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Inflation Is Not The Solution To The Economic Crisis

August 20th, 2012 Comments off

Almost instantaneously, as soon as governments across the globe went into unparalleled debt to bail out their financial systems beginning in 2008, economists openly were discussing  the impossibility of ever paying back those sovereign loans, and that a different solution was required. The answer, so the economists said amongst themselves, was targeted inflation. In effect, so argued those economists, inflation significantly higher than recent levels, targeted at a level of at least 5 percent, would be “good.”

Why would inflation, a fiscal and monetary circumstance which human beings by instinct regard as an ill omen, be seen in such positive hues by economists as renowned as Nobel Prize winner Paul Krugman? The answer is that inflation is viewed as the ideal solution for eliminating sovereign debts that can never be repaid. In effect, inflation is the methodology by which a nation-state defaults on its loan obligations stealthily. The printing presses expand money supply beyond the level generated through real economic productivity, in the process depreciating the value of the currency. The nation-state , on paper, doesn’t default on its loan repayments, since the contractual obligation is repaid in monetary terms. However, inflation depreciates the value of the currency, so the outstanding loan obligation shrinks in real terms. In addition, so argue the economists, inflation, by destroying the value of money, discourages savings, leading to higher spending and improved economic growth.

It is a neat gimmick, one resorted to by indebted sovereigns throughout history. However, despite claims by economists that precisely targeted inflation has worked in the past, history tells a different story. In the great majority of examples where countries deliberately employed inflation as a fiscal and economic policy, the results were not only counterproductive; very often the social anguish created by the policymakers resulted in political consequences of dire proportions. One can look back at Weimar Germany’s bout of inflation, which went out of control and morphed into rampant hyperinflation. There are many countries that experimented with inflation at levels far less  than those experienced by Weimar Germany and, more recently, Zimbabwe, which still did no good and much harm economically and socially.

The basic problem with modern economic policymaking is that it is too fixated on fiscal gimmickry to resolve core problems. Whether it  is quantitative easing and “Operation Twist” by the Federal Reserve or stealth sovereign bond purchases by the European Central Bank,  the “experts” play fiscal games rather than address the fundamental factors underlying the global economic crisis; flawed systems and economic architectures that have transformed nations that formerly focused on production into entities of debt-financed consumption.  Regrettably, instead of coming to grips with the true underlying factors responsible for the first global economic depression of the 21st century, the economists advising our policymakers look increasingly towards inflation, and the destruction of whatever financial assets are still retained by the increasingly beleaguered middle class, as the last best hope for resolving the sovereign debt crisis.

It is unfortunate that our modern-day economic gurus have not read Santayana, who warned that those who disregard the mistakes of the past are condemned to repeat them.

 

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Former Fed Chairman Paul Volcker Urgently Warns Against “Planned” Inflation

September 19th, 2011 Comments off

 

In an Op-Ed  piece in The New York Times, Paul Volcker, chairman of the Federal Reserve during 1979- 1987, issued an eloquent warning against economic policymakers deliberately increasing the inflation rate as a way of dealing with escalating economic and fiscal problems that have defied all other policy measures. Volcker’s Op-Ed, entitled, “A Little Inflation Can Be a Dangerous Thing,” warrants serious reading by all concerned with the global economic crisis. Paul Volcker knows what he is talking about; it was he as Fed Chairman during the Reagan administration who squeezed high inflation out of the U.S. economy through a draconian process of high interest rates.

 

Here are extracts of what Volcker wrote in his Op-Ed piece:

 

There is great and understandable disappointment about high unemployment and the absence of a robust economy, and even concern about the possibility of a renewed downturn. There is also a sense of desperation that both monetary and fiscal policy have almost exhausted their potential, given the size of the fiscal deficits and the already extremely low level of interest rates.

“So now we are beginning to hear murmurings about the possible invigorating effects of ‘just a little inflation.’ Perhaps 4 or 5 percent a year would be just the thing to deal with the overhang of debt and encourage the ‘animal spirits’ of business, or so the argument goes… Some mathematical models spawned in academic seminars might support this scenario. But all of our economic history says it won’t work that way. I thought we learned that lesson in the 1970s. That’s when the word stagflation was invented to describe a truly ugly combination of rising inflation and stunted growth… At a time when foreign countries own trillions of our dollars, when we are dependent on borrowing still more abroad, and when the whole world counts on the dollar’s maintaining its purchasing power, taking on the risks of deliberately promoting inflation would be simply irresponsible.”

In particular, due to the global sovereign debt crisis, economists and policymakers are discussing behind closed doors the desirability of a 5-6 percent annual inflation rate as a way of reducing the burden of national debts in advanced economies. As if the experience of Weimar Germany and Zimbabwe wasn’t enough to show the irrationality of such an approach, Paul Volcker again reminds us of the futility of engineering deliberate inflation as a policy “cure” for our economic woes. One can only hope that the former Fed Chairman’s clear warning is heeded.

                 

 

 

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Ben Bernanke’s Wrecking Crew Engineers Downward Spiral of the U.S. Dollar

May 2nd, 2011 Comments off

If anyone really believed that Federal Reserve Chairman Ben Bernanke was not deliberately destroying the intrinsic value of the American dollar through his recklessly loose monetary policies, the current downward spiral of the greenback is abundant evidence to the contrary. Most telling, despite severe fiscal problems in the Eurozone, even the wobbly euro is gaining strength in significant measure against the U.S. dollar.

It is not only against the basket of foreign currencies, including those considered weak, that the American dollar is winning the dubious race to the bottom. Commodities across the globe have risen sharply against the dollar. This is reflected not only in the price of known hedges against price inflation and currency manipulation such as gold and silver. A diverse range of resource commodities, including oil and natural gas, minerals and basic foodstuffs have increased in their dollar price. With the U.S. dollar remaining (for now) the global reserve currency, the morbidly inverse ratio between the plummeting value of the dollar and rising cost of commodities has had severe negative repercussions across the globe, both economically and politically. The current unrest sweeping the Arab world is at least in part due to rising food prices precipitated by Bernanke’s deliberate policy of eroding the value of America’s dollar.

My read of this situation is that the Federal Reserve is in a panic. They know that the American fiscal imbalance is unsustainable, and it seems Bernanke and company are deliberately eroding the value of America’s currency in order to default stealthily on the nation’s massive foreign debt, which the Fed knows can never be repaid, at least in terms of real value as opposed to nominal repayment. Inflation is the direct outcome of the Fed’s quantitative easing and monetization of the debt. The American taxpayer and consumer is being sacrificed, at whatever the cost, in order to inflate away that portion of the U.S. national debt which cannot be repaid.

The fools at the Federal Reserve really believe that China, OPEC and other foreign creditors are going to accept the destruction of their investment in U.S, Treasuries lying down, and that the U.S. dollar will forever remain the world’s reserve currency. I think that sooner rather than later future developments will render inoperative all the flawed assumptions of Ben Bernanke and his wrecking crew, otherwise known as the Federal Reserve.

Paul Krugman is Wrong on Inflation

May 31st, 2009 Comments off
In an Alice in Wonderland column published in The New York Times on May 29, economist Paul Krugman launched an attack on those such as myself who have expressed concern that the profligate budget deficits being enacted by the Obama administration are laying the foundation for high inflation. In my piece published in the Huffington Post, “U.S. Economy Risks Dire Prospect of Hyperinflation,” I made specific reference to the possibility that the Obama economic team may be pursuing an inflationary course as a strategy to reduce the real value of the exploding national debt. It seems that this point in particular caught the ire of Professor Krugman.
There is one point in Krugman’s piece that I concur with; we are enduring an unprecedented economic crisis. This calls for thoughtful debate and deliberative argumentation. Unfortunately, even as distinguished an economist as Paul Krugman can at times slip into a mode of petty banalities. As such, his New York Times polemic adds nothing consequential to the discourse on critical issues such as the risks as well as benefits of massive fiscal and monetary intervention on the part of the Obama administration and Federal Reserve. There are, however, a number of points raised by Krugman that warrant a response.
One point promulgated by Professor Krugman is that the unprecedented level of quantitative easing by the Fed is not inflationary, and that those such as myself who have raised this concern are “just wrong.” This is what Krugman had to say on this matter, “Now, it’s true that the Fed has taken unprecedented actions lately. More specifically, it has been buying lots of debt both from the government and from the private sector, and paying for these purchases by crediting banks with extra reserves. And in ordinary times, this would be highly inflationary: banks, flush with reserves, would increase loans, which would drive up demand, which would push up prices. But these aren’t ordinary times. Banks aren’t lending out their extra reserves. They’re just sitting on them.”
So, Krugman agrees that quantitative easing in ordinary times is “highly inflationary” but in our present predicament those rules are suspended. What is left out of Paul Krugman’s rationalization is that banks are sitting on the infusion of liquidity they have received from the Fed because of their chronic need to shore up their balance sheets, which are saturated with toxic assets. However, it is the intention of the Fed to facilitate credit easing on the part of financial institutions through its quantitative easing, which leads to the possibility of future inflation, unless the Federal Reserve is a model of perfection in tightening up on the money supply when the credit crunch abates. Based on the overall performance of the Federal Reserve since the initial stages of the subprime mortgage meltdown, I would not be sanguine about their ability to inhibit the expansion of the money supply when inflationary pressures return.
Professor Krugman also adds that the primary concern currently is deflation, which I agree with in my Huffington Post piece, however, I disagree when he claims that there are currently no inflationary pressures. Due in large part to the falling value of the U.S. dollar, we have recently witnessed a substantial increase in the price of oil, despite weak demand due to the ongoing synchronized global recession. What appears to be an anomaly is actually a harbinger of future trends, in my view. Excessive deficit spending is contributing to the weakening of the dollar, which has price consequences for an economy as dependent on imported goods and commodities as is the case with the United States.

A major point made by others and me is that a high ratio of national debt to GDP creates a substantially elevated risk of inflation. Furthermore, I suggest that this may lead to a conclusion by decision-makers that the only policy response that can reduce this dangerous ratio of public indebtedness is to allow high levels of inflation, which in turn “grows” the nominal GDP not through higher output of goods and services, but through reduction of the constant value of the currency. Professor Krugman is dismissive of this point, making reference to the United States having a level of public debt that exceeded the GDP right after World War II, without severe consequences.

Let us look at the facts. The United States ended World War II with a labor force, including a substantial military, which was fully employed but had been restricted in the opportunities to spend disposable income. This was due to rationing on basic commodities such as foodstuffs, and the termination of production of major consumer durables such as automobiles owing to industrial mobilization in support of the war effort. After VJ day the pent-up consumer demand exploded, while consumer goods remained in short supply in the immediate post-war period. The result was a combination of real growth and high inflation, both dynamics contributing to the attenuation of the public debt to GDP ratio. Thus in 1946, the national debt ratio reached its highest level, 121%. By 1948, that ratio had declined significantly, at 93.7%. Now, let us observe the inflation rate during this period: 8.3% in 1946, a staggering 14.4% in 1947 and 8.1% in 1948. These figures clearly demonstrate that having a level of public debt exceeding 100% of the GDP does have inflationary consequences, and suggests that inflation in turn reduces the real value of the nominal public debt as a proportion of national GDP.

Perhaps the most disturbing aspect of Paul Krugman’s piece, beyond superficial and trivializing dismissal of those he disagrees with on the question of high levels of deficit spending, is his marginalization of those he disputes by resorting to rhetorical generalizations. Thus, he issues this inexplicable diagnosis of those who hold economic views that are contrary to his own: “But it’s hard to escape the sense that the current inflation fear-mongering is partly political, coming largely from economists who had no problem with deficits caused by tax cuts but suddenly became fiscal scolds when the government started spending money to rescue the economy. And their goal seems to be to bully the Obama administration into abandoning those rescue efforts.”

One of the inflation fear mongers is a supporter of President Obama’s stimulus spending program, NYU economics professor Nouriel Roubini. This is what he had to say at a recent symposium on the economic crisis, which Professor Krugman also participated in: “…we have to worry about the long run. If we’re going to finance budget deficits by printing money, we may have high inflation, even risk of hyperinflation in some countries. That’s what happened in Germany in the 1920s during the Weimar Republic. We are having large budget deficits and increasing the public debt, we don’t know whether it’s going to be $5 trillion or $10 trillion of more debt. But there are only a few ways of resolving that debt problem: either you default on it as countries like Argentina did; or you use the inflation tax to wipe out the real value of the debt; or you have to raise taxes and cut government spending. And given the size of the deficits, over time that’s going to be a painful political choice to make. So we need the stimulus in the short run, but we need to restore medium-term fiscal sustainability.”

Another supporter of President Obama’s economic policies, who also opposed George W. Bush’s deficit-financed tax cuts, is billionaire investor Warren Buffet. This is what the oracle of Omaha had to say about the linkage between high public debt to GDP ratios and the risk of inflation: “A country that continuously expands its debt as a percentage of GDP and raises much of the money abroad to finance that, at some point, it’s going to inflate its way out of the burden of that debt.”

In writing off those observers who are concerned about the inflationary dangers emerging from the exploding national debt, Paul Krugman resorts to paraphrasing Franklin Roosevelt, claiming the only thing we have to fear about inflation is the fear of inflation itself. It seems, however, that there is one authority that is of like mind with Professor Krugman. In December 2002, Treasury Secretary Paul O’Neill, about to be fired for opposing the Bush tax cuts, had a meeting with Vice President Dick Cheney. In response to O’Neill’s warning of the long-term implications for the nation’s economic health of escalating federal deficits, Cheney told the soon-to-be but prescient ex-Treasury Secretary, “You know, Paul, Reagan proved deficits don’t matter.”

I never thought I would witness the day when Paul Krugman and Dick Cheney agree on economic policy.

 

For More Information on “Global Economic Forecast 2010-2015” please go to the homepage of our website, http://www.globaleconomiccrisis.com 

 

 

 

 

 

 

 

U.S. Economy Risks Hellish Prospect of Hyperinflation

May 24th, 2009 Comments off
The global financial and economic crisis arose out of radical deflation in the U.S. housing market, as the real estate asset bubble split asunder. With the collapse in housing prices came the contraction of another asset bubble; equities. The ongoing demand destruction has also deflated commodity prices from their recent peaks, giving rise to a collective view among economic policymakers that deflation represents the single greatest risk to the global economy.
In itself, deflation is a dangerous economic phenomenon. Historians of the Great Depression often refer to deflation in the 1930s as a contributing factor to the prolongation of that epochal downturn in the world’s economy. Looking closely at the dynamics of deflation, it is not difficult to see why this is a dangerous economic state to be in. When prices of major durable goods, especially homes, continue to decline, this inserts a strong dose of uncertainty into the human decision-making process. Not many consumers are likely to take out a mortgage on a home that they believe will actually decline in value right after the legal papers are signed. Or so the classical economic theory goes.
However, though not downgrading the danger of deflation, I believe policymakers are ignoring other factors regarding this economic and financial condition. Furthermore, the U.S. government and Federal Reserve in particular, are taking steps to “cure” deflation that will inevitably lead to hyperinflation, which in the long-term may prove far more destructive to the long-term health of the U.S. economy.
History demonstrates that deflation is not a permanent condition. Market forces, unencumbered by fiscal and monetary intervention, eventually restore pricing equilibrium. At a certain point prices of major durables such as homes are low enough to encourage new categories of consumers to enter the marketplace. As demand is restored, prices stabilize and then resume their upward ascent. It is all a question of time. However, key decision-makers in the United States are not paragons of patience. They want deflation cured immediately, which explains why the U.S. Treasury and Federal Reserve are hell-bent on policies that are guaranteed to be inflationary. The question is how bad will inflation ultimately be.
Massive quantitative easing by the Fed is pouring trillions of fiat U.S. dollars into the money supply, essentially conjured out of thin air. This is being done without transparency, the rationale being that frozen credit markets require a vast expansion of the money supply in an attempt to get the arteries of commerce flowing again. Similarly, the U.S. government is spending vast amounts of money it does not have, with the Treasury Department selling unprecedented levels of government debt in a frantic effort to fund the wildly expanding U.S. deficit. These two forces, quantitative easing and multi-trillion dollar deficits, are the core ingredients of an explosive fiscal cocktail that I believe will ultimately lead to hyperinflation.
What exactly is hyperinflation? Economists disagree on a common definition, so I will offer one myself. Double-digit inflation extending over a period of at least two years would arguably be a hyperinflationary period. It can get much worse, witness Weimar Germany in the early 1920’s and Zimbabwe at present. The most recent experience the United States had with this unstable economic condition was in 1981, when the annual CPI rate exceeded 13%. The cure was draconian; Federal Reserve Chairman Paul Volcker engineered a severe economic recession that created the highest level of U.S. unemployment since the Great Depression-until now. The federal funds rate, currently near zero, rose to above 20% under Volcker’s harsh discipline. Eventually high inflation was purged out of the system and economic growth was restored, however the monetary regimen was punitive for several years.

The current monetary and fiscal policies being enacted by the key economic decision-makers in the United States are laying the groundwork for a far more dangerous inflationary environment than anything encountered by Paul Volcker. The explosive growth in the money supply and government debt is simply unsustainable without severe inflation. It must be kept in mind that the Federal government is not the only public authority engaged in massive deficit spending. Throughout America, state, county and municipal governments are faced with imploding tax revenues and lack the ability or political flexibility to cut services to a level commensurate with revenue flows. Both the Fed and the public sector are engaging in a reckless gamble; borrow like crazy in the hope that this overdose of economic stimulation will restore growth to the economy and normal tax revenues, leading to a decreased and sustainable level of public sector indebtedness.

If one believes that the policymakers running the Federal Reserve, Treasury and Federal government, the same architects of the Global Economic Crisis, are smart enough to now get everything right, perhaps we may escape the worst consequences of their turbo-charged fiscal and monetary policies. However, there are growing indications that global investors and the broader market are beginning to reach a far more sobering assessment.

In an interview with Bloomberg News, Bill Gross, co-chief investment officer of PIMCO (Pacific Investment Management Company) suggested that the coveted AAA credit rating U.S. government debt now benefits from will eventually be downgraded. “The markets are beginning to anticipate the possibility of a downgrade,” Gross said.

China, the major purchaser of Treasuries and holder of $1 trillion of U.S. government debt, is already on record as expressing concern for the integrity of its American investments, and has begun actively exploring alternatives to the U.S. dollar as the primary global reserve currency. These moves by China are not based on fears of expropriation of its U.S. assets, but focuses on the specter of hyperinflation destroying much of the value of assets denominated in U.S. dollars. No doubt China’s economic experts are well aware of the growing number of economists who are convinced that the U.S. will be unable to service its rapidly expanding debt burden without significant inflation. Inflation in monetary terms means the erosion of the intrinsic value of the American dollar.

What is most frightening about the policy moves being enacted by the Fed and Treasury is that their actions may not be a reckless gamble after all. They may have come to the conclusion that only hyperinflation will enable the United Sates to avoid national insolvency. In effect, they may be pursuing the exact opposite course undertaken by Paul Volcker in the early 1980’s. If that is their prescription for the dire economic crisis confronting the U.S., then one must conclude that Ben Bernanke, Timothy Geithner and Larry Summers have learned nothing from history Once the spigot of hyperinflation is tuned on, it becomes a cascading torrent that is almost impossible to switch off, and which in its wake inflicts inconceivable levels of economic, political and social devastation. Before it is too late, President Obama should put the brakes on his economic team’s dangerous gamble with the haunting specter of hyperinflation. If he fails to act in time, a hellish prospect may be his economic and political legacy.

 

For More Information on “Global Economic Forecast 2010-2015” please go to the homepage of our website, http://www.globaleconomiccrisis.com