Kevin Drum is an Economic Illiterate

Drum posts today that:

higher inflation would be good. The simplest way to see this is to look at interest rates. Once the Fed has reduced interest rates to zero, it can't go any further. But what if the economy is so bad that all the standard models suggest you need negative interest rates to get the economy back on track? 

What he doesn't realize is that all his "standard models" are wrong.  They say that reducing interest rates is stimulative.  What they don't get is that the government pays the interest  Lower rates mean less money injected by the government into the economy.  So lower rates are deflationary, 180 degrees different from Drum's assumption.

Drum assumes that government lends money to the private sector and that lower rates means lower borrowing costs for the private sector.  However, the private sector does not generally borrow from the government to finance loans.  Rather, there is a pool of money available for loans that is the product of past government deficits.  The money has been spent into the economy by the government, and the government pays interest on this money (Treasury bonds or interest on reserves).

When the Fed lowers interest rates, the opportunity cost of lending by any single bank is lowered, since it will collect less interest on money that is saved.  That will stimulate private money creation (bank lending) in the short run, but those debts will have to be paid back, so the effect is contractionary after a year or two.  In 2012, after 30 years of steadily declining interest rates intended to boost short term private sector debt, there is little more short term gain to be achieved, as consumers are paying back money previously borrowed from the private sector.

So the net effect of continually decreasing interest rates is a double whammy to the economy:

1. Less money is provided to the economy by the government.
2. Private debt can only be juiced so far before it becomes a burden to the economy.

Anyone, like Drum, who imagines that low interest rates generate inflation, is extremely short-sighted.  Take a minute to look at the history of interest rates in the United States and Japan and you will see the proof of the point I am making.  For example: US_Inflation_rate_vs_3month_T_bill_rate --



Note that interest rates track inflation and the two are positively correlated.  Compare this reality to Drum's assumption that interest rates are inversely correlated with inflation...

Inflation Expectations and Quack Economists

There have been a lot of quack economists recommending that the Fed raise inflation expectations as a means of increasing overall economic activity and employment.  The following graph (from Cullen Roche) shows pretty clearly that this has not been effective:



Inflation expectations have spiked a couple of times in recent years and inflation, as measured by CPI, has jumped a couple of times.  But wages have steadily decreased.  Thus, increasing inflation has been of the bad type (food, gasoline) which decreases purchasing power for workers whose wages have continued to decrease.  Goosing inflation expectations is quack economic medicine which has masked a continuing deterioration in purchasing power...

Risks of Additional "Monetary Easing"

Back on August 1, Kevin Drum commented:

Easier monetary policy might or might not be effective, but it seems like even the Fed thinks it would be a pretty low risk thing to try. So why not try it? 
Kevin Drum, 8/1/2012

Since then, I've been collecting reasons why this might not be a good idea.  

As far as I know, the only monetary action under consideration is additional asset purchases, i.e. more bond swaps for reserves.   Here are some reasons why this "monetary easing" might be counterproductive:

- Lowering interest rates (by liquidating bonds) is fundamentally deflationary.  Injections of 5% or more annual interest paid on long term bonds are replaced by reserves which earn 1/4% interest.  See Ed Harrison, for example:

in periods of low credit demand growth, it is the effect on lost interest income that overwhelms the effect on credit growth. In fact, I would argue that this policy actually helps tip economies into deflation... the same people who were concerned about low rates stealing interest income become coupon clippers, knowing that deflation will bail them out. Suddenly, your economy is trapped in a deflationary rut – and central bank policy of zero rates helped to get it there.

- Banks make money by borrowing short and lending long.  You can only reduce long term rates so much before such a business model collapses.  Ed Harrison again:

the signs of malinvestment excess from extremely low interest rates are all around us. When recession hits, these losses will crystallize. And there will be no steep yield curve to bail out the banks as we saw in in the early 1990s. The banks will have to take it on the chin like the Japanese banks did in 1997 – and we know what happened there...

- Focus on Fed fixes diverts attention from the fiscal fixes that are needed.

- Removal of interest bearing bonds leads some investors to alternative investments such as commodities, pushing up the price of gasoline, for example.  Any inflation caused by debt monetization is in assets, which is the bad kind of inflation in the present economy.

- Money market funds are already unstable, as they are not legally guaranteed but cannot be allowed to fail. Reducing the interest on reserves from the current 1/4% to 0% could cause failure in this part of the financial system.  The prospect of further bailouts for the banks and the wealthy will not be popular and could cause political turmoil.  Here's a post by Cardiff Garcia of FTalphaville on this subject:

The ECB’s recent decision to lower its deposit rate to zero raised speculation in the market that the FOMC might be considering the reduction or elimination of the 0.25 per cent interest the Fed pays on excess reserves.

interest on excess reserves is like a safe asset for banks — you can consider it an imperfect near-substitute for the Treasuries and agency MBS that the Fed has removed from the market. And along with the unlimited deposit insurance on non-interest bearing accounts, it is (from a certain point of view) a kind of ongoing bailout for money market fund investors.

The risks, in sum, are that rates will plunge to zero or negative, money market funds and their investors would panic as their sources of yield disappeared, and that banks will follow Bank of New York Mellon’s lead last year and consider the (politically uber-controversial, btw) possibility of charging fees on deposits.

Money market funds would likely be subsidised for a time by their sponsors, but that can’t be counted on to the extent that it was before the crisis. Were this to pass, we couldn’t with any certainty predict the consequences — but given the panic that ensued when Reserve Primary broke the buck, it’s worth taking none of this lightly.

But in addition to general chaos in money markets, here are three more possible worries resulting from the above...

it is just as possible to imagine how, regrettably and almost perversely, negative rates would actually make things worse. How they would lead to higher demand for money itself — to deflationary expectations.

So if the economy slides back into recession in 2013, which is a likely prospect given the approaching fiscal cliff and our highly polarized and dysfunctional political environment, visions of hyperinflation caused by debt monetization may give way to a deflationary reality.  We'll see soon enough...

Second Dip Coming?

A good post by Ed Harrison got me thinking about the severity of the next recession.  The economy has been weak for the last 5 years (and was unhealthy for the previous 8 or so).  Some people (the majority of the outspoken financial community) seem to think that this means we are due for a bull market / growing economy.  My take is that we are not out of the woods yet, and in fact may be taking some counterproductive measures.  Moreover, the (neo)liberal Democratic commentariat is just as counterproductive in one respect as everybody else.

Specifically, I think that efforts to use monetary policy to boost the economy may be counterproductive.  To start with, monetary policy is massively misunderstood, as noted in my March 2012 post here.  The ongoing push, mainly by the (neo)liberals, to push interest rates down even further may be deflationary in the long run.    This is obvious from the fact that interest paid by the federal government represents money given to the private sector.  In other words, lower interest payments decrease the fiscal deficit.

So what is the real problem facing the economy, and how will decreasing the fiscal deficit affect the fundamentals? The basic problem is stagnating wage incomes, which have gotten out of whack with asset prices and consumption habits. The gap has been filled with unsustainable household debt, and this is still a problem. While housing prices have come down substantially, other asset prices, including the common stocks that many depend upon for retirement, are still overvalued. Decades of investment incentives (e.g. reduction of capital gains tax) have led to excess investment.

By seeking to further reduce interest rates in order to stimulate more investment, the neo-liberals are foolishly trying to reblow the same bubble that popped 4 years ago. Only deficit spending can provide the needed boost to household income that is needed.  As noted above, reducing interest rates reduces the desparately needed fiscal stimulus.  Trying to reignite private borrowing will just exacerbate the problem. When the next downturn comes, zero interest rates will be telling indicator of deflation, not the go signal that so many seem to assume….

Will Corporate Bosses Keep Republicans in Line?

The corporate bosses that call the shots in the Republican Party can't have been happy with the debt ceiling shenanigans last year. Rich people do not look kindly on anyone messing with their financial instruments. This year we face the "fiscal cliff". Corporate folks surely do not want economic warfare, which can only hurt them.

Obama should have a lot of leverage to follow through on his pledge to raise taxes on the wealthy. In return he'll probably make concessions on entitlements. That is, if (relative) sanity prevails. If this is how it plays out (a best case, as far as the status quo goes), then this will have a slight depressing effect on the economy next year, as increased taxes for the wealthy will mean less money around to invest in stocks and other assets. 

Here are a few things that could go wrong and make 2013 even worse:

- The temporary payroll tax cuts are allowed to expire.  This is actually likely and will be a significant blow to the economy in 2013.
- Romney gets elected and foolishly cuts government spending.
- Israel and/or U.S. attacks Iran and oil supply is disrupted.
- Obama caves and cuts spending sooner rather than later.
- A faction of Republicans favors economic pain to teach the Dems (another) lesson.  Chaos ensues, as in the debt ceiling negotiations.  To save face, the Republicans insist on some stupid budget cuts.

Here's How Screwed Up the Conventional Economic Wisdom Is

Conventional economic wisdom:
1. Interest rates for government debt are determined by the market, and are susceptible to strikes by bond vigilantes.
2. The Fed (central bank) is all powerful and can control inflation and unemployment. The only thing it can't do is control interest rates (see item 1 above).

Real World:
In fact, the only the thing the Fed does control is the interest rates on government debt.

Conclusion:
The conventional wisdom on the role of the central bank and monetary policy is exactly wrong...

The Coming Revolution

Call me a naive Pollyanna, but I believe that both parties have moved so far away from the interests of the middle class that significant change with regard to workers' rights is becoming more of a possibility.  Disillusionment with the status quo is off the charts.  

One of the major factors in the recent ascendance of capitalists at the expense of workers was the co-opting of much of the middle class through 401k plans and other similar initiatives which greatly expanded the number of voters benefiting from high returns to capital.   Can this be rolled back?  I believe so, since capitalism as always contains the seeds of its own destruction.  

Politicians have been afraid to let stock values fall.  This was seen clearly in the fall of 2008 when the bailout was rushed through in response to panicking markets.  The longer this goes on, the more overvalued markets become, and the higher the potential for a crash.  And fundamental values are actually harmed as a higher percentage of national income is devoted to capital at the expense of labor, as capital prices rise and consumption potential falls.  

With the public already massively disillusioned with the last set of bailouts for the 1%, the stage is set for political chaos the next time markets panic.  If the political system fails to prop up the markets in which many of us have invested our life savings, the ownership society we've built over the last 30 years will collapse.   If the government does prop up the markets again, both the right and the left will revolt unless the socialist intervention extends deeper into the middle class.

This is the setting that will greet President Mitt Romney, should he win the presidential election in November.  Obama has been a decent president, but has been victimized by a dysfunctional political system and will have trouble overcome racial favoritism.  Should the tone deaf Romney win, all the pieces will be in place for a middle class or 99% revolt.  Once that gets rolling, it will become self-sustaining.  As laws favoring capital are rolled back, stock market values will fall in reflection of the less friendly investment climate.  The ownership society and markets will take another credibility hit, and the rising tide favoring workers and social insurance programs will sweep away the opposition...

Republicans are Cracking Up

From the NY Times:

WASHINGTON — The House Republican leader on Sunday flatly rejected a short-term, bipartisan Senate measure to extend a payroll tax break and unemployment insurance, setting the stage for a bitter year-end Congressional collision and the potential loss of benefits for millions of Americans...The surprising setback threatened the holiday plans of lawmakers and President Obama, deeply embarrassed Republican leaders in both chambers and raised the specter of a Jan. 1 tax increase that economists have warned could set back the already fragile economic recovery...

Senator Mitch McConnell of Kentucky, the minority leader who, like scores of his colleagues, voted for the Senate-brokered agreement to extend the tax cut temporarily, retreated from the measure Sunday, throwing his support behind Mr. Boehner’s idea to come up with a yearlong extension, which was the original goal of Mr. Obama and Senate Democrats.

I'm pretty sure this is a sign that the Republicans are falling apart. Mittens will be probably be our next president, but that will be their last hurrah...

democratic Woes in the U.S. and Europe

Predictably, the Great Recession is taking its toll on democracy in the U.S. and Europe. I've recently read a couple of well written columns on this, and have a few thoughts to add in light of the Gingrich revival. Here is the short version:

1. Class war is on in the U.S.
   
2. Unpopular technocrats are running Europe.
   
3. The G.O.P. has been playing with fire for some time now and it's finally caught up with them.
   
4. The national and international politic mood has changed dramatically, and consequent political storms are headed our way.
   

We'll start with Frank Rich in The Class War Has Begun and in a follow up interview.

Just in time for election season, Obama has recovered his populist rhetoric (if not populism itself) and will say the right things about Wall Street, about that “frustration” out there, about the modest reforms of Dodd-Frank, and about millionaires who don’t pay their fair share of taxes. It’s not clear if anyone believes it, including him. Having been a bystander to history when the tea party harvested populist rage during the summer of 2009, he may have a tough time co-opting Occupy Wall Street now to plug the so-called enthusiasm gap in his base...

Despite all the chatter to the contrary, Obama is so far outdrawing all the GOP candidates combined in Wall Street contributions. His best hope is that that fact is blurred by Romney, the plutocrat from central casting...

Elections are supposed to resolve conflicts in a great democracy, but our next one will not. The elites will face off against the elites to a standoff, and the issues animating the class war in both parties won’t even be on the table.

The two powerful forces that extricated America from the Great Depression—the courageous leadership and reformist zeal of Roosevelt, the mobilization for World War II—are not on offer this time. Our class war will rage on without winners indefinitely, with all sides stewing in their own juices, until—when? No one knows. The reckoning with capitalism’s failures over the past three decades, both in America and the globe beyond, may well be on hold until the top one percent becomes persuaded that its own economic fate is tied to the other 99 percent’s. Which is to say things may have to get worse before they get better.

Though the Bonus Army was driven out of Washington in the similarly fraught election year of 1932, the newsreels they left behind turned out to be previews of coming attractions for the long decade still to come...

I wouldn't want to be an incumbent in either party (except, of course, in all those gerrymandered House districts — part of our democracy's problem). I am wary of predictions, but my guess is that there will be a political stalemate until one of the following: an unexpected speedy recovery on the jobs and housing fronts; an external existential threat to the country (see Depression and WWII); the emergence of a reformist populist leader with enormous public support. All unlikely at least in the near future; we may stew in our anger and this listless economy for quite some time.

And here's Paul Krugman from 12/11/2011 on Depression and Democracy:

It’s time to start calling the current situation what it is: a depression. True, it’s not a full replay of the Great Depression, but that’s cold comfort. Unemployment in both America and Europe remains disastrously high. Leaders and institutions are increasingly discredited. And democratic values are under siege.

Let’s talk, in particular, about what’s happening in Europe — not because all is well with America, but because the gravity of European political developments isn’t widely understood.

First of all, the crisis of the euro is killing the European dream. The shared currency, which was supposed to bind nations together, has instead created an atmosphere of bitter acrimony.

Specifically, demands for ever-harsher austerity, with no offsetting effort to foster growth, have done double damage. They have failed as economic policy, worsening unemployment without restoring confidence; a Europe-wide recession now looks likely even if the immediate threat of financial crisis is contained. And they have created immense anger, with many Europeans furious at what is perceived, fairly or unfairly (or actually a bit of both), as a heavy-handed exercise of German power.

Nobody familiar with Europe’s history can look at this resurgence of hostility without feeling a shiver. Yet there may be worse things happening.

Right-wing populists are on the rise from Austria, where the Freedom Party (whose leader used to have neo-Nazi connections) runs neck-and-neck in the polls with established parties, to Finland, where the anti-immigrant True Finns party had a strong electoral showing last April. And these are rich countries whose economies have held up fairly well. Matters look even more ominous in the poorer nations of Central and Eastern Europe.

Last month the European Bank for Reconstruction and Development documented a sharp drop in public support for democracy in the “new E.U.” countries, the nations that joined the European Union after the fall of the Berlin Wall. Not surprisingly, the loss of faith in democracy has been greatest in the countries that suffered the deepest economic slumps.

And in at least one nation, Hungary, democratic institutions are being undermined as we speak... this amounts to the re-establishment of authoritarian rule, under a paper-thin veneer of democracy, in the heart of Europe. And it’s a sample of what may happen much more widely if this depression continues...

The European Union missed the chance to head off the power grab at the start — in part because the new Constitution was rammed through while Hungary held the Union’s rotating presidency. It will be much harder to reverse the slide now. Yet Europe’s leaders had better try, or risk losing everything they stand for.

And they also need to rethink their failing economic policies. If they don’t, there will be more backsliding on democracy — and the breakup of the euro may be the least of their worries.

In the US, The Republicans have been playing with fire, and the old guard may be close to panic. Here's David Brooks last week in the NY Times on The Gingrich Tragedy:

As nearly everyone who has ever worked with Gingrich knows, he would severely damage conservatism and the Republican Party if nominated.

And here's former chief advisor (2000-2006) to President George W. Bush, Michael Gerson, in the Washington Post on Newt Gingrich’s lack of discipline:

As speaker of the House, he conducted an affair during the impeachment of a president for lying under oath about an affair. It helped undermine a movement Gingrich had helped to build.

And this indiscipline was not an aberration. It indicated an impulsiveness found elsewhere in his career. Gingrich has a history of making serious charges that turn out to be self-indictments — witness his recent attack on congressional advocates for Freddie Mac, despite having been one of its well-paid consultants. Gingrich’s language is often intemperate. He is seized by temporary enthusiasms. He combines absolute certainty in any given moment with continual reinvention over time.

Peggy Noonan in the Wall Street Journal -- Gingrich Is Inspiring—and Disturbing:

Former New Hampshire governor and George H.W. Bush chief of staff John Sununu told The Wall Street Journal this week: "Listen to just about anyone who worked alongside Gingrich and you will hear that he's inconsistent, erratic, untrustworthy and unprincipled." In a conference call Thursday, Jim Talent, who served with Mr. Gingrich in the House from 1993 through 1999, said, "He's not reliable as a leader." Sen. Tom Coburn, a member of the House class of 1994, called the former speaker's leadership "lacking," and according to a local press report, he told Oklahoma constituents last year that Mr. Gingrich was "the last person I'd vote for for president of the United States."

Who could predict the rise of a right wing demagogue in difficult economic times?

At any rate, here's (liberal) Nate Silver in the NY Times:

Republicans are dangerously close to having none of their candidates be acceptable to rank-and-file voters and the party establishment. It’s not clear what happens when this is the case; there is no good precedent for it. But since finding a nominee who is broadly acceptable to different party constituencies is the foremost goal of any party during its nomination process, it seems possible that Republicans might begin to look elsewhere...

One possibility — probably the most likely one — is that Mr. Gingrich wins South Carolina, wins Florida and holds on to win the Republican nomination.

But Mr. Gingrich might nevertheless be considered an unacceptable choice by much of the party establishment. That would put us in uncharted waters... a brokered convention is plausible...

Liberal John Cole sums things up nicely at Balloon Juice:

The thing to remember about the chaos ensuing in the GOP primaries, where each week a different candidate is the new new savior before publicly shitting the bed, is that this is all the fault of the Republican party itself. They allowed the party to create this alternate reality about, well, everything that happened the last decade. They are the ones who encouraged their party to believe that a center-left Democrat is actually an America hating socialists. They are the ones who made this mess, so when they are all horrified when each week a different candidate looks the fool by pandering to the base, remember, they are the ones who encouraged the base to think all this crazy shit.

Whew!

The mood of the country has shifted. The Republican base is no longer enamored of mega-rich establishment figures such as George W. Bush and Mitt Romney. They want red meat. The Occupy movement struck a chord with both the left and right, and the situation is Europe is as dire as it is here in the States.

Seen in the current light, Obama is a compelling figure for 2012 -- a centrist figure who might be able to hold things together. However, if Romney survives the Gingrich onslaught, which I believe he will given unanimous support for his candidacy by the GOP establishment, then we'll probably see the Republicans close ranks and successfully demonize Obama once more. The 2012 presidential election will then play out as elite vs elite as suggested by Rich. But the stage will be set for further disruption of the status quo by insurgents from the left and right, at home and abroad. Fasten your seatbelts...

Sample Blog Posting

I am with my friend Oumar at the Sierra Literacy Center demonstrating the blogging...

Here is a sample link to another blog posting.

Fundamental Issues and Symptoms

Many people are worried about the federal budget deficit, and these worries have widely been conflated with worries about our trade deficit. The result is widespread confusion, amongst our political and economic elite as well as the unwashed masses.

(As I write this, a gold commercial (with an end times subtext) is playing on MSNBC. Both right and left have been bullish on gold in recent years. This is symptomatic of the issues I am discussing.)

My take is that the currencies of industrially developed nations, including especially the United States, are grossly overvalued. This basic fact is driving everything else.

I lived in the Philippines from 1977-1979, and was figuratively clubbed over the head with the enormous disparity in the relative values of the U.S. dollar and the Philippine peso. One could live like a king in the Philippines on the income of a poverty-stricken American. Middle class Filipinos, of comparable intelligence with middle class Americans, would earn 1/10 the salary. No doubt there are logical historical explanations for such disparity, but going forward it's not surprising that there is a narrowing of the income gap, as globalization facilitates international diversification, outsourcing, and migration of labor and capital.

In an ideal free market world, the global economy would quickly adapt to globalization by lowering the value of the U.S. dollar. But of course, in the real world, there is economic friction (resistance to change). The U.S. dollar remains overvalued, in spite of an enormous trade deficit, as developing nations undervalue their currencies in the mercantilist tradition. The U.S. government enables the mercantilist policies of developing nations by running large fiscal deficits, which keeps U.S. consumption strong in the face of reduced private sector income.

The statistical manifestations of the scenes described above are large trade and budget deficits. The trade deficit is rightly seen to be endogenous. That is, the trade deficit is not the result of a single government policy. Rather, it is the market determined product of numerous factors, including the imbalance inherent in currency valuation.

By contrast, the fiscal budget deficit is seen as something that is directly under the control of the federal government. For wont of a more convenient target, the budget deficit is fingered as the culprit for the problems stemming from the initial imbalance in currency values. In the sense that the budget deficit enables the trade deficit, there is a germ of truth in this. But the preponderance of the truth lies in the fact that the former wage disparities are not sustainable in a global economy.

With respect to the current hysteria in the U.S. political zeitgeist, the emphasis on the fiscal deficit is clearly misplaced. The fiscal deficit is keeping our heads above water as our international competitiveness diminishes. Without a huge fiscal deficit, the U.S. economy would be in deep depression. Many argue that we should let that happen, so that the necessary adjustments will begin at once. I am sympathetic to that position, but also sympathetic to the plight of Americans who would be devasted by a deep depression.

An informed analysis would recognize that the fundamental problem with the U.S. economy is our overvalued currency, and would recognize that the budget deficit is a symptom rather than a cause of our misfortunes. Addressing the budget deficit will not cure the problem; rather it will cause more misery and then force us to address the root cause...

I Like Ed Schultz

The MSNBC prime time hosts are all winners, in my opinion. Uygur, O'Donnell, Maddow, Schultz and even Matthews are credible, in contrast to the conventional wisdom which likens them to Fox hacks...

And Still More

With regard to the Volcker recession in the early '80s, this was clearly a case where monetary policy did make a difference, albeit not one that we would want to repeat. Randall Wray puts this incident in perspective:

Milton Friedman played the biggest role in promoting the Fed as the all-powerful Wizard of Oz, spinning dials and controlling the money supply which then determines output and employment. However (according to Friedman), the Fed is not to be trusted, hence, should be constrained by a constant-rate-of-growth-of-money-supply rule. This was finally tried in the disastrous early 1980s great monetarist experiment run by Fed Chairman Paul Volcker (simultaneously attempted in Thatcher’s UK). I say disastrous because it wiped out half of our thrifts (home mortgage lenders-but not before helping to set off a wave of fraud that was the subject of Bill Black’s book). By the mid-1980s the Fed had given up money targets, and had also abandoned the Friedmanian myth that money and output are closely correlated-with money driving output.

In truth, central bank policy has always determined the overnight interbank lending rate (the fed funds rate in the US). Leaving to the side regulatory and supervisory power, that really is all the central bank does. There is no evidence that changing the overnight interest rate (within the usual range) has any significant or predictable impact on the economy. It truly is a Wizard of Oz-if one recalls that the Wizard behind the curtain actually had no power at all. What is unfortunate is that for a very long time policymakers believed that economic policy could be left to the “omnipotent” Fed-which means that the truly powerful fiscal policy has been neglected.

More on Monetary Policy

Here's why I say the conventional wisdom regarding monetary policy is absurd. We've had 30 years of loose monetary policy. The Fed Funds rate has decreased in fits and starts from 19% to 0%. During that same period, the rate of inflation has steadily declined. So after 30 years of loose monetary policy by the Fed, we have much lower inflation and much higher unemployment than we had to begin with! This is the exact opposite of what one would expect according to the conventional wisdom.

The simple explanation is that encouraging more private sector debt (by lowering interest rates, amongst other tools) when the economy is slumping is not the way to run an economy. While the increased borrowing will temporarily boost the economy, the more lasting effect is to increase private sector debt to unsustainable levels. This is obviously what has happened, aided and abetted by repeated bailouts of the private sector by the federal government.

Monetary Policy is a Joke

Recently, my favorite blogger (Kevin Drum) wrote what I consider to be his dumbest post in the 9 years I've been reading him. He claimed that the U.S. middle class has been "screwed" because of overly tight monetary policy. The Fed, he said, has ignored the full employment part of its mandate, in favor of fighting inflation.

This seems ludicrous to me. The main tool in the Fed's toolbox is setting interest rates. Drum's argument must be that the Fed has been keeping interest rates too high, thereby keeping the volume of loans too low and consequently failing to promote employment. A moment's reflection on the repeated bubbles we have experienced, most recently in housing, shows this to be absurd. The problem has been just the opposite of what Kevin said -- there have been unsustainably high levels of private debt. The U.S. has one of the lowest savings rates in the world as we learned to finance consumption with debt. After 25 years of increasingly loose monetary policy, the result has been the high unemployment that we have today.

The situation is equally absurd if we look at the short term effects of monetary policy. The Fed reduced interest rates aggressively beginning in August 2007. This had no discernible effect in boosting employment. In fact, unemployment soared in the face of this supposedly loose monetary policy. This is just one example of what I have noticed since I began paying attention to this sometime around 2004. Monetary policy, it seems to me, is a joke -- a sort of 21st century voodoo that generally serious people like Kevin Drum fall for...

Monetary Apologists

Not so long ago in the United States and Europe, basic religious facts were considered to be unknowable. Some still are unknowable in our day and age, but other religious assertions have become increasingly absurd over the years. For example, there is evidence that the age of the earth is billions of years, rather than the thousands of years that it would seem from a literal reading of the Bible. The facts surrounding the birth of Jesus are hard to swallow in light of historic facts such as that many of the myths are plainly recycled from other religions. Inconsistencies in the Biblical text are readily identifiable and easily communicated in modern times.

Still, for the last several hundred years, Christian apologists have tried to reconcile the absurdities. Generally liberal, the apologists tried to make sense of the changing intellectual landscape, while reassuring the powers that be and the people that believe in them that the old beliefs are still valid.

Paul Krugman is an apologist for the increasingly implausible monetary theories that we are governed by. Obviously, sovereign governments create money at will. Yet we pretend that governments borrow money from the private sector to finance their expenditures. The fact that this is untrue, in all but the most manipulated and superficial manner, cannot be acknowledged, because the nation sees this as a moral issue.

People see the workings of the macro-economy as fundamentally unknowable. Common sense dictates that government finances are just like the finances of a household or business. A moment's reflection will show this to be untrue, but we are unwilling to openly acknowledge something that may have morally deleterious consequences. If government deficits are okay, then nothing is true and the forces of hedonistic anarchy will have won.

The Mother of all Analogies

The Cheney Administration very publicly derided the CIA for not clearly identifying Saddam Hussein as having a massive WMD program, and thereby justifying the 2003 U.S. invasion of Iraq. It is well known that Cheney established his own intelligence office to bypass the old CIA and provide the intelligence that he wanted. Then, when it was evident that the logic for the Iraq invasion was based upon false claims of Saddam Hussein having a massive WMD program, the Cheney Administration blames the intelligence agencies!

Similarly, the Bush/Administration presided over a massive economic and financial collapse. Bush himself told Congress that a massive Wall Street bailout was necessary to prevent the collapse of the financial system. This was true. But then, after the financial system was saved by the government, the Republicans blamed the federal government for spending too much money, as if this was at the root of the massive problems that brought the economy to its knees.

The enormity of these lies boggles the mind, and indicates the depravity of our political system and indeed, since the lies have been swallowed to a significant degree by the conventional wisdom, of our nation itself...

Modern Monetary Theory Gains Popularity

Courtesy of Mike Norman, here are some recent articles about how the economy works (which doesn't correspond to conventional wisdom of the Democrats or Republicans):

• The Big Danger In Cutting The Deficit, John T. Harvey in Forbes
  
• Debt and Deficit in a Nutshell (9 minute YouTube video)
  
• Bill Mitchell in The Nation
  

Middle East Musings

I just finished reading a book about Hezbollah -- "A Privilege to Die: Inside Hezbollah's Legions and Their Endless War Against Israel", by Thanassis Cambanis. It's a fascinating account of Hezbollah's rise, the 2006 war with Israel, and the subsequent ascension of Hezbollah to dominance of Lebanon and leadership of an anti-western "axis of resistance" throughout the Arab & Islamic worlds. With Bill & Misty traversing the region, Joe Chahine reminding me of the intense Dearborn connection, and ongoing uprisings in Tunisia, Egypt, Libya, Yemen, Oman, and Bahrain, it's highly relevant. While extremely sympathetic, the book is an ultimately damning (perhaps excessively so) account of the principled, dedicated, and fanatical leaders (and followers) of the Shia axis of resistance.

The anti-western axis of resistance includes Hezbollah and their patrons in Iran and Syria, along with Muqtada al-Sadr in Iraq. Though a Shia movement, there are many Sunni sympathizers including Hamas. Opposed to the axis of resistance are the forces of accommodation led by Saudi Arabia. The accommodationist Sunni Arabs have been weakened by the recent revolutions including, especially, the ouster of Hosni Mubarak in Egypt. The Taliban and al-Qaeda are a third loosely-affiliated group on the fringe of current developments.

It remains to be seen what will happen as a result of the Egyptian revolution and the ongoing conflicts in Libya, Bahrain, and Yemen. There are two clear sides struggling for preeminence -- the Shia led axis of resistance and the Sunni led axis of accommodation. While the Iranian led axis of resistance is on the offensive with the fall of Mubarak, it is doubtful that the Saudis, with their enormous wealth, can be toppled. It is more likely that leadership of moderates will pass to more democratic regimes in Egypt, Qatar, and Jordan.

While openness will provide an opening for anti-western factions in the Sunni lands, it is likely that the economic might of the capitalist west will predominate. Sunni self-interest lies not in futile resistance, but rather in independent pursuit of modern technology and human rights. The best case scenario is that the axis of resistance is slowly marginalized as more liberal movements succeed. With prudent behavior by the western powers, the axis of resistance will crack when one of its members decides the west isn't so bad after all, and strikes a deal to open up and reap the rewards of modernity and liberalism. Iran is the most likely prospect in this regard, and its change of heart would likely spell the end of the axis of resistance.

Worst case scenarios include the following possibilities:

• A crushing of the axis of resistance by the overwhelming firepower of Israel and its U.S. ally. This might be similar to the crushing of Jewish resistance in the 132 CE revolt of Bar Kochba. As described in Wikipedia, "The Bar Kokhba revolt (132–136 CE) against the Roman Empire was the third major rebellion by the Jews of Judaea Province and the last of the Jewish-Roman Wars. Simon bar Kokhba, the commander of the revolt, was acclaimed as a Messiah, a heroic figure who could restore Israel...580,000 Jews were killed, and 50 fortified towns and 985 villages razed...Hadrian attempted to root out Judaism, which he saw as the cause of continuous rebellions...Modern historians have come to view the Bar-Kokhba Revolt as being of decisive historic importance. The massive destruction and loss of life occasioned by the revolt has led some scholars to date the beginning of the Jewish diaspora from this date...The disastrous end of the revolt also occasioned major changes in Jewish religious thought. Messianism was abstracted and spiritualized, and rabbinical political thought became deeply cautious and conservative."
  
• Another worst case scenario would be more of the same as we have experienced in recent years. Israel, with the backing of America, would continue to confiscate Palestinian land and mistreat Arabs in the region. The power and prestige of the axis of resistance would continue to grow as a result. Eventually, the axis of resistance could obtain weapons of mass destruction.
  

The middle case, which I would like to think of as the most likely case, is that the Saudis will be unable to continue their leadership position in the Islamic world. While western power will ensue that the oil fields are protected from radicals, the Saudi royalty will realize that their best prospects lie in relinquishing absolute power and retiring as wealthy international citizens (see Aga Khan). In combination with a more liberal Egypt and increasingly liberal regimes in Jordan, UAE, Libya, and perhaps Syria and Iran, the balance of power will tilt in favor of regimes that more legitimately represent their citizens.

Israel, faced with the prospect of an increasingly powerful, balanced, and coherent Arab periphery, will eventually make peace. Israel will retain deterrent military power, but move beyond the siege mentality and become a more mature and independent middle eastern democracy.

I admit that I'm engaged in wishful thinking here. My middle case sounds suspiciously like my best case. May it be so...

Mike Norman Says It Well

From Mike Norman --

But since global capacity exceeds the demand that the US and rest of the world can absorb, the world is faced with a demand shortage, which manifests as massive unemployment and underemployment, as well as sub-optimal economic performance resulting in massive foregone opportunity. The present approach is not working and cracks are widening in the foundation. The fact that the dollar is a source of controversy shows this. On one hand, China wants to export to the US, and on the other, fears dollar depreciation that would affect its savings in dollars.

The challenge is to increase effective demand in order to grow the global economy. Ideally, this would evolve from a democratic new world order based on interdependence in a way that is sustainable financially, economically, politically, socially, environmentally, and ecologically. For this to happen, a fresh approach to globalization based on a new vision of possibilities and a grand strategy for achieving this vision are required. This is the discussion that we need to be having now. Neoliberal austerity is leading to economic underperformance and social unrest.