Archive for the ‘weakening of the dollar’ Category

Bernanke should read Silber’s biography of Volcker

September 30, 2012

Richard L. Silber has written a detailed new biography of Paul Volcker, the former chairman of the Federal Reserve who successfully eliminated the stagflation of the late 1970’s in the United States.  Appropriately, his biography is entitled, Volcker: The Triumph of Persistence.

In response to questions posed by Neil Irwin of The Washington Post (September 30, 2012),  Silber draws important insights for current Fed policy from his in-depth analysis of Paul Volcker’s lasting contribution to price stability in the United States.

“Bernanke gets an A for what he did in 2008.  He did exactly what a central banker, knowing the history of the Great Depression, should have done when confronted with the potential for panic. Open up the floodgates and lend.  But now he should worry about the fallout from remaining too easy for too long, which Volcker maintains is the reason we lost the battle against inflation before.” Neil Irwin, ‘Volcker biographer: Bernanke needs to embrace lessons of  ’70s’, The Washington Post, September 30, 2012

In his response to Irwin’s questions, Silber identifies two major lessons that must be learned from the 1970s:

“The 1970s delivered two important messages.  First, we can’t get a permanent reduction in unemployment by inflating. It doesn’t work.  And second, we’ve got to worry about inflation, even with unemployed resources. Waiting until we see a clear and present danger is too late.” ibid.

Why is inflation such a serious problem?

“He (Volcker) believes that the main problem with inflation is that it undermines trust in government.  We, as citizens, give the government the right to print money, not to abuse that right by inflating. When the government inflates, it breaks its pledge and undermines our trust.  Right now, we need trust in government more than anything else.” ibid.

Is inflation currently a realistic impending problem?

“The big difference today versus the problem Volcker confronted in 1979 is that inflationary expectations were already out of hand back then.  Today, they are still under control, but no one knows how fragile they are.  More importantly, it will be difficult for Ben Bernanke, or whoever follows him, to maintain low expectations of inflation by raising real interest rates – the way Volcker did – when that’s needed.  We have had five years of unemployment, and the American public may not tolerate a central bank that acts preemptively, as it must, to prevent inflation.  The Fed is independent, but it cannot do whatever it wants.” ibid.

I offer these words of distilled wisdom for your consideration.  Unusually, they arrive as a useful warning before, and not after, the impending crisis has  emerged.  As such they are to be treasured.

Congressional votes on the federal budget

March 30, 2012

On March 28, 2012, The House of Representatives put President Obama’s 2012 budget proposal to a floor vote. Talk about dead on arrival!  The President’s budget proposal went down to  unanimous defeat. Fifteen House Democrats did the White House the favor of abstaining on a measure that would raise taxes by $1.9 trillion. The rest simply gave the President the proverbial bird.

Other budget proposals fared better in the House, though none has any chance of passing through the Senate or the President’s veto pen.  Wisconsin Congressman, Paul Ryan’s budget proposal passed 228-191, with a loss of only 10 Republicans, including three conservatives who considered the proposal to be insufficiently stringent. This budget proposal is half-baked only, because Ryan failed to identify the tax exemptions that must be excised to achieve his revenue prognosis. In any event, it has no chance whatsoever in the Senate.

A more stringent budget proposal  designed to balance the budget in six years won a majority of 136-104 among House Republicans, but was trounced overall.  A bipartisan alternative,  that codified the budget proposal from the President’s 2010 Simpson-Bowles deficit commission, was also trounced 382-38 with support from only 16 Republicans and 22 Democrats. The President failed to support his own commission.

So the Ryan plan – leaky-sieve though it clearly is – is the budget proposal that will form the basis for the Republican Party’s campaign  in November 2012. The Democrats pretty much will run without any proposal at all,  given that Harry Reid has already stated that the Senate will not pass a budget prior to the November 2012 elections.

Some way to govern a constitutional republic, you may well say! Yes, but a constitutional republic surely gets the government that it deserves. So much for the citizenry of the United States in the early years of the 21st century. Free bread and circuses, is the popular cry? Was that not the cry that ultimately brought down the Western Roman empire once its African granaries had been seized by barbarians?

China diversifies foreign exchange reserves

March 2, 2012

Although  the news does not appear center-stage in any of the major media outlets,  a recent analysis by the United States Treasury Department indicates that China, with $3.2 trillion in foreign-exchange reserves, is rapidly diversifying its currency portfolio away from the U S. dollar.

In absolute terms, China’s dollar holdings continue to increase – by $115 billion over the past twelve months – but the percentage of dollar holdings declined from 65 percent in July 2010  to a decade low of 54 percent in June 2011. During that one year period, U.S. securities accounted for a mere 15 percent of the overall increase in China’s foreign-exchange reserves.

If this pattern continues – and most especially if it accelerates –  yields on U.S. Treasuries will inevitably increase, and borrowing costs will rise across the United States economy. If China chooses to diversify into euros, then the dollar-euro exchange rate will move adversely against the United States, and the cost of U.S. imports from Europe will increase.

China’s move to diversify the foreign-exchange portfolio is not necessarily harmful to the United States.  Yields on U.S. Treasuries are unhealthily low at this time. As yields rise, so pressure will increase on the U.S. federal government to rein in its deficits. As interest rates rise more generally, investment decisions will  tighten and marginal projects will be rejected. The long-term rate of growtrh of the economy may well increase under such circumstances.

But in the short-term, expect some increased turbulence across the financial markets.

Obama does not cut the budgetary mustard

February 14, 2012

I have suggested for some time that President Obama is completely overwhelmed in his role as President. He lacks the basic intellectual skills and work ethic  to analyze problems rigorously and to find effective resolutions.

This inability impacts every aspect of his responsibilities, both domestic and international. It is a sad commentary on the dominance of personal ambition over concern for the people that he has decided to run for a second term. For, without question, President Obama now understands that he simply does not cut the presidential mustard; and never will.

The President’s proposed budget for October 2012 quite frankly is a disgrace. It demonstrates a complete lack of understanding of the nature of the debt crisis that confronts the United States and offers nothing whatsoever towards resolving the long-term problem.

The chronic long-term debt problem arises because public expenditure, at some 25 per cent of GDP, is five percentage points higher than it should be for a vibrant mixed economy and because tax revenues, at 15 per cent of GDP, is five percentage points lower than it should be for a country with an aging population.

The principal drivers of excessive expenditure are the three major entitlement programs: social security, medicare and medicaid, together with the flawed Obamacare program that will begin to exert its impact in 2014. These programs require radical attention, if the debt crisis is not to become a Greece-style debt black hole within the next ten years. President Obama does not address this issue at all in his proposed budget.

Tax reform is essential if increased tax revenues are not to serve as a long-term drag on the U.S. economy.  A solution close to a flat tax at rates capable of generating sufficient federal revenues is feasible and even politically attractive. Instead, the President chooses to wage war on the most productive members of society. History should tell him that such assaults are rarely effective.  The relative price of tax avoidance falls sharply as marginal tax rates rise.

Worst of all, the President has created a proposed budget that has a zero probability of  being enacted into law during the final year of this administration. President Obama’s proposed budget is not a budget proposal at all. It is designed as political red meat to lure disaffected left-wing supporters to the polls in November 2012.

 The proposal, fortunately,  is dead on arrival in the the U.S. Congress, the Senate as well as the House. Whether or not President Obama is politically dead on arrival at the November 2012 polls depends on the good sense of the  electorate.

With a President like Barack Obama, the United States would be far better off with a Westminster-style parliamentary system.  At least, the British coalition government quickly identified the debt crisis that it inherited and moved to eliminate it. Obama has been in office now for three long years, and has yet to identify the nature of the beast.

Sensible asset portfolios for an inflationary U.S. future

February 12, 2012

The U.S. financial system is heavily regulated by the Federal Reserve at the present time. The Fed has and is  holding short term  interest rates at near to zero by a massive expansion of base money. Simultaneously, the Fed is  driving down long term Treasury Bond  interest rates to historically low levels, partly in order to prop up the housing market. Given the more than doubling of base money since September 2008, serious inflationary pressure lies waiting in the wings for the first green shoots of economic recovery.

In such circumstances, what  can individuals do to build savings and protect their savings over a medium term, say of ten to fifteen years? This is a major issue confronting those who are preparing for retirement, or who are already retired and seeking to protect their assets through their golden years.

This week saw the publication of two studies that provide relevant  cross-country data that go back 100 years: the Barclays Equity Gilts Study and the  Credit Suisse Global Investment Returns Yearbook.  John Authers of  the Financial Times  (February 11, 2012) reviews the data and provides the following insights.

1.  Equities do outperform other financial assets in the long run.  But that long run can be very long indeed. In the United States, since 1900, the longest an investor has had to wait to derive a positive real return from stocks is 17 years. That is a stretch for many retirees.

2.  The data suggest that  stocks are more likely to outperform if they are smaller.  U.S. micro-cap companies have grown at 12.6 per cent per annum since 1926, compared with 12 per cent for small cap companies and 9.5 per cent for larger companies. Stocks also tend to grow faster if they are higher rather lower yield. Stock also tend to grow faster if they have momentum. So avoid the laggards may be good advice.

3.  For investors who are risk-averse, safety has never been so expensive.  Long-term interest rates on U.S. sovereign debt are unprecedentedly low. Markets expect 10-year bond yields to average exactly 1 per cent per annum from 2022 to 2032.  This market assessment extends dramatically beyond the current 2014  horizon of the Fed.  Only 30 years ago, those bonds yielded as much as 15 per cent per annum. 

4. The long-term depression of U.S. sovereign debt yields is predicated on an expected shortfall in supply.  Since September 2008, several asset classes have been struck off the safe list: U.S. mortgage agency debt, structured credit, and several European government bonds. The shift in demand in favor of those that remain accounts for low U.S. Treasury yields into the very long-term.

5.  However, should the specter of inflation strike the United States – as assuredly it will –  those U.S. Treasuries will be dangerously unsafe. As nominal yields rise, bond prices will fall and the capital losses occurred will be savage indeed.

6. An obvious safe haven, for such an expectations-environment, are inflation-linked bonds issued by the United States Treasury. Inevitably they are expensive, offering  negative yields  while inflation holds back.  However, they do provide an effective buffer against inflation, always assuming that the U.S. Treasury will not default.

7. Equities tend to be badly affected by inflation, although they do outperform bonds.

8. Housing tends to be adversely affected by inflation, though less so than equities. However,  the U.S. housing market is over-priced at the present time.

9. Gold is as close to an inflation hedge as the authors of the two volumes can find. However, gold shows volatility over time,  and it returns no yield other than capital gains; so risk-averse investors are afraid to hold  significant quantities in their portfolios.

So there we have it. The environment for savers has rarely been so bad as is now the case.  A diversified portfolio is the tempting way to go. In my judgment, a portfolio balanced 40 per cent in TIPS, 15 per cent in gold, and 45 per cent  in diversified equities provides a good  way to survive 15 years of retirement  in an inflationary environment as long as one does not seriously anticipate government sovereign debt default.

For those who really fear government debt default, switch the balance between gold and TIPS, and take personal delivery of the gold.  Remember FDR and gold confiscation in the 1930s!

The importance of protecting the U.S. government’s triple A rating

January 2, 2012

In 2011 the United States government forfeited its long-held triple A rating for its debt obligations. Standard & Poor’s down-graded the U.S. credit rating late last summer to AA-plus, while placing that lower rating on review for a possible future downgrade. Moody’s and Fitch, the remaining major ratings agencies, both held the U.S. credit rating at triple A, but with a negative outlook. A negative outlook signals to markets a real prospect of a downgrade within the next two or three years.

The weakening of the credit rating of the United States government should not be brushed lightly away as having no meaningful economic impact. For a triple-A credit rating is an important signal to global markets:

“A triple-A credit rating is what economists call a public good.  By reducing borrowing costs and increasing the availability of financing, it is ‘consumed’ and of benefit to many.  But this public good is also difficult to value holistically or to sustain properly…The U.S credit rating not only benefits financial conditions at home but matters to the global economy.  It facilitates the intermediation of surpluses and savings today and for future generations.  It is a key component of the nucleus of the international monetary system.” Mohamed El-Erian, The Washington Post, January 1, 2012

Americans should not be fooled by the falling rather than the rising yelds on Treasuries following the downgrade. This was a short-term reaction to unusual circumstances.  The Federal Reserve announced that it would policy rates floored at zero at least until June 2013 – a pro- Obama-election pledge by Ben Bernanke .  The European debt crisis conveniently channeled flight-money into U.S. Treasuries. The reluctance of Moore’s and Fitch to downgrade U.S. debt protected Treasuries from automatically-triggered guideline restrictions for investors desirous of holding U.S. debt. And the absence of an immediately available major triple-A alternative slowed any immediate rush to exit U.S. Treasuries.

The S & P message, however, is clearly writing on the wall for all Americans. If King Obama and his councils (for that is what they have allowed themselves to become under America’s Imperial Presidency)  choose to ignore it, like  King Nebuchadnezzar before him, then, just like the Chaldean or Neo- Babylonian empire of 550 B.C., another great Empire assuredly will decline and fall. As all great empires have declined and fallen throughout the history of mankind.

Temporary payroll tax-cuts are a clear and present danger

December 6, 2011

As America’s crazed 13-month election mania kicks-in, politicians enter into a frenzied bidding-war to purchase votes by offering free bread and circuses to the median voter. Extending the temporary payroll tax-cut is a highly favored spectacle for the 2012 games. $100 billion here, $200 billion there!  And I retain my seat for another two or six years of personal wealth accumulation!

The economic argument against this circus is absolutely overwhelming. The national debt of the United States has already been downgraded, justifiably, by reference to default risk criteria. So the circus actually has to be funded. Since the proposed millionaire tax would be spread over 10 years, pay as you go for that policy proposal is not even on the table. Since Medicare reform must be part of any long-term solution to the existing debt problem, charging higher fees to the better off  is deceitful unless the additional premia will exactly offset the payroll tax reduction bill in 2012. And that is not on the GOP table. So, either way, the payroll tax-cut will add to the national debt. Bad economics.

Only hydraulic Keynesian remnants believe that temporary tax cuts will stimulate economic recovery. Pull your heads out of the sand you haybags!  A wealth of empirical evidence indicates that households increase consumption expenditures in response to permanent, but not to transient income increases. So, as in the recent past, temporary payroll tax-cuts are largely saved or used to pay down debt. Only hydraulic Keynesian remnants believe that future decade-long tax increases on the most productive members of society will have no drag effect on investment decisions.  Expectations matter, Larry Summers, Christina Romer, Joe Stiglitz, Paul Krugman, Bradford De Long and all the rest of you Keynesian economic dynosaurs. Bad economics, once again.

Edward Gibbon marks the beginning of the decline of the Roman Empire with the death of Emperor Marcus Aurelius in AD 180.  Thereafter, his corrupt successors indulged Rome with an ever-increasing sequence of circuses and ‘free’ bread.

The beginning of the decline of the American Empire began in  AD 2000, with the accession to office of a ‘free’ bread and circuses president. Wake up America, read the history books, and move swiftly to put an end to wealth-degrading popularity-buying by corrupt politicians. Only you can stop them from ruining the economy of a once-frugal and proud nation.

Barack Obama – true believer in the European welfare state

November 25, 2011

Barack Obama has been President of the United States now a little shy of three years. His policy positions have remained clear and unswerving both when he had workable majorities in the Congress and , since January 2011, when he has not.

Unlike President Clinton, President Obama will not adjust to accommodate changes in electoral preferences. So, if he is re-elected in November 2012, a decisive plurality of voters, as reflected in the Electoral College, will overtly and explicitly endorse his policy platform. This time, there will be no error of calculation. Americans will know precisely what they have chosen, and why they have registered that choice.

“President Obama…is a true believer in the European model of the welfare state.  Everybody who was listening learned that three years ago.  The fact that the European welfare states are crashing is irrelevant ti him; true believers are never rattled by facts, not even facts that slap them in the face like a cream pie.  The opportunity to impose a failing welfare state on America is what drew him to the presidency in the first place.  The congressional elections last year, the Republican rout that Mr. Obama rightly called a ‘shellacking’ of his party, made no impression either.  The results were all about cutting taxes and dismantling government, but not to Mr. Obama.  Those elections were merely a few pebbles on the road to Utopia.” Wesley Pruden, ‘If only pigs really could fly’, The Washington Times, November 25, 2011

Barack Obama is running for re-election on a platform of consolidating forever  the expansion of government during his first two years at 25 per cent of gross domestic product or more, while increasing federal taxes to 28 per cent of gross domestic product or more in order to pay lip-service to debt reduction. That involves almost doubling federal income taxes. And that cannot remotely be achieved on the backs of the top 1 percent alone.

The path that Barack Obama has chosen is unsustainable in the longer-term. Greece, Spain, Portugal and Italy have already demonstrated that. And France is right on the edge. The only country that conceivably can pull it off is Germany, because their population is industrious and frugal.And the German government is already trimming its spending.  A majority of other Europeans and Americans do not share those  Germanic qualities. So they are on the big spenders’ roads to ruin.

Barack Obama, of course, does not care at all about the longer-term. He cares only about the present and the following fours years. By then, wealthy as he and his immediate family will be, he can relocate anywhere across the globe. And allow the United States to go to Hell in a handbasket:

“Everyone knows that unless someone does something, everything will be swallowed by one of those black holes from outer space.  Health care costs, which already consume 3.7 per cent of the gross domestic product, will take almost twice that by the year 2020.  Democrats are determined not to reform any of that.  Who will still be in Washington then?  The distance to 2020 might as well be measured in light years.  Next year is the short run, where Washington measures it all.  In the long-run, as Winston Churchill famously said, there is no long run.” Wesley Pruden, ibid.

The right approach to US budgetary reform

November 23, 2011

As I have mentioned many times, the United States has no government at this time. The President is in way over his head on issues that he simply does not comprehend. Intellectually, he is completely out of his depth.  The Congress is polarized into dysfunctional inaction at a time of crisis for the nation. American exceptionalism is dying through apathy and neglect. Free bread and circuses dominate individual enterprise and self-reliance. And that proved to be the ultimate death-knell for the Roman Empire of the West.

Yet there remains a narrow route back from the precipice.  That route is grounded in the classical political economy of budget balance.  So here, as a Thanksgiving offering, is my outline recipe for the Restoration:

1. Acknowledge economic reality: Over a foreseeable future, federal spending will not be reduceable beyond a minimum 20 per cent of gross domestic product. To cut further from the current bloated level of 25 per cent will provoke serious public unrest, and will be unacceptable politically under any regime that can be voted into office. That is what entitlement programs are designed to do. They lock in voting majorities among those who have gained access to the public troughs.

Given the debt crisis, this reality exposes a corollary. Federal tax revenues must exceed federal spending until the debt is reduced to acceptable levels. This implies that federal tax revenues must be increased to say 21 per cent of gross domestic product, from 15 per cent, for any foreseeable future. This is a sizeable increase in the overall tax burden on the nation. It is the inevitable price to be paid for past over-indulgence in free bread and circuses.

2.  Do well while doing good:

“what is needed is spending reform that offers goals, specifics and ways to blend fiscal responsibility with modernizing government. This includes near-term action on discretionary spending and longer-term action to reform entitlements and reduce the growth of Social Security and Medicare. Then revenue contributions can be addressed in the context of tax reform.” Glenn Hubbard, ‘It’s Still Possible to Cut Spending: Here’s  How’,  The Wall Street Journal, November 23, 2011

The short term cuts would impact virtually all subsidy programs to businesses in the United States, including high-speed rail grants, community development, fringe education, and would involve the repeal of Obamacare. They would impact the defense budget, reflecting the winding down of two minor wars in Iraq and Afghanistan. They would impact significantly on aid to the Middle East other than to Israel. Long-term cuts would involve raising the age of eligibility for Social Security and Medicare to 70 years and shifting Medicaid block grants to the states who would be entirely responsible for Medicaid decisions. Means testing would be applied to Medicare , which would be reformed into premium support, allowing individuals to choose among a range of differentially valued options, paying out of pocket to access the more expensive options. Annual  COLA adjustments to Social Security would be adjusted downwards . Federal employees would confront real wage reductions to bring their risk-adjusted remuneration in line with the private sector. Federal employees would be expected to fund their own retirement pensions.

Federal tax revenues would be increased, not by raising bracket rates, but by eliminating most tax expenditures and tax preferences, save for households that earn below a tightly defined poverty line. Such a tax reform would be progressive in nature, impacting high earners most, because they would no longer have access to tax avoidance measures. It would be growth-enhancing, much in the way that the Reagan tax reforms were in 1986.

In a nutshell, that is my proposed Thanksgiving feast. Eat well and think hard. Otherwise there will not be many well-endowed Thanksgiving feast in our American future.



United States on the edge of a political-economic black hole

November 21, 2011

The United States has no effective government at the present time. The President is AWOL and the Congress is completely dysfunctional, while the federal system slides towards irreversible debt default. 

Congress and the President cannot even delegate their respective powers effectively to ameliorate the debt crisis. The so-called supercommittee appears to comprise 12 low-grade,  self-seeking politicians, who put their own electoral interests above those of the People. Unless there is an 11th hour transformation, no budget-cutting proposals will emanate from their rent-seeking hands.

In earlier times, a cabal of that kind, that failed utterly to deliver the goods, when ordered so to do, would have been strung up in the streets. Maybe their comfortable offices on Capitol Hill should be occupied instead of Wall Street.

It would seem as though the federal non-government has placed itself in a state of war against the People. In such circumstances, John Locke recognized the right of the people to respond by taking down the existing political system and rebuilding it anew. Thomas Jefferson surely would have concurred with that sentiment.