Tag Archive for: FedMonetaryPolicy

The Democrat Playbook: How To Look Like You Are Fighting Inflation Without Really Trying

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Estimated Reading Time: 5 minutes

“Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”  Professor Milton Friedman

 

You want to bring down inflation? Let’s make sure the wealthiest corporations pay their fair share.  President Joe Biden

Inflation is the relationship between the quantity of money in circulation and the supply of goods and services.

Government and central banks can create money but they can’t create oil, copper, food, housing, hip surgeries, or Tootsie Rolls.  But government can create conditions that stifle the production of these things through taxation, regulation, import restrictions, and arbitrary credit restrictions.

The basic rule in dealing with inflation, if you are a Democrat, is to blame everyone, and everything, for the price spiral.  Never look at your own insane monetary and fiscal policy.  Then, start tinkering with the economy to show that you care.

Republicans have played the game as well, with wage and price controls by Nixon and WIN buttons (Whip Inflation Now) promoted by President Ford. But Democrats are better at the game.

Being old enough to remember the inflation of the 1960-1980 period, the tried-and-true response is to blame greedy corporations. From that follows the imposition of “windfall profits” taxes. Of course, inflation was only 1 ½% under Donald Trump, so corporations must have undergone tremendous change very quickly, with greedy people taking them over, just to frustrate Biden. That includes, of course, many of the “woke” corporations run by Progressives. They raise their prices as well.

Price controls are also part of the toolbox. Democrats know what the “just” and “honest” price should be, and thus they will attempt to fix prices to what they believe is the correct level.

The problem with price-fixing is well established since attempts go back to the Code of Hammurabi in Mesopotamia.

They were tried by Greeks and Romans, especially under Diocletian.

The Church (allied with the government) tried price fixing based on “the just” price during the Middle Ages.

Almost all Socialist governments do the same, to some degree or another. Things like the Medicare Codes, which fix the price for specific procedures, are a good example. So is rent control in Democrat-controlled cities like New York.

If you establish a price above what the market determines through free exchange, based on real supply and demand data, it will create surpluses.

If you fix prices below the real cost of production, based on free exchange and real supply and demand, you will create shortages.  This is the most common outcome.

A spinoff of shortages is long wait periods (waiting in the queue) or rationing, which is simply an attempt to equalize the misery of shortages.

An interesting book written during the last great inflation period was Forty Centuries of Wage and Price Controls by Robert Schuettinger and Eamonn Butler. The conclusion of the book, after exhaustive historical examples, is wage and price controls have never worked anywhere, at any time in history.

The reason they never work is that they never address the underlying causes of inflation, which is excessive government spending funded by monetary creation.

Price fixing inevitably leads to expansive and usually authoritarian government. For example, let’s suppose the government decides a particular item, let’s say milk, is vitally important to the population. So, they fix the price to stop public outrage.

To be even partially effective, you then must proceed to fix the price of dairy cattle, milking machines, barns, hay, farmland, farm labor, processing, transportation, and dozens of other price inputs that create what you see as the “price” of milk.

The price of anything is simply the sum of hundreds of prices of the applicable inputs. You can’t control one, without trying to control the others. Hence, attempts to control inflation through price control creates a gigantic and intrusive government that destroys the free market and its wealth-producing capacity. That is why Venezuela can sit on the largest reserve of oil per capita in the world, and be impoverished with oil over $100 a barrel.

The softer version of price controls is jawboning or attacking corporations for what the government has caused.

So, blaming corporations, taxing them heavily, and excoriating them in public (jawboning) should be expected.

Windfall profit taxes are likely as are price controls.

We may also see rationing.

Jawboning is an attempt to deflect blame onto someone else, typically business owners. Sometimes this gets very ugly when particular religious or ethnic groups are cited as exploiting inflation. Sometimes it has been Jews, sometimes ethnic Chinese,  Koreans in some neighborhoods, and sometimes kulaks.

Then, there is usually an attack on “hoarders”.

Hoarding is a rational response to expected shortages. Governments are against hoarding and prefer rationing. If you try to get supplies that you need, you are to be condemned as a hoarder. If your costs go up, you will be accused of exploitation and price gouging if you pass those costs along. If you correctly anticipate inflation and profit from it, you will be called a speculator. In all these cases, the government simply blames individuals and corporations for responding to something the government itself caused.

Finally, there is what could be called ‘the switch”.

This is a variation on the old theme of passing out public money to buy votes. Here is how it works: Take money from the public through taxation. Take money from the public secretly through currency debasement. Then hand money back to the public to help them deal with the excessive price inflation the money printing caused.

It is almost a perfect circle. Give the money back to the public that you took from them, to acculturate the public to taking government money and make them politically dependent on politicians.

A good example has actually been proposed. Drive up the cost of fuel by harassing and regulating oil producers, forcing the Green agenda, and printing excessive money. Then ride to the rescue by sending the public a check so they can deal with the high fuel costs. Since the government is running huge deficits anyway, simply print the money you will pass out to the public. The belief is the public will be too stupid to understand the game.

A variation of this scheme was the stimulus checks. Shut the economy down using Covid restrictions, causing great pain. Relieve some of that pain by sending checks to those harmed, hopefully, to make them grateful and dependent.

Thus, the way not to fight inflation is to harass and harangue businesses and housewives, print excessive money to pass out to the public to help with inflation, impose wage and price controls, blame corporations, and impose “windfall” profit taxes.

As to what to do to really fight inflation, the following steps are necessary. If inflation is too much money chasing too few goods, one needs to decrease the amount of money and increase the supply of goods.

Slow dramatically the growth of government spending and the growth of the money supply.

Increase the supply of goods by deregulating and rewarding production. Avoid at all cost wage and price controls, rationing, and windfall profit taxes. Foster vigorous competition, knocking down legal and regulatory barriers that block new producers from entering the market.

In short, do the opposite of what Democrats propose.

If the program is both credible and consistent, consumer hoarding will stop as the public learns there is no rational reason for doing it. When supplies of goods and services are reliable, and if prices moderate, there is no reason to buy before prices climb even further. It takes time to break the back of inflationary psychology. However, if the underlying cause, too much money and too few goods is addressed, the inflation will subside.

 

The Fed’s Doomsday Prophet Has a Dire Warning About Where We’re Headed

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Estimated Reading Time: 4 minutes

Thomas Hoenig knew what quantitative easing and record-low interest rates would bring.

Thomas Hoenig doesn’t look like a rebel. He is a conservative man, soft-spoken, now happily retired at the age of 75. He acts like someone who has spent the vast majority of his career, as he has, working at one of the stuffiest and powerful institutions in America: the Federal Reserve Bank. Hoenig has all the fiery disposition that one might expect from a central banker, which is to say none at all. He unspools sentences methodically, in a measured way, never letting his words race ahead of his intended message. When Hoenig gets really agitated he repeats the phrase “lookit” a lot, but that’s about as salty as it gets.

This makes it all the more surprising that Tom Hoenig is, in fact, one of America’s least-understood dissidents.

In 2010, Hoenig was president of the Federal Reserve regional bank in Kansas City. As part of his job, Hoenig had a seat on the Fed’s most powerful policy committee, and that’s where he lodged one of the longest-running string of “no” votes in the bank’s history.

Hoenig’s dissents are striking because the Fed’s top policy committee — called the Federal Open Market Committee, or FOMC — doesn’t just prize consensus; it nearly demands it. The committee likes to present a unified front to the public because it is arguably the most powerful governing body in American economic affairs. Hoenig’s string of dissents shattered that appearance of unanimity at a critically important time, when the Fed was expanding its interventions in the American economy to an unprecedented degree. It was a hinge point in American history, and the economy has never been the same since.

Between 2008 and 2014, the Federal Reserve printed more than $3.5 trillion in new bills. To put that in perspective, it’s roughly triple the amount of money that the Fed created in its first 95 years of existence. Three centuries’ worth of growth in the money supply was crammed into a few short years. The money poured through the veins of the financial system and stoked demand for assets like stocks, corporate debt and commercial real estate bonds, driving up prices across markets. Hoenig was the one Fed leader who voted consistently against this course of action, starting in 2010. In doing so, he pitted himself against the Fed’s powerful chair at the time, Ben Bernanke, who was widely regarded as a hero for the ambitious rescue plans he designed and oversaw.

Hoenig lost his fight. Throughout 2010, the FOMC votes were routinely 11 against one, with Hoenig being the one. He retired from the Fed in late 2011, and after that, a reputation hardened around Hoenig as the man who got it wrong. He is remembered as something like a cranky Old Testament prophet who warned incessantly, and incorrectly, about one thing: the threat of coming inflation.

But this version of history isn’t true. While Hoenig was concerned about inflation, that isn’t what solely what drove him to lodge his string of dissents. The historical record shows that Hoenig was worried primarily that the Fed was taking a risky path that would deepen income inequality, stoke dangerous asset bubbles and enrich the biggest banks over everyone else. He also warned that it would suck the Fed into a money-printing quagmire that the central bank would not be able to escape without destabilizing the entire financial system.

On all of these points, Hoenig was correct. And on all of these points, he was ignored. We are now living in a world that Hoenig warned about.

The Fed is now in a vise. Inflation is rising faster than the Fed believed it would even a few months ago, with higher prices for gas, goods and automobiles being fueled by the Fed’s unprecedented money printing programs. This comes after years of the Fed steadily pumping up the price of assets like stocks and bonds through its zero-percent interest rates and quantitative easing during and after Hoenig’s time on the FOMC. To respond to rising inflation, the Fed has signaled that it will start hiking interest rates next year. But if that happens, there is every reason to expect that it will cause stock and bond markets to fall, perhaps precipitously, or even cause a recession.

“There is no painless solution,” Hoenig said in a recent interview. “It’s going to be difficult. And the longer you wait the more painful it will end up being.”

To be clear, the kind of pain that Hoenig is talking about involves high unemployment, social instability, and potentially years of economic malaise. Hoenig knows this because he has seen it before. He saw it during his long career at the Fed, and he saw it most acutely during the Great Inflation of the 1970s. That episode in history, which bears eerie parallels with the situation today, is the lodestar that ended up guiding so much of Hoenig’s thinking as a Fed official. It explains why he was willing to throw away his reputation as a team player in 2010, why he was willing to go down in history as a crank, and why he was willing to accept the scorn of his colleagues and people like Bernanke.

Hoenig voted no because he’d seen firsthand what the consequences were when the Fed got things wrong, and kept money too easy for too long…..

*****

Continue reading this article at Politico.

 

Left and Right: Both Mistaken on Inflation

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Estimated Reading Time: 3 minutes

With inflation hitting a 31-year high, commentators are now routinely giving their opinions on inflation. Unfortunately, most of them—on both the left and the right—are mistaken.

The left initially claimed there was no inflation before switching to its oft-repeated line that inflation is transitory, meaning not long-lasting. But inflation has proved to be quite resilient. More recently, many on the left have taken to extolling the apparent benefits of inflation, such as cost-of-living adjustment (COLA) increases for those on fixed incomes.

NBC correspondent Stephanie Ruhle recently tried to make the case that savings have risen faster than inflation, so people have the money to pay higher grocery bills, and those people are better off. But wages and savings have not kept up with inflation and consumers are worse off now than they were a year ago.

But some on the right have made the same misinformed arguments. Only days after criticizing a competitor’s misleading headline, Fox Business had an article citing record-setting COLA increases for Social Security recipients as a benefit from inflation.

This is no benefit at all. Those on fixed incomes are suffering through a year of rising prices to have their incomes raised some time in the future, and only as much as prices have increased. Meanwhile, anyone with a retirement account has seen its relative value decreased by the hidden tax of inflation.

And both the left and the right of late have ignored the reality of inflation when evaluating economic data.

The most recent retail trade report from the Census Bureau showed retail sales in October being significantly higher than expectations, but more than half of the increase was inflation. After accounting for this, the report was actually well below expectations.

Similarly, most people, regardless of political affiliation or philosophy, seem unaware of how inflation drives asset bubbles—which is contributing to the current growth in house and stock prices.

Those on the right also say deficit spending by the government will add to inflation. This is not exactly true either.

When pressed by a reporter, White House Press Secretary Jen Psaki said, “No economist out there is projecting that this [more deficit spending] will have a negative impact on inflation.” While her claim is completely untrue, since many economists argue precisely that, those economists are also misguided.

Under President Ronald Reagan, the nation had record-setting deficits and amassed record levels of debt, all while inflation decreased. Conversely, in the 1920s, the federal government ran a surplus every year of the decade, but inflation towards the end of that period caused a bubble in the stock market, leading to the infamous crash in 1929.

History—and sound economic theory—tells us that federal deficits are not the primary catalyst for inflation. Excessive government spending certainly has negative consequences, but inflation only arises when the Federal Reserve (the Fed) purchases debt instruments, like government bonds. That has happened whenever the Fed tries to implement monetary “stimulus,” which often happens to occur when Congress borrows excessively. This coincidence has clouded the distinction of which agency is causing what.

President Abraham Lincoln, while ruminating on the Civil War and the perspectives of both the North and South, observed that one side must be and both may be morally in the wrong. Similarly, the popular takes on both the left and right regarding inflation are incorrect; neither side understands the fundamental principles behind inflation.

Only the Fed can cause inflation because only it controls the ability to create money, which it does chiefly by purchasing government debt with money created out of nothing. Likewise, only the Fed can rein in the beast that it set loose.

The one data point in favor of those on the right is the recent rise of Modern Monetary Theory (MMT). It is a bit of a misnomer, as there is nothing modern about it and it focuses less on monetary theory and more on the fiscal policies of taxes and government spending.

Nevertheless, a key feature of the theory is that the Fed essentially acts as the principal financing arm of Congress’ deficit spending. With Lael Brainard as Vice Chair, the Fed will likely pursue MMT. That will make government deficit spending inherently inflationary. At that point, the political right will be genuinely right, but for the wrong reason.

As is often the case, the talking points of both the left and right on inflation are mistaken; it turns out their soundbites are not very sound.

*****

This article was published on December 1, 2021, and is reproduced with permission from The Texas Public Policy Foundation.

Can Government Tolerate the Crypto Explosion?

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Estimated Reading Time: 7 minutes

Cryptocurrencies as they are called, are a relatively new asset class. They were virtually unknown until they made their first appearance about 10 years ago and it is only in the last few years that they have gained wider acceptance. Whether they actually have the characteristics of currency (a medium of exchange, a store of value, a unit of account) is debatable.

Whatever they are, they have become a true phenomenon.

On December 6, 2021, the Wall Street Journal reports investment clubs have now formed around these investments for education and promotion to the public.

By early November of 2021, the total market capitalization of all cryptos reached $3 trillion. According to CoinMarket.com, there are now more than 6,000 of these “things”. They will either prove to be one of the great financial innovations of the age, or perhaps the greatest speculative bubble ever produced by mankind.

Martin Pring, the senior technical writer for Stockcharts.com, points out this market cap is about 13% of the $23 Trillion Gross Domestic Product of the United States.  It is about the same size as the total GDP of England. It is huge and growing.

Bitcoin, perhaps the earliest and most successful, went from a low of $164 as recently as 2016, and recently hit a high of $68,000 before backing off somewhat.

This is an astounding performance for something that does not generate a cash flow, pay dividends, or can be consumed by industry.  Its technology has not as yet spun off major industries, other than supporting itself.

The motivation to purchase seems to be privacy, hedging against the potential of a weakening dollar, and just plain profit potential. At least for Bitcoin, the argument is blockchain technology provides confidentiality and limits supply.

We will admit some sympathy with the motivation. If the government was producing a stable monetary unit and did not tax production so voraciously, there would not be an elevated desire to find alternatives.

Much of this depends on the proposition that cryptos will be superior to government money. Limitation on issuance remains the key. That might be true for Bitcoin, but if more Initial Coin Offerings are provided, there is no limit to the total amount of cryptocurrency that can be created. If that were not true, there could not be 6,000 and counting growing varieties.

Maintaining Bitcoin’s unique blockchain technology does not come cheap. It is estimated the “mining of Bitcoin” consumes about as much electrical power as the entire nation of Sweden. So-called Bitcoin mining may consume substantially more energy than conventional mining for gold, silver, copper, and other metals and materials. That is a considerable expense just to maintain a monetary alternative.

As cryptocurrencies become more accepted, we can expect Wall Street to offer new financial instruments denominated in them. However, given their extreme volatility, it would be difficult to use in bonds, mortgages, loans, and other financial instruments over intermediate to longer periods of time. However, it is highly likely you will see more cryptos and more investment vehicles that use them. Right now, a number of credit card companies allow them to be used to settle payments.

The extreme volatility on the other hand will likely lead to futures markets, options markets, leveraged ETFs, and all manner of leveraged and geared investments to cater to speculators, large and small.

It is worth mentioning that under the gold standard since money was stable, there were no foreign exchange futures markets or bond futures. Those markets developed after the final break with gold in 1971 and we went to “floating currencies.” Today, these areas of financial speculation dwarf traditional commodity speculation

Cryptos seem to introduce even more financial volatility, rather than less.

We will not enter the torrid debate between advocates and critics, as we have other things to discuss. Clearly, cryptos are here and are reshaping the financial landscape. One casualty of this shift might be precious metals. Gold and silver have traditionally been the only accepted “non-government issued money”. At one time, they were the very basis for money. But with this new form of privately issued money, it is likely crypto growth has drained away at least some money that likely would have gone into precious metals, given the excessive government spending, FED monetization of debt, and long period of negative interest rates.

Last time we checked, Bitcoin was up over 60% year to date, while gold bullion was down about 6%.

Money is a remarkable social convention, a product of spontaneous order much like language.  Many things have been money at some point or another.   The process by which society decides what is money, and what is valuable, is organic. Typically, they have been metals, such as copper, silver, or gold. The Chinese were early innovators in paper money. But in some societies, it can be seashells, beads, cattle, grain, and among some ancient Pacific societies, large stones, which made payment transfer comically difficult in rough seas.

Money has always been associated with the power of government, the sovereign. Often, money was issued by the king and in later years, the nation-state. The government would enforce its will by requiring payment in taxes to be made in a currency they controlled and they also used the power of law to see that private debt, public and private, be settled in the government’s money. All these things, the payment of taxes, and legal tender laws guarantee a market for the government’s money, and more importantly, the debt floated by the government denominated in that money. Such a constant demand for government money is thus important for the government to fund itself.

For many years, money was little more than a warehouse receipt for precious metals. Look closely at the wording on the picture above of the dollar bill. It says the note certifies there is on deposit silver in the US treasury, payable on demand by the holder of the note. The money supply could only grow slowly, along with the supply of gold and silver. In addition, there were circulating gold and silver coins.

Although the appearance of the note today is quite similar, today’s money is not backed by metals on demand. Rather, it is held up by law or fiat. Hence, the term fiat currency.

On a few rare occasions, there could be some inflation within a precious metal system, such as when the Spanish made huge discoveries of gold and silver in the “new world” of today’s South America. But for the most part, the gold standard created centuries of price stability where the money would maintain its value over long periods of time. This helped to develop long-term credit markets where governments or capital-intensive industries such as railroads, could borrow money for periods of 50 and even 100 years.

However, the gold standard put the government in a monetary straight jacket. It really was difficult to grow the government because what the government could print was restricted and so was the amount they could borrow. A simple voluntary mechanism helped hold the government in check. If citizens felt the government was becoming profligate, they could turn in their paper money for the gold and silver behind it. Likewise, foreign holders of money could turn their paper in for the real thing, at any time, on-demand. As gold left the treasury, the money supply was forced to contract. Government spending was kept on a short leash.

The history of fiat money is quite different. No fiat paper money has held its value over time. There are no exceptions. And, you know why. Government cannot restrain itself. It requires external constraints such as a written Constitution and external constraints such as a gold standard.

As Progressives desired to get out of the realm of limited government into the realm of big government socialism, they broke down both the Constitutional and monetary obstacles put in place by the Founders. They wanted a fiat currency controlled by the government or the government’s central bank.

In the case of gold-backed money, it was made illegal by FDR in 1933, when gold was removed from money and gold clauses were outlawed. Silver was removed from money in 1965 because of the excessive budget deficits to fight the Viet Nam War and fund the Great Society. By 1971, the ability of foreigners to get the gold behind the dollars they held, was unilaterally canceled by President Nixon. We have been on fiat money since.

Thus, the control of money is the control of political power. Having an unbacked fiat currency that can be printed at will, gives the government much greater power to spend and borrow.

Now comes along cryptocurrencies, supposedly private money that can keep transactions and taxes hidden from the government. Their “limited” supply is supposed to offer an alternative to the constantly depreciating money issued by the government.

The government needs to force the creation of demand for its own money and its bonds. This is particularly the case when the government spends way beyond its means. While there is talk of governmental fiat money that is digital, you could argue it already exists. The amount of currency that circulates in physical terms is a small percentage of the total. Overwhelmingly, the bulk of fiat money is simply electronically transferred around the system, and hence digital.

An electronic or digital currency need not be limited in supply. In fact, it can be created by the keystroke of a computer and does not even require the printing of physical notes.

Again, without entering the contentious debate between crypto advocates and critics, we would simply like to point out that government, in the end, cannot tolerate the widespread use of privately issued money with a limited supply. They have spent the past century wriggling out of the restrictions imposed by the gold standard and it is highly unlikely they will yield the tremendous advantages given to the government by its monopoly on money, just for the profit of private actors.

This is more than just our historical observation. Last September, the Chinese government, arguably the first or second largest GDP, made cryptos illegal.

The government of India is now also anticipating banning cryptos with laws expected early next year.  However, the law is ambiguous and may create more confusion than order.

The US government is starting to regulate trading in cryptos, in part because of substantial fraud in the space. But also, the government is concerned about people evading taxes, engaging in illegal activities, and frankly, the development of a competing currency to that issued by the government. The most recent “infrastructure bill” has a provision subjecting cryptos to the $10,000 reporting requirement that exists for cash transactions. If so, the advantage of anonymity could go out the window.

As the reader may sense, our view is the government, in the end, cannot tolerate private money that allows citizens to hide their transactions, beat the tax system, and compete against the government-issued money.

As the government moves against cryptos, what happens to the $3 trillion in this investment space?

That is a subject reserved for another day. But given the size and level of speculation, anything that reduces the utility and value of cryptos has the potential to be a very destabilizing event.

Problems for cryptos will not occur in a vacuum. They will occur with key markets already juiced to historically high valuation levels by huge injections of monetary liquidity by both the Congress (fiscal stimulus) and the Fed (monetary policy). Negative interest rates, that is a rate below inflation, have driven money out of bonds and bank deposits and into equities.

For a sense of magnitude, flows into the US stock market this year are more than the flows over the past 12 years combined!  Thus, the present price level of equities reflects this torrential flow of money, which is not guaranteed to continue.

Cryptos are simply another parallel bubble being blown up by government policy.

The potential for economic destabilization is high, as is the risk of a policy error by the FED. Oblivious to all of this, the government keeps its foot on the monetary gas pedal, the fiscal gas pedal, no doubt hoping everything will look good for the mid-term Congressional elections.

As they say, hope is not always the best plan.

*****

Neland D. Nobel is Editor-at-Large of The Prickly Pear and a retired portfolio manager and Certified Financial Planner.