Monday, January 21, 2008

Winter Of Discontent

As global markets plunge for reasons I've long warned about in this space, I'm seeing a lot of apocalyptic gloating from bears who seem to view all this in a vacuum. But let's be clear: no one reading this has an interest in a repeat of the 1970's or 1930's. Even if you're short the market and long oil and gold out the wazoo, and stocks crash while oil goes to $200 and gold to $2,000, your profits ultimately will be rendered moot by the declining standard of living around you -- you or your family members losing jobs, your house losing value, your kids' school cutting back on resources, your local hospital not hiring a much-needed specialist or building that new wing, that bridge you drive across every day not getting repaired. We all have an interest in policymakers succeeding.

I'm very worried about the chances of that happening. It may be understandable, because nothing really changes until a crisis passes, but the "solutions" being batted around are little more than retreads of what got us here in the first place. Policymakers both elected and appointed have spent the past ten-plus years trying to repeal the economic cycle. There's always been a crisis to ameliorate, an election to make things look good for, a war to pay for, an ass to cover. This has resulted in two of the largest speculative bubbles (and subsequent busts) in human history, at least one and almost certainly two recessions, all-time highs in oil and gold, bulging national coffers for non-allies including Russia, Iran, and Venezuela, the uniquely American concept of upward mobility discredited for millions of experience-hardened erstwhile home owners, and dollar-inspired belly laughs from the desks of the world's largest central banks to the cardboard countertops of black market currency changers in Kinshasa and Kathmandu. That's quite a record of achievement for any ten-year period. Regular readers also know my belief that it was, at least in part, the Bush administration's desire to avoid blame for the consequences of bad monetary policy that got us into a war and open-ended occupation on a false pretense.

Some headlines from the past few weeks:
  • "The Fed to the rescue"

  • "Fed puts up united front to rescue weak economy"

  • "Bernanke to the rescue as stocks fall"

  • "Washington To The Rescue"
Recall this passage from Bresciani-Turroni:
The eyes of all were turned to the Reichsbank. The pressure exercised on it became more and more insistent and the increase of issues, from the central bank, appeared as a remedy....

The authorities therefore had not the courage to resist the pressure of those who demanded ever greater quantities of paper money, and to face boldly the crisis which...would be, undeniably, the result of a stoppage of the issue of notes. They preferred to continue the convenient method of continually increasing the issues of notes, thus making the continuation of business possible, but at the same time prolonging the pathological state of the German economy....

It is certain that the rise in home prices, which was the immediate consequence of the depreciation of the exchange, had given a definite thrust to the increase of note issues and of the floating debt.

But it is important not to forget that that last stage of the depreciation of the mark was, in a great part, the direct consequence of an erroneous financial policy in the preceding years. Besides, the increase of the note-issues, following the increase of home prices, was not at all a necessary action, as some writers seem to believe. An energetic financial and monetary policy and a more circumspect banking policy would have broken the vicious circle....
In this sort of environment, concerns about political influence on the Federal Reserve, while valid, are almost beside the point. One of the destructive effects of monetary policy since the mid-90's has been to turn the stock market into the country's moral support system. It's become the most accurate barometer of public psychology. That's made the Fed chairman psychologist-in-chief, and created a perverse situation in which the nanny state, by giving Americans their sense of purpose and self-worth via the stock and real estate markets, usurps the role of family, neighbors, schools, and churches. Greg Djerejian coined the phrase "surge nation" last year in a post about Iraq, and it describes the Fed's role perfectly. As I argue in this piece in The American Conservative, this should deeply offend those conservatives who understand what's intrinsically valuable about this country. But as long as monetary fixes take the place of "hard work" by elected officials on issues like education and trade, and the Fed does nothing to dispel the perception of itself as "keeper of the flame of national purpose," the destructive boom/bust cycles will worsen. What might change this? A rediscovery, as a nation, of those natural, traditional support systems. This would pave the way for the next move up, economically as well as geopolitically, because the "surge" would come from within instead of a short-timer politician or a Beltway statist with his finger on the interest rate button. That sort of rediscovery and spiritual awakening comes only from hardship, so Washington will do everything possible to prevent it.

Of course it's easy to sit here anonymously criticizing policymakers who are in the trenches dealing with this stuff every day and getting pulled in a dozen different directions. So if I had five minutes with Ben Bernanke, here's what I'd tell him (and I know this blog has readers at the Fed, so maybe someone will send him the link). In terms of his legacy, he's already got one foot in the grave. He can either jump all the way in and start shoveling the dirt onto his own head by taking rates down to 3% or 2% or 1%, or he can take that shovel, bash the ghost of Rudolph Havenstein in the head, and show some Volcker-esque leadership (Volcker, by the way, worked under far more difficult circumstances). If Bernanke does the latter, he needs to tune out the chair-throwing TV pundits (who care only about their ratings and website subscriptions) and make a major speech in which he states clearly that monetary policy earlier this decade veered too sharply in one direction, and that the Fed cannot be expected to cure all ills. My recollection is that he flirted with this notion in a speech a year or two ago, but promptly dropped it after the next down day in the stock market. If he wants to cut rates another quarter or half-point here, fine, as long as he makes that speech then follows up with appropriate policy. It may cause some short-term pain and affect the Fed's cherished "flexibility." But it will assuage foreigners on the dollar (crucial right now), make speculators think twice during the next up cycle, and encourage economic activity by spurring those waiting for ever-lower rates to borrow now.

The alternative? Monetary policy as usual, with heaping portions of expediency and no doubt some taxpayer-financed bailouts, eventually sending oil well over $100, gold to $1000 and higher, and the dollar further into the crapper. Then, when all that hits the economy, lower rates again. Wash, rinse, repeat, until the next war or terrorist attack provides some much-needed cover by conveniently distracting voters from the failure of policy and providing an excuse to take rates back to 1%. (Can there be much doubt that some in Washington would secretly welcome that scenario right now?) Keeping in mind that Bernanke's scholarly interest is the Great Depression and he once promised Milton Friedman that "we won't do it again", which path do you think he'll choose?

Meanwhile, for those who can't be bothered with all this and just want to know who to blame as they watch the stock and housing markets plunge and the job market dry up, culpability should be in this order: Bush, Greenspan, Bernanke. Bush, for presiding over one of the most stunning reversals in a nation's economic position ever, in which the economic and moral costs of a war of choice played and continue to play an important role; Greenspan, a latter-day John Law, for blowing the monetary bubble (at least Law had the decency to slink off to Italy after he was discredited; here, he would have written a book and made speeches); and Bernanke, for overseeing the bubble's important final stage, during which he did nothing (until the last week or so, perhaps -- long after the damage was done) to dispel the market's perception of him as a monetary Santa Claus.

If the polls and the likely outcome of November's election are any indication, most voters already get it.


Anonymous Anonymous said...

Cunning says: "He can either jump all the way in and start shoveling the dirt onto his own head by taking rates down to 3% or 2% or 1%, or he can take that shovel, bash the ghost of Rudolph Havenstein in the head, and show some Volcker-esque leadership" I don't see the ghost of Rudolph Havenstein getting exorcised, alas. Indeed, much of the market chatter I'm hearing today (markets are closed, but everyone is waiting for tomorrow given the bloodbaths in Euro-zone and Asia overnight) points to Chopper Ben getting rolled out w/ an emergency rate cut even before next fed meeting(29/30th) maybe 50 bps as early as tomorrow am and another 50 bps on 'regularly scheduled' date. We'll see, perhaps sanity will prevail, but somehow I doubt it (after all, 'core' inflation is a-ok!)...Nor do I have much faith in the efficacy of much of the cruder stimulus packages getting bandied about willy-nilly among many in the know-nothing class down in DC...the questions now re: the so-called 'credit crisis' (let's just call it a banking crisis, no?) is are we now heading towards wider-spread contagion (see Bank of China write-downs etc resulting from US subprime exposure), w/ greater systemic risk beckoning...Perhaps my bearishness is getting the better of me, but I see in '08 a truly awful year--and indeed '09--these credit bubbles are just starting to unwind...Bernanke's 'medicine' will likely just prolong the agony...

p.s. as for my random turn of phrase re: 'surge nation', some intrepid soul should do a lexis/nexis on use of term "surge" in past, say 24 months--as compared to prior time periods. every day something is surging anew, it seems...perhaps not for much longer, however!

1/21/2008 1:54 PM  
Blogger mrmetrowest said...

The most responsible thing Bernanke could do is make a speech where he tells people 'We didn't get into this overnight. We won't get out of it overnight." Wall Street, the punditocracy would all have fits, but it's the truth.

How likely is this? As likely as Bush quickly winding down his excellent foreign adventures, and also acknowledging that the US spending more on defense than the rest of the world combined is unsustainable.

1/21/2008 2:56 PM  
Anonymous Anonymous said...

Plenty of blame to go around. I wouldn't just point at Bush, Greenspan, and Bernanke. Our political leaders have been preaching American exceptionalism for some time now. The American public was an easy sell.

I'm seeing a lot of apocalyptic gloating from bears who seem to view all this in a vacuum

Hey, I resemble that remark. LOL. I have to protest the vacuum part. I haven't been living in a vacuum because I saw all this coming a long long time ago. That is why I'm in Gold. I've studied what happened in Argentina. I know how peoples' life savings were wiped out. I'm not happy about it but at the same time to not minimize the effects to your own assets would be just plain stupid. I've been largely ignored and pooh poohed the whole time. Not so much anymore. Of course nobody wants to see a really bad recession but honestly with the policies we have pursued the last 10 years how could we have anything else? Most of the American public have cheered it on! America needs a recession, we must have a recession. All these delusions can only get out of peoples' heads if they are forced to deal with bad consequences. I have no faith in our political leaders to do anything right. It has been their decision making that has gotten us to this point. Can Bernanke pull off a Volcker? I don't think he'll be allowed to. He would probably be taken down by a lynch mob. No...sorry TCR...I don't see any way out of this thing but pain and misery.

1/21/2008 3:36 PM  
Blogger Miss Bliss said...

well I gotta say as an yahoo who doesn't a dang thing about economics I'd really welcome someone coming out in the media right now and saying, "It's a mess and to get out of we're gonna have to clean things up and it isn't going to be fun but it can be done." I'd like to hear from the Fed Chairman and I'd REALLY like to hear it from the Presidential Candidates. Average Americans KNOW up close and personal right now that it's bad, bad, bad and it's TERRIFYING to hear our supposed leaders yammering on about stupid "solutions" that involve making tax cuts permanent or sending people $200.00 checks in the mail. For the love of mike...I don't need a $200.00 I need the economy to settle down so that I don't have to worry night and day about my retired parents' ability to pay for food.

1/21/2008 5:52 PM  
Anonymous Anonymous said...

Hey CR,

I agree with your analysis of the situation very much. Unfortunately, I'm afraid we probably part company when it gets to the underlying fault for this. Essentially I agree with Goldhorder's point about American exceptionalism, but more specifically I think we need to put this at the feet of Saint Ronnie Reagan.

Who appointed Volcker? Jimmy Carter. What did Volcker do in 1979? Changed the approach to monetary policy such that it started to put the economy into the recession of Reagan's first couple of years. Among many of Carter's other problems, he refused to inflate the economy to get himself re-elected. He may not have been re-elected regardless, but he did a good thing with his Volcker pick.

Reagan, like it or not, put us on the path of running big deficits -- cutting taxes without cutting spending. Dick Cheney even referenced this in 2002 saying "Reagan proved deficits don't matter". Well, maybe not so much.

Democrats may have been guilty of "tax and spend" behavior, and Johnson in particular guilty of guns and butter thinking, but no administration prior to Reagan's was ever so cavalier about running big deficits. We traded "tax and spend" for "borrow and spend", with the consequence being that everybody started to think there really was a free lunch. "Tax cuts pay for themselves" -- what an utter load of crap.

Look at the dollar's performance during the end of Reagan's administration and during George HW Bush's admin. Crummy.

Look at the dollar performance during Clinton's administration, and compare/contrast with what came before and after. The dollar strengthened considerably during Clinton's administration, and turned into a debacle under GW Bush. Although the ramifications of that are varied, we can all agree that a weak dollar helps US domestic oil producers. Coincidence?

So, today, we have a bunch of people depending on the stock market for their retirements. We have lots of people thinking that cutting taxes is somehow a cure for economic ills, along with cutting interest rates. Wrong, wrong, wrong. But who is going to tell the truth?

Anyway, I will say that I'm glad that "sane" conservatives like yourself and Djerejian appear to be interested in "doing the right thing". But I gotta ask you guys to look in the mirror and to see what you helped enable with your historic support of Reagan, Bush, et al. Please don't do anything like that again ;-).


1/22/2008 12:07 AM  
Anonymous Anonymous said...

3/4 point drop by Big Ben which is a bit suprising.

And dissapointing.

1/22/2008 8:44 AM  
Blogger Jimmy the Saint said...

Considering what happened in the markets yesterday and today, did you expect anything less? "B-52" Ben is the market's bitch. He couldn't even carry Volcker's jock strap. Anyone seen what the dollar is doing?

1/22/2008 9:20 AM  
Anonymous Anonymous said...

"...your profits ultimately will be rendered moot by the declining standard of living around you -- you or your family members losing jobs, your house losing value, your kids' school cutting back on resources, your local hospital not hiring a much-needed specialist or building that new wing, that bridge you drive across every day not getting repaired. We all have an interest in policymakers succeeding."

What's this? Is this Collectivism rearing it's ugly head? I'm pretty sure this is the type of thing liberals are talking about when they say that we are all in this together, and that huge disparities in wealth are not a good thing, and that what happens to the least among us affects everybody. If there are no atheists in foxholes, are there no free-marketeers in recessions?

I will have to go with Whammer here. This is the result of right-wing Republican economic policy. Deregulate! Cut taxes! Privatize! Boot straps! Well, welcome to "unfettered" capitalism. Now is the time when all of those who wanted government to stay off the backs of business expect the government to bail them out. It really is a sight to see. I guess we don't need a welfare state until we do. Oh, right, its really just a matter of who is faring well.

I will certainly agree that we all lose if this thing doesn't end well. But the fallout may finally show that the rugged-individualist, self-made-man is a myth; that we are all interconnected and interdependent; that what happens to my fellow man affects me. Then maybe Mammon would not be our god. Then maybe we can value sustainability and public equity along with profit. Then maybe we can see how enlightened self-interest can save us, just as narrow self-interest has doomed us.

Or maybe the public can bail out the "risk-takers" and we can just be glad it's over.

1/22/2008 12:06 PM  
Anonymous Anonymous said...

A great post, CR. Your posts on economics are always the most interesting and insightful to me.

I guess we have our answer today - Havenstein it is?

1/22/2008 5:24 PM  
Blogger Traveleur said...

Kilfarsnar, I could not agree more with what you said!

Some people conveniently forgot the crappy "economic" policies that all those right-wing Republicans have been peddling and implementing since the 70s!

You rightly mentioned Deregulation, immoral tax cuts, Privatization, sophistic "small government" talk, or the so-called virtues of the "free market" as culprits for the systemic crisis that is currently unraveling.

But what permitted all of these immoral and frankly evil policies to come into practice was President Nixon's decision to take the dollar from the GOLD STANDARD! The abandonment of FIXED EXCHANGE RATES is what allowed the unfettered speculation that everyone seems to bemoan nowadays.

And I can't help but be amazed by this reflective deification of a vulture like Volcker! I wasn't yet born when that spineless Carter "appointed" him (actually wasn't it Brzezinski and Rockefeller who appointed him?) but I know a little bit about the consequences of those 20% interest rates on AMERICA'S MANUFACTURING SECTOR!

Not to mention the way that extremely austere regime "DISCIPLINED" the American workforce and society; with a special additional benefit of converting all of those left behind by such destruction into fervent BORN-AGAIN Christians firmly aligned with the Republican Party......

Too many people seem to have too short memories, or is it selective amnesia? The destruction of the manufacturing sector by Volcker et al. get us in the position where we increasingly depended on the generosity of foreigners to sustain our unsustainable way of life. We completely became a debtor nation because of Volcker et Al., and our trade deficit became a joke as a result.

But hey, OUTSOURCING was not a good idea? How about “competitive advantage”or sorry, COMPARATIVE ADVANTAGE as they now call it in Business Schools in America?

But luckily for all those irresponsible free-marketeurs, a student of the "great" Milton Friedman is at the helm of the Fed! And what did he promise his master about the "cause" of the Great Depression? Of course: NEVER AGAIN!!!!!

So, as for those who are still wondering about the direction that we're taking, just know that you don't have to look to far ahead, or behind to find your answer. It's right here, actually a little bit down below: CHILE with Pinochet at the helm!!!

1/22/2008 9:21 PM  
Anonymous Anonymous said...

I don't understand how lowering the Fed rate even further can solve the problem when one of the roots of our sub-prime lending/banking/economic crisis was an artifically low Fed Rate in the first place.

1/22/2008 10:29 PM  
Anonymous Anonymous said...


Pretty much in agreement, although I'm not really in Traveleur's boat given my support of Volcker.

What continues to amaze and astonish me is that the phenomenon of "banks create financial debacles, vastly enriching the principals, then get bailed out one way or another after it becomes apparent that they have put the economy at risk" keeps repeating over and over.

In the late 70s/early '80s, it was loans to developing countries. Then it was Milken/junk bonds and the S&L crisis. Then it was Asia/Russia and Long Term Capital. Now it is mortgages/CDOs/etc. I suspect I'm forgetting some.

Specifically, what astonishes me is the fact that the vast majority of the perpetrators of these debacles end up making a spectacular fortune and they suffer no consequences when the inevitable chickens come home to roost. That is a great gig if you can get it, but the idea that criticizing the compensation of these people is somehow "class warfare" is an amazing achivement of the right-wing noise machine.

Once upon a time, this kind of stuff was scandalous, and I have trouble understanding why it isn't anymore. I am very confident that if we really, truly had a "liberal press" that we wouldn't have all become such sheep on these issues.


1/23/2008 12:24 AM  
Anonymous Anonymous said...

I don't understand how lowering the Fed rate even further can solve the problem when one of the roots of our sub-prime lending/banking/economic crisis was an artifically low Fed Rate in the first place.

That's what baffles me as well. Defaults are through the roof on money already borrowed and the fed's solution is to make it easier for them to borrow even more? And those who say "but credit card rates will drop so they'll be able to more easily pay their bills" don't get it reason whatsoever to think lenders won't reprice credit card indexes (higher) to account for the fed dropping rates. I don't see lenders dropping loan rates much (if at all)...far too risky given conditions.

1/23/2008 6:48 AM  
Anonymous Anonymous said...

Wow...this discussion went down hill in a hurry. Blaming Volcker for the decline of our manufacturing base? You are very lost. IMHO. We were experiencing a currency crisis not unlike the one we are today. Gold shot up over $800. LBJs guns and butter approach to government forced Nixon to break the gold standard admitting the US was broke. We had to inflate to pay our bills. Volker increased the rate to solve our currency crisis. To force Americans to scrimp and save. To build up a credible currency again. The opposite is to "Argentina" your economy. Didn't work out so well for Peron. I'm in total agreement with Bush and Reagan having unsound economic ideas. Bush is far worse than Reagan was. Bush is another LBJ except without higher taxes. Borrow and spend is far worse than Tax and Spend. I am in agreement there. Where America has gone wrong is we use the power of our central government to subsidize our financial and military power. China uses the power of central government to subsidize its manufacturing sector. Building your economy and manufacturing sector up is what rising powers do. Maintaining a financial and military power is what mature or declining powers do. We are now like children we take the short view of history because we have gotten used to being on top. Kissinger described our leaders philosophy...

"Who controls the food supply controls the people; who controls the energy can control whole continents; who controls money can control the world."
Henry Kissinger

This is what Bretton Woods did for us after WW2. It put us in charge of money. We have been abusing that position since 1972. A rising China and a declining standard of living is the price we pay.

Kissinger on manufacturing
"The question really is whether America can remain a great power or a dominant power if it becomes primarily a service economy, and I doubt that," Kissinger said in an India Financial Express article that appeared in July 2003. "l think that a country has to have a major industrial base in order to play a significant role in the world."

Chalmers Johnson on our military works project!

1/23/2008 9:39 AM  
Anonymous Anonymous said...

I think you're right on the military power thing, Goldhorder.

And, if I'm the Chinese, I'm happy as a pig in mud to see the US pouring money into adventures like Iraq, because I know it just makes my turn come sooner.

Here's another link to the same story:


1/23/2008 12:39 PM  
Blogger Traveleur said...


After reading your post, it seems to me that you pretty much agree with what I said about Volcker, without perhaps realizing it. You said:

Where America has gone wrong is we use the power of our central government to subsidize our financial and military power. China uses the power of central government to subsidize its manufacturing sector. Building your economy and manufacturing sector up is what rising powers do.

So now tellme HOW you can build a manufacturing sector when you raise interests rates to 20%? Who can borrow, at these rates, for capital investments?

And please tell me when OUTSOURCING became a good thing for America?

The Fed cannot possibly increase rates at any level because that will simply bring about the total meltdown of the global financial sector. Of course, the same thing will eventually happen with an easy monetary policy...

My solution: PUT THE ENTIRE FINANCIAL INDUSTRY IN BANKRUPCY PROTECTION and work out all of this unpayable debt out of the system, while keeping essential functions operating.

1/24/2008 1:13 AM  
Anonymous Anonymous said...

I agree with your solution, I just think you overlook the currency crisis that was taking place at the time and why Volcker's actions helped solve it. Higher interest rates mean less consumption and more savings and a greater return on those savings. More savings means less debt. Over the long haul people with savings have more money to invest and build up infrastructure. Volcker's action caused a slow down in economic activity at the present time but enabled the US to have greater economic activity at a later date. We are now an economy that runs on debt. Those debts are getting higher and higher. Interest payments on those debts are getting higher and higher. Years of low interest rates have caused a misallocation of capital because there have been no repercussions for bad decision making. The people follow the governments policies so this is true of both the public and private sectors. Volcker believed that there is no free lunch. If you make bad economic decisions you must face up to those and take appropriate corrective action.

In 1980 we had very little competition from China. We had competition from Japan but that wasn't much of a worry. Japan is a US satellite. We knew that the Japanese will recycle money back to the US and even build new plants here. They have to do something with those dollars after all. Will China and India do the same thing? Both these countries have their own interests and their political leaders are not beholden to ours. They will not behave like Korea and Japan. They will propably use their dollars in a strategic manner to excert influence over our political leaders' actions.

1/24/2008 12:09 PM  
Anonymous Anonymous said...

Goldhorder, Traveleur,et al, agreed.

It's time for discussion about tax cuts and what exactly they've meant to our economy. Marginal tax rates make excessive compensation unattractive. The net effect of high marginal taxes incents high earning individuals to distribute wealth in other ways: investing in property and business, deferring income into tax sheltered investments, distributing more wealth down the ladder to salaried employees and labor. Supply-side economics claims that lower taxes eventually results in wider distribution of 'trickle down' wealth, when we see the exact opposite is true. Lowering the marginal tax rate on the top 4% of income earners has only concentrated wealth and rewarded greed. This economy is the product of excessive 'borrow and spend' government investment in financial and military sectors and the anemic distributions of wealth to the bottom 50% of earners. Incenting people to sign half-million dollar mortgages on promises of economic growth that would sustain their ability to service the debt has been nothing more than bait and switch. Friedman is a fraud, as are the enablers who've allowed greed to run rampant.

The 'freemarketeers' who champion the military dominance required to support the petrodollar standard are most culpable. I believe that fiscal policy must be more biased toward productive investment in infrastructure, education, medicine and renewable clean energy. If we redirected spending away from the waste required to support a global Empire and back into productive innovation we'll see the markets respond in kind.

1/25/2008 5:53 PM  
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