Who is to blame for inflation?

          Who is to blame for inflation?  And, what are the risks of a recession?

 Jim Staudt, PhD, CFA

  copyright 2022, all rights reserved

Who is to blame?  Republicans wanted to blame Joe Biden and profligate federal spending, but they ignore the fact that Dwight Eisenhower was the last fiscally-responsible Republican to sit in the White House (see my book, Grand Collusion).  Democrats want to blame the pandemic and the war in Ukraine.  The truth is something that most economists want to ignore.  The Fed is mainly to blame, with some blame put to forces (like the pandemic and the war in Ukraine) that have temporarily disrupted supply.  But, the Fed is the biggest culprit.

The Fed is always late to act against inflation - always.  This is because it is easy and popular to maintain accommodative money policy, as Bernanke and Yellen did in the aftermath of the 2008 financial crisis well after unemployment went below targeted levels and financial markets stabilized.  Greenspan, with Bernanke's support, did the same thing prior to the 2008 financial crisis - which is what contributed to the crisis.   Keeping interest rates low, well after the financial system has stabilized from a crisis and employment achieved targeted levels, is popular because mortgage rates drop and the prices of various assets increase.  Issue of credit grows, as credit is cheap, which benefits the banks and anyone who wants to borrow.  Many economists, especially those who work in the banking system or in government positions that are close to banking, have a cognitive bias against scrutinizing policies that benefit them personally.  Even many academic economists are drawn into this bias because most of their research is funded by the Fed, the Treasury, or banks.  Besides, few are willing to argue that the Fed should pull away the punch bowl and stop the party.  It's no way to make or keep friends in the banking sector.

Will inflation continue for a while?  I think so.  Inflation has been more sticky than economic prognosticators had hoped, and this is the historical norm.  Many economists were hoping that once the supply disruptions of the pandemic situation improved, inflation would improve.

My thoughts are that we are in for a situation similar to what happened in the 1970s and 1980s, perhaps much worse (and I'll address that later).  This is because we have inflation resulting from monetary policy induced inflation, plus some other effects that I will discuss that make the situation worse.

How monetary policy induced inflation works

Although the Fed funds rate gets the headlines, the Fed's market operations (purchase and sale of securities in the market) are what impact the money supply and also impact market interest rates, along with the funds rate.  So, the combination of the funds rate and market operations are the tools the Fed uses to regulate monetary policy.

I will caveat this discussion by saying that many academic, government or banking economists do not buy into this description of how monetary policy induced inflation works.  They tend to ignore the historical record that there is a delay between monetary stimulus and inflation in goods and services.  However, economists who are practitioners (especially, Ray Dalio, who has published on this) are more likely to see inflation working this way.  Folks like Dalio, who make their living by anticipating how markets will behave, need a much better functional understanding of the economy than academics tend to appreciate.

Monetary policy induced inflation is inherently delayed.  This is because of how accommodative monetary policy functionally puts money into the economy - more on this below.  As a historical example, the abandonment of sound money policies started in practice in the 1960s (when quarters were no longer made from silver) and officially in 1971 (when Nixon officially abandoned the gold standard).  These enabled the Fed to print as much money as they wanted and make federal deficits (and other debts) painless.  Yet, official inflation numbers did not peak until 1980 at nearly 14%.  Why was there a delay of about a decade?

Inflation is measured in terms of the cost of goods and services relative to a prior period of time.  Loose monetary policy does not immediately translate into increases in the prices of goods and services because the money initially goes from the Fed to banks, that sell their debt to the Fed when the Fed buys debt instruments from banks.  This is how the money supply is regulated.  The debt issued by banks is used by borrowers to buy assets, such as real estate, stocks/bonds, and other assets.  The money introduced in this manner does not yet go to goods or services that are the components of inflation, but assets.  These assets all rise in value, which is good for those who own these assets.

So, loose monetary policy will result in an immediate increase in the prices of assets and an increase in wealth for the wealthy.  But, the rise in price of these assets don't immediately translate into inflation because inflation (as it is measured) does not incorporate the price of these assets in determining the value of inflation.  So, in the short term, loose monetary policy makes the wealthy wealthier, and makes it easier for everyone to borrow money.  This is why loose monetary policy is popular.

But, over time these increases in asset prices do eventually trickle into the prices of goods and services as home buyers find themselves needing more money to buy homes or rent a home.  Eventually, wealthy people who have improved balance sheets from the asset inflation may buy more goods and services, driving up the cost of these goods and services. This is when you start to experience inflation.

Globalization has helped to delay the increase in the cost of goods and services as suppliers of goods and services have been able to search the globe for the least expensive supplier of the good or service.  This has the effect of depressing wages at home.  So, globalization has been a disinflationary effect.

Inflation (and globalization, for that matter) most harms those folks who are on the bottom of the economic scale, as they did not benefit from the rise in asset prices and their incomes do not provide much or any cushion to absorb the increased cost of goods and services.

So, in effect, the money injected into the economy by loose monetary policy initially just moves into asset prices and debt before it makes its way into goods and services.

Monetary Policy and fighting inflation

Now, just as there is a delay between loose monetary policy and the resulting inflation, there is a delay between when restrictive monetary policy starts and when inflation turns around.  When the Fed initiates tighter monetary policy, asset prices initially fall, and this is an immediate effect.  But, the prices of goods and services don't immediately drop.  That's what we are seeing right now.  Inflation that resulted from loose monetary policy becomes sort of "baked in" for a while.  It is why it took so long and such severe Fed intervention in the 1980s to get inflation under control.

Are we heading to a recession, and how bad will it be?

The arguments for a recession are:

• Of the last 13 Fed tightening cycles, 10 have led to recessions.  So, from the perspective of Fed tightening alone, one would expect a recession.
• The yield curve has inverted, which also tends for foretell recessions.
• Recessions are often preceded by very low unemployment that limits economic growth as productivity and available new labor stalls.  That is the case now.
• The benefits of the tax cuts of 2017 are over.  Most money went to corporate share buybacks, which don't lead to productivity growth.  There was an uptick in capital expenditure, but it was muted.  As a result, the tax cuts will not provide the level of productivity growth that are needed to compensate for the shortage of workers.
• At over ten years since the last recession, we are well beyond the norm between recessions

Those that argue that we are not heading to recession point to low unemployment and high consumer spending.  However, low unemployment normally precedes the beginning of a recession because of the limitations on economic growth and the increased wages that cut into corporate profits. High consumer spending is consistent with low unemployment, but this also precedes a recession.  Moreover, while the Fed does not predict a recession, they have never predicted a recession.  A recession is only recognized once it has already become apparent.

Given that the indicators suggest a recession is coming, it is worth considering what might happen.  Unfortunately, the United States and the world are deeper in debt than they were prior to the 2008 financial crisis.  It is, however, allocated differently.  Mortgages are not the problem - at least not now.  The really bad debt is mostly corporate debt, a good deal of which matures in the next two years and must be rolled over into higher yielding debt. Companies will need to pare costs in order to service the new debt or they will need to see their debt downgraded.  Right now over 50% of investment grade debt is triple B, double what it was in 2007 (the Fed bought most of the downgraded debt during the pandemic).  As a result, most investment grade bond portfolios are holding lower quality debt than they did in 2007.  As debt gets downgraded bond funds will need to sell debt that is no longer investment grade.  

As companies lay off workers (this has already started in the tech sector), this will put more pressure on the housing market.  So, the mortgage market is not where the next crisis will start, but the crisis will reach mortgages.

The dilemma we face with a recession is similar to what happened in 2007/8 due to high debt levels.  Although mortgage debt is not the main problem as before, the bigger problem is corporate debt.  Banks may be in better shape than in the previous crisis, but the biggest problems are those we don't know about yet and we only realize are there once they become large.  There is no telling what ways bank management may have become creative in circumventing reforms by hiding liabilities, as they did prior to the 2008 crisis.  Although there are new rules, bankers have shown themselves to be creating in finding the loopholes.

On the media's push back against Trump

by

James E Staudt

copyright 2018, all rights reserved

Across the United States the media is pushing back against President Trump's attacks on them as being "Fake News" and "the enemy of the people".  There is always a grain of truth to any great lie.

A free and independent press is one of the critical pillars necessary for a democracy to survive.  In this respect, the president's attacks on the media are wrong.  While the media doesn't always get it right (more on this later) it is necessary to have a free press to preserve democracy and prevent a government from becoming a tyranny.  This is why freedom of speech and freedom of the press are preserved in the first amendment to the constitution.  The colonies wanted the ten amendments in the Bill of Rights to prevent the federal government that had been established in the constitution from turning into a tyranny.  That is why so many of these ten amendments relate to prohibition of certain practices that were used by the British during colonial rule - such as housing soldiers or preventing assemblies.  So, President Trump is clearly wrong in calling many of the press outlets "enemies of the people".  

On the other hand, a loss in confidence in the media as an independent and trusted source of information is well justified.  An important theme discussed in my book Grand Collusion is that the two political parties and the media have a vested interest in keeping Americans misinformed and fighting one another.  The media is the chief benefactor of political spending and the political parties are able to use controversy as a means to motivate political donations.  This symbiotic relationship has made the commercial media too close to the two major parties.  Over time, the for-profit media outlets have become more of a mouthpiece of the government, large corporations or other influential groups that provide "information" (or, propaganda) at no charge. With this model, the media outlets don't need the expense of investigative journalism to examine information and question it..  For example, the media acted as a mouthpiece for the Bush administration in promoting the Iraq War.  It did not critically evaluate the evidence presented by the George W. Bush Administration in its argument for invading Iraq, which led to destabilization of most of the Middle East.  In fact, Judith Miller (then at the New York Times and later Fox News) was criticized for her role at the New York Times in promoting the Bush administration's arguments for the war.  In effect, Ms. Miller and the New York Times acted as a political agent for the Bush administration.  Unfortunately, she was not alone.  Many news outlets, Fox News for example, are not truly independent and act almost as an agent of a political party.

The media must be free to critically examine the information from the government, regardless of who is president.  But, they should do so thoughtfully, thoroughly and without bias.  Unfortunately, in today's media, which focuses more on entertaining rather than informing and also has close ties to political parties, there is no room for a trusted reporter such as Walter Cronkite to calmly report the news of the day without drama or injection of bias. When issues are discussed on today's news stations, they are often sensationalized in a contentious battle between talking heads with a banner across the bottom saying "Such and Such Fiasco".  This may make for entertaining television, but it does not inform.  If we are to preserve the United States as a democratic republic, the media must step up to its responsibility of informing the citizenry rather than attempting to use every opportunity to create controversy.

Be Afraid.  Be Very Afraid

by James Staudt

copyright 2018, James E Staudt, all rights reserved

With John Bolton appointed to replace H. R. McMaster as National Security Advisor to President Trump, President Trump is replacing one of the few remaining "adults" in the Trump administration with one of the most dangerous people in Washington, D.C.  General McMaster had a distinguished military career and in his book Dereliction of Duty demonstrated that he understands how the US can be drawn into unnecessary wars and then have these wars mismanaged and bungled by politicians and policy advocates who do not truly respect the military.  It is a great book worth reading that demonstrated that Vietnam, Iraq, and Afghanistan had a great deal in common.  In contrast to General McMaster, Bolton is the consummate Washington advocate.  He has cycled in and out of positions with Republican administrations and the American Enterprise Institute (AEI) - the right-wing "think tank" that promoted the Iraq War on behalf of it's defense industry benefactors under the guise of the Project for a New American Century.  Unlike McMaster, Bolton has no professional military or intelligence background to qualify for the post that he will now hold.  He has long been a policy advocate and therefore has the same cognitive bias that blinded Paul Wolfowitz (another AEI alum who guided the US into the Iraq War) as described in my book Grand Collusion.  Bolton is a staunch believer in "regime change" not only in Iran and much of the Middle East (except of course Israel, where he is close with Benjamin Netenyahu) but in North Korea.  As such, there is no chance that Bolton will advise President Trump to avoid war with either Iran or North Korea.

This might not be quite as alarming were President Trump more seasoned on foreign policy or more contemplative in nature, but he is neither.  It also might not be so alarming if congress had not surrendered its constitutional responsibility to authorize war with the horribly misguided Authorization of the Use of Military Force (AUMF), which effectively gave the president blanket authority to wage war against anyone and anywhere he chooses.  While intended in principle to be used against the perpetrators of the September 11 attacks, the AUMF has been used by presidents Bush, Obama, and now Trump to conduct military operations in the jungles of Niger, in Yemen, in Libya, and elsewhere against people who bore no responsibility for the September 11 attacks.  In effect, President Trump has already been granted the authority to go to war against Iran and North Korea should he choose to, and with John Bolton at his side, he will most certainly be advised to do so.  Congress cannot stop President Trump from going to war without repealing the AUMF, which will never occur with a Republican-controlled congress and would be very unlikely even if the Democrats controlled congress.  Moreover, it would require a veto-proof majority to repeal the AUMF because President Trump would no-doubt veto such a measure.

Bolton's appointment also demonstrates the hypocisy of President Trump.  As a candidate, then Mr. Trump repeatedly emphasized that he had been opposed to the Iraq War.  Why then would he turn around and appoint one of the architects of it to the critical role of National Security Advisor?  Candidate Trump was clearly telling us what we wanted to hear, not what he truly believed.

My fear is that President Trump will act as many embattled presidents do and go to war - hoping that the nation will rally around him as often happens to presidents when war occurs.  The Mueller investigation appears to be honing in on something that is creating more agitation for President Trump.  We don't know if Mr. Mueller will find actual collusion with Russia, but he could come across something else that is either embarrassing to President Trump or creates problems with people in his administration or members of his family.  For this reason, war with North Korea or Iran could start looking like a very attractive distraction from the investigation while also serving to rally the support of Americans.

So, be afraid.  Be very afraid.

On the DNC revelations

copyright, James Staudt, 2017, all rights reserved

The recent Donna Brazile revelations about the control that the Hillary Clinton campaign exerted over the DNC prior to even a single primary vote was cast may not seem surprising.  What it certainly proves is that neither of the two major party candidates - Trump or Clinton - was worthy to hold the office once held by Abraham Lincoln.

So, how did this happen?  The DNC under Debbie Wasserman Shultz, was financially in trouble.  In 2015 they made a deal with the Clinton campaign that the Clinton campaign would help with their debts and in return the DNC would turn over all decision-making, including staffing, to the Clinton campaign.  The Clinton campaign made numerous staff replacements, including according to Tulsi Gabbard (former vice chair of the DNC and a representative from Hawaii) replacing long-time DNC staff with Clinton-selected lobbyists.  In addition, state DNC party contributions would be funneled to the Clinton campaign through the DNC.  According to Representative Gabbard, 99% of such contributions were sent to the Clinton campaign.  So, contributors, thinking that they were helping local candidates, now realize that their contributions were being funneled to the Clinton campaign.

Supporters of Bernie Sanders, who suspected a rigged system, have been vindicated.  My democrat friends have had a very difficult time accepting the fact that the reason Donald Trump is president is not because of Russia as much as it is the fact that the democratic party offered a candidate that is at best extremely divisive or worse, untrustworthy.  This is not to excuse Donald Trump, who I have never considered an acceptable person to serve as president (and, I did not vote for Trump).  However, many of those who voted for Trump were people who knew that the Washington DC deep state is not working for them and were hoping for change from an outsider.  Most, I suspect, have been disappointed.  Nevertheless, this revelation about Clinton campaign control of the DNC will, hopefully, cause democrats to reflect on the party and demand reform.  However, I'm not going to hold my breath.

Are We Going to War?

by James Staudt

copyright 2017, all rights reserved

I hope not.  But, I fear that President Trump's speech at the UN brought back memories of the George W. Bush administration - especially the "Axis of Evil" speech where he told the world that "you are either with us or you are against us".  The stark "us versus them", "good versus evil" tone of the Trump speech is reminiscent of Bush and Cheney at their worst.  Also, President Trump is leading an administration that can't seem to get anything done domestically and is seeing key people from his presidential campaign, such as Paul Manafort, indicted.  A war tends to get the country to rally around a President, no matter how beleaguered he might otherwise be.  So, there are political reasons why President Trump, like President Bush before him, might be inclined to go to war.

Unfortunately, we cannot rely on Congress to prevent the war.  Although our Constitution (Article I, Section 8, Clause 11) gives Congress the sole authority to declare war and the President, as Commander-In-Chief, the power to conduct the war, since World War II Congress has consistently voted to grant the authority to commit troops to military action overseas ("war" by any other name) to the President, rather than make the affirmative choice themselves as was intended by the writers of our Constitution.  This works out well for both Congress and the President.  When things go wrong the President gets to do what he wants and can share the blame with Congress who allowed him to do what he wants.  Congress gets to put the blame on the President by saying that they didn't actually vote for the war but voted to give the President the choice to go to war and the choice was his.  Essentially, each gets to pass the buck to the other.  How convenient.

Make no mistake, there is no happy ending with a war against North Korea or Iran.  Iran is three times the size of Iraq in terms of land and population, and we know how well the Iraq War has gone.  A war with North Korea, while not much of a threat to US citizens at home, puts millions of our friends (and US citizens) in South Korea and Japan at risk and also risks a war with China.  China has made it clear that they will not accept US troops in North Korea, and we saw how well crossing the 38th parallel went about 70 years ago when China entered the Korean War.  President Truman deeply regretted taking General MacArthur's advice on that matter.

Even targeted strikes against North Korea would be a mistake. Kim Jong Un would hardly stand by, or he would risk losing power.  North Korea can easily bombard Seoul with its artillery and would likely do so in retaliation for a strike.  The population of the Seoul metro area is over 25 million.  My son is currently in Seoul on a semester abroad, and I am understandably worried about this.  Even if he weren't in Seoul, I would be opposed to an attack on North Korea.

The only world leader that applauded President Trump's speech was Prime Minister Benjamin Netanyahu.  Netanyahu encouraged the United States to invade Iraq.  He has encouraged a very militant posture with Iran, opposing the nuclear agreement.  In a war with Iran, Mr. Netanyahu's Likud government would be the main beneficiary.  As the United States and Europe have become more preoccupied with turmoil in the Middle East and elsewhere, there is less pressure on Israel to negotiate with the Palestinians.

I fear that we are getting ever closer to a serious war, perhaps even the use of nuclear weapons.

Trump and Dodd-Frank - No Surprise Here

by James Staudt, PhD, CFA

copyright 2017, all rights reserved

President Trump may be changing aspects of the regulations issued in response to the Dodd-Frank law.  How is that even possible?  As described in more detail in Grand Collusion, despite the 2000+ pages of Dodd-Frank, the law did not set any statutory requirements on the banks.  Much was to be determined in future executive branch rulemakings.  Therefore, it is pretty easy for President Trump, or any other president for that matter, to dismantle much of what few actual requirements were imposed on the banks.  This is not to say that there are no procedures that must be followed and that litigation might slow things down; however, because Dodd-Frank set very few statutory requirements and left so much to future executive branch rulemakings, Democrats cannot even filibuster to prevent fairly substantial changes.

This exposes what, in my view, was the fatal flaw of Dodd-Frank - it did not establish much in terms of statutory requirements.  By contrast, the Banking Act of 1933 that was under 60 pages long and gave us over 50 years of banking stability, had very clear statutory requirements - separating investment banking from commercial banking along with other requirements.  The argument that is always made is that there are too many details to be included in the 2000+ page law.  The reality is that today the laws that congress passes are mostly written by lobbyists because lawmakers and their staffs are far too busy raising money to devote much time to writing laws.  So, it was no surprise that Dodd-Frank - despite its length - set very few real requirements on the banks.  Agencies therefore set rules intended to achieve the goals set forth in the law, rules that must go through a proposal and public hearing process, rules that later get litigated, and therefore take a long time to enact and can get further watered down.

So, there is no surprise here.  The only surprise might be that candidate Trump, who railed against Wall Street, now perhaps wants to relax the rules.  However, if you've read Grand Collusion, this should be no surprise.  Wall Street owns both major political parties.  In fact, there is no reason to believe that Hillary Clinton wouldn't have taken steps to change the rules issued in response to Dodd-Frank.

This is not to say that the rules put in place after Dodd-Frank was passed cannot be improved upon in some ways.  They probably can.  However, with Goldman-Sachs executives advising President Trump, it seems likely that changes will be made that favor the banks even if they raise the risk to the taxpayer.

A complaint of the banks is that some institutions find the requirements costly and burdensome. If the current requirements are replaced with simpler capital buffer requirements that are more straightforward to follow but establish a solid bulwark against future failures, that could be an improvement.  Prior to banking deregulation, capital buffer requirements were very straightforward, making "stress testing" unnecessary.  On the other hand, if rules to prevent excessive risk taking through proprietary trading by depository institutions are relaxed (the so-called "Volker Rule"), that could pose a problem regardless of whether or not capital buffers are improved.

The truth is that right now we don't know for sure what President Trump has in mind.  So, we can only speculate at this point.  But, given the influence of Wall Street on every President for the past few decades, we should not be surprised if the already weak requirements of the rules established in response to Dodd-Frank get even weaker.

Flipping Washington The Bird

by Jim Staudt, PhD, CFA

Copyright, 2016

Donald Trump’s victory was unexpected. Some of my Democrat friends (who are in a state of shock) claim that this is a case of racism or White Nationalism. This is a mistake on their part. While I'm sure that there were some racists among the 59+ million people who voted for Mr. Trump, there were simply too many Americans who voted for Mr. Trump to blame it entirely on racism or White Nationalism.  Some polls show that college educated women, a group that Mr. Trump was expected to do poorly with, voted for Mr. Trump at a rate of 45%.  That is much higher than I expected given that his opponent was an extremely smart and accomplished woman.

My opinion is that the Democrats ignored the fact that a lot of Americans have suffered from economic policies put in place by both major parties over the past several decades that enriches Wall Street and big business at the expense of Main Street. These policies have hollowed out the American middle class and left us with wealth disparity that exceeds that of any country one might want to live in.  Hillary Clinton is viewed – rightly or wrongly (rightly, in my opinion) – as part of the political system that created those policies. Many Americans are weary of Washington and feel powerless against the forces that have controlled the two major political parties for several decades. Our government has grown increasingly detached from the people it governs, creating what many would consider a ruling elite.

Bernie Sanders would likely have defeated Mr. Trump. But, Senator Sanders, if elected president, would have upset the economic order that funds both political parties, which is why the DNC worked against him and for Hillary Clinton. After Bernie Sanders lost the Democratic nomination, voting for Donald Trump became the only viable option people had to give the middle finger to the political status quo.

The Democrats need to do a great deal of self-reflection.  They were once the party of the working class.  While the GOP has long been the party of big business, since the 1980s the Democrats have also become the party of big business.  As manufacturing jobs went overseas and private sector labor unions grew weak, the Democrats sidled up to Wall Street and big business to remain competitive. The result is that neither party represents Main Street any more, which is why there was a populist revolt in both parties.  In this case the GOP picked the populist candidate while the Democratic Party held on to the status quo, and the populist candidate won.  This is how Donald Trump made it to the White House.

Let's hope that Mr. Trump is up to the job.

Jim Staudt

On the IMF Warning

by James Staudt, PhD, CFA

Copyright 2016, all rights reserved

As noted on today’s front page article in the Financial Times, the International Money Fund has issued a warning that global debt, at a record of $152 trillion, or 225% of global GDP, poses a threat to the global economy.  Most of that debt – about two thirds of it – is private sector debt.   The IMF acknowledges the role of central banks by stating that debt has grown very rapidly since the financial crisis as central banks have been promoting debt expansion in an effort to promote economic growth. 

This is the challenge that we are faced with today after decades of debt fueled stimulus.  Economists have, for decades, ignored the risks of ever increasing debt levels because of their faith in their economic models that conveniently also ignore the risks of increasing debt levels.  This is also why their models are unable to anticipate financial crises.  It is like a weather forecasting model that ignores the role that ocean temperatures have on creating hurricanes.  This has allowed economists, including those in the academic community, to promote policies that are in the interests of their clients (such as investment banks, like Goldman Sachs) while conveniently ignoring the risks of these policies to the rest of us.

Our central bank, as well as other central banks, has been a major culprit in creating this situation.  As Mohammed El-Erian notes in his book The Only Game In Town, central banks felt that unconventional (and untested) means of stimulus were necessary to initially address the banking crisis and then to promote growth.  The use of these methods for such a prolonged period after the financial crisis created risks as well as an apparent windfall for the financial classes while not providing the kind of durable economic growth Main Street had hoped for.  Increased debt, whether public or private debt, poses risks, but the ease at which central banks can create money has created an illusion that debt is risk free and does not impose a cost.

The dilemma with debt is the fundamental problem that you are spending today what would be available for you in the future.  If your spending is on productive assets, like infrastructure or factory machinery, etc., this might provide more for you in the future.  But, if the debt is used to spend today simply for the sake of consumption or it is spent on productive assets that don’t provide an adequate future return, you dig yourself a hole.  Central banks can implement policies that promote or discourage use of debt, but they can’t tell people how to use that debt (nor should they).  The answer to this problem for the central banks has been to simply create more money, but this has a punishing effect on some while creating a windfall for others, without doing anything to promote investment in productive assets.

But, this gets to a very fundamental question.  Imagine a place where a group of unelected officials, not accountable to anyone, make key decisions about who are economic winners and losers.  You might think that this sounds like the old Soviet Union.  But, it is right here in the United States as well as other countries.  Our central bank has effectively been stealing from savers planning for future obligations (individual savers, pension funds, insurance companies) and giving it to those who are deeply in debt (investment banks, private equity funds, individuals who are over-extended on debt, and, of course, our federal government).  These policies have also promoted increased use of debt for no or low return investment, exacerbating the long term debt problem further.  It also raises the question of whether or not the central bank should really have such an outsized role in our economy without any oversight.  I will explore this in an upcoming blogpost.

Getting back to stimulus through debt, normally, such policies would punish a nation’s currency with high inflation.  But, with virtually every nation on earth pursuing these policies, it has become a race to the bottom.  Because global economic growth is so slow, nations are trying to grow by "stealing" growth from other nations though weak currency policies.  Are there periods in the past that we can look to for guidance?  I'm afraid so, but they are not a source of optimism. The period after World War I was the last time that most of the developed world was pursuing such policies.  The German Weimar Republic was printing money in an effort to promote the domestic economy while it was suffering under highly punitive war reparations to France.  France was deeply in debt to England, and England to the United States.  These nations, having abandoned monetary standards were printing money and experiencing high inflation.  Global trade also dropped as nations adopted "beggar thy neighbor" policies.  The United States for its part was on a debt binge that fueled a real estate and stock market bubble.  Inflation on consumer goods wasn’t a problem in the United States due to a gold standard and because, on balance, we were the largest creditor country.  However, we know how badly things ended that time. 

Let’s pray for a happier ending this time around.

On the IMF Warning

by James Staudt, PhD, CFA

Copyright 2016, all rights reserved

As noted on today’s front page article in the Financial Times, the International Money Fund has issued a warning that global debt, at a record of $152 trillion, or 225% of global GDP, poses a threat to the global economy.  Most of that debt – about two thirds of it – is private sector debt.   The IMF acknowledges the role of central banks by stating that debt has grown very rapidly since the financial crisis as central banks have been promoting debt expansion in an effort to promote economic growth. 

This is the challenge that we are faced with today after decades of debt fueled stimulus.  Economists have, for decades, ignored the risks of ever increasing debt levels because of their faith in their economic models that conveniently also ignore the risks of increasing debt levels.  This is also why their models are unable to anticipate financial crises.  It is like a weather forecasting model that ignores the role that ocean temperatures have on creating hurricanes.  This has allowed economists, including those in the academic community, to promote policies that are in the interests of their clients (such as investment banks, like Goldman Sachs) while conveniently ignoring the risks of these policies to the rest of us.

Our central bank, as well as other central banks, has been a major culprit in creating this situation.  As Mohammed El-Erian notes in his book The Only Game In Town, central banks felt that unconventional (and untested) means of stimulus were necessary to initially address the banking crisis and then to promote growth.  The use of these methods for such a prolonged period after the financial crisis created risks as well as an apparent windfall for the financial classes while not providing the kind of durable economic growth Main Street had hoped for.  Increased debt, whether public or private debt, poses risks, but the ease at which central banks can create money has created an illusion that debt is risk free and does not impose a cost.

The dilemma with debt is the fundamental problem that you are spending today what would be available for you in the future.  If your spending is on productive assets, like infrastructure or factory machinery, etc., this might provide more for you in the future.  But, if the debt is used to spend today simply for the sake of consumption or it is spent on productive assets that don’t provide an adequate future return, you dig yourself a hole.  Central banks can implement policies that promote or discourage use of debt, but they can’t tell people how to use that debt (nor should they).  The answer to this problem for the central banks has been to simply create more money, but this has a punishing effect on some while creating a windfall for others, without doing anything to promote investment in productive assets.

But, this gets to a very fundamental question.  Imagine a place where a group of unelected officials, not accountable to anyone, make key decisions about who wins and who loses in our economy.  You might think that this sounds like the old Soviet Union.  But, it is right here in the United States as well as other countries.  Our central bank has effectively been stealing from savers planning for future obligations (individual savers, pension funds, insurance companies) and giving it to those who are deeply in debt (investment banks, private equity funds, and individuals who are over-extended on debt).  These policies have also promoted increased use of debt for no or low return investment, exacerbating the debt problem further.  It also raises the question of whether or not the central bank should really have such an outsized role in our economy without any oversight.  I will explore this in an upcoming blogpost.

Getting back to stimulus through debt, normally, such policies would punish a nation’s currency with high inflation.  But, with virtually every nation on earth pursuing these policies, it has become a race to the bottom.  Because global economic growth is so slow, nations are trying to grow by "stealing" growth from other nations though weak currency policies.  Are there periods in the past that we can look to for guidance?  I'm afraid so, but they are not a source of optimism. The period after World War I was the last time that most of the developed world was pursuing such policies.  The German Weimar Republic was printing money in an effort to promote the domestic economy while it was suffering under highly punitive war reparations to France.  France was deeply in debt to England, and England to the United States.  These nations, having abandoned monetary standards were printing money and experiencing high inflation.  Global trade also dropped as nations adopted "beggar thy neighbor" policies.  The United States for its part was on a debt binge that fueled a real estate and stock market bubble.  Inflation on consumer goods wasn’t a problem in the United States due to a gold standard and because, on balance, we were the largest creditor country.  However, we know how badly things ended that time. 

Let’s pray for a happier ending this time around.

Is Summers Right about Trump?

by Jim Staudt

Copyright 2016, all rights reserved

Professor Larry Summers’ recent Financial Times article “The economic consequences of a Trump win would be severe” is misleading.  He forecasts that he expects that if Trump were elected, he “would expect a protracted recession to begin within 18 months.”  Regardless of who is elected president, a major recession is a near certainty (more on this later).  First, I will examine the charges Summers levels against Trump.

I am no fan of Mr. Trump, who has made misogynistic and racist comments that are unworthy of a presidential candidate.  But, there are numerous holes in Professor Summers’ arguments.  First, the claim of concern over a $10 trillion tax cut over the next few decades is off.  Even if such a tax cut and deficit increase were to happen, the United States has been running deficits for decades.  While I personally believe this has been an irresponsible policy that has enabled reckless behavior by our government, such as the Iraq War, such a policy would not be a major change from policies that Mrs. Clinton has herself advocated as a US Senator.  Moreover, Congress actually holds the purse strings in the US government.  A President Trump cannot act without the help of Congress.  Regarding the second and third concerns of Professor Summers regarding trade and security policies, Professor Summers fails to recognize that a President Trump cannot on his own end trade agreements or treaties.  Again, a President Trump needs Congress, specifically, the US Senate. Regarding the fourth concern about Mr. Trump’s authoritarian style, here Professor Summers conveniently assumes away the US legal system, which is in place to prevent the abuses Professor Summers alleges a President Trump would commit, such as torture.  Professor Summers also forgot that in October 2006 then Senator Clinton stated to the New York Daily News that she was in favor of exceptions to the no torture policy, especially when there is a “ticking time bomb”.   The final charge about lack of business confidence is pure conjecture, and ignores the fact that Mr. Trump’s own fortune would be adversely impacted by a loss of business confidence.  So, while I do not relish the thought of a President Trump, Professor Summers’ charges are entirely baseless.

As for why a recession is a near certainty over the next few years regardless of who wins the election in November, here are the arguments.  The first reason is timing.  We are long overdue.  The average time between recessions is about 6-7 years, and we are on year eight with every economic indicator sputtering and flashing yellow.  Moreover, since the beginning of financial deregulation in the US, we have had a banking crisis roughly every ten years, each of increasing severity.  If the trend continues, that means 2018 is time for the next banking crisis.  But, these past trends do not guarantee future behavior.  The second reason is that the fundamentals point toward another recession.  Every economic indicator is flashing yellow - from employment statistics, to productivity, to outlook of CEOs.  It is clear that after decades of central bank intervention to achieve the “great moderation” prior to 2008 and the inability of central bankers to achieve sustainable growth since the 2008 crisis, Hyman Minsky’s concerns (published decades ago) about financial instabilities associated with what he calls “Ponzi finance” are prescient.  Ponzi finance is where  “cash flows from operations are not sufficient to fulfill either the repayment of principle or the interest due on outstanding debts by their cash flows from operations”, and a unit must sell assets or borrow.  As Minsky stated in 1992, “over a protracted period of good times, capitalist economies tend to move from a financial structure dominated by hedge finance units to a structure in which there is large weight to units engaged in speculative and Ponzi finance.”  Our government and much of the private economy has been practicing Ponzi finance for decades.  In fact, much of our economic growth over the past several decades has been the result of Ponzi finance – enabled by central bank interventions to prevent market corrections - with total debt to GDP in the US rising from under 150% in the 1950s through 1970s to well above 300% in the post 2000 period.  Ponzi finance is not sustainable, and therefore corrections are inevitable.  We are at the end of what some call a debt supercycle that was enabled by our central banks, and history shows that there is no easy way out of this.  In my book, Grand Collusion, I discuss the challenges we face and some solutions.  But, like a cancer patient facing surgery or chemotherapy, there is no easy path back to good health.  I’m afraid that a recession, or worse, is a near certainty regardless of whether Mr. Trump or Mrs. Clinton wins in November.

Our nation has reached this point - deeply in debt with growth highly elusive and a wealth disparity unlike any other western nation one would want to live in - thanks to policymakers, including Mrs. Clinton, who have misled the public over the past several decades.  Many Americans instinctively know that something in Washington really stinks - even if they can't put their finger on the precise cause.  It is clear that Washington is not working for most Americans.  That is what has powered the unlikely rise of Bernie Sanders and Donald Trump.

Sadly, in the forty years I've been voting, this is the worst choice the two parties have offered us in a presidential race.  It is a choice between bad and horrible.

The Age of Bizarro Economics
by Jim Staudt, PhD, CFA
copyright 2016, all rights reserved

In DC Comic’s Superman, there is a Bizarro world on the cube-shaped planet htraE (Earth spelled backwards) where everything is the opposite of Earth. Ugliness is worshiped over beauty. Stupidity is preferred over intelligence. And, even bonds are sold that are guaranteed to lose money.

In an age where about 25% of the world’s economies (Japan and much of Europe) are practicing negative interest rates, we have reached a point that might be called the age of Bizarro Economics. A fundamental principle that economists have relied upon for ages is that there should be a cost to borrowing capital because capital is useful, and the cost charged for borrowing capital should increase with the risk of the associated investment. Thirty years ago the thought of a world with negative interest rates would be akin to a world without gravity – something inconceivable. Today, thanks to central bank intervention in many countries we now have a cost to possessing capital. Possessing capital is no longer desirable, but now incurs a burden! Much has been written about the risks of this policy – risks of depositors removing deposits from banks, risks to insurance and pension funds and to savers, risks associated with investment in low return projects that will drag down economic growth for decades, and other risks associated with misallocation of capital. On the other hand, the promoters of low to negative interest rate policies argue that this is what is necessary to promote economic growth. They believe that the failure of Quantitative Easing (QE) to provide sustainable growth is not because QE doesn’t work (unlike pushing a rope?), but that we didn’t have enough QE – in effect we should “double down” on a policy that didn’t deliver. They argue that negative rate policies have prevented the Eurozone and Japan from suffering deflation, although we can’t be certain what might have happened if interest rates had been permitted to normalize.

What I argue is that negative rates are where decades of “growth at any cost” easy monetary policy have led us to. Credit expansion can stimulate economic growth by increasing credit purchases. But, too much easy credit will lead to misallocation of capital, such as people purchasing homes they can ill afford, as happened in the run up to the 2008 crisis. As I argue in Grand Collusion, it also leads to nations being tempted to act recklessly and pursue unnecessary wars.   And, use of credit for promoting consumption is by its very nature consuming today in exchange for reduced consumption tomorrow. But, tomorrow does eventually come. In effect, the world economy has grown addicted to easy credit, and for an addict more of what he or she is addicted to always seems like a good solution.

In A Brief History of Financial Euphoria John Kenneth Galbraith wrote “All crises have involved debt that, in one fashion or another, has become dangerously out of scale in relation to the underlying means of payment.” For many nations, including the United States, debt relative to gross domestic product is currently well above where it was immediately before the Great Depression. Central bankers believe that they are smarter than they were in the past and can navigate the risks of negative interest rates and ever-expanding credit.  In 2004 Ben Bernanke, not yet Fed Chairman but a member of the Board of Governors of the Federal Reserve and the heir apparent to Alan Greenspan, stated in his “Great Moderation” speech that improved monetary policy had reduced macroeconomic volatility.  In other words, in his view central bankers had played an important role in taming the business cycle. Yet, despite Dr. Bernanke’s words and his succession as Fed Chairman, we suffered the greatest economic downturn since the 1930s only four years after his statement.  In light of this, should we really have such confidence in our central banks that this time will be different?

Unfortunately, decades of expansionary monetary policy have backed the central banks into a corner where there are no means left at their disposal to promote economic growth other than entering the Bizarro World of negative rates. But, the bigger question is whether the central banks should have been managing our prosperity in the first place. In other words, is economic growth the responsibility of the central bank? At initial blush, this seems a strange question. In recent decades we have grown so accustomed to the Fed’s role in “managing” the economy that to argue otherwise may seem like heresy. But, the original role of the Federal Reserve was not to manage our prosperity, but to be the regulator and guarantor of our banking system. What we have seen over the past several decades is what military strategists call “mission creep” – where the initial mission morphs into another one and you lose sight of what your objective was in the first place.   Managing the economy was never the original intent of the Federal Reserve.  What the 2008 crisis proved beyond a doubt is that the Fed failed miserably in both its original mission of ensuring bank stability and its adopted mission of managing the economy.

The Fed and other central banks, increasingly staffed with academics trained in neoclassical economics, have come to have great faith in their ability to “fine tune” the economy with the help of their economic modelling. These computer models have given the Fed and other central banks the mistaken idea that they can actually manipulate the economy to some end - in effect, central banks now think that they can be the "Wizard of Oz" running the economy from behind a curtain. This has tempted central banks to move their attention from their original responsibility of ensuring banking system stability to the role of managing (or trying to manage) our economy. In this respect central banks believe that Adam Smith’s “Invisible Hand” can be put under the control of the Fed and the other central banks.

And, if one accepts the notion that the Fed should manage our prosperity with pro-growth policies (I don’t, but supposing one did), this raises still another question: What level of risk is a society willing to accept to achieve this growth? Is it worth risking severe economic crises to achieve that growth? This is an important question that the central banks are ignoring with their short-sighted perspective and what I believe is hubris in thinking that they can really tame the business cycle.

Unfortunately, the Bizarro World that we live in, unlike that of DC Comic’s Superman, is real. It doesn’t go away when we close a comic book. We have to deal with the effects of decades of credit expansion at rates that far exceeded the growth in the world economy. The debt, unless written down at a large cost to investors, will be a drag on economic growth for decades.

For those of you looking for the figures for Grand Collusion, go to the January 28, 2016 posting.

I've recently uploaded a revised version of Grand Collusion, which I hope is it for a while.  It incorporates a discussion of the dynamic going on with the "outsider" candidates - Sanders, Trump and Cruz as well as a new and improved discussion of foreign policy, along with a number of other tweaks and improvements.

Figures from the book, Grand Collusion

Grand Collusion

 

How the two parties collude to divide the spoils of governing, corrupting democracy and American capitalism.

 

By James E. Staudt

 

 Because of the poor image quality on some ebook readers this provides figures from the book available from Amazon as a Kindle ebook

 

 

This book is published directly by the author and is distributed only as an ebook

 

 

 

© Copyright, James E. Staudt, 2016 all rights reserved

 

All rights reserved.  None of these figures or tables may be reproduced in any form or by any means – electronic or otherwise –

without the express, written permission of the author.

 

 

Figure 1. Total House and Senate Election Spending, current dollars

(data source: Campaign Finance Institute)

 

 

Figure 2.  Congressional districts in the Houston area.

 

 

Figure 3.  Congressional Districts in Texas

 

Figure 4.  Federal Receipts and Outlays, and the party of the President

Data from US Treasury

 

Figure 5.  Marginal Tax Rates, Capital Gains and Wages (data from US Treasury)

 

Figure 6.  Receipts and Outlays, and Cumulative Federal Debt Outstanding – nominal values (data: US Treasury)

 

Figure 7.  Federal Outlays (million current dollars - data from US Treasury)

 

Figure 8.  Human Services Outlays (million current dollars - data from US Treasury)

 

Figure 9. The Largest Outlays (million current dollars, data from US Treasury)

 

Figure 10.  Inflation and Fed Funds rate by year

(periods of war or military buildup in red, depressions or recessions in blue, oil embargo in yellow)

 

Figure 11a

. Household, Federal, and Domestic Financial New Credit Market Annual Borrowing and Fed Funds Rate

(developed from US Federal Reserve)  recession periods in yellow shade

 

Figure 11b

Domestic Financial New Credit Market Annual Borrowing

(developed from US Federal Reserve)  recession periods in yellow shade

 

Figure 12a.  US Credit Market Debt Owed and by Whom, percent of GDP

(developed from US Federal Reserve)

 

 

 

Figure 12b.  Who Holds US Credit Market Assets – percent of GDP

(developed from US Federal Reserve)

 

 

Figure 13.  Growth rate of CPI adjusted wages (calculated from US Census data)

Figure 14a.  10-year US Treasury rate, change in rate

 

Figure 14b.  Federal Deficit

 

Figure 15a.  Change in GDP versus Capital Gains Tax Rate (1947-2012)

 

 

Figure 15b.  Change in GDP versus Capital Gains Tax Rate (1945-2012)

 

Figure 16a.  Change in GDP versus Highest Income Tax Rate (1947-2012)

 

Figure 16b.  Change in GDP versus Highest Income Tax Rate (1945-2012)

 

Figure 17.  The Dow Jones Industrial Average January 1900 to March 2015

 

Table 1.  GINI Index (World Bank)
Country name	Most recent of 2005-2013
Ukraine	24.8
Slovenia	24.9
Sweden	26.1
Iceland	26.3
Czech Republic	26.4
Belarus	26.5
Slovak Republic	26.6
Norway	26.8
Denmark	26.9
Romania	27.3
Finland	27.8
Kazakhstan	28.6
Hungary	28.9
Netherlands	28.9
Albania	29
Iraq	29.5
Pakistan	29.6
Serbia	29.7
Armenia	30.3
Timor-Leste	30.4
Germany	30.6
Moldova	30.6
Montenegro	30.6
Egypt, Arab Rep.	30.8
Tajikistan	30.8
Niger	31.2
France	31.7
Cambodia	31.8
Bangladesh	32.1
Ireland	32.1
Japan	32.1
Lithuania	32.6
Estonia	32.7
Nepal	32.8
Poland	32.8
Azerbaijan	33
Bosnia and Herzegovina	33
Mali	33
Burundi	33.3
Kyrgyz Republic	33.4
Croatia	33.6
Ethiopia	33.6
Canada	33.7
Guinea	33.7
Jordan	33.7
India	33.9
Sao Tome and Principe	33.9
Bulgaria	34.3
West Bank and Gaza	34.5
Greece	34.7
Sudan	35.3
Sierra Leone	35.4
Italy	35.5
Indonesia	35.6
Vietnam	35.6
Spain	35.8
Tunisia	35.8
Mauritius	35.9
Yemen, Rep.	35.9
Latvia	36
Lao PDR	36.2
Sri Lanka	36.4
Mongolia	36.5
Tanzania	37.8
United Kingdom	38
Liberia	38.2
Iran, Islamic Rep.	38.3
Bhutan	38.7
Thailand	39.4
Russian Federation	39.7
Burkina Faso	39.8
Turkey	40
Congo, Rep.	40.2
Senegal	40.3
Mauritania	40.5
Madagascar	40.6
Cameroon	40.7
Morocco	40.9
United States	41.1
Uruguay	41.3
Georgia	41.4
El Salvador	41.8
China	42.1
Gabon	42.2
Angola	42.7
Fiji	42.8
Ghana	42.8
Israel	42.8
Nigeria	43
Philippines	43
Cote d'Ivoire	43.2
Chad	43.3
Benin	43.5
Argentina	43.6
Cabo Verde	43.8
Macedonia, FYR	44.2
Congo, Dem. Rep.	44.4
Uganda	44.6
Venezuela, RB	44.8
Peru	45.3
Dominican Republic	45.7
Mozambique	45.7
Nicaragua	45.7
Togo	46
Malawi	46.2
Malaysia	46.2
Bolivia	46.6
Ecuador	46.6
Kenya	47.7
Paraguay	48
Mexico	48.1
Costa Rica	48.6
Chile	50.8
Rwanda	50.8
Swaziland	51.5
Panama	51.9
Guatemala	52.4
Brazil	52.7
Colombia	53.5
Lesotho	54.2
Central African Republic	56.3
Honduras	57.4
Zambia	57.5
Botswana	60.5
Namibia	61.3
South Africa	65
Seychelles	65.8

GINI index - Gini index measures the extent to which the distribution of income or consumption expenditure among individuals or households within an economy deviates from a perfectly equal distribution. A Lorenz curve plots the cumulative percentages of total income received against the cumulative number of recipients, starting with the poorest individual or household. The Gini index measures the area between the Lorenz curve and a hypothetical line of absolute equality, expressed as a percentage of the maximum area under the line. Thus a Gini index of 0 represents perfect equality, while an index of 100 implies perfect inequality.  – World Bank

 

 

Figure 18.  Estimated Eligible Voter Turnout by State[55]

[55] Data from the United States Election Project

 

 

 

About the Author

 

Jim Staudt makes a living from examining data and working with policymakers and industry primarily on energy and environmental policy.  In Grand Collusion he shares his analysis and insights on some of the disturbing trends in our political system, explains how we got to where we are, and makes suggestions about where we need to go from here.

 

For decades Jim worked in the energy and environmental industries and now consults to industry, to states and the federal government. He is a graduate of the United States Naval Academy and served in the Navy Nuclear program aboard the nuclear powered aircraft carrier USS Enterprise CVN-65.  He later received his MS and his PhD from the Massachusetts Institute of Technology and also holds the Chartered Financial Analyst (CFA) designation.

 

He lives with his wife and two children in the Boston area.