THE BEAR'S
LAIR Four
more downhill years By Martin
Hutchinson
President Barack Obama's
intransigence on economic matters is increasingly
clear, so compromise seems unlikely and a
succession of tax increases and wasteful spending
programs seems inevitable.
Meanwhile Ben
Bernanke's Fed enables this dangerous course by
massive "quantitative easing". Assuming Bernanke
is succeeded by a like-minded colleague (more on
that below) we will thus suffer this economically
poisonous combination of policies until January
2017. The US economy is unlikely to make it that
far in anything like its present shape.
Neither Obama's nor Bernanke's damaging
policies would be possible without the cooperation
of the other. If the Fed was
maintaining short-term rates
at above the rate of inflation, without buying
large quantities of Treasuries, the Treasury would
have great difficulty financing endless US$1
trillion deficits without pushing up long-term
interest rates to intolerable levels and loading
future years with huge debt interest payments.
Without Obama and his deficits, Bernanke
would have great difficulty purchasing $1 trillion
of long-term Treasuries and Agency securities
annually, since new Treasury bonds would only be
issued to replace retiring bonds. The distortions
he created by doing so would disrupt the bond
market, feeding rapidly into a level of consumer
price inflation that he would have a statutory
duty to address.
Both Obama and Bernanke
appear determined to continue pursuing their
ruinous policies. Obama has announced he will not
permit spending cuts in connection with a debt
ceiling hike, while Bernanke on January 14 said
the "worst thing the Fed could do" would be to
raise rates "prematurely".
Had we gone
over the "fiscal cliff" as this column advocated,
more than three quarters of the federal deficit
would have been eliminated, and further deficits
could have been prevented by the Republican House
of Representatives. However, the GOP House
leadership wimped out, and as a result we are left
in a position where taxes on the rich have already
been raised substantially, but the deficit has
been left almost unaffected - indeed it has been
increased in the first year by the disgraceful $60
billion of tax breaks granted to politically
favored corporations and scam artists.
Obama is with us until January 2017, but
Bernanke has indicated he may retire next January
when his term of office is up. In general,
Bernanke's is the scalp lovers of sound policy
should seek. Obama's damage has already been done,
and while he may prevent any near-term attempt to
address the deficit, Republican control of the
House means he cannot increase spending more than
marginally. Every extra month of Bernankeism, on
the other hand, distorts the economy further.
It was not difficult to determine before
his appointment that Bernanke would be a disaster
as Fed chairman; this column said so in a piece
published a week before he was appointed,
remarking that "Bernanke's approach to monetary
policy, in which all economic problems can be
solved by creating money, is that of the 1919-23
Weimar Republic, which achieved in September and
October 1923 inflation rates of 2,500% per month."
This column can claim only partial credit
for prescience; in the event we got the policy,
but did not suffer the predicted inflation, being
rewarded by an exceptionally deep and prolonged
recession instead. Such are the vagaries of
economic prognostication!
Next time
around, there are few candidates who might move to
a tighter policy, although former Fed vice
chairman Roger Ferguson, currently CEO of the
pension fund TIAA-CREF, is eminently qualified and
as a registered Democrat is at least a plausible
appointment for President Obama. More likely
however is the current Fed vice chairman Janet
Yellen, whose published views suggest that she
would favor even more easing.
However, as
a known liberal Democrat without Bernanke's long
service she might find it more difficult to
attract a majority on the Federal Open Market
Committee than has Bernanke. A Yellen Fed would
thus probably be a modest improvement over the
current one. One disquieting suggestion I have
seen recently is that New York Mayor Mike
Bloomberg might want the job; his combination of
primitive Keynesianism and proven tendency to
meddle obtrusively in everybody's lives would be
truly frightening in a job with such power.
Thus it is highly unlikely that Bernanke's
successor will be much of an improvement. Hence we
are for the next four years likely to be subject
to ultra-loose monetary policy and trillion-dollar
budget deficits.
One area where my crystal
ball is now unclear is whether this will cause an
outburst of inflation. By monetarist theory it
should; M2 money supply has risen at an annual
rate of 9.9% in the last six months, while the St
Louis Fed's MZM, the nearest proxy we have to M3,
has risen at 10.6% in the same period. With output
rising at only 2%, that should produce inflation
of around 8%.
Milton Friedman said
"Inflation is always and everywhere a monetary
phenomenon", so where the hell is it? Leads and
lags are all very well, but even taking into
account a flat stretch between mid-2009 and
mid-2010 M2 has been growing at an annual rate of
7.2% since the end of 2007, far in excess of the
feeble 2.3% growth in nominal GDP.
Monetary "velocity", that elusive concept,
has dropped like a rock (mathematically, it had to
given the data), but its ability to do so without
any reasonable explanation in itself makes
monetary theory look increasingly chimerical.
More likely than a sudden resurgence of
Weimar-like inflation is a market crash. Global
sub-zero real interest rates have boosted
corporate profits to record levels (in terms of US
gross domestic product) as well as the value of
bonds, commodities and other assets. The Dow Jones
index remains about 6,000 points higher, in terms
of US GDP, than when then Federal Reserve chairman
Alan Greenspan began easing monetary policy in
February 1995. Gold is at double its 1980 high. US
house prices have bottomed out and are rapidly
reflating. Global foreign exchange reserves have
been increasing at 16% annually since the Asian
crash of late 1997.
For the current market
to be sustainable for another four years, the
value of capital assets would have to have moved
to a permanently higher level in terms of the
value of everything else. Capital assets have
become the destination for the world's excess
money supply, but it doesn't seem likely that even
Ben Bernanke and his colleagues can sustain this
disequilibrium forever.
Most likely, like
tech stock prices in 1997-2000 and house prices in
2004-06, the overvaluation will persist long
enough for a substantial body of dozy opinion to
decide it's permanent and put all their money on
it continuing, doubtless leveraging up to the
eyeballs to do so.
Once the silly money
has piled in, as with housing in 2007 and tech
stocks in 2000, valuations will start to slip.
Most likely this will be seen first in the
Treasury bond market, where even Bernanke's
trillions will prove insufficient to keep the
10-year yield below 2% forever. That will cause a
price collapse similar to that of 2007, where
previously unassailable financial institutions
will be found to have eroded their capital base by
overinvestment in T-bonds.
Since the
Treasury bond market is so huge, this in turn will
cause a sell-off in the world's equity markets,
with corporate earnings being eroded by the rise
in interest rates.
Another example of such
a slow-motion collapse is Japan after 1990, where
eventually a high percentage of Japan's most
admired corporations were found to have speculated
excessively in short-term tokkin funds. In
that case, the major banks propped up the loser
corporations, wrecking the banking system, filling
the country with zombie corporations and causing a
20-year period of economic sluggishness.
In the early years of that period, Japan's
policy responses remained fairly orthodox, but
since Bernanke's visit to the country in 1998,
dispensing truly awful advice, it has been plagued
by misguided Keynesian "stimulus" and
money-printing by the central bank, prolonging the
downturn more or less ad infinitum. On the Japan
analogy, if US policy remains as bad as Japan's
has been, we are due a downturn lasting until 2035
or so.
If the Obama/Bernanke policies do
not cause inflation, but instead produce a
collapse of markets and a major recession, we will
finally have an answer to the century-old battle
between monetarists, Keynesians and the Austrian
school of economists.
Keynesian economists
will be discredited by the failure of $1 trillion
annually of deficit "stimulus" to stimulate
anything beyond an asset bubble, with unemployment
remaining stubbornly high. Monetarists will be
discredited by the failure of Bernanke's gigantic
monetary stimulus to produce economic recovery,
and by the corresponding absence of a serious
burst of inflation.
The winner in the
intellectual battle will be the Austrian school,
in its pure Ludwig von Mises form, which will have
seen monetary and fiscal expansion produce only a
mountain of "malinvestment", the collapse of which
will take several years and a major depression to
work out. Of course, that economic victory will be
of little consolation to those of us forced to
live through the depression, although we can hope
that the next such episode in 2070 or so will be
solved more effectively, with Keynes and Friedman
relegated to the sidelines.
As for the
timing, I have said before that I don't think 2013
will be the year in which the bubble bursts -
there is as yet insufficient speculative frenzy,
although the market temperature is certainly
rising. Moreover, it would be a pity to have such
a record-breaking blow-off without a serious
speculative bubble in gold similar to that of
1978-80 - which if the $1,500-1,900 gold price of
the past 15 months is regarded as a base, suggests
a gold price peaking certainly above $3,000, very
possibly above $5,000.
Equally, it would
seem impossible for the present bubble to outlast
President Obama, and fairly unlikely for it to
last into the election year of 2016. The 18-month
period between July 2014 and December 2015 would
thus be my best guess for the onset of collapse,
with a prolonged rolling crisis lasting for the
greater part of that period being the most likely
outcome. 2016 and 2017 would then be years of
grinding depression, benefiting the 2016 electoral
prospects of both Republicans and extremist
fruitcakes on both ends of the spectrum.
In the very long term, US reserves of
cheap energy, the intellectual capital in its
research facilities and the political distaste of
its people for infinite Washington expansion are
pretty good guarantees that we will again see
prosperity. But it's not going to happen within
the next four years.
Martin
Hutchinson is the author of Great
Conservatives (Academica Press, 2005) - details
can be found on the website
www.greatconservatives.com - and co-author with
Professor Kevin Dowd of Alchemists of Loss
(Wiley, 2010). Both are now available on
Amazon.com, Great Conservatives only in a
Kindle edition, Alchemists of Loss in both
Kindle and print editions.
(Republished
with permission from PrudentBear.com.
Copyright 2005-13 David W Tice &
Associates.)
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