Tonight, we are going to review an old Bernanke speech. This is the one he made in 2002, before he took over the Federal Reserve. Here, he talks about the infamous helicopter money drops. He talks about inflation and gives a really erroneous history of inflation and money. He obviously has a very shallow conception of how money really works! He also tries to talk about the Japanese depression. No wonder our trade situation stinks.
Before the National Economists Club, Washington, D.C.
November 21, 2002
Deflation: Making Sure “It” Doesn’t Happen Here
Since World War II, inflation–the apparently inexorable rise in the prices of goods and services–has been the bane of central bankers. Economists of various stripes have argued that inflation is the inevitable result of (pick your favorite) the abandonment of metallic monetary standards, a lack of fiscal discipline, shocks to the price of oil and other commodities, struggles over the distribution of income, excessive money creation, self-confirming inflation expectations, an “inflation bias” in the policies of central banks, and still others. Despite widespread “inflation pessimism,” however, during the 1980s and 1990s most industrial-country central banks were able to cage, if not entirely tame, the inflation dragon.
Actually, the inflation dragon was NOT tamed by the central bankers. What killed it was simple, there were three major forces that made inflation vanish, temporarily: Russia and England [North Sea Oil] both entered the world oil markets very aggressively after 1990 and this drove down the price of oil to $10 a barrel. High oil price shocks always generates inflation spurts.
The second force at work was ‘free trade’: the US ceased to protect native industries. By allowing a flood of imports with no taxes or charges, flowing into the country, the cost of manufactured goods fell. US wages for industrial workers began to either fall or the jobs simply vanished, by the millions. This created a false sense of inflation being whipped.
The third factor, of course, I harp on all the time: the Japanese ZIRP system and how this created the Japanese carry trade. Lending became immensely cheap. Greenspan joined this and made US loans cheaper, too. This, in turn, created the global housing bubble.
Although a number of factors converged to make this happy outcome possible, an essential element was the heightened understanding by central bankers and, equally as important, by political leaders and the public at large of the very high costs of allowing the economy to stray too far from price stability.
With inflation rates now quite low in the United States, however, some have expressed concern that we may soon face a new problem–the danger of deflation, or falling prices. That this concern is not purely hypothetical is brought home to us whenever we read newspaper reports about Japan, where what seems to be a relatively moderate deflation–a decline in consumer prices of about 1 percent per year–has been associated with years of painfully slow growth, rising joblessness, and apparently intractable financial problems in the banking and corporate sectors. While it is difficult to sort out cause from effect, the consensus view is that deflation has been an important negative factor in the Japanese slump.
In 2002, Japan was already in its historic export profit boom, one that was greater than any previous export boom in their history! True, the workers were losing jobs, dropping wages and benefits but then, so were the US workforce! Both were already heading into Depression Hell. Both had seen their unions stripped of all power to go on strike. Both in the US and Japan, workers were forced to compete with cheap labor in China on top of cheap imported labor brought legally and especially, illegally, into the countries.
So, is deflation a threat to the economic health of the United States? Not to leave you in suspense, I believe that the chance of significant deflation in the United States in the foreseeable future is extremely small, for two principal reasons. The first is the resilience and structural stability of the U.S. economy itself. Over the years, the U.S. economy has shown a remarkable ability to absorb shocks of all kinds, to recover, and to continue to grow. Flexible and efficient markets for labor and capital, an entrepreneurial tradition, and a general willingness to tolerate and even embrace technological and economic change all contribute to this resiliency. A particularly important protective factor in the current environment is the strength of our financial system: Despite the adverse shocks of the past year, our banking system remains healthy and well-regulated, and firm and household balance sheets are for the most part in good shape. Also helpful is that inflation has recently been not only low but quite stable, with one result being that inflation expectations seem well anchored. For example, according to the University of Michigan survey that underlies the index of consumer sentiment, the median expected rate of inflation during the next five to ten years among those interviewed was 2.9 percent in October 2002, as compared with 2.7 percent a year earlier and 3.0 percent two years earlier–a stable record indeed.
After Bernake made this stupid speech, he was made the head of the Federal Reserve. Based on his prognosis in this speech, he should be thrown out, now. His predictive abilities stink. Quite frankly, it was obvious to me that Greenspan and Bush were flooding the economy with debt: the tax cuts were huge and government spending took off, at the same time. So this sector was 100% debt. On top of this, the misallocation of resources was obvious: this would bankrupt the nation since we allowed at this time, a FLOOD of Asian and European goods to flow, unhindered into the US. The trade deficit shot up. It went from just $150 billion a year to nearly a trillion a year!
How dare Bernanke talks about the ‘resilience and structural stability of the US economy’ when it was already painfully obvious, our economy was both weak and unstable…soaring public debts coupled with soaring trade deficits is the definition of ‘weak and unstable’?
Then there is his remark that our banks were ‘well regulated’! Just as the last of the post-1929 Crash regulations were being stripped? He said that???
The second bulwark against deflation in the United States, and the one that will be the focus of my remarks today, is the Federal Reserve System itself. The Congress has given the Fed the responsibility of preserving price stability (among other objectives), which most definitely implies avoiding deflation as well as inflation. I am confident that the Fed would take whatever means necessary to prevent significant deflation in the United States and, moreover, that the U.S. central bank, in cooperation with other parts of the government as needed, has sufficient policy instruments to ensure that any deflation that might occur would be both mild and brief.
In all the stories and testimonies involving Bernanke, no one mentions his predictions here. This deflation spiral into the pits of hell will not be mild nor brief. The fact that he believed, in 2002, this crock of piss, disqualifies him to be the head of the Fed today.
Of course, we must take care lest confidence become over-confidence. [HAHAHAHA] Deflationary episodes are rare, and generalization about them is difficult. Indeed, a recent Federal Reserve study of the Japanese experience concluded that the deflation there was almost entirely unexpected, by both foreign and Japanese observers alike (Ahearne et al., 2002).[HAHAHA]So, having said that deflation in the United States is highly unlikely, I would be imprudent to rule out the possibility altogether. Accordingly, I want to turn to a further exploration of the causes of deflation, its economic effects, and the policy instruments that can be deployed against it. Before going further I should say that my comments today reflect my own views only and are not necessarily those of my colleagues on the Board of Governors or the Federal Open Market Committee.
Deflation: Its Causes and Effects
Deflation is defined as a general decline in prices, with emphasis on the word “general.” At any given time, especially in a low-inflation economy like that of our recent experience, prices of some goods and services will be falling. Price declines in a specific sector may occur because productivity is rising and costs are falling more quickly in that sector than elsewhere or because the demand for the output of that sector is weak relative to the demand for other goods and services. Sector-specific price declines, uncomfortable as they may be for producers in that sector, are generally not a problem for the economy as a whole and do not constitute deflation. Deflation per se occurs only when price declines are so widespread that broad-based indexes of prices, such as the consumer price index, register ongoing declines.
The sources of deflation are not a mystery. [Good gods!] Deflation is in almost all cases a side effect of a collapse of aggregate demand–a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers.1 Likewise, the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending–namely, recession, rising unemployment, and financial stress.
Why does demand ‘drop’? People don’t cease wanting to buy things or eat. They always want to spend. Why do they stop spending? This is where bankers come in: they give out loans. People go into debt so they can spend money on things today, and then pay for it over time. When too many loans crash head on into dropping wages, we get a depression as fewer and fewer people can pay off their debts or if they can’t take on new loans. Then, all excess income is used to pay the interest on loans. This pay-back period can last an entire generation.
However, a deflationary recession may differ in one respect from “normal” recessions in which the inflation rate is at least modestly positive: Deflation of sufficient magnitude may result in the nominal interest rate declining to zero or very close to zero.2 Once the nominal interest rate is at zero, no further downward adjustment in the rate can occur, since lenders generally will not accept a negative nominal interest rate when it is possible instead to hold cash. At this point, the nominal interest rate is said to have hit the “zero bound.”
Deflation great enough to bring the nominal interest rate close to zero poses special problems for the economy and for policy. [No kidding!] First, when the nominal interest rate has been reduced to zero, the real interest rate paid by borrowers equals the expected rate of deflation, however large that may be.3 To take what might seem like an extreme example (though in fact it occurred in the United States in the early 1930s), suppose that deflation is proceeding at a clip of 10 percent per year. Then someone who borrows for a year at a nominal interest rate of zero actually faces a 10 percent real cost of funds, as the loan must be repaid in dollars whose purchasing power is 10 percent greater than that of the dollars borrowed originally. In a period of sufficiently severe deflation, the real cost of borrowing becomes prohibitive. Capital investment, purchases of new homes, and other types of spending decline accordingly, worsening the economic downturn.
It is obviously worse: depressions come along when people cannot capitalize the costs of paying off loans. In other words, if the price of wheat falls, the farmer gets squeezed since his loans remain as an overhead on top of him being now unable to turn over old loans. If his profits were rising, he could turn over higher-cost loans by taking cheaper loans and using these to pay off the older, higher-rate loans. But if his profits are falling, no one will lend to him at even 0%.
We already can see in Japan, low interest loans are NOT for consumers and small businesses. They are for export giants. And outside investment bankers [the carry trade]. As wages drop, banks don’t want to lend anything to workers. In the US, interest on consumer loans are not near 0%. They are closer to 28% which is outrageous.
The Bank of Japan said it will buy corporate bonds for the first time, widening its asset-purchase program to prevent a shortage of credit from deepening the recession.
The central bank will buy as much as 1 trillion yen ($10.7 billion) in bonds rated A or higher from March 4 to Sept. 30. The policy board kept the overnight lending rate at 0.1 percent in a unanimous vote, it said in a statement in Tokyo today.
Governor Masaaki Shirakawa said the economy will remain in a “severe” state next quarter and companies will continue to struggle to obtain financing as investors shun risk. With the key rate close to zero, the central bank is buying assets from lenders to lower longer-term borrowing costs, and its next moves may include adding stocks as collateral and purchasing more government bonds, economists said.
“The only policy options the bank has available to it are to either accelerate or deepen existing corporate financial- support measures,” said Glenn Maguire, chief Asia economist at Societe Generale SA in Hong Kong.
Although deflation and the zero bound on nominal interest rates create a significant problem for those seeking to borrow, they impose an even greater burden on households and firms that had accumulated substantial debt before the onset of the deflation. This burden arises because, even if debtors are able to refinance their existing obligations at low nominal interest rates, with prices falling they must still repay the principal in dollars of increasing (perhaps rapidly increasing) real value. When William Jennings Bryan made his famous “cross of gold” speech in his 1896 presidential campaign, he was speaking on behalf of heavily mortgaged farmers whose debt burdens were growing ever larger in real terms, the result of a sustained deflation that followed America’s post-Civil-War return to the gold standard.4 The financial distress of debtors can, in turn, increase the fragility of the nation’s financial system–for example, by leading to a rapid increase in the share of bank loans that are delinquent or in default. Japan in recent years has certainly faced the problem of “debt-deflation”–the deflation-induced, ever-increasing real value of debts. Closer to home, massive financial problems, including defaults, bankruptcies, and bank failures, were endemic in America’s worst encounter with deflation, in the years 1930-33–a period in which (as I mentioned) the U.S. price level fell about 10 percent per year.
Beyond its adverse effects in financial markets and on borrowers, the zero bound on the nominal interest rate raises another concern–the limitation that it places on conventional monetary policy. Under normal conditions, the Fed and most other central banks implement policy by setting a target for a short-term interest rate–the overnight federal funds rate in the United States–and enforcing that target by buying and selling securities in open capital markets. When the short-term interest rate hits zero, the central bank can no longer ease policy by lowering its usual interest-rate target.5
This is the old ‘gas pedal’ approach to banking. The bank uses these tools which are based on a collapsing system of fiat currency manipulations of markets. This way, they can either put on the brakes by artificially forcing rates upwards or ignore inflation by reducing rates. Japan has had the ‘pedal to the metal’ for years now: 0% lending despite obvious raging inflation, for example. They got away doing this because the West depended on this liquidity pouring out of the Bank of Japan via the carry trade!
Now, due to the utter collapse of the entire global financial systems due to US economic weakness, the US is joining Japan in the ZIRP business. Both hope to restart inflation by encouraging even more debt creation. The US is enabling this by having the government flood the US economic system with deficit spending on heroic levels. Soon, our national debt will be well over 100% of GDP. This is not a good thing.
Because central banks conventionally conduct monetary policy by manipulating the short-term nominal interest rate, some observers have concluded that when that key rate stands at or near zero, the central bank has “run out of ammunition”–that is, it no longer has the power to expand aggregate demand and hence economic activity. It is true that once the policy rate has been driven down to zero, a central bank can no longer use its traditional means of stimulating aggregate demand and thus will be operating in less familiar territory. The central bank’s inability to use its traditional methods may complicate the policymaking process and introduce uncertainty in the size and timing of the economy’s response to policy actions. Hence I agree that the situation is one to be avoided if possible.
Bernanke and Greenspan ran the Federal Reserve in the run-up to this disaster. Far from avoiding this situation, they are the authors of it. Bernanke should be forced to resign.
However, a principal message of my talk today is that a central bank whose accustomed policy rate has been forced down to zero has most definitely not run out of ammunition. As I will discuss, a central bank, either alone or in cooperation with other parts of the government, retains considerable power to expand aggregate demand and economic activity even when its accustomed policy rate is at zero. In the remainder of my talk, I will first discuss measures for preventing deflation–the preferable option if feasible. I will then turn to policy measures that the Fed and other government authorities can take if prevention efforts fail and deflation appears to be gaining a foothold in the economy.
As I have already emphasized, deflation is generally the result of low and falling aggregate demand. The basic prescription for preventing deflation is therefore straightforward, at least in principle: Use monetary and fiscal policy as needed to support aggregate spending, in a manner as nearly consistent as possible with full utilization of economic resources and low and stable inflation. In other words, the best way to get out of trouble is not to get into it in the first place. Beyond this commonsense injunction, however, there are several measures that the Fed (or any central bank) can take to reduce the risk of falling into deflation.
This is just so childish! Spending our way out of a debt/ZIRP trap is silly if all it does is add even more debt. If we fall into a depression due to too many people and businesses going bankrupt due to too much debt, having the government join them is pure stupidity.
Keynesians love to point to WWII and how military spending got us out of the hole. But do we want WWIII? On top of this, taxes during and after WWII were 90% in England and America for the top brackets! And on top of all of this, there is Hitler and the Japanese warlords: they funded their own Keynesian spending by looting minorities [such as the helpless Jews in Germany and the helpless Chinese]. Without this flow of loot, their own spending would have simply bankrupted both Germany and Japan. The need to keep on looting drove forwards, both nation’s war actions.
The US could fund WWII based on a gold-linked currency due to many nations parking all their gold here in the US. A lot of it still sits in the deep vaults of the Bank of New York, in Manhattan.
First, the Fed should try to preserve a buffer zone for the inflation rate, that is, during normal times it should not try to push inflation down all the way to zero.6 Most central banks seem to understand the need for a buffer zone. For example, central banks with explicit inflation targets almost invariably set their target for inflation above zero, generally between 1 and 3 percent per year. Maintaining an inflation buffer zone reduces the risk that a large, unanticipated drop in aggregate demand will drive the economy far enough into deflationary territory to lower the nominal interest rate to zero. Of course, this benefit of having a buffer zone for inflation must be weighed against the costs associated with allowing a higher inflation rate in normal times.
The year here is 2002: Japan’s ZIRP had already been running for a while. Why doesn’t he examine this in light of Japan’s rising trade surplus with the US? For YEARS I have hammered away at this topic, nearly alone. Any long meditation on modern 0% systems must examine the Japanese phenomenon very closely. Instead, he barely mentions it.
Second, the Fed should take most seriously–as of course it does–its responsibility to ensure financial stability in the economy. Irving Fisher (1933) was perhaps the first economist to emphasize the potential connections between violent financial crises, which lead to “fire sales” of assets and falling asset prices, with general declines in aggregate demand and the price level. A healthy, well capitalized banking system and smoothly functioning capital markets are an important line of defense against deflationary shocks. The Fed should and does use its regulatory and supervisory powers to ensure that the financial system will remain resilient if financial conditions change rapidly. And at times of extreme threat to financial stability, the Federal Reserve stands ready to use the discount window and other tools to protect the financial system, as it did during the 1987 stock market crash and the September 11, 2001, terrorist attacks.
AAARRGH. This is just infuriating! All I have learned from the history of bubbles bursting leading to depressions is this: they ALL have TREMENDOUS amounts of lending just prior to crashing. The bubbles ARE lending bubbles, not price bubbles. Prices are bid up if the bidders get their paws on infinite lending. Why hesitate? The sky is the limit if you plan on selling to even higher bidders using this infinite flow of lending! The system is too ‘well capitalized’!
Third, as suggested by a number of studies, when inflation is already low and the fundamentals of the economy suddenly deteriorate, the central bank should act more preemptively and more aggressively than usual in cutting rates (Orphanides and Wieland, 2000; Reifschneider and Williams, 2000; Ahearne et al., 2002). By moving decisively and early, the Fed may be able to prevent the economy from slipping into deflation, with the special problems that entails.
Following this belief system, Greenspan and Bernanke both enabled too-easy lending during two bubbles, the Dot Com bubble and the Housing bubble. The easy lending also created a sudden, violent burst of hyper-inflation in 2008.
As I have indicated, I believe that the combination of strong economic fundamentals and policymakers that are attentive to downside as well as upside risks to inflation make significant deflation in the United States in the foreseeable future quite unlikely.[Arrest Bernanke for endangering the public!] But suppose that, despite all precautions, deflation were to take hold in the U.S. economy and, moreover, that the Fed’s policy instrument–the federal funds rate–were to fall to zero. What then? In the remainder of my talk I will discuss some possible options for stopping a deflation once it has gotten under way. I should emphasize that my comments on this topic are necessarily speculative, as the modern Federal Reserve has never faced this situation nor has it pre-committed itself formally to any specific course of action should deflation arise. Furthermore, the specific responses the Fed would undertake would presumably depend on a number of factors, including its assessment of the whole range of risks to the economy and any complementary policies being undertaken by other parts of the U.S. government.7
Let me start with some general observations about monetary policy at the zero bound, sweeping under the rug for the moment some technical and operational issues.
As I have mentioned, some observers have concluded that when the central bank’s policy rate falls to zero–its practical minimum–monetary policy loses its ability to further stimulate aggregate demand and the economy. At a broad conceptual level, and in my view in practice as well, this conclusion is clearly mistaken. Indeed, under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero.
The Zimbabwean solution! If there is a depression, the government, using the magic of fiat paper printing presses, can create inflation by flooding the economy with government debts! And then, just add zeros. Did this lunatic ever read about the Weimar Republic? Always, this is a fine and wonderful thing as everyone suddenly gets checks from the government for $600. Then, we get this micro-burst of inflation. Note that the previous micro-burst of inflation coincided exactly with the 6 month period of the government handing out those $600 checks!
The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning.[HAHAHA] A little parable may prove useful: Today an ounce of gold sells for $300, more or less. Now suppose that a modern alchemist solves his subject’s oldest problem by finding a way to produce unlimited amounts of new gold at essentially no cost. Moreover, his invention is widely publicized and scientifically verified, and he announces his intention to begin massive production of gold within days. What would happen to the price of gold? Presumably, the potentially unlimited supply of cheap gold would cause the market price of gold to plummet. Indeed, if the market for gold is to any degree efficient, the price of gold would collapse immediately after the announcement of the invention, before the alchemist had produced and marketed a single ounce of yellow metal.
What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.
Oh lord! If only we could have had Dr. Fekete at this lecture! He would have given Bernanke a spirited debate. Of course, gold is valuable because it is not only rare but is hard to destroy! It won’t rust or lose atomic structure if exposed to oxygen or water. It can lie at the bottom of the sea or deep in caves for billions of years and remain intact and whole. This is why it is a good measure of ‘value’ or even ‘weight’. It is unusual as it doesn’t shatter like gems, under the hammer, just for example.
The very fact that it is a limited resource makes it ideal as a controlling factor for lending: if you lend too much paper money backed by gold, outsiders will use this to loot the gold from the system. Because it ONLY works if you can get your paws on the gold! This is why Roosevelt ceased to honor the gold certificate dollars. I have one of these, for example. It says clearly, ‘Pay gold ON DEMAND.’
Paper money issued against gold which then, is irredeemable, is quite common. The Confederacy did this during the Civil War. The Federal Reserve did this from WWI to 1933. Having a gold basis doesn’t stop degrading of the currency! Usually, countries doing this simply slam the gold door shut and don’t honor their pledges.
U.S. Offers Discounts to Lure Buyers of Failed Banks
U.S. regulators are being forced to sell real-estate loans of failed banks at a discount to lure buyers spooked by the likelihood of increased loan losses amid a deepening recession.
The assets of four community banks have been sold to healthier rivals at a combined discount of $107 million this year, the Federal Deposit Insurance Corp. said. The FDIC had to offer a discount just once in 2008, when it engineered 25 bank takeovers. The Washington-based agency has overseen 13 bank failures this year.
Buyers for banks are in short supply after last year, when regulators closed the most lenders since 50 were shuttered in 1993. RBC Capital Markets analystG erard Cassidy predicts as many as 1,000 more will collapse within five years. The result may be a buyer’s market in which the FDIC will lay out even bigger sums to get rid of seized banks.
No one wants the bank’s LOANS. They are seen as worst than worthless. These phantom loans have the potential of sucking all asset values out of any bank foolish enough to touch them. Will Bernanke’s magical piggy bank printing press improve this?
The goddess of History laughs. She has written this story many times. Bernanke refuses to read her books, of course. How did this ignorant fool get into power, anyway? Don’t tell me. Heh.
Of course, the U.S. government is not going to print money and distribute it willy-nilly (although as we will see later, there are practical policies that approximate this behavior).8 Normally, money is injected into the economy through asset purchases by the Federal Reserve. To stimulate aggregate spending when short-term interest rates have reached zero, the Fed must expand the scale of its asset purchases or, possibly, expand the menu of assets that it buys. Alternatively, the Fed could find other ways of injecting money into the system–for example, by making low-interest-rate loans to banks or cooperating with the fiscal authorities. Each method of adding money to the economy has advantages and drawbacks, both technical and economic. One important concern in practice is that calibrating the economic effects of nonstandard means of injecting money may be difficult, given our relative lack of experience with such policies. Thus, as I have stressed already, prevention of deflation remains preferable to having to cure it. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.
ARRRGH. There he goes again with the childish notion, we can simply print our way out of a depression which was created by too much lending, collapsing into mass bankruptcies. If it were so easy, why didn’t our ancestors do this over and over again? OOPS!!! They did! And each time, it failed.
Congress in the Gold Reserve Act of 1934 appropriated to the ESF $2 billion out of the increment resulting from a reduction in the weight of the gold dollar. Section 7 of the Bretton Woods Agreements Act of 1945 made the ESF’s operations permanent. This Act also directed the Secretary to pay $1.8 billion from the ESF to the IMF in partial payment of the initial U.S. quota subscription in the IMF, thereby reducing the ESF’s appropriated capital to the level of $200 million. An amendment to the Bretton Woods Agreements Act (passed in 1962) provided that any currencies or gold purchased by the United States from the IMF may be transferred from the Treasury General Account to the ESF and administered as part of the ESF.
The ESF statute requires the Secretary to “report each year to the President and the Congress on the operation of the fund [the ESF].” As part of the annual report by the Secretary to the President and the Congress on the operations of the ESF, Treasury includes an audit report of the ESF. The audit is performed by Treasury’s Office of the Inspector General.
The Special Drawing Rights Act of 1968 likewise provided that any SDRs allocated by the IMF or otherwise acquired by the United States are resources of the ESF. In accordance with the Act, SDRs can be “monetized” (i.e., converted into dollars) through the issuance of Special Drawing Rights Certificates (SDRCs) by the Secretary to the Federal Reserve System in an amount not to exceed the dollar value of the ESF’s SDR holdings. The dollar proceeds of such monetizations are assets of the ESF, and the SDRCs are a counterpart liability of the ESF.
BOE Unanimously Asks For Authority to Create Money
Bank of England policy makers unanimously agreed to ask the government for authority to create money in an effort to kick start the economy, saying further interest rate cuts may hurt the profitability of banks.
The Monetary Policy Committee, led by Governor Mervyn King, voted 8-1 to cut the main rate to 1 percent, the lowest since the central bank was founded in 1694, minutes of the Feb. 5 decision published in London today show. David Blanchflower, argued for a deeper reduction so rates go as low as possible “without delay.”
The minutes suggest rates cuts are becoming less potent, pushing the central bank to use unprecedented means to revive the economy from its worst slump since 1980. King and Chancellor of the Exchequer Alistair Darling will exchange letters about the next steps within a few days, a spokesman for the Treasury said.
See? England is now going ZIRP as well as revving up the printing presses. If all the G20 nations do this, what do we get next? YIKES! Global hyper-hyper inflation? Or a collapse of all trade due to no one trusting anyone’s currencies or abilities to pay up on trade? The only way out of this is for some nation which happen to be former communist powers, using their large gold reserves to launch a gold-based trade currency? I can see such a consortium growing. The US has a lot of debts but we also still have a lot of gold. This would balance our trade as well as allow us to be still somewhat powerful, compared to many other nations with no gold hoards.
So what then might the Fed do if its target interest rate, the overnight federal funds rate, fell to zero? One relatively straightforward extension of current procedures would be to try to stimulate spending by lowering rates further out along the Treasury term structure–that is, rates on government bonds of longer maturities.9 There are at least two ways of bringing down longer-term rates, which are complementary and could be employed separately or in combination. One approach, similar to an action taken in the past couple of years by the Bank of Japan, would be for the Fed to commit to holding the overnight rate at zero for some specified period. Because long-term interest rates represent averages of current and expected future short-term rates, plus a term premium, a commitment to keep short-term rates at zero for some time–if it were credible–would induce a decline in longer-term rates. A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years). The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields. If this program were successful, not only would yields on medium-term Treasury securities fall, but (because of links operating through expectations of future interest rates) yields on longer-term public and private debt (such as mortgages) would likely fall as well.
Lower rates over the maturity spectrum of public and private securities should strengthen aggregate demand in the usual ways and thus help to end deflation. Of course, if operating in relatively short-dated Treasury debt proved insufficient, the Fed could also attempt to cap yields of Treasury securities at still longer maturities, say three to six years. Yet another option would be for the Fed to use its existing authority to operate in the markets for agency debt (for example, mortgage-backed securities issued by Ginnie Mae, the Government National Mortgage Association).
A fly in Bernanke’s tea cup is this: no one will buy his six year bonds if they expect hyper inflation. If the Chinese buy it, they will demand we open our doors further to their trade. Ditto, Japan. Both Asian export giants already hold the bulk of our most recent debt sales. Hillary Clinton is coming back from there with pledges of us opening free trade even further while they will continue to buy Bernanke’s funny money bonds based on printing infinite dollars.
Historical experience tends to support the proposition that a sufficiently determined Fed can peg or cap Treasury bond prices and yields at other than the shortest maturities. The most striking episode of bond-price pegging occurred during the years before the Federal Reserve-Treasury Accord of 1951.10 Prior to that agreement, which freed the Fed from its responsibility to fix yields on government debt, the Fed maintained a ceiling of 2-1/2 percent on long-term Treasury bonds for nearly a decade. Moreover, it simultaneously established a ceiling on the twelve-month Treasury certificate of between 7/8 percent to 1-1/4 percent and, during the first half of that period, a rate of 3/8 percent on the 90-day Treasury bill. The Fed was able to achieve these low interest rates despite a level of outstanding government debt (relative to GDP) significantly greater than we have today, as well as inflation rates substantially more variable. At times, in order to enforce these low rates, the Fed had actually to purchase the bulk of outstanding 90-day bills. Interestingly, though, the Fed enforced the 2-1/2 percent ceiling on long-term bond yields for nearly a decade without ever holding a substantial share of long-maturity bonds outstanding.11 For example, the Fed held 7.0 percent of outstanding Treasury securities in 1945 and 9.2 percent in 1951 (the year of the Accord), almost entirely in the form of 90-day bills. For comparison, in 2001 the Fed held 9.7 percent of the stock of outstanding Treasury debt.
This was a very singular time frame indeed! Post WWII, there was only ONE major industrial power: the US. We literally, had no rivals. Also, there was only one creditor nation which also had a lot of gold: the US! Again, a unique situation! On top of that, we had a very, very high tax rate on earnings of the upper classes. They had only one escape route: buy US Treasuries and support the war debts. So they did and they prospered. We threw all of this away, over the years, of course.
To repeat, I suspect that operating on rates on longer-term Treasuries would provide sufficient leverage for the Fed to achieve its goals in most plausible scenarios. If lowering yields on longer-dated Treasury securities proved insufficient to restart spending, however, the Fed might next consider attempting to influence directly the yields on privately issued securities. Unlike some central banks, and barring changes to current law, the Fed is relatively restricted in its ability to buy private securities directly.12 However, the Fed does have broad powers to lend to the private sector indirectly via banks, through the discount window.13 Therefore a second policy option, complementary to operating in the markets for Treasury and agency debt, would be for the Fed to offer fixed-term loans to banks at low or zero interest, with a wide range of private assets (including, among others, corporate bonds, commercial paper, bank loans, and mortgages) deemed eligible as collateral.14 For example, the Fed might make 90-day or 180-day zero-interest loans to banks, taking corporate commercial paper of the same maturity as collateral. Pursued aggressively, such a program could significantly reduce liquidity and term premiums on the assets used as collateral. Reductions in these premiums would lower the cost of capital both to banks and the nonbank private sector, over and above the beneficial effect already conferred by lower interest rates on government securities.15
Welcome to the world of TARP. Gnomes love TARP. US tax payers will curse TARP. Arrest Bernanke!
The Fed can inject money into the economy in still other ways. For example, the Fed has the authority to buy foreign government debt, as well as domestic government debt. Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchase by the Fed is several times the stock of U.S. government debt.16
Meeting with Canada’s prime minister on his first official trip abroad, President Obama warned against a “strong impulse” toward protectionism while the world suffers a global economic recession and said efforts to renegotiate NAFTA will have to wait. In a joint press conference after meeting for almost two hours at Parliament Hill here, Obama said he wants to find a way to keep his campaign pledge to add labor and environmental standards to the continent’s trade agreements without disrupting trade.
“Now is a time where we’ve got to be very careful about any signals of protectionism,” the president said. “Because, as the economy of the world contracts, I think there’s going to be a strong impulse on the part of constituencies in all countries to see if we — they can engage in beggar-thy-neighbor policies.” Obama said during the campaign that he would consider opting out of NAFTA if he proved unable to renegotiate it. On Thursday, the president said that he raised the issue with Harper but indicated that he hoped advisers and staff from both countries could work out the issue.
AARRRGH! OK: how does the deep in debt US buy other nation’s debts? Through the IMF? But we are not a creditor nation! We can’t do this because, right at the same time this stupid speech was made, the US was going deeper into trade debt! Look at Obama’s speech in Canada! He is warning Canada to keep free trade going! WE are the ones being bankrupted by free trade? What gives here? Before the election, Obama isn’t working to save America, he is working for the export powers. Most US corporations are not American at all nor are they patriotic entities. Take Walmart, for example: it is a tentacle of the Chinese communist system.
I need to tread carefully here. Because the economy is a complex and interconnected system, Fed purchases of the liabilities of foreign governments have the potential to affect a number of financial markets, including the market for foreign exchange. In the United States, the Department of the Treasury, not the Federal Reserve, is the lead agency for making international economic policy, including policy toward the dollar; and the Secretary of the Treasury has expressed the view that the determination of the value of the U.S. dollar should be left to free market forces. [There is no such creature, all central bankers manipulate their currencies vis a vis the US $] Moreover, since the United States is a large, relatively closed economy, [What the fucking hell????] manipulating the exchange value of the dollar would not be a particularly desirable way to fight domestic deflation, particularly given the range of other options available. Thus, I want to be absolutely clear that I am today neither forecasting nor recommending any attempt by U.S. policymakers to target the international value of the dollar.
All our trade rivals fear the US manipulating the dollar. This is what Bretton Woods II and the Plaza Accords were all about. Now, all we do is whine about things. And scream at the Chinese.
Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it’s worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt’s 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934.17 The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt’s devaluation.
These things seem to work until they don’t. Starting WWII due to these various currency games wasn’t so smart, I would suggest. The British pound was still the main currency for trade, the dollar didn’t entirely take this over until WWII began. Both Britain and the US cut the gold peg at the same time. One big difference, too, is—Britain, Germany and France all owed the US lots of money for WWI. We were the creditor nation.
This is why I am just amazed to hear Beranke talk about ‘buying other nations debts.’ This is just insane. By the way, when Roosevelt devalued the dollar, this was stupid because the US was the creditor nation. Our trade rivals who all owed us billions of dollars, would have been happy because we slit our own throat. But Germany didn’t care in 1934. Hitler already threw away Germany’s debt obligations.
France, on the other hand, was furious. They were collecting dollars and changing this into gold because they just finished building this huge vault in Paris where they wanted to store the gold and were rapidly transferring gold from Fort Knox to Paris [guess who ended up taking over Paris!]. This cut the value of the dollars in Paris by nearly one half! This, incidentally, is another way of saying ‘cheat everyone you possibly can if your economy goes off a cliff.’
Each of the policy options I have discussed so far involves the Fed’s acting on its own. In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman’s famous “helicopter drop” of money.18
HAHAHAHA. The infamous helicopter!
When the government mailed me a check… which was not extra money but a LOAN which I must pay back, in the future, via taxes…I used the money for exactly one thing: ridiculously high food and energy costs. I didn’t use one penny for anything else. Just filling the tanks of my diesel tractor cost me an extra $200 last summer. I paid down no debts. I bought nothing new. When I used to spend $75 a week on food, I ended up paying over $130 a week. I gained NOTHING. And still have to pay for this with extra interest charges, too.
Of course, in lieu of tax cuts or increases in transfers the government could increase spending on current goods and services or even acquire existing real or financial assets. If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets.
No, no, no! It was a direct raid on my future earnings! I gained absolutely nothing and got, in return, more debts in my name! And in the name of all Americans. If we raise taxes on the rich to pay for all this then bravo. But we didn’t. We are dropping taxes.
The claim that deflation can be ended by sufficiently strong action has no doubt led you to wonder, if that is the case, why has Japan not ended its deflation? The Japanese situation is a complex one that I cannot fully discuss today. I will just make two brief, general points.
First, as you know, Japan’s economy faces some significant barriers to growth besides deflation, including massive financial problems in the banking and corporate sectors and a large overhang of government debt. [We should talk! Good grief.] Plausibly, private-sector financial problems have muted the effects of the monetary policies that have been tried in Japan, even as the heavy overhang of government debt has made Japanese policymakers more reluctant to use aggressive fiscal policies (for evidence see, for example, Posen, 1998). Fortunately, the U.S. economy does not share these problems, at least not to anything like the same degree, suggesting that anti-deflationary monetary and fiscal policies would be more potent here than they have been in Japan.
What planet does this idiot live on? True, in 2002, our national debt was only $6 trillion. But I never heard Bernanke yell about the tax cuts or the wild overspending our various wars. As our debts doubled, I heard little from Bernanke. Neither does Bernanke mention who owns whose debts. By 2002, Japan’s FOREX reserves had grown into the greatest on earth, this was before China doubled their own to nearly $2 trillion.
Japan’s debts are owed to the Japanese. Our debts are owed to the Japanese and the Chinese. This is a very significant difference.
Second, and more important, I believe that, when all is said and done, the failure to end deflation in Japan does not necessarily reflect any technical infeasibility of achieving that goal. Rather, it is a byproduct of a longstanding political debate about how best to address Japan’s overall economic problems. As the Japanese certainly realize, both restoring banks and corporations to solvency and implementing significant structural change are necessary for Japan’s long-run economic health. But in the short run, comprehensive economic reform will likely impose large costs on many, for example, in the form of unemployment or bankruptcy. As a natural result, politicians, economists, businesspeople, and the general public in Japan have sharply disagreed about competing proposals for reform. In the resulting political deadlock, strong policy actions are discouraged, and cooperation among policymakers is difficult to achieve.
In short, Japan’s deflation problem is real and serious; but, in my view, political constraints, rather than a lack of policy instruments, explain why its deflation has persisted for as long as it has. Thus, I do not view the Japanese experience as evidence against the general conclusion that U.S. policymakers have the tools they need to prevent, and, if necessary, to cure a deflationary recession in the United States.
Earlier, I mentioned how Bernanke couldn’t talk about Japan. He felt a need to talk more about Japan but he has NO NEW INFORMATION. What he says here is exactly what he said earlier only more verbosity. Why does he say, there is a ‘deadlock’ in Japan? The LDP runs everything there! It is basically a one-party state that will finally be changed due to huge dissatisfaction with the LDP’s rule.
It is commone knowledge that if the Japanese don’t want to do something we want them to do, they pretend to be confused and at odds with each other. This way, they don’t have to do anything they don’t want to do, anyway. They LOVED the ZIRP system. They loved the pretend depression. Their industrial powers expanded greatly. They were able to expand deeply into US markets. The US is about to lose our entire auto industries. Japan’s are suffering, of course, but are stronger and will survive just fine. They will have several auto corporations. The US will have none.
Sustained deflation can be highly destructive to a modern economy and should be strongly resisted. Fortunately, for the foreseeable future, the chances of a serious deflation in the United States appear remote indeed, in large part because of our economy’s underlying strengths but also because of the determination of the Federal Reserve and other U.S. policymakers to act preemptively against deflationary pressures. Moreover, as I have discussed today, a variety of policy responses are available should deflation appear to be taking hold. Because some of these alternative policy tools are relatively less familiar, they may raise practical problems of implementation and of calibration of their likely economic effects. For this reason, as I have emphasized, prevention of deflation is preferable to cure. Nevertheless, I hope to have persuaded you that the Federal Reserve and other economic policymakers would be far from helpless in the face of deflation, even should the federal funds rate hit its zero bound.19
This is just too pathetic. Bernanke is now wrestling the Zero Alligator and frankly, I would place my bets on the Alligator eating Bernanke.
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