“Soft despotism is a term coined by Alexis de Tocqueville describing the state into which a country overrun by "a network of small complicated rules" might degrade. Soft despotism is different from despotism (also called 'hard despotism') in the sense that it is not obvious to the people."

Monday, June 28, 2010

"Deflation: Making Sure It Doesn’t Happen Here"

RBS tells clients to prepare for 'monster' money-printing by the Federal Reserve

As recovery starts to stall in the US and Europe with echoes of mid-1931, bond experts are once again dusting off a speech by Ben Bernanke given eight years ago as a freshman governor at the Federal Reserve.

By Ambrose Evans-Pritchard, International Business Editor
Published: 5:11PM BST 27 Jun 2010

Entitled "Deflation: Making Sure It Doesn’t Happen Here", it is a warfare manual for defeating economic slumps by use of extreme monetary stimulus once interest rates have dropped to zero, and implicitly once governments have spent themselves to near bankruptcy.

The speech is best known for its irreverent one-liner: "The US government has a technology, called a printing press, that allows it to produce as many US dollars as it wishes at essentially no cost."

Bernanke began putting the script into action after the credit system seized up in 2008, purchasing $1.75 trillion of Treasuries, mortgage securities, and agency bonds to shore up the US credit system. He stopped far short of the $5 trillion balance sheet quietly pencilled in by the Fed Board as the upper limit for quantitative easing (QE).

Investors basking in Wall Street's V-shaped rally had assumed that this bizarre episode was over. So did the Fed, which has been shutting liquidity spigots one by one. But the latest batch of data is disturbing.

The ECRI leading indicator produced by the Economic Cycle Research Institute plummeted yet again last week to -6.9, pointing to contraction in the US by the end of the year. It is dropping faster that at any time in the post-War era.

The latest data from the CPB Netherlands Bureau shows that world trade slid 1.7pc in May, with the biggest fall in Asia. The Baltic Dry Index measuring freight rates on bulk goods has dropped 40pc in a month. This is a volatile index that can be distorted by the supply of new ships, but those who watch it as an early warning signal for China and commodities are nervous.

Andrew Roberts, credit chief at RBS, is advising clients to read the Bernanke text very closely because the Fed is soon going to have to the pull the lever on "monster" quantitative easing (QE)".

"We cannot stress enough how strongly we believe that a cliff-edge may be around the corner, for the global banking system (particularly in Europe) and for the global economy. Think the unthinkable," he said in a note to investors.

Roberts said the Fed will shift tack, resorting to the 1940s strategy of capping bond yields around 2pc by force majeure said this is the option "which I personally prefer".

A recent paper by the San Francisco Fed argues that interest rates should now be minus 5pc under the bank's "rule of thumb" measure of capacity use and unemployment. The rate is currently minus 2pc when QE is factored in. You could conclude, very crudely, that the Fed must therefore buy another $2 trillion of bonds, and even more if Europe's EMU debacle goes from bad to worse. I suspect that this hints at the Bernanke view, but it is anathema to hardliners at the Kansas, Richmond, Philadephia, and Dallas Feds.

Societe Generale's uber-bear Albert Edwards said the Fed and other central banks will be forced to print more money whatever they now say, given the "stinking fiscal mess" across the developed world. "The response to the coming deflationary maelstrom will be additional money printing that will make the recent QE seem insignificant," he said.

Despite the apparent rift with Europe, the US is arguably tightening fiscal policy just as hard. Congress has cut off benefits for those unemployed beyond six months, leaving 1.3m without support. California has to slash $19bn in spending this year, as much as Greece, Portugal, Ireland, Hungary, and Romania combined. The states together must cut $112bn to comply with state laws.

The Congressional Budget Office said federal stimulus from the Obama package peaked in the first quarter. The effect will turn sharply negative by next year as tax rises automatically kick in, a net swing of 4pc of GDP. This is happening as the US housing market tips into a double-dip. New homes sales crashed 33pc to a record low of 300,000 in May after subsidies expired.

It is sobering that zero rates, QE a l'outrance, and an $800bn fiscal blitz should should have delivered so little. Just as it is sobering that Club Med bond purchases by the European Central Bank and the creation of the EU's €750bn rescue "shield" have failed to stabilize Europe's debt markets. Greek default contracts reached an all-time high of 1,125 on Friday even though the €110bn EU-IMF rescue is up and running. Are investors questioning EU solvency itself, or making a judgment on German willingness to back pledges with real money?

Clearly we are nearing the end of the "Phoney War", that phase of the global crisis when it seemed as if governments could conjure away the Great Debt. The trauma has merely been displaced from banks, auto makers, and homeowners onto the taxpayer, lifting public debt in the OECD bloc from 70pc of GDP to 100pc by next year. As the Bank for International Settlements warns, sovereign debt crises are nearing "boiling point" in half the world economy.

Fiscal largesse had its place last year. It arrested the downward spiral at a crucial moment, but that moment has passed. There is a time to love and a time to hate, a time for war and a time for peace. The Krugman doctrine of perma-deficits is ruinous - and has in fact ruined Japan. The only plausible escape route for the West is a decade of fiscal austerity offset by helicopter drops of printed money, for as long as it takes.

Some say that the Fed's QE policies have failed. I profoundly disagree. The US property market - and therefore the banks - would have imploded if the Fed had not pulled down mortgage rates so aggressively, but you can never prove a counter-factual.

The case for fresh QE is not to inflate away the debt or default on Chinese creditors by stealth devaluation. It is to prevent deflation.

Bernanke warned in that speech eight years ago that "sustained deflation can be highly destructive to a modern economy" because it leads to slow death from a rising real burden of debt.

At the time, the broad money supply war growing at 6pc and the Dallas Fed's `trimmed mean' index of core inflation was 2.2pc.

We are much nearer the tipping today. The M3 money supply has contracted by 5.5pc over the last year, and the pace is accelerating: the 'trimmed mean' index is now 0.6pc on a six-month basis, the lowest ever. America is one twist shy of a debt-deflation trap.

There is no doubt that the Fed has the tools to stop this. "Sufficient injections of money will ultimately always reverse a deflation," said Bernanke. The question is whether he can muster support for such action in the face of massive popular disgust, a Republican Fronde in Congress, and resistance from the liquidationsists at the Kansas, Philadelphia, and Richmond Feds. If he cannot, we are in grave trouble.


  1. If I was Obama I'd ask for a "Recount."

  2. "Like textbook Keynesianism, "monetarism" has also suffered in its explanatory power. This theory holds that big injections of money ("reserves") into the banking system by the Federal Reserve should lead to higher lending, higher spending and -- if large enough -- inflation. Well, since the summer of 2008, the Fed has provided about $1 trillion of reserves to banks, and none of these things has happened. Inflation remains tame, and outstanding bank loans have dropped more than $200 billion in the past year. Banks are sitting on massive excess reserves.

    "There's a great deal economists don't understand. Not surprisingly, the adherents of "rational expectations" -- a theory that people generally figure out how best to respond to economic events -- didn't anticipate financial panic and economic collapse. The disconnect between theory and reality seems ominous. The response to the initial crisis was to throw money at it -- to lower interest rates and expand budget deficits. But with interest rates now low and deficits high, what happens if there's another crisis?"

    Economics is Hard


  3. Our Banks are sick, and addled, but still standing.

    Income, and Spending reports were okay this morning.

  4. Economics is, indeed, Hard.

    Possibly, the hardest part is understanding the fact that, sometimes, the ultimate virtue is "patience."

    Considering that we were on the brink of "disaster," we're doing okay. Not Good (that would be expecting Way too much,) but "okay."

    It's going to take a while for the banks to recover, and it's going to take a Long while for the housing market to right itself.

    We've got some "Structural" Trade issues with energy. It looks like Mother Nature is going to make us address those pretty soon.

    Right now, I'd preach something called "Common Sense" Economics, or "Steady as She Goes" Economics. Probably the best thing is pick the team most likely to win the World Series, and become a Baseball Fan.

    This one's going to take time.

  5. "This one's going to take time.

    True enough. I year or so ago I was a lot more confident about what needed to be done.

    Now all the rules are kinda out the

    It would be nice to say that we should get a good feed on the right way to go since the EU is moving towards austerity and the US is continuing with the easing, however, the economies around the world are so interconnected it's hard to say that what is happening over there isn't affecting the US and vise versa.

    Just from a personal standpoint, I'd like to see the US continue its safety net benefits such as unemployment since they are minimal in relative terms at this point.

    As you say, things are going to be tough for a long time.

  6. My personal opinion? NAFTA, WTO, and various "Free Trade" Agreements save our bacon, again.

  7. "..."Free Trade" Agreements save our bacon, again..."

    A lot of these continue to languish under Obama; Colombia, South Korea, et all.


  8. Panama being the other major one. He's making noises about S. Korea. We'll see.

    Pity the poor S. Korean legislators that ratified the FTA. It was wildly unpopular among a large segment of the population. there were demonstrations, riots, hell-raising in general; and then Oshithead stalls the ball.

  9. This comment has been removed by the author.

  10. Supreme Court Rules That Gun Rights Apply to Local Laws

    "The ruling is an enormous symbolic victory for supporters of gun rights, but its short-term practical effect is unclear. As in the Heller decision, the justices left for another day the question of just what kinds of gun control laws can be reconciled with Second Amendment protection…

    "Many constitutional scholars across the ideological spectrum had hoped that the court would used Monday’s decision, McDonald v. Chicago, No. 08-1521, to revise its approach to how constitutional protections are applied to, or “incorporated against,” the states.

    "They argued that that the court should instead rely not on the due process clause but on the 14th Amendment’s “privileges or immunities” clause, which says that “no state shall make or enforce any law which shall abridge the privileges or immunities of citizens of the United States.”

    Scotus Rules on Local Gun Laws

    A moral victory but not much else. Without some specific federal ruling on acceptable laws, even with a CCL you still have to check on each individual state's local laws in order to carry. For instance, MI has reciprocal agreements with 38 other states but to carry in anyone of those states you have to check on the local laws.

    I assume the only states affected by this ruling are the heavily restrictive states.


  11. it's still better to be caught with one than without.

  12. The question is: Does the Fed have enough air to reinflate the balloon?

  13. If a President can Rally the Country he can raise more money than "Anyone" could Ever imagine. Think "Great Depression"/WWII.

  14. Krugman said:
    And this third depression will be primarily a failure of policy. Around the world — most recently at last weekend’s deeply discouraging G-20 meeting — governments are obsessing about inflation when the real threat is deflation, preaching the. need for belt-tightening when the real problem is inadequate spending.

    Wow, what a mess. China could experience inflation as it raises worker pay by 100% or more while the US and Europe could slide into deflation despite the rising costs of Chinese imports.

    The Keynesians, risen from the grave, are calling for massive Federal spending. Massive.

  15. And they may be right...or not.

    "They" say, consumer and corporate spending is next to nil. Based on my own personal spending, I'm inclined to agree.

  16. We'll see what spending cuts and taxhikes does for the Brits.

  17. Then you have Obama at the G20, throwing down the gauntlet:

    President Obama on controlling the debt: "Somehow people say, why are you doing that, I'm not sure that's good politics. I'm doing it because I said I was going to do it and I think it's the right thing to do. People should learn that lesson about me because next year when I start presenting some very difficult choices to the country, I hope some of these folks who are hollering about deficits and debt step-up because I'm calling their bluff. We'll see how much of that, how much of the political arguments that they're making right now are real and how much of it was just politics."

    Oh boy, we will face some stark choices in the coming elections. Everything D.C. does from here on out is all about getting the pole position.

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