The fact is that it is their money pumping that is driving both GDP growth and commodities prices — but not the real economy. FULL ARTICLE by Kel Kelly
Source link: http://archive.mises.org/16922/macro-confusion-inflation-commodities-and-the-fed/
Macro Confusion: Inflation, Commodities, and the Fed
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Mr. Kelly,
Thanks for your excellent article.
A few comments:
1. You refer to Liesman as an “expert economist”. Actually his profile at CNBC.com does not refer to him as an economist but merely an “economics reporter”. His degrees are in English and Journalism. He’s an amateur who has learned the Keynesian jargon.
2. Re inflation vs. deflation. I’m not convinced that the Fed printing money will necessarily produce inflation. Since so much of the money supply is created by banks lending against fractional reserves, as the banks deleverage and write off bad loans, this may result in less overall money supply. Maybe the Bernanke is printing to offset this?
3. China as a bubble: Just attended a conference where Vitaliy Katsenelson convincingly says China is a bubble. He believes that there is too much command and control which are causing massive misallocations.
See:
http://contrarianedge.com/2011/04/01/china-the-mother-of-all-gray-swans-japan-past-the-point-of-no-return/
http://myinvestingnotebook.blogspot.com/2010/07/vitaliy-katsenelson-presentation-on.html
Barry Milliken
China is definitely in a bubble. While the US was building skyscrapers containing unsold condos in Miami, San Diego and other localities, the Chinese have build cities no one lives in. Malinvestment was (and is) a problem in the US, but is an even larger problem in China.
http://www.businessinsider.com/pictures-chinese-ghost-cities-2010-12?slop=1
I wouldn’t be so sure. Those houses are empty *now*, but keep in mind that China has a policy to control domestic migration from one province to another. If this policy is relaxed, you could (artificially, of course) generate demand for those empty houses as people move towards the more affluent areas of the country (my comment is based on the premise the new developments are in such areas, or relatively close to them).
Also, from what I read (but I could be wrong), these new developments are being sold to investors, and not to potential dwellers. So, the situation is not similar to that of the US or other parts of the world.
The thing is: is China’s expansion in housing due to the expansion of housing credit, as in the US?
“Our calculations suggest that even modest declines in expected appreciation would lead to large price declines of over 40% in markets such as Beijing, absent offsetting rent increases or other countervailing factors.” (Joseph Gyourko, Yongheng Deng, NBER working paper 16189)
I guess when you criticise the Chinese for being in a bubble, you need to consider that their bubble is at least funded by their own savings, unlike the US where its bubbles are funded by the savings of the Chinese and Japanese. Don’t ever think that the US has more smarts than the Chinese, and more especially the Japanese! Get your own house in order first. Believe me, Australia is fast headed the same way as the US due to reckless Keynesianism!
You may want to reconsider.
http://www.minyanville.com/businessmarkets/articles/asia-china-housing-bubble-china-mriacle/8/9/2010/id/29519
The following is from Simon Johnson, a professor at the M.I.T. Sloan School of Management and a senior fellow at the Peterson Institute for International Economics:
http://www.nytimes.com/roomfordebate/2011/04/14/chinas-scary-housing-bubble/where-control-exists-in-china
Yes the argument for price stabilization is the loss of loan portfolios and the inability of workers to demand more wages in a 9% unemployment environment. A couple of problems.
The assets still exist as unused housing stock that eventually must be destroyed or put back into circulation. These “zombie” banks keep hitting the discount window and buying treasuries to try and revitalize after the life was sucked out of them in the housing bust. If the Fed is successful in creating “housing inflation” you will see overall inflation skyrocket as these zombie banks unload their dead portfolios.
The money supply and dollar devaluation does not care the unemployment rate is 9% in the US. As the rest of the world grows economically the dollar will continue to devalue causing inflation in the US. People forget from 1933 to 1936 inflation during the darkest days of the Great Depression was 41%. The Fed increased the money supply by changing the gold exchange rate from $28 to $35 and whola! Asset appreciation!
Why can’t velocity of money spiraling out of control cause the wage inflation spiral? I know that back in the 80′s when interest rates where high people would put their money to use as soon as they got a paycheck, which seems like it would make velocity skyrocket as more people do the same.
Hi Drigan. Velocity does not have a life of its own. It is an effect, not a cause. For details on this, please see the last footnote in the article.
Ah thanks, clearly I need to start reading the footnotes. :-/
Great article from Henry Hazlitt,
1.Velocity of circulation is a result, not a cause. It is commonly a passive resultant of changes in people’s relative valuations of money and goods.
2.Velocity of circulation cannot fluctuate for long beyond a comparatively narrow range, because it is closely tied (except for speculation) to the rate of consumption and production.
3.V does vary with the volume of speculation, but an increased volume of speculation may accompany either rising or falling prices.
4.V is never an independent factor on the side of money, because the transfer of goods must speed up, other things being equal, to an equal amount. It is just as valid to think of the velocity of circulation of money being caused by what happens on the side of goods as by what happens on the side of money.
5.Actually it is psychological factors — desire to buy and sell, produce and consume — that determine V.
6.Monetary theory would gain immensely if the concept of an independent or causal velocity of circulation were completely abandoned. The valuation approach, and the cash holdings approach, are sufficient to explain the problems involved.
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The reason, I believe, that stupid economic schools have such a stranglehold of the mainstream is because of their ownership of the macroeconomic indicators GDP and inflation. Of course GDP has gone up because government spending has skyrocketed, but that does not mean that real growth has occurred. And inflation is not too bad because they only look at price inflation and because they only look at goods that do not fluctuate much in value. How can you combat orthodox economics when you have to play by their rules?
We need to keep up on PPR and monetary inflation to show the real damage that is happening.
The government started paying academic elites in the early 20th century to do the intellectual bidding for the government. Most professors are Keynesian because they want a nice high paying job with lots of time off. It is a sick system dominated by public universities.
I think that the ultimate irony is when Obama says that “we” cannot leave the retirement of people up to the randomness of the stock market when the Fed has made it impossible to earn a decent return on your savings.
Excellent article Mr. Kelly. People need to understand the system of excess reserves in better detail.
Mr. Kelly,
In your answer to the first question you posted (Will the Fed Raise Rates?), you assume that the federal funds market is in normal mode. Normal mode is characterized by an unkinked reserves demand curve, which intersects the kinked supply curve. (Supply’s vertical section is equal to the sum of borrowed and non-borrowed reserves while its horizontal section equals the discount rate). Hence, your answer to your first question is valid but only when the fed funds market is in normal mode.
The federal funds market, as I explain to my students, is currently in “crisis” mode. The difference between it and normal mode is in the demand curve. When the Fed purchased all of that paper from banks during the bank-bailout period, it recognized that such large purchases from banks would make the federal funds rate negative. In order to avoid this, it imposed a price floor, which we all know as Interest On Reserves (IOR). IOR kinks demand horizontally.
During a recent trip my students and I made to the Charlotte, NC branch of the Richmond Fed, Fed officials showed and explained how IOR kinks demand. According to the presenters, the horizontal section of the kinked demand curve intersects the vertical section of the supply curve at IOR. Hence, IOR is the equilibrium federal funds rate. The new monetary tool, IOR, allows the Fed to buy as much paper from banks as it wants without changing the funds rate. In addition, the Fed, theoretically, can simply raise and lower the IOR to raise and lower the funds rate. At the 2009 MVEA conference in Kansas City, an official representing the Fed said it would probably have to conduct several open market sales while raising IOR to return the market back to normal mode. I posted a video to my YouTube channel that explains how this new monetary tool works. It begins at 7:40 of the video accessed with the following link: http://www.youtube.com/watch?v=lIxzy9rupxc .
Hence, the Fed can raise the federal funds rate theoretically by raising IOR without affecting the quantity of reserves in the federal funds market while it is in crisis mode.
Hal W. Snarr.
Damn I envy you if you can explain things that fast to your students and they understand. My students would be lost after the third talking point.
Crisis mode is the final topic covered in my macro class, and is never on the final. I do it for fun. So, they too might be lost.
BRILLIANT ARTICLE!
Please make this into an article as it is well constructed and brilliantly destroys the many myths out there. More like this and Murray Rothbard will attend your Nobel prize givingfrom the other side!
Hal, thanks for your comments. I want to get back to you but simply haven’t had a chance. Since I have only a moment now, I’ll just ask: is part of what I wrote incorrect? I’m not sure—at first, brief, blush—that I see where the mistake is.Is my last paragraph not in accordance with what you stated? I just read your comments briefly, and have not looked at the video. I will try to go back over it soon. Thanks. (I see I posted this to the wrong space…)
Kel, theoretically, the fed can raise IOR without affecting the quantity of reserves in the funds market because the horizontal section of kinked demand intersects the vertical section of supply. However, ceteris is never paribus in the real world. The Fed representative presenting at the MVEA conference I mentioned above said that the Fed would likely raise IOR as economic growth accelerates. This was said because, when the desire/need to borrow is much higher, banks would rather lend to consumers and firms at higher rates than what it gets for lending to the Fed (IOR). If the Fed does not raise IOR as private sector borrowing needs increase, reserves would poor out of the banking system like the Mississippi pouring over levies. If unchecked, this flood of money could generate some serious inflation. (Using a modest money multiplier of 2, a trillion dollars of reserves would metastasize into 2 trillion new dollars.) The Fed is probably being too cautious with IOR, which is why velocity is so low. I think I’d be pretty cautious too with trillions of dollars in excess reserves ready to break through the levy. The cost of maintaining IOR at its present rate keeps holds inflation flood waters at bay, but at the same time holds back private sector lending. This, in my opinion, explains why GDP is growing so sluggishly. The bank-bailout, the new monetary tool, all of the new regulations, and our new status as the country (in the OECD) with the highest corporate tax rate clearly demonstrate why (a) China is moving away from central planning, (b) central planning killed the USSR, and (c) the US economy is stuck in a rut.
I like this analysis. Very good job. I have been watching the monetary base for the last three years in amazement grow 200% and be told constantly that its okay because the old assets are off the books. Ah yea okay. Certainly not off the books here in Florida where housing and construction employment continue to plunge as we work off excess inventory.
I think you did a excellent job of visualizing the problem the Fed faces with
#1 bailing out all these banks and buying all these assets.
#2 Now that the bail out is done and there is all this liquidity out there the possibility for inflation just gets bigger by the day.
And as for the inflation the PPI has increased 20% + the last two months.
Magnificent, Kel! Many thanks. There’s so much here. I hammered into my students’ brains at the U. of Iowa George Reisman’s formula that the price level is determined by the demand for goods (as represented by total spending) divided by the supply of goods. This simple formula really helps the students think clearly about what really causes overall prices to rise.
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