Saturday, April 19, 2008

Brave Words From A Dissenter

Two Fed presidents dissented with the previous rate cut. One of them was Charles Plosser, president of the Federal Reserve Bank of Philadelphia. Yesterday, in a speech at Drexel University, he had this to say about the limits of rate cuts:

The idea that interest-rate cuts can solve any economic ills is a misleading perception. Not only is that not true, it is a dangerous misconception and runs the risks of setting up expectations that monetary policy can achieve objectives it cannot attain.

To ensure the credibility of monetary policy, we should never ask monetary policy to do more than it can do. Lower rates, for one thing, cannot solve the problem of bad debts in the mortgage markets. Nor can they reprice the risks of securities backed by subprime loans.

Mr. Plosser, you just became my Federal Reserve resident hero.

Many think that further rate cuts can and will provide an economic boost. But with real rates already at minus 1.75% - after the fastest plunge into negative territory ever - what we are going to get is plenty of dashed hopes, if the economy does not pull out of its tailspin very soon.

Data: FRB St. Louis

The real estate bubble was created by Mr. Greenspan's spate of negative rates. We are now getting a frenzy in commodities from Mr. Bernanke's negative rates. But unlike previous bubbles that mainly involved speculators in shares and housing, the current spike in food and fuel prices is causing hunger and misery across the globe.

In a fiat currency world experiencing resource limitations there are no more "good" bubbles to blow by using negative rates. Instead, we are implementing a "beggar thy neighbour" policy by stealth, a version of the Smoot Hawley Act updated for 21st Century conditions.

A fiat currency regime, where monetary policy reigns supreme, was appropriate for an expanding world unhindered by resource depletion. An ever-expanding supply of money fit the Permagrowth model well - indeed, it was a necessary condition. However, we are now transiting to a different socio-economic model and the evidence is all around us, plain for all to see: zooming prices for low value-added necessities.

Why has the price of rice quadrupled? Does it now contain four times as much technological or knowledge value-added? Of course not. It is all about scarcity value, a concept we have not experienced in centuries, outside of war.

If I may spin Mr. Plosser's remarks to another level: We can't buy Manhattan for a bag of beads any more. There are too many buyers around and the natives are restless.


  1. Hel,

    The only way that the dollar will be defended is if Ben and Hank are removed. To Ben's core, he is a "protect the corrupt and fiscally irresponsible at the expense of the few responsible citizens that remain". He has more tricks up his sleeve, such as the Fed directly buying treasuries to fund massive government spending programs; conducting "monetary rains" where the Fed simply give it away to the citizens (no corruption there); and my favorite, the implementation of negative real savings rates, where bank account and money market interest is negative in real terms...he explicitly steals your savings (vs the implicit theft occurring via devaluation today).

    Sound unrealistic? They are all described in speeches by Ben himself the past few years.

    When China decides we are not buying enough lead-laden children's toys and lethal pet food (and reverse their buying of treasuries and agencies), you better have an off-shore account to which to protect your wealth.

    You think you've seen devaluation? You ain't seen nothing yet.

  2. Well, Hank will most likely be gone in 8 months and Ben is unlikely to stay if the economy crash lands and a Dem is elected.

    But then what? Who will replace them? Likely another duet from Wall/academia bent on defending, preserving and upholding the status quo of Permagrowth. Larry Summers as SecTreas? Bob Rubin at the Fed?

    I don't see them as radically different. They, too, strongly believe in the efficacy of monetary/fiscal policy in shaping the real economy. They will make the same mistakes, in different ways.

    Somebody please teach thermodynamics to those Wall Street guys...particularly the concept of entropy.

  3. Once middle America gets upset from food and gas prices, dollar will be defended or Bernanke's ass will be set in fire.

    If you are a generous, nice-hearted person, I doubt Wall street will allow you to be elected to Fed. These guys are all political appointees.

    For example, this guy Plosser is not talking against rate cut, because he has a good heart or active brain. He represents a large manufacturing region, which is getting raped by high oil prices.

    I expect the coming Fed meeting to be the turning point for commodities. Seems like the idiots in Fed are already sweating. Also, stocks are not crashing this time and so they have more room to be aggressive on inflation.

  4. Another article came out in WSJ echoing the same message as Plosser.

    "Enough with interest rate cuts" - Feldstein

  5. Greenie,
    Thanks for yesterday's post on Simmons, its good to know but in my personal experience the people who create the wealth are almost always better people than the people who inherit it. There are 2 reasons for this I think:

    A) GenOne remembers what it was like to be one of the masses and has some empathy with them. GenTwo grows up pampered and only feels an exagerated sense of self importance and entitlement.

    B) To create that wealth GenOne had to be above average and so has the self confidence to give away large sums secure that they can always earn plenty more. GenTwo may not be so above average and so to maintain their wealth they become stingy and use unsavory or illegal tactics to generate income since they're not as talented as their forebears. And as is said, a fish rots from the head.

    Corruption at the top quickly infects those below since everyone does it and soon you have junior traders adamantly insisting that they become billionaires in time for their big 30th birthday bash. Of course only one in 10,000 might make it but alot of them will compromise themselves trying and cause untold harm to others.

    Of course I don't trust the govt but it needs X amount to function at whatever level the electorate deems appropriate. If that X amount can be derived mostly from the rich their power will be reduced and the govt will not be any bigger or smaller than what the voters have decided on.

    W/respect to govt funds being recycled to the rich, so what. At least needed services will have been provided to those who need them before the money finds its way back upstairs. I do agree with you on the need for rationing. Right or wrong it's unavoidable and if done rationally very desirable. In a world of increasingly limited resources it would be wrong to expend one or two million$ on a hopelessly ill patient who has very little chance of recovery when dozens of less sick patients can be helped instead.

    Amen. There is alot more that society can do given the resources but there will be tough decisions about who can and who can't be helped; that's what elections are supposed to be for if the voters followed Ralph Nader's advice and became as well informed about the issues that affect them as they are about their favorite sports teams.

    I agree with Thai, the rest of the world is catching up and not even the most benevolent and egalitarian govt can prevent Americans from getting poorer but that doesn't mean the rich can cecede with their wealth.

    For the record, this isn't just some lefty-marxist venting. Mr. Market himself, George Soros said that markets are completely amoral and that society should be protected from the depredations of him and people like him. The only reason he does what he so strongly disapproves of is because the system has decided to make it legal and if he didn't do it someone else would. By making as much money as possible he can redirect it from greedy pockets into charity. He has made these comments several times on TV.

  6. I never thought that I would ever agree 100% with Marty Feldstein on anything. What can I say... unusual times make for strange bedfellows.

    Thanks for the link greenie.

  7. Isn't the "Manhattan for beads" deal now considered good value, once inflation is taken in to account?

  8. Hellasious,

    Excellent blog. Resource depletion, monetary systems built on debt, and globalization. These are likely to become some of the historical landmarks of our era. And thus interesting topics for intelligent thought. Unless there is a change in banker psychology, Bernanke may deplete the Fed's monetary resources and begin to plunder our significantly indebted US Treasury. Peak oil theory has serious implications for a monetary system dependant on permagrowth. As greenie suggests, the tide of public opinion may be starting some gluteal fires that may also eventually burn Bernanke's puppetstrings much to the chagrin of his puppetmasters. I am not holding my breath, however.

    Hell, I think the big players understand thermodynamics well, and they are attempting to hoard as much heat as possible hoping that the shivering masses will not revolt. I am not sure the escalation of food and energy prices are predominantly due to peaking resources rather than another speculative bubble forming. It is one thing to lose a home that you had little or no equity in and another to starve to death. How will the financial wizards and the politicos address these problems. I have my guesses.

    One pertinent question is how will different nations deal with these changing paradigms? I suspect, probably not well.

  9. Its going to be Atlas Shrugged v. Grapes of Wrath here in 'Murica.

    Googled "devaluation" due to shawn h's post. One of the returns was for borderline personality disorder. Intrigued, I jumped in. People w/this disorder take the neutral actions of others and read in secret attacks and conspiracies against them. Thus devaluing the character of the person who was in reality neutral. Sufferers tend to be narcistic and relate all events as involving themselves.

    This of course isn't the devaluation shawn h was referring to, but it did seem to fit in w/discussions about the rich or gov being out to destroy the middle class. Example: there isn't a cabal raising the price of gas to bankrupt commuters. There's just less oil than the world needs so the price is going up.


  10. However, we are now transiting to a different socio-economic model and the evidence is all around us, plain for all to see: ???

    H, I wish! Visual acuity is quite impaired here - (Ireland).

    Residential and commercial RE is declining at -15%; mortgage lenders want 20% up-front with Revenue docs for proof of income; LTV at 80%. New home construction in 2008 will be 50% 2007 level.

    Finance houses are very coy about their solvency. Roy. Bank Scot. was 'fine' last week, now they would like to raise Eu12B from investors! Commercial and personal interest rates are being increased.

    Unemployment is rising sharply. As are costs of staples and energy. Diesel is equivalent to USD8 per gal (4 litre). Many private motorists use diesel vehicles.

    Politicians are behaving like rabbits in front of a snake; MSM are, just about, reporting the reality.

    National Pay Talks are currently underway - Union reps want wage increases to match price increases, employers want 'greater productivity' - aka. a 'wage cut'. Farmers are looking for more subsidies!!

    Know any good spectacle providers?

    Brian P.

  11. Adding to Hellasious' post, from a November 2007 Food and Agricultural Organization (FAO) report (HIGH PRICES AND VOLATILITY IN AGRICULTURAL COMMODITIES):

    Beyond the usual supply and demand factors

    Market-oriented policies are gradually making agricultural markets more transparent and, in the process, are elongating the financial opportunities for increased portfolio diversification and reduction in risk exposures. This is a development that is taking place just as financial markets around the world are experiencing the most rapid growth, driven by plentiful international liquidity. This abundance of liquidity reflects favourable economic performances around the world, notably among emerging economies, low interest rates and high petroleum prices. These developments have paved the way for massive amounts of cash becoming available for investment (by equity investors, funds, etc.) in markets that use financial instruments linked to the functioning of agricultural commodity markets (e.g. future and option markets). The buoyant financial markets are boosting asset allocation and drawing the attention of speculators to such markets, as a way of spreading their risk and pursuing of more lucrative returns. Such influx of liquidity is likely to influence the underlying spot markets to the extent that they affect the decisions of farmers, traders and processors of agricultural commodities. ...

    Soaring petroleum prices have contributed to the increase in prices of most agricultural crops: by raising input costs, on the one hand, and by boosting demand for agricultural crops used as feedstock in the production of alternative energy sources (e.g. biofuels) on the other. ...

    Freight rates have become a more important factor in agricultural markets than in the past. Increased fuel costs, stretched shipping capacity, port congestion and longer trade routes...

    Exchange rate swings play a critical role in all markets and agricultural markets are no exception. Yet, rarely have currency developments been as important in shaping agricultural prices as in recent months. ...

    NB the above is global and that some conditions have changed in the interval and that there are many other informative articles and reports, from price indices to food security, at the FAO's relatively new World Food Situation site:

  12. Hell wrote:

    "A fiat currency regime, where monetary policy reigns supreme, was appropriate for an expanding world unhindered by resource depletion."

    This is exactly why the present global system of finance is failing and doomed to ruin. The essential underlying condition that allowed the soon to be obsolete system to maintain itself is no longer in place. And in a world, well, at least this corner of the world, where the vast majority are barely making payments on the necessities, the present bubble in commodities can only cause all sorts of chaos.

    With respect to capital flight in the form of an exit from our debt markets by the Chinese, that is, as Shaun asserts, coming at some point. But don't think for a minute that the Chinese will not suffer a severe recession as the U.S. consumer stops buying their manufactures. Everyone is going to feel this one big time, as decoupling is a fantasy.

    And when the unemployed in China get restless, and they will, I expect Taiwan and some other key spots, (Tibet is already feeling the heat) to be in real peril. After all, nothing distracts quite like war. My timeline for that, though, is a few years away.

    Regarding the stock market's prospects, to say the present rally is a sell, is a gross understatement.
    The earnings will not be there despite the jiggery pokery that went into Google, Intel, etc. "beating the estimates" last week. What's more the bond market is set to put the kibosh on this rally. The Fed will not take back any rate cuts now as it would fatally undermine their authority and weigh heavily on an economy that is cracking anyway. When things get worse, The Fed wants to be able to say, we did everything we could, even if a sophisticated analysis would show that what they did caused far more harm than good. Anyway you slice it, the Fed's days are numbered.

    Pardon my rather rambling discourse.

  13. Thai,
    I left you a couple responses on yesterday's blog (Lords of Hedgistan) to round out my position without imposing on this thread more than I have.

  14. Just so you don't have to google the Bernanke/Fed quotes, here are a few word-for-word:

    - In ordinary circumstances, monetary policy exerts its stimulative impact in part through increasing the financial wealth of the public — such as producing capital gains in bond and equity markets. If, at the zero bound, the Federal Reserve had already taken what actions it could to raise bond and equity prices, it might look to other tools it has to increase the public’s wealth. One tool ... is that of conducting “money rains”...that is, *GIVE* money away either through directly disbursing currency to the public or by disbursing it through the banking system.

    - No one would be willing to hold any asset that pays a negative nominal rate, as long as zero interest money is available as a store of value. The strategy for eliminating the zero bound, therefore, is to make money pay a negative nominal interest rate, by imposing some type of “carry tax” on currency and deposits. A tax or fee on Reserve deposits of 1 percent per month, for example, would mean that those deposits, in effect, pay a nominal interest rate of roughly minus 12 percent.

    - Why not have the Fed just conduct an open market purchase of real goods and services? This strategy would represent a direct stimulus to aggregate demand...the Fed “could theoretically buy anything to pump money into the system” including “state and local debt, real estate and gold mines — any asset”.

    - 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, that allows it to produce as many U.S. dollars as it wishes at essentially no cost.

    - Another option would be for the Fed to use its existing authority to [directly purchase] in the markets for agency debt

    - 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.

    - During the Depression, "the Fed foolishly...allowed the weak banks to fail"

  15. Dink-- LOL! :)

    yoyomo- thanks, I just finished reading them. :-)

    Edwardo-- Where are you investing if at all?

    Greenie- Thanks for the Feldstein link

    Shawn h-- perhaps Ben will add this old ER (Emergency Room) physician quote to his list of toddies: "all bleeding eventually stops"

  16. Hell, you know I tend to see the world in fractals (things look the same when you 'fracture' them apart), I wondered if you saw this and if so what you thought...

  17. "Somebody please teach thermodynamics to those Wall Street guys ... particularly the concept of entropy."

    The Street is an artificial construct and the Powers to be have the power to change the rules that govern the construct.

    Not withstanding, one of the reasons why God does not play dice with the universe, may be that mucking around with the rules perturbs stability over the long term. The long term is something that the Powers to be have little interest in - e.g. Bubbles R' GreenSpan.

  18. Great post, but I would disagree with the thought that there ever is an "appropriate time" for a fiat currency. As we are witnessing again, even with early and mid stage benefits, these fiat currencies come and inevitably implode with destructive force.

    When you look at the big picture and remember that there are 300 mln in this country, it's no wonder that Bernanke has turned on the monetary fire hose and gone to 10 alarms. A depression in the 30's was bad enough with what, about a third of the population? Even Ben knows that things could get mighty bad for him and his cohorts if 300 mln wake up in a foul mood and each decide to "make a difference" in a collective sort of way, if you get my drift. And this is to say nothing of the impact that our falling dollar is having globally.

  19. buying power, and irrational consumption.

    isnt this the crux of the post, in any transaction you establish two things:
    1. The buyer thinks its worth more.
    2. The seller thinks its worth less.

    The notion of the trade: beads for Manhattan is false. The concept of private lands seemed a fallacy to the Natives in America, and the bead "sellers" were the fools. But the game changed, and we all know how that affair turned out.

    Look into the abyss of the Global Natives bead collection...

    The natives selling thingies to Americans for modern day beads (oil for dollars)....the natives then bundle the dollars in a bank, and print local beads for Natives to exchange for thingies, such as food.

    If you are looking for a game changing momment, look at the dollar recycling campaigns in the emerging markets and its relation to clearly unanchored inflation expectations of the Natives. When you tether an historically unstable currency in an emerging market, to a very stable industrialized nations currency in a credit bubble...dangerous games of hot money capital flows at the push of a button will reveal significant limitations of arbitraged swapped synthetic derivatives...the complexity, speed, and efficiency of the global financial industrial complex is, in and of itself, an impendiment to the recovery.

    Capital controls are on the way, and yes, they will result in unintended consequences. The currencies that collapse will be a function of too much hot money going beserk with bi-polar behavior.

  20. Hell,
    been reading the blog for a while now. It's excellent. Keep it up. I'm also wondering if you could comment on the following:

    Marx developed the immiseration thesis which works like this, in this order:

    1• The capitalists would begin to suffer from a falling rate of profit.

    2• The workers would therefore be "immiserized"; they would become poorer as the capitalists struggled to keep their own heads above water.

    3• The poverty of the workers would drive them to overthrow the capitalist system--their poverty, not their ideals.

    The resultant would be a natural shift towards socialism, which he says would be inevitable.

    This seems to have been proven wrong, because capitalists were not experiencing poverty (in comparison to soviet Union).

    But then Baran-Wallerstein revised the immisuration thesis, showing that the permagrowth of capitalist society was due to the exploitation of the resources in the 3rd world, which propped up growth at others expense.

    I look at the situation today- the one that you define- and see limited resources creating a condition which negates the permagrowth model, and wonder if in fact Marx was right?

    it seems as if condition 1 has been met (falling profit), and it seems condition 2 is being met (workers becoming poorer as capitalists struggle to keep their heads above water).

    What then is your opinion of condition 3 happening (revolution)? And IF it does happen, do you think it follows that we enter a system which is MORE socialist, and eventually (x number of generations in the future) completely socialist?

    because after all, isn't the realization of a renewable energy policy you desire, ultimately socialist in nature (unlimited energy for all)?

  21. Hot Damn! This site is hotbed of freethinking! The other sites are still stuck on when the economy will rebound and we're heretically wondering what will happen if it doesn't. We must be the quick adapters.

    Fiat currency, Newtonian physics, fractals, international perspectives, agricultural market reports, beads, "arbitraged swapped synthetic derivatives", and intergenerational squabbling...SWEET!

    6 billion+ H.Sapiens making decisions based on different data sources with different analytical techniques...some decisions far more beneficial to survival than others. So if we're going to regulate ourselves for the common (and our individual) good we're going to have to decide who makes the best decisions and then obey them. Any nominations for Philosopher King? (Note: We are SO hosed).

    "all bleeding eventually stops"

    SNORT! I am absolutely going to plagiarize this at every possible opportunity :O

  22. Doug Noland over at Prudent Bear noticed an interesting oversight in Feldstein's Op Ed piece:

    While I concur with the basic premise of the article (stop the cuts!), the substance of Mr. Feldstein’s analysis leaves much to be desired. First of all, I find it strange than he would address the issues of overly accommodative Federal Reserve policy, commodity price risk, and inflationary pressures without so much as a cursory mention of our weak currency. The word “dollar” is nowhere to be found – not a mention of our Current Account Deficits. The focus is only on interest rates - and such one-dimensional analysis just doesn’t pass muster in our complex world.

    Most remain comfortably oblivious to today’s inflation dynamics. Mr. Feldstein mentions increased demand from China and India. He seems to imply, however, that portfolio buying (financed by low interest rates) by “commodity investors and speculators” is providing the major impetus to rising inflationary pressures generally. Perhaps price gains could have something to do with the $2.5 TN increase in global official reserve positions over the past two years (85% growth). I would also counter that destabilizing speculative activity is an inevitable consequence – rather than a cause - of an alarmingly inflationary global backdrop.

    Link to full article here:

    Scroll down to the last subhead.

    Noland's basic premise is that the Fed's Bear Stearns bailout ended for the time being the risk of imminent financial system implosion and thus has set the stage for rampant inflation. Since analysts I deeply respect are reaching diametrically opposite conclusions on the inflation/deflation debate, I remain agnostic and have been reduced to technical analysis. VIX below 20 is saying this sucker's rally has about run its course, but the ag ETF and GLD charts look awful as well, notwithstanding the shortages causing the food riots. We are living the Chinese curse in more ways than one.

    Hell, absolutely brilliant post. I think I am going to quit talking to people about this scary situation and instead just print out this very post, hand it to people and say, "What Hell said!"

  23. Can anyone recommend a decent book on thermoeconomics?


  24. Veritas,
    The folks over at:

    are deep into the Fed taking over the function of the Treasury and basically usurping the power to tax. I'm not sure exactly how that would work but it is a recurring theme in (the debt rattle) section of the website. Same over at market-ticker-denninger, he's really worked up over it.

    On the topic of western capitalism sustaining itself on 3rd world resources, I read an article several years ago in a LaRouche publication citing a previously classifed policy paper written by Kissinger in the early 70s stating that the US must obstruct industrial development in the 3rd world to prevent them from competing for raw materials that the US wanted to aquire at low prices.

    There was also a British documentary series that ran on the Discovery Channel in the mid 90s called "Connections". One episode covered the industrial revolution and basically claimed the the industrialization of the west was mostly financed with the surplus capital extracted from colonial possessions and after independence was formally granted the colonies were locked into continuing exploitative relations with their former colonial masters.

    If western capitalism can no longer extract these tributes then your scenario becomes increasingly problematic for those societies that have grown accustomed to profligate lifestyles.

    I think the big disconnect between those predicting inflation vs deflation has alot to do with the volume of foreign held dollars and the demand for those dollars.The US is not as self sufficient as Japan which ran a huge trade surplus throughout their recession and didn't owe anybody any money. No matter how deflationary the debt defaults become, if those foreign dollars are dumped then everything that isn't nailed down is going to be bought up and exported to redeem those dollars. As supply crashes domestically then prices can go up based on scarcity value even as money supply contracts.

    notso-liquid predicted currency controls but if this crisis spirals out of hand there will be all sorts of controls imposed. The confluence of the credit crunch with peaking food and oil supplies is shaping up into a perfect storm. I wouldn't be surprised if the ethanol program is mainly a tactic to increase commodity prices of US exports and put pressure on oil exporters, oil for food.

  25. I clicked on your link, the one that went to voxeu. I noticed the collapse of default rates during the period after 1520. That was during the gold inflation happening after the Spanish finally stopped putzing around in the Caribbean and made it to the mainland, and all that Aztech and Incan gold.

  26. The $0.54 per gallon tariff on ethanol will have the same effect on this recession that the Hawley-Smoot Tariff Act had on the Great Depression.

  27. wkwillis... yes, I just thought it interesting. :-)