dems had only a very weak advantage (1 seat) in the Senate.

By the way, the Dems are obviously far from blameless. It would be nice if we had a two-party system. We have the best government money can buy. But it's the GOP, not the Dems, that has chronically presented itself as the party of fiscal responsibility. And they're doing it again. Even though history (at least since 1981) shows that this is a charade.
3.3.2009 1:35am
jukeboxgrad (mail):
A related fact: GWB was the first president since Truman who had his own party in control of the House for six years.
3.3.2009 1:44am
LN (mail):
So someone brings up "the Bush-Obama years," and then someone else argues that Bush did not have true conservative policies, but when it's pointed out that Saint Reagan ballooned the deficit, suddenly another person has the insight that the President should not be blamed for deficits because it's Congress that makes the budget. That's what I love about these Volokh threads.
3.3.2009 2:03am
BGates:
That's what I love about these Volokh threads.

And for my entertainment are the Obamatons who can't conceive of the President (or at least, their President, the first one they've recognized in eight years) having a negative effect on international economies, and scholars like yourself who think Congress has no connection to the budgeting process. Here's a hint: before the Golden Age arrived, members of Congress didn't only read the bills before voting on them, they were sometimes involved in writing them.
3.3.2009 5:49am
Strict:

Obamatons who can't conceive of the President (or at least, their President, the first one they've recognized in eight years) having a negative effect on international economies


Of course Obama, as President, could possibly do the wrong things and hurt the economies.

I just haven't been shown anything that he has done anything yet that hurts the economies.

He's continuing the string of bailouts that started at the end of Bush, and the economy is still slipping.

Does that mean the Obama-promoted bailouts are CAUSING this slip? You have to consider what would be happening of the Executive was just sitting back, relaxing, letting the markets do their markety thing.

Please explain how things would be better right NOW if McCain had won the election.

In early October, Bush said, ""We know what the problems are. We have the tools to fix them. And we're working swiftly to do so." OH RLY??

Around the exact same time, he also said "My first instinct was to let the market work, until I realized, upon being briefed by the experts, of how significant this problem became." Classic do-nothing instincts. Maybe read a little "Pet Goat" and crash on the couch at 8 PM in front of the TV, as per usual.

All I've seen is wild speculation - hiring Timmy Geithner made the markets jump an extraordinary amount, Michelle wearing that Spider-man dress made stocks in the textile industry crash, Obama's proposed tax-increases on the rich is causing people to quit their $300k jobs...
3.3.2009 9:49am
jukeboxgrad (mail):
In early October, Bush said, ""We know what the problems are. We have the tools to fix them. And we're working swiftly to do so."


As late as 9/15, McCain was still saying "the fundamentals of our economy are strong." And it took until 12/5 for Bush to be willing to say the word "recession."
3.3.2009 12:34pm
Harry Eagar (mail):
Zarkov sez: 'we'd see the DJ hit 4,000 in no time...'

The DJIA (and other stock indexes) are not indexed to inflation, so -- given around 40% loss in the value of the dollar over the last decade -- the DJ is within striking distance of hitting a real 4,000 in a day or two.

No time at all, hardly.

It's as if all the effort expended during the Bush regime was for nothing.
3.3.2009 1:23pm
Bob Goodman (mail) (www):
Based on this data, neither M1 nor M2 have appreciated astronomically. In fact, in January, M1 decreased.

How does this fit in with the St. Louis data?

People don't want to borrow, so the base doesn't get "multiplied". But eventually people will want to borrow, and, banks being in the biz of lending, the money supply will multiply to the point of the reserve ratio.

The fact that M1 is sinking while the base increases shows how lousy the economy is right now -- the pessimism of investors about profitability. The ratio of M1 or M2 to base is sometimes used as such a measure -- by Jim Davidson, for instance.

This happens over &over. A central bank expands the money base vastly, but it's too late to stop or even have much effect on the business contraction. Eventually, however, you get an inflation, because of the effect I just explained. It's just a question of how long it takes, which nobody can foresee, because it's based on mass psychology, which is in turn based on individual psychology.
3.3.2009 11:15pm
scattergood:
The problem is that on the one hand we have the massive force of inflation being unleashed by the Gov't through its various arms. Borrowing, lowering interest rates, spending, buy 'toxic' assets, guaranteeing banks, bailing out fiscal companies, etc. are all intended to get more money into the system and flowing faster. The intent is clearly to inflate falling asset prices because the pain of these falling prices is extreme.

On the other hand we have the massive forces of deflation. Fiscal institutions need to repair their balance sheets and aren't lending, borrowers are at their limits and aren't borrowing, the general economic downturn makes borrowers and lenders hesitant to extend or take on risk. Thus the rate of growth in aggregate money is slowing if not reversing. There is no other logical reason why the Dollar is doing so well against every other currency. The Yen is holding up because it already deflated against the Dollar.

With forces this massive and fundamental, the question really is, which one will win the the death match between them? I guess one COULD argue that the the two waves of deflation and inflation will just hit and sort of negligibly cancel each other out, but I just don't think that is the case.

If inflation wins, then look for an sharp inflation for 2-3 years followed by deflation, recession and possibly depression. Why? Because the inflation is really gov't caused. And once those lending money to us get wise to the fact that all we are doing is inflating the currency to pay them back in lesser real dollars, they will demand higher interest rates and end that game.

If deflation wins, then look for a deflationary depression which will be sharp and hard for 3-5 years. Why? Because once asset values have been crushed, and the financial institutions have written off the losses their books will look better. And once everybody believes that there aren't any more shoes to drop, they will start to step in to purchase assets and take on risk.

Either way the poison is bad. The question is which is less worse. My personal vote is for deflation. It is going to happen anyway, and let's just get it over with and NOT be $3 to $5 to $10 trillion more in debt when it happens.
3.4.2009 11:33am

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