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Friday, November 5, 2010

Transcript: 411 Austerity, Idiots and Potential Mistakes, with Allan Meltzer and Robert Pollin

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The clash of headlines has been remarkable since the election.

Stocks closed Thursday at their highest level since the collapse of Lehman Brothers

On news of an unexpected surge in unemployment appllications -- up to 467,000

No, probably on the long-anticipated acquiescence of the Fed to the Market's demand for more money.

Dollar down, oil prices up.

Bloomberg reports: The dollar fell against all of its major peers as the European Central Bank signaled it will likely stick with its stimulus-exit strategy even as the Federal Reserve buys $600 billion of bonds to boost the U.S. economy.

The greenback reached a nine-month low versus the euro as the ECB said it will decide on further exit steps next month. The pound rose as the Bank of England refrained from adding to its asset purchases. The New Zealand dollar climbed against all of its counterparts as commodities surged.

“The lack of policy adjustment from the ECB, from the Bank of England and the aggressive action by the Fed gives traders no reason that there’s not going to be a steady depreciation of the dollar,” said Jessica Hoversen, a Chicago-based analyst at the futures broker MF Global Holdings Ltd.


Oil prices hit $86.25. It's not supply and demand. It is all dollar weakness and speculation.


This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

Contrat this with Jeremy Grantham's blistering critique in his latest letter, entitled "Night of the Living Fed."

Evidence for increased debt increasing growth is nonexistent in the long term. Stable, low debt levels prior to the 1970s produced higher growth than the ballooning debt levels since then. And what is the point of lower interest rates except to generate more debt. But the level of debt is not on the Fed's radar. This is the great blind spot of people who are supposed to know what they are doing. That increasing debt decreases current flexibility and spending power is almost too obvious to have to say out loud. But the Fed assumes that there is a borrower Fred and a lender Henry and when Fred pays his loan Henry buys at just the same rate as Fred. So it doesn't matter, basically. I kid you not. The logic is exactly this. Ignore the fractional banking system. Ignore the evidence. Ignore the debt.

We found an amusing, well-produced animation online which described this process. The Fed from its elevated vantage point sees unemployment. It buys bonds from banks. That gives them extra reserves and they lower their interest rates. The factory owner is enticed by lower interest to expand his plant. Employment increases, wages go up, demand is spurred, a virtuous cycle begins.

Unfortunately, it is fantasy, an animated fantasy. Capitalists do not invest in plant and equipment on the basis of the cost of money, they do it based on the strength of demand. Large projects are typically financed in steps and nobody can predict the interest rate they will face at the next step. The certainty of demand and thus the prospect of profit is by far the largest consideration. Of course, the government can make investment literally free through the tax code, as it did under Reagan in the early 1980s. People will invest if it costs them nothing. But that investment is typically badly targeted.

But let's get back to the episode we interrupted on Wednesday


Allan Meltzer


Here we protest. The great fable of monetarists and Fed apologists is that the Fed is independent by way of a legal framework. This is not the case. 1951 was not the year in which a statute or Constitutional amendment elevated the Fed to the fourth branch of government. 1951 was the year in which the so-called Treasury Accord was negotiated in a back room in the dark of night with the sitting president -- Truman -- at the nadir of his popularity on account of recalling Douglas MacArthur from Korea and the Treasury Secretary in the hospital. It extracted essentially for the banking sector control of the Fed and from that point to this, though to a far greater extent in more recent times, the Fed has exercised control of one-half of economic policy, that is monetary policy, largely outside control from the elected branches of government. It has done so primarily for the benefit of its constituent private banks, who control its board and hold its stock. To say this has any legal legitimacy is a stretch, however accepted it may be.

Excess interest payments by the federal government alone in years subsequent to 1951 are in the trillions of dollars. We may be alone among modern economists in supporting the position of Leon Keyserling, Truman's chair of the council of economic advisers and arguably the most influential person ever to hold that position, but we do. Keyserling never tired of castigating then Treasury Deputy William McChesney Martin for his role in the backroom deal. Martin very soon became Chairman of the Federal Reserve.

Arguably Fed independence could be a good thing. It probably is in the parallel universe where they do not operate for the benefit of the big banks and have some more coherent economic understanding than the Supply Side Monetarism that has fueled bubbles and restrained prudential oversight. On this planet, it is a bad thing.

I suppose we should just be grateful that no other of the quasi-independent governmental organizations like the FCC or FDA have gone rogue.


Well, this is right. Trying to get the hated politician to take the fall is a bit of a stretch. It is, of course, the Market's control of the Fed and of Congress that instigated the purchase of illiquid assets that are even now decaying in value on the Fed's balance sheet. Since the Fed has refused to disclose to the public and Congress the nature of its purchases, it is problematic to say that Congress pressured them to do the deals. There will be an audit of the Fed coming up that will display exactly the mood of Congress with regard to these.


This fever about inflation without understanding inflation and money is simply wrong, widespread -- and even dominant at the Fed -- but wrong. But here is something with which we agree wholeheartedly.


And here's some more bad analysis, at least from the benefit of hindsight. Remember, this interview was August 2008.


So. That is Allan Meltzer from 2008. History supplies the critique. Let's see what he's up to in 2010. From October 2010, and On Point with Tom Ashbrook, we have Mr. Meltzer speaking in contradiction of Robert Reich, who points out the historically unprecedented disparity of incomes and wealth in America today and the danger, if not the fact, of plutocracy -- rule by the rich.


Painfully wrong on many levels. The Tea Party as an objection to the redistribution of income? Hard to see where that comes from.


First we need to object that the pre-tax distribution may be similar in these countries, but the after-tax distribution is not similar. This fact is convenient for Mr. Meltzer to ignore. Second, the educational performance of all countries is not as bad as that of the United States. And lastly, to say that the income moves up and down and bounces around using the years Mr. Meltzer does is simply disingenuous. It ballooned to 1928 and collapsed to 1950. A great part of the collapse was due to the Depression and World War II. Was that a virtue of capitalism. During the 1950s and 1960s the economy was stable and vibrant. In part this was due to the absence of wealth and income disparity. As it has grown to the present, so has growth decayed and the well-being of the population deteriorated.


And also wrong. Per capital median income in the United States is less than $40,000. And it has been stagnant in real terms for decades. These are facts Mr. Meltzer as an economist knows, or should know. There is no excuse to say things are good or are getting better. And for this alone, he deserves the title this week.

Now directly to Robert Pollin.

Contrary to Allan Meltzer, Pollin, who is co-director of the PERI -- Political Economy Research Institute -- at UMass Amherst, does not see the Market moving in to straighten things out. Although that may not be fair to Mr. Meltzer, since his view in 2010 may be widely different than that in 2008, when many of his comments were recorded. But here is Robert Pollin courtesy of the Real News Network.

Pollin begins here with a response to the contention that large fiscal deficits will create inflation, high interest rates and large government debts.


Well, what about business confidence?


That's it for this time.

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