A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Wednesday, September 1, 2010

Transcript: 402 Confusion in Jackson Hole


Today on the podcast, confusion from Jackson Hole, but also some slow movement toward realism. We feature Bill White and Carmen Reinhart. From another time and place and level of understanding we share a clip of this Saturday's relay of Joseph Stiglitz speaking in Australia.

The markets took heart when Baffled Ben Bernnake promised to do something if things got worse. This demonstrates the childlike simplicity combined with the superficiality of the political and financial establishment. What Ben will do was not important. The fact that he has a beard and a powerful position was much more significant.

What would Ben do? The buzz was more quantitative easing. That is, buying securities. If they buy Treasuries, that will be monetizing the debt. If they buy other forms of securities, it would be outside their purview, but that hasn't stopped them before. And why bother with Treasuries, when they are loaning money at zero to the banks who buy them to collect the spread. That is, we are already monetizing the debt and paying the banks for the privilege.

Paul Krugman and others have called for a way of finessing the darned zero bound, which prevents monetary policy from working. Not unlike complaining that the runway cannot be made low enough. It is not preventing the crashing of the airplane. Better to give a little juice to the engine than to pretend we can dig fast enough.


The Jackson Hole Symposium of central bankers displayed three years on that these people have no idea of what they're doing. The market response to Bernanke's speech displays that the markets have no idea that the Fed has no idea of what it's doing.

How can it be that the phrase "Bernanke and the Fed will do whatever it takes" has any punch left? In this case it is deflation. Bernanke will do whatever is necessary to avert deflation. In the fall of 2007 it was to avert a recession. Bernanke will do whatever it takes to avert a recession. They got blindsided by a financial crisis. They did whatever they could to avert a financial meltdown. Neither recession, financial meltdown, nor deflation were averted. I use the past tense purposely. Asset price deflation is in full swing.

House prices dropping to 60 percent of their previous high and commercial real estate prices following. There may be some noise from commodity markets, where cost-push and speculation creates volatility that are picked up by the broad CPI and PPI. But consumer price deflation is sure to follow asset price deflation, as all business activity comes to be focused on producing consumer goods even while consumer demand is shrinking by virtue of unemployment and heavier debt loads. To restate that. In a healthy, growing economy, there are both investment goods and consumer goods being produced, and the workforce is divided between the two, with those in investment goods typically garnering higher wages. In a stagnating, shrinking economy, there is only the consumer goods sector, with business and labor watching their wealth shrink and racing each other to the bottom in terms of prices.

Bill White, formerly of the Bank for International Settlements and now at the OECD and Carmen Reinhart spoke outside the meeting hall at Jackson Hole shortly after Reinhart presented her research on the historical record of the decade before and the decade after financial crises. We panned the recent book by Reinhart co-authored with Ken Rogoff, which purported to find a tipping point at 90 percent of GDP where government debt begot a declining economy. That didn't hold empirical or theoretical water. Here, however, Reinhart has come up with something in the lead-off presentation at the central bankers' symposium.

She has identified the tremendous build-up of debt leading to a crisis and the constriction of economies by this debt after the crisis as the salient feature of crises. She could have just read Steve Keen's blog, but at least she came up with the information, if still lagging on the theory. Keen used exactly the evidence of this debt build-up to predict the financial crisis. It got him a Revere Prize, but not yet standing in the coterie of PHUDS, Ph.Ds who run the economic establishment for their own purposes.

But we are too cynical. Here is Bill White, chief discussant of the Reinhart paper, speaking to Bloomberg.


and here is Carmen Reinhart herself.


Now as we said the one person who has been out in front is Steve Keen. He employed his appreciation of rising debt levels to predict the GFC. Reinhart is coming along with the empirical details, but everyone is still behind the curve in theory except Keen.

His observations on Bernanke's speech are up on his web site. They begin

Bernanke’s recent Jackson Hole speech didn’t contain even one reference to the key force driving the American economy right now: private sector deleveraging (here’s the previous year’s speech for comparison’s sake). The reason the US economy is not recovering from this crisis is because all sectors of American society took on too much debt during the false boom of the last two decades, and they are now busily getting themselves out of debt any way they can.

Debt reduction is now the real story of the American economy, just as real story behind the apparent free lunch of the last two decades was rising debt. The secret that has completely eluded Bernanke is that aggregate demand is the sum of GDP plus the change in debt. So when debt is rising demand exceeds what it could be on the basis of earned incomes alone, and when debt is falling the opposite happens.


All these characters in Jackson Hole would gain a great deal of clarity if they understood another thing that Minsky and Keen and others are trying to tell them. The money supply is endogenous. The Fed does not control the money supply. It will shrink in a falling economy and expand in an expanding economy as a function of internal dynamics. Bankers will create money for a boom. They will destroy money in a bust. Intermediation, innovation, disintermediation and deleveraging.


So just as the recession was already in progress when Bernanke promised to do whatever it took to avoide it, so the deflation is already in progress even as Bernanke -- or his apologists -- promise to do whatever it takes to avoid it.

But do low Fed interest rates CAUSE deflation. This suggestion was raised by Minnesota Fed President Narayana Kocherlakota and immediately attacked by Paul Krugman and his liberal fellow travellers as ludicrous. While we do not follow Kocherlakota's line of reasoning which has to do with long-term expectations, we do, again, wonder why making new investment cheaper than existing investment goods by way of low interest rates does not erode the value of existing investment that may compete.

At the risk fo losing our left-leaning listeners, we'd like to point out that Paul Krugman is not in the direct lineage of Keynesian financial theory. That line runs through Hyman Minsky and Steve Keen, both of whom -- yes -- view the money supply as endogenous and the interest rate in a much different light.

Krugman's obsession with the zero bound, that monetary policy is frustrated because interest rates canot go below zero sounds to us like claiming that if only the runway were lower, the planes would not crash. In fact, in anything resembling a pragmatic world, you need more juice in the aircraft and less focus on excavation of interest rates by unconventional means. It seems as likely to us that the exercise of keeping interest rates low for the banks will only further reduce the value of existing assets. If new investment goods can be produced more cheaply that existing goods, it will drive the prices of existing assets to the new level, stimulate further distressed sales and contribute to debt deflation.

So, taking it up thirty thousand feet.

The brain trust in power during the run-up to the housing bust is still in power. The financial crisis occurred and the brain trust bailed out banking to the tune, "Save banking and we will save the real economy." The real economy was not saved, but bankers continue to get bailed out, because the same brain trust is still in power.

The division and dissension at the Fed is not evidence of anything except confusion. They operated in unanimity under Greenspan when they were doing equally badly. Now at least there is some appreciation that things are not going according to plan.

As the central bankers back away from the rubble and for reasons of maintaining professional capital maintain something along the lines of what they have always said, we should ourselves look to the only alternatives for stability, growth and financial reconstruction.

Economic stability based not on interest rates but on mandated full employment, which we will get to in an upcoming podcast by reviewing the plan put forward by Hyman Minsky. Economic growth must be based on investment in public goods, infrastructure and energy projects, that can be funded by positive interest rate "recovery bonds." Financial reconstruction has to be based on reconstructing the finances of households, not big banks. It needs to begin with writing down debt, converting debt to equity, and fully funding education so as not to generate debt in the normal activity of a healthy economy.


Now, in a peek at the return of the Saturday Demand Side Relay, here is a segment from the speech by Joseph Stiglitz to the Australian National University earlier in August.

Look for the rest of that on Saturday's Relay.

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